Corporate Governance Post Enron

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Corporate GovernancePost Enron

• By Martin Lipton

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What went wrong Wall Street

• Poor performance in 70s and 80s
• US firms lost competitive edge
• Shareholder activism grew
• Led to
• Managing earnings short-term
• For option maximization
• Made any level of compensation acceptable

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What went wrong Wall Street

• Analysts glorified and overvalued steady earnings
• Led firms to strain rules to meet expectations
• Many managers thought of nothing else
• Pre-occupied with short-term results

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What went wrong Wall Street

• Special purpose entities marketed to create
  revenue of remove debt from balance sheet
• Analysts accepted pro forma earnings
• Hot IPOs became a currency for courting favor
• Media extolled the new era
• SEC and Congress ignored problems

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What went wrong Corporate Governance

• Boards of directors independent in name only
• CEO dominated boards
• Ethics codes waived by directors
• Board meetings short and unfocused
• Audit committees did not understand accounting
  and failed to insist on adequate explanations

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What went wrong Corporate Governance

• Whistleblowers silenced
• Non-management directors had no leader or a forum
• Companies made unsecured loans to officers
• Large stock profits realized by managers shortly
  before stock price declines

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What went wrong Corporate Governance

• Executive compensation increased exponentially
• Decisions on compensation often accepted based
  solely on recommendations by compensation
  consultants

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What went wrongAccountants

• Accountants failed to demand true transparency
• Auditors routinely went to work for client after
  leaving CPA firm
• Auditor also did internal audit
• Could use rules-based GAAP rules to present a
  misleading picture

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What went wrongAccountants

• Auditors basic relationship with management not
  board
• Auditors were paid more and better for consulting
  rather than auditing
• Might low ball audit fee to get engagement

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What went wrongGatekeepers

• CEOs and CFOs used creative accounting
• Blamed subordinates and accountants for failure
• Board of directors blamed management and
  accountants
• Accountants blamed management

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What went wrongGatekeepers

• Lawyers approved questionable transactions and
  did not force recognition or disclosure
  violations
• Investment bankers assisted accountants and
  management by developing more sophisticated
  financing vehicles
• Sometimes suggested alternatives

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Where do we go from here

• Shift power to board
• Make majority of board independent
• Limit board interlocks
• Exclude CEO from some board meetings
• Shareholders approve use of stock in compensation
• Enhance shareholder powers
• May encourage more proxy fights
• Result may be that CEO tenure will be shorter
  with more tension with board in poor performers

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Where do we go from here

• Board meetings will be longer and more meaningful
• Hard questions expected
• Dissent viewed as an obligation
• Board make customary strategic reviews
• Only independent directors on key board committees

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Where do we go from here

• Directors serve on fewer boards
• Boards will be smaller
• Ten or fewer
• Board do meaningful self evaluation and peer
  reviews
• Board seek help from independent advisors

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Where do we go from here

• Board less tolerant of poor performance
• Director compensation will be higher
• National rather than local boards consisting of
  comparable execs
• Executive compensation receive more scrutiny

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Where do we go from here

• Accounting and disclosure more transparent
• New rules limit ability of pro forma earnings
  being misleading
• Audit committee much more aware of auditors
  qualifications and history of problems

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Where do we go from here

• Audit committee will insist auditor take more
  responsibility on disclosure
• Gatekeepers will be gatekeepers
• Directors exposure to liability will not increase
• SEC and NYSE will insist on limit to exposure to
  director acting in good faith

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Where do we go from here

• Corporate governance, and accounting, in US and
  EC will converge

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Recommendations from Higgs Report in UK

• Majority of board should be independent
• Still should be strong executive representation
• Roles of Chairman and chief executive should be
  separated
• Responsibilities of each determined by Board

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Recommendations from Higgs Report in UK

• Rules set down for what is an independent
  director
• Annual report should disclose which directors are
  independent
• Independent directors should meet at least once a
  year alone
• A senior independent director should be
  identified as being available to shareholders

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Recommendations from Higgs Report in UK

• Chairman and CEO should establish training
  programs for future directors
• An annual evaluation of board, committees and
  individual directors
• Terms should be limited to two three year stints
  with limited exceptions
• A full-time exec should serve on the board on no
  more than one other company