Nell Minow on Apple, HP, and What Enables Bad Boards
Nell Minow has been called the "CEO killer" and the "queen of good corporate governance." She is a former president of Institutional Shareholder Services and has literally written the textbook on corporate governance -- it's titled Corporate Governance and is now in its fifth edition. Nell is co-founder of The Corporate Library, which is now part of GovernanceMetrics International, where she serves on the board of directors.
At our recent Motley Fool 2011 Investing Conference, Nell talked about all matter of corporate governance topics ... including the most awkward phone call of her life. What follows is a lightly edited transcript of her interview with Motley Fool Money host Chris Hill. Note: The conference took place on Sept. 22, 2011.
Chris Hill: So at GovernanceMetrics International, we were talking earlier about a new report coming out that I know you are excited about, but if you could talk about that and also just a couple of things that investors like us can do, things we can look at when we are trying to gauge the strength of a company's board of directors.
Nell Minow: I am happy to talk about that because I think you guys do an amazing job. I am always so impressed with what you do and the things that you look at that so many people who work with the institutional investors overlook. However, it really bugs me that you do not spend enough time looking at corporate governance as a risk factor. If I could just wave one magic wand and get you to make one change it would be if you are going to write about a restatement, mention the names of the members of the audit committee. They are responsible for that. If you are going to talk about executive compensation, which you don't do nearly enough, mention the names of who is on the compensation committee. Don't say Company X paid the CEO $300 million. Say, Apple (NAS: AAPL) just gave the new CEO $300 million and here are the members of the compensation committee that approved of that. I think that that is tremendously important.
The one thing that enables a lot of bad behavior is that no one ever mentions the board of directors, so I think that is really, really critical and I think that when somebody gets paid $300 million "showing-up money," we have found in the past as an empirical matter, that the return on investment of that $300 million is not actually very good. It is sort of piggy-bank level. It seems to me that you need to look at compensation a lot more critically and look at it in terms of return on investment, like any other allocation of corporate capital.
We have a report we come out with periodically, which is kind of one of our "duh" reports, which is that companies that are really profligate with use of the corporate jet tend to do poorly -- not because there is a specific correlation that people are flying around and not doing their jobs, but because it is evidence of a lack of oversight from the board of directors, and let's mention again who they are. So that is my one thing that I want you to do.
The new report, which I was just editing the draft of before I came over here, I am really excited about because as you heard, I was one of the co-founders of The Corporate Library, which looked at governance, but in the last year, we have merged with two other companies and created an alliance with a third so that we would have a much more integrated, much more robust, much more granular report. We are not just looking at governance; we are looking really thoughtfully at accounting, financial reporting, auditing stuff, and more ESG stuff and a lot more international stuff, so those were the areas where we really needed to be beefed up.
So we are going to come out with a new report of what I guess I would call the highest risk, most overlooked high-risk companies, the ones that we think are I don't want to say destined for disaster; I just want to say higher risk, that people are not paying attention to, and what I am particularly excited about is we have identified an entire sector that we think is really, really overlooked that all have consistently the same problem. There is one that is a bit of an outlier and isn't worse than the others, but we think that is going to be a real breakthrough.
So we are going to be releasing that report, I hope pretty soon and in each case, we are going to give an example of the kind of thing we look at. So here is an example of the kind of accounting risk that we are currently looking at. Here is an example of the kind of governance risk. Here is an example of some other kinds of risk, and this is an area where really 2+2=5 because when you see more than one of these things, when you see bad accounting and a very insular board, that is a real problem.
And I also want to say one other thing about it, which is that Fidelity did a rating of us along with a whole range of other people who look at risk, and they found that we were the second best at predicting returns in excess of the market and the best at risk.
Hill: Have you thought about something catchy like "GMI's List of Companies About to Die"?
Minow: You know, one of the companies...
Hill: Because that would get noticed.
Minow: Yeah, one of the companies that we acquired, Audit Integrity, did come out with a list once that was the bankruptcy risk, and they got sued for libel, even though they were successful, because as I am sure you all know, the expression of opinion is not subject to the libel laws. It is still a very expensive thing, so they are a little touchy.
Hill: Let's talk about a few companies in the news recently and get you to weigh in on their boards of directors, and one making headlines today, Hewlett-Packard (NYS: HPQ) .
Minow: How long have we got? [Laughter.]
Hill: If I have this right, I believe you called them "serial corporate governance offenders."
Minow: Yeah, you know, I don't want to keep you guys from happy hour, so I am going to make this really short. But, basically, could there be a worse board? They are the gang that can't shoot straight. They just cannot do anything right. You all know already so many of the things they did wrong, so that I can just sort of zip through and say Carly Fiorina, the merger, her arrival package, her departure package, the dismissal of Mark Hurd with his departure package, hiring a CEO that most of them hadn't met.
Hill: So you are saying that is a strike.
Minow: Yeah. But I want to talk about one issue that I think is exactly the kind of thing that I want you guys to pay more attention to. So I am going to go back for a minute to Mark Hurd. When HP hired Mark Hurd, they had it in his contract that all of his first-year goals were deemed to have been met.
Minow: Yeah, duh, winning. Right. You know, people sort of chuckle when they hear that. That is actually a really serious thing. That is the board of directors putting up a big banner that says, "We have no idea what we are doing." I would put that in the same category as my favorite oxymoron, the guaranteed bonus, and I have already mentioned the signing bonus at Apple, the taking-the-job bonus at Apple. These things actually do not work. They do not pay off. If they paid off, I'd be for them. As Robin Williams said in Awakenings, "If you were right, I would agree with you." And so when the board of directors does that, that is the time to write about it. When Tyco agrees to an employment contract for Dennis Kozlowski that says "conviction of a felony is not grounds for termination," you know, that is the time to write about it because if there is such a thing as a "likely to die" list, that would put the company on it, I think.
Hill: Let's stick with Apple for a second because when Tim Cook's compensation package was revealed, you said it was disappointing but not surprising. Why?
Minow: Again, the Apple board are serial offenders. I don't ever want anybody to talk to me about how Steve Jobs got a dollar a year. He got a plane. He got a $90 million plane. He got backdated options, and when they took back the backdated options, they gave him the equivalent. When they did the investigation of the backdating -- I love me my Al Gore, I gave his movie an A. I think he is great. I voted for him, but he was heading up that investigation and he did a terrible job, so I am not surprised that Apple still hasn't figured out how to pay people. I am just disappointed.
Hill: I almost hesitate to ask, but do you have any thoughts on News Corp.'s (NYS: NWS) board of directors?
Minow: Oh yes, I do. Again, serial offenders. ... News Corp., when they decided to incorporate in the United States for the first time, they met with a lot of the investors and the investors said we are not really happy about your dual class of stock. We are not really happy about your incorporation in Delaware. We are very concerned. Frankly, we don't trust you. News Corp. said, Well, what would you like? And they said, well, we would like you to agree. You have plenty of takeover protections. You have got dual class of stock, for goodness sake. We'd like you to agree not to adopt a poison pill without shareholder approval. And they said, oh, OK, yeah, absolutely. We guarantee you we will not adopt a poison pill without shareholder approval if you will allow us to incorporate in Delaware. The shareholders approved that -- and how long did it take them to adopt a poison pill without shareholder approval? It was less than a year.
I spoke to some of the board members about that and I said, "What were you thinking?" And they said, Well, John Malone had bought a lot of stock. I said, OK, remember that dual-class structure? You are really not at any risk there, but let's say that you are. Let's say that you are at a risk from him and let's say that the shareholders agree with you that there is a risk. Why not put it to a shareholder vote? Well we were afraid he would do something right away. Fine. Adopt a poison pill for three months, until the next annual meeting and then put it to a shareholder vote. Well, what if they didn't vote for it. Well that is kind of the point, you know.
So again, way back when, way back when, you should have known that News Corp. was a disaster waiting to happen, and it has continued to be; it is still a ticking time bomb. I think more bad things are going to happen. You saw this week that they have discovered that the problem of hacking was worse than they thought. They have already been turned down for an $87 million contract with the city of New York because of ethical violations. I think they have got some very serious Foreign Corrupt Practices Act issues ahead of them, and I think that we are going to have more bad news from News Corp.
Hill: Earlier in your career, I think you were working in Chicago and had to make arguably a really tough phone call to a board member who you had recommended to your clients; essentially, this guy has got to go.
Minow: Yeah, that was my dad. That was when I was at Institutional Shareholder Services. I was the fourth person hired there, and when I left there were only 25 people, so it was still quite a small company back then. That was with the same partners that are in my current company.
So I was the president of ISS, and I had been very, very interested in this issue of boards of directors. We had been advising people on how to vote proxies and I always thought we should do something about the board. There is something interesting about the board. And I said, well; so I gathered the 25 people together and I said OK; you know we know two things about the board, really. We know: Do they come to meetings, because the SEC makes them tell us if they come to meetings, and do they have any stock?
So let's, for fun, let's just recommend a vote against, even though it is purely symbolic, let's just recommend a vote against any director who after a year on the board doesn't have a single share of stock, and any director who has not been able to attend 75% of the meetings. So they said, great, that's a good idea. So about a week later one of the staff people came in to me and said, well, guess what? The first name to come up here of not attending meetings is your dad. And I said, OK, well I think we established a policy that we would call the company and ask if there was an excuse. Did you ask? And they said yeah. The excuse was he is a busy man. I said [head-chopping sound]. So I had to call my dad, who is the greatest guy in the world, and I had to call him. I said, Dad, you know you missed more than 25% of the meetings at Aon. And he said, oh, how many did I go to? And I said, well you went to 73%. And he said, well, that is really close. And I said, Dad, when I came home at 12:15 and my curfew was midnight...
Hill: That was close.
Minow: You explained to me that close wasn't good enough. And he said you were an English major, weren't you? And I said yeah. He said, Do you remember King Lear? How sharper than a serpent's tooth it is to have a thankless child?
Now he was an extremely good sport about it, and I never told anybody about it. He later, in an article for Fortune magazine, to show you what a menschy guy he is, he told them the story. He thought it was very funny. So that is why the story has been following us both around ever since.
Hill: Let's wrap up the part about boards of directors having gone through HP and News Corp. and the like. What are a couple of companies that you think really have fantastic boards? Whether you give them an A rating or not?
Minow: You know, I always say I am a lot better at picking out the bad ones than the good ones. I am always afraid that our good guy companies are more absence of terrible than presence of greatness, and I think the one thing that I do love about boards is that when disaster happens, they tend to pull it together. And so the companies that I think have very good boards are the ones that are grappling with disaster, so that the post, the third catastrophe in a row at Fannie Mae, they kind of pulled together and they had a good board. And of course, I always love Berkshire. They break all the rules and yet they manage to keep to fundamental rules, and I think they do a great job.
Hill: A company that has come up a lot today is very much in the movie business, and that is Netflix. I am curious what, observing the last couple of months, that company has had. What do you make of what is going on at Netflix?
Minow: Well, I thought Megan made some very good points about Netflix. [Editor's note: Read Megan McArdle's take on Netflix here.] I think that; you have to give them props for trying to deal with technological obsolescence. They handled it very, very badly, and the problem with companies is that they get invested in one way of doing things and it is very, very hard for them to shift around. My business partner of 25 years and I, Bob Monks, have written a textbook for MBA students called Corporate Governance. The fifth edition came out in July of this year, so we wrote the first edition I guess in 1995. So in each of these editions, we have the same chart, which we continue to update, which is the biggest companies by market cap at each decade, going like to 1980, 1990, and I call it the Ozymandias chart, because as I am sure you guys know better than anybody, I think three out of the top 10 didn't even exist 20 years ago. I don't think any company has been on the top 10 for the entire period of the chart. That is not because they don't do good things and make good products. It is because it gets harder and harder and harder to shift to new technologies and new delivery systems, and Netflix is very deeply invested, as Megan said, in warehouses and red envelopes. It is very, very hard to switch over, and I don't think they are going to make it. I think that Hulu and other kinds of delivery systems are going to be more effective.
For five business movies Nell Minow recommends,click here. And for all our Investing Conference coverage, see:
- Advisor Roundtable: Netflix, Apple, and 5 Stocks Our Advisors Like
- Justin Fox on Buffett, Bogle, and the Myth of Rational Markets
- Megan McArdle on Netflix's Self-Cannibalization
- Megan McArdle on the Solyndra Scandal
- The State of the Real Economy
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