The Cisco move is just the latest example of companies that put too much time and creativity into dreaming up elaborate financial schemes —schemes which, by some remarkable consistency of nature, always wind up adding to the CEO’s pay package.
I am not a big fan of company stock repurchasing. While I am the first to admit that today’s global corporations are complex institutions on almost every level, including financial, I think stock buybacks often drain potentially valuable funds that could be put to better use in research or in adding value to the traditional business chain, and serve to benefit insiders and the investment bankers arranging the deals more than anyone. One of the pluses that private equity advocates often talk about is that corporate funds for unlisted companies don’t need to be diverted into exercises like buying back stock because the price can’t be raised any other way. I don’t usually align myself with the private equity crowd, but on this point they seem to make sense.
And so it was with a somewhat jaded eye that I read of Cisco Systems’ plans to add billions to its already lavishly endowed program to buy back its stock. It just kicked in $10 billion more to an already huge $52 billion pot. And who do you suppose will come off best from the deal? How about Cisco insiders, like CEO John T. Chambers, who typically receives most of his compensation in the form of stock options. The company’s 2007 proxy circular notes:
During fiscal 2007, as part of the on-going companywide grant, the Compensation Committee granted Mr. Chambers an option to purchase up to 1,300,000 shares of Cisco common stock at an exercise price of $23.01 per share…. The option grant places a significant portion of Mr. Chambers’ total compensation at risk, since the option grant delivers a return only if Cisco’s share price appreciates over the option’s exercisable term.
In September 2007, the Compensation Committee also made an annual stock option grant to Mr. Chambers to purchase up to 900,000 shares of Common Stock, and the right to receive a target of 200,000 future restricted stock units based on Cisco’s financial performance in fiscal 2008.
So we have a situation at Cisco where the CEO, who also chairs its board, stands to gain significantly from a buy-up of stock that is being paid for with shareholder money from a company where the CEO is the chief decider on how it is used. An interesting moving around of the financial shells on the boardroom table, don’t you think?
The old fashioned idea of issuing a dividend —one that worked very well in the era of the Fedora CEO, as I have affectionately called them— is just too passé for Cisco. They don’t do dividends. I guess that would be too much like something that could benefit all investors in equal proportion to the shares they actually own —not the shares that might be bought on a discounted basis by a lucky CEO if things pick up.
The Cisco move is just the latest example of companies that put too much time and creativity into dreaming up elaborate financial schemes —schemes which, by some remarkable consistency of nature, always wind up adding to the CEO’s pay package— when the time and creativity and investment banking costs could instead be used for purposes of product innovation, employee education and in finding better and more efficient ways to add value to the customer.
In too many ways, the primacy of the ordinary individual —as citizen, employee and investor— which has long been the backbone of modern social progress, is being left to disappear amid an onslaught of privileged special interests, civil rights-invading bureaucrats, unwatchful corporate guardians and greedy financial contortionists.
In Canada, it was the no-fly list, which the Harper government created to ban certain individuals from flights inside or leaving the country. In the United States, it was the no-sue list, which directors, executives and corporations now find themselves on courtesy of the Supreme Court’s 8-1 decision raising the bar for shareholders to commence litigation in respect of civil fraud. While they may seem unrelated, these two decisions share a common connection with an unsettling trend in the exercise of corporate and government power.
In too many ways, the primacy of the ordinary individual —as citizen, employee and investor— which has long been the backbone of modern social progress, is being left to disappear amid an onslaught of privileged special interests, civil rights-invading bureaucrats, unwatchful corporate guardians and greedy financial contortionists. We call this the Vanishing Stakeholder. Left unchecked, it is a trend that threatens to undermine the fabric of our society, our prosperity and our freedoms.
The U.S. decision, which was handed down this week, imposes standards that most investors, because they do not have the power to subpoena documents or to interview corporate parties such as directors and executives, can never meet. As a result of the Court’s ruling, investors must show “cogent and compelling” evidence of intent to defraud. Some, including Justice John Paul Stevens who dissented from the decision, believe the standard being set for this kind of civil litigation is as high as, if not higher than, that applied in criminal prosecutions. The decision pleased Bush administration officials and a large platoon of business lobbyists who have been moving toward a general loosening of post-Enron era reforms of the kind found in the Sarbanes-Oxley Act of 2002.
Under the Canadian program, which came into force this week, the government will identify people who pose “an immediate threat to aviation security” and place them on its no-fly list, without due process or prior notice. They might be part of a terrorist group, or, as Senator Ted Kennedy found himself after the U.S. introduced its version, someone with the same name as an embargoed passenger. They will only find out that they are on the list —or that they have been confused with some other person of the same name— just as they are about to board a plane. And the onus rests upon innocent people improperly placed on the list (has there ever been a major government effort that has not been bungled by bureaucratic incompetency or twisted by the vanity of some power drunk official?) to prove their innocence while being interrogated by law enforcement officials at the airport, in a closed room and without legal counsel. We thought that only happened in authoritarian regimes and in George Orwell’s fictional world.
But in the world that is becoming all too real for the treatment of individuals, shareholders are regularly seen as an inconvenience who need to be treated like annoying children instead of the owners of the corporate enterprise which they actually are. Citizens are viewed as suspects and potential lawbreakers in a time when even the library reading habits of young children cannot escape the alarmed and ever watchful gaze of law enforcement officials.
No sensible person wants to make it easier to clog the courts with frivolous lawsuits or for terrorists to plot their evil plans. But there has been a rising tendency of late to allow big corporations and big governments to become even more powerful and to make more difficult the ability of ordinary stakeholders to hold them to account. When that happens, fewer individuals, whether investors, employees or citizens, are inclined to stand up and assert their rights. Many fear the fix is in and that it is impossible to challenge the excesses and abuses of either government or business.
Last month, the U.S. Supreme Court made it more difficult for workers to sue in cases of pay discrimination under Title VII of the Civil Rights Act of 1964. In a 5-4 opinion, the Court held that such lawsuits —which almost invariably involve lower paid women— must be brought within 180 days of the initial alleged discriminatory act, not when the worker discovers it. And finding out what others in a factory or office are paid is not the easiest thing. Workers should not have to become pay stub sleuths in order to ensure that they are being fairly treated.
Ordinary investors, like average workers, are also getting the back of the hand from those in charge. Just look at the number of shareholder resolutions that have failed to win a bare majority in recent months when boards and management have opposed them —even resolutions like say on pay, which would have had only an advisory influence upon compensation committees. As for shareholder lawsuits —frivolous or otherwise— they are hardly an epidemic. Their numbers are considerably down in the years since Sarbanes-Oxley.
An equally disturbing trend is seen in the swallowing up of North American and European business icons by the elusive and expanding private equity whale. The stake that individuals have had as investors, and the benefits that come from being able to witness transparently the use of economic power and how it is wielded, seem now to be regarded by many commentators as only a passing fad in the natural evolution of a more concentrated form of capitalism —concentrated in fewer and richer hands, that is.
The current model of the publicly traded, widely-held, corporation, and its espoused link to the well-being of individuals, developed over a considerable period of time. Symbolized by the huge American flag that drapes the facade of the New York Stock Exchange, the motivating idea was that individuals could be something more than cogs in the wheel of capitalism; they could be the owners of its engines as well. Under this vision of the capital markets system, Wall Street and Main Street were inseparably linked. This idea was taken even further in the aftermath of the attacks of 9/11 with the posting of military personnel around the New York Stock Exchange. An attack on Wall Street was generally considered to be an attack on the financial nerve center of America itself.
Corporate leaders have consistently expressed the view that individuals have a genuine stake in American business —through pensions funds or mutual funds or as direct investors—and that such roles create a level of harmony between what’s good for most folks and what’s good for the modern corporation. As more and more companies begin to be taken over by essentially anonymous actors, or become absorbed by entities controlled by a few multi-billionaires, those interests may be starting to diverge. Indeed, there is some concern now as to exactly what role countries like China, headed by a dictatorial and communist regime, will have as their level of investment and alliance with private pools of corporate gobbling capital expands. Is this in the long-term interests of either democracy or society? Are policy makers and business leaders even pondering these kinds of questions? Again, the role of the individual in these new equations of commerce and capital seems essentially overlooked, if not regarded as entirely disposable.
The trend in this regard is paralleled by another significant phenomenon in the United States: widening economic division as reflected in the fact that the top one percent of households controls more wealth than at any time since 1929. As we have noted previously, it was a gap that ended abruptly –some might say catastrophically– at that time. There is little evidence that those at the top today are giving much thought to the impact of the current trend or exactly how much further it can be permitted to advance before serious damage is done to the social contract that has existed between the class of ordinary individuals and those in the upper tier of power and wealth. The average stakeholder has been just as absent from the cares of the corridors of privilege as he and she has been from participation in the income gains enjoyed in recent years. And, as we have documented repeatedly on these pages, few inside major corporations, much less the wider workforce, have seen anything approach the soaring level of pay advancement or galloping annual increases that CEOs and senior executives have received over the past decade.
Bear Stearns’s $3.2 billion bailout this week of a troubled hedge fund, and the sudden decline in the Dow Jones average as a result, is just one more in a series of telling reminders of how dependent individuals are on the guardians of capitalism and the watchdogs of sound business practice, including the credit rating agencies that seemed to miss the red flags. Recent testimony at the trial of Conrad Black from the high profile directors on Hollinger International’s audit committee, who admitted under oath that they did not read documents put before them, provides a vivid illustration of how boards so often fall short in their duties as stakeholders’ sentries. We would not be surprised to see further disturbing developments over the next several weeks as the world discovers (again) that the hedge fund kings and Wall Street wizards have not entirely rewritten the laws of market physics and may not be quite the extraordinary wonders their publicity departments or their huge fees would suggest.
As the Outrage of the Week prepares to take some time off for the summer, we think it is appropriate to leave on the larger note of concern for what we see as the receding role of the individual in society. We view this trend, where leaders in business and government are a little too quick to trample on a right here or remove a benefit there because it is the expedient or profitable thing to do when it comes to dealing with average stakeholders, as emerging on too many fronts to ignore.
Some of us actually believe that we live in a democracy. We like it that way. We take its freedoms and responsibilities seriously, including the idea of a market economy where individuals ultimately control even the mightiest pools of power. We are mindful of the continuing sacrifices made by men and women in countless battles around the world who have made our freedoms possible. If we wanted a different system, we would be living under any number of regimes that do not share a respectful belief in the role of the individual and who take a dim view of the rights of citizens or investors when they are exercised. The worry is that too many entrusted with power here are apt to forget that under our concept of democratic government and accountable markets, they are answerable to the people, not the other way around.
The Outrage may drop in from time to time, but will otherwise return to its regular weekly slot in early September. In the meantime, we thank our readers —affectionately known as our Outrangers— for your many suggestions for this well-read feature at Finlay ON Governance. We understand it is a frequent topic of conversation around the water cooler and at the kitchen table and has caught the eye of a few tycoons and political shakers on more than one occasion.
We wish them and everyone a safe and pleasant summer. There is much in the use and abuse of power and leadership that properly warrants our indignation. But there is also a good deal in the world around us among families and hard working people and in the wonders of nature that commends itself to our admiration and our gratefulness.
We hope you all have a chance to experience the latter to the fullest over the next several weeks, and that our many readers in the southern hemisphere have an equally pleasant winter.
Every few years, business needs to come up with a new savior. If only we had zero-based budgeting; if only we were driven by the search for excellence; if only we could stick to our knitting or follow the seven habits of seven successful people. If only… The newest addition to this grand litany of salvation seems to be the arrival on the scene of huge private equity funds and their ability to rescue publicly traded corporations from the curse of public shareholders. We have discussed this subject, and our reservations about the trend, on a few occasions previously.
So often it seems there has to be a crutch to explain away failure or a magic elixir that will solve all the problems. Rarely will management admit that it dropped the ball or that a company’s difficulties were the result of limited vision or poor judgment. You never see complacency, which is often the real culprit in boardroom misadventure, booked and fingerprinted as an accomplice to underperformance. Spend a few hours with senior managers, as I have done on thousands of occasions over some 30 years, and you will quickly see that arrogance, denial and a stunning disconnection from the real world of customers and markets are too often the overriding characteristics of their style and the seeds of their folly. As I have long contended to rather stunned audiences of business students and corporate executives alike, if businesses were actually run by well-grounded managers with a true sense of vision, a genuine appreciation of the people and stakeholders who shape corporate success and an ability to be governed by sound judgment, many companies could improve their performance by between 20 and 33 percent. Too often, it is the over-paid, game-playing manager with the Napoleonic power complex, the one who will cut corners to look good in the short run, who places himself ahead of all others and lacks an understanding of the contribution of employees and other stakeholders —and then looks for scapegoats when his plan fails— who is at the helm today.
Which brings us to the Chrysler-Cerberus deal. Look at these words carefully:
We’ll be able to run it the way we want to run it and not worry about quarterly numbers or what somebody might think on the outside. We’ll do what’s best.
—Chrysler CEO Tom LaSorda, May 15, 2007
To suggest, as Mr. LaSorda has, that Chrysler’s investors, or the fact that its stock was traded on the New York Exchange for the better part of the past century, prevented the company from being run the way they “want to run it,” or that they were hampered from doing “what’s best” during this period, shouts of a disingenuousness that will not serve the company well. Why not blame the full moon? At least it has some effect upon the Earth’s reality.
Chrysler performed unsuccessfully because of a number of factors —high production costs, poor image, quality problems and the fact that Japanese makers seem to get so much more right. The company was looking for a crutch when it merged with Daimler nine years ago in another deal that many, myself included, thought ill-advised. (Is it not curious that, during this time, the Mercedes-Benz division also experienced a marked deterioration in the quality and reputation of its cars, along with a significant slump in sales? As a three time Benz owner, I can attest to the fact that cars being built during much of this period were nothing like the ones built in the pre-merger days, which is why I have a new Japanese-brand car today.)
Chrysler is looking for another crutch with Cerberus. Many depend upon Chrysler, especially its 88,000 employees and 111,000 retirees and their families, so it is natural to hope for the company’s success —if one views success as restoring Chrysler to a point where it is optimizing its assets and its capacity for innovation and advancing the well-being of customers and stakeholders.
I am skeptical that the Cerberus deal will do that, however. Chrysler was a great American icon — a business institution that had a distinct culture and history. It was the master of its own destiny for generations. That will change with its new owners. Cerberus makes money, not icons and institutions. It does so secretly and behind closed doors, not as a transparent corporation with pubic investors. There’s no roster of executives or board of directors on its web site. There’s no code of ethics that is held out to the public governing the way they do business. You don’t get to see who is behind the company and from where —and what countries— the investing dollars are coming. If you believe that accountability and transparency are indispensable attributes of success, and that they are necessary characteristics of great power in a complex society, as I do, you might have some misgivings about this deal.
Ultimately, what is likely to happen is that much of the company will be dismantled and the American public will be saddled with a large part of the pension and health care liabilities facing Chrysler. Cerberus can play hardball with unions, governments and others, and not care much about what people think. They can hire—and already have— platoons of lobbyists to advance their case, which will invariably involve whatever enhances their profits —the profits of a select and unknown few. It can become a troubling matter when concentrations of wealth and power become untethered from the discipline of public opinion. Because it is not a publicly traded company, it is said Cerberus doesn’t need to be worried about how it is perceived by the public. J.P. Morgan and his cronies thought the same. Then there were those pesky hearings in the House of Representatives headed by Arsène Pujo in 1912 that changed some of the ground rules under which the likes of Mr. Morgan operated. The power and privilege which today’s cabal of private capital is accumulating, and the troubling issues of responsibility, lack of transparency and social impact it raises, will, I predict, one day see a similar burst of legislative involvement.
The myth that removing the company from what some now regard as the shackles of quarterly statements will make all the difference is just one of the ironies in this deal. Cerberus, like the other members of this secretive club of private funds, is known neither for its patience nor its altruism. When you move from the cold of the storm into the mouth of the whale it may seem warm and quiet. But it’s only a short-term feeling.
You’re still in the mouth of the whale.
There can be few more heart wrenching moments than seeing a loved one racked with pain and being desperate to find them relief —except, perhaps, if you are the person in pain yourself.
In the search for something that would help, millions turned to a new drug called OxyContin, which promised relief without the curse of addiction. My mother was one. Yet it soon became apparent that the medication was not quite the miracle its makers purported it to be. By the mid-1990s, press reports began to raise the possibility that the drug was far more addictive than originally claimed. The death toll from the drug’s overuse began to mount. A whole new class of addicts was created. Court records now show that the drug’s maker, Purdue Pharma L.P., repeatedly and willfully ignored those concerns.
This past week, the company pleaded guilty in U.S. federal court to criminal charges in connection with the deceptive claims it made about the drug. Three of its officers, including its CEO, top lawyer and former chief medical officer, pleaded guilty to less serious misdemeanors. Purdue will pay a fine of $470 million and its current and former executives will pay some $35 million. A further $130 million will be set aside to settle civil claims resulting from injuries and deaths. Nobody is going to prison.
Even in the face of warnings from health-care professionals, the media and members of its own sales force . . . Purdue continued to push a fraudulent marketing campaign,” U.S. Attorney John L. Brownlee said in a justice department press release.
Now, here’s a question: Why is Purdue CEO Michael Friedman, one of the three who pleaded guilty to misdemeanor charges involving “misbranding,” still on the job? The answer lies in the difference —too little considered by advocates of private equity— between a publicly traded company and a private corporation. Purdue is in the latter category. Its web site does not even disclose the names of its executive officers. Its sales are not reported. Its board of directors is not easy to identify. It is, in most respects, a closed, secretive and opaque company. It is also a corporate felon. But because it is a private entity, it is much less influenced by public opinion and the résumés of those in control.
Fortunately, my mother saw the troubling reports about this drug early on and insisted that her doctor take her off the medication. Not all patients were as alert as my mother; many had become too addicted to do anything about it. The company knew it was deceiving medical professionals and vulnerable patients. It did so solely to enhance the profit and wealth of its already well-heeled private owners —names, by the way, the public does not get to see. Billions poured into the company from the sale of this drug, according to court papers.
Like many companies, Purdue boasts on its web site that “Honesty, integrity, and respect for the individual are at the core of our culture.” Its conduct makes a mockery of such values and the company should probably be prosecuted for lying about that, as well.
But there is a larger issue at work here, and it involves the actions of the government itself. When corporate heavyweights have engaged in wrongdoing, such as what Martha Stewart did in obstructing justice or Alfred Taubman did in price fixing at Sotheby’s, they were sent to prison. Nobody died or even got sick because of their actions. In contrast, Purdue not only orchestrated a plan of deliberate deception, but when it became aware of the drug’s damage, it turned a blind eye and continued the scam —over and over again.
Companies are eager to write a check when confronted with their misdeeds. Many insiders see it as a cost of doing business. When executives are sent to prison, however, it tends to elicit a different appreciation for the consequences of wrongdoing.
Individual officers and employees at Purdue made the decisions that took the company down this criminal path —their evil transgressions were not forced upon them. Yet everyone connected with this criminal conduct is free today. Ms. Stewart and Mr. Taubman, on the other hand, will be considered ex-felons for the rest of their lives. There is something terribly wrong when fiddling with the price of antiques can send a man to prison and peddling a drug that is branded in deceit and causes enormous pain and suffering does not even result in a jail door opening, which is why the actions of the U.S. Justice Department in failing to demand prison time for those responsible for the criminal actions at Purdue Pharma is our choice for the Outrage of the Week.
Last week, we observed that BCE’s board has taken too low a profile in the process to consider going private —so low as to be almost invisible. As we said then:
The fact that management appears to be leading the process, and has selected partners it feels comfortable with, is also troubling.
It is the board that needs to be carefully and undeniably setting the tone for these discussions. That voice is too faint and its timing has been unimpressive thus far.
Late on Sunday, BCE issued a statement confirming that its board is on the job. Here is part of what was said:
The Board and the Strategic Oversight Committee are committed to conducting a process that all qualified parties can participate in. The Board also indicated that all parties wishing to qualify to participate in the privatization process must be able to establish adequate financial capacity for a transaction of this size and complexity.
Nice to have the directors back online. We were glad to encourage their reappearance and hope they will stay connected.
Another puzzling sign surfaced at BCE this week, when its board announced that it had established a special committee to handle its friendly going private transaction involving Canada Pension Plan and KKR. Unless BCE has gone into the acrobatics business too, it seems to be making a habit of getting things backwards.
First, there was the blanket denial of March 29th regarding any intention to pursue a private equity deal. That was reiterated on April 10th. Many investors relied upon those statements, and, judging by the calls and email received at The Centre for Corporate & Public Governance, some sold their shares as a result. Then, out of the blue, BCE twisted itself into a pretzel and announced that it was happy to do exactly what it said it had no intention of doing just a few days earlier and named CPP and KKR as friendly suitors to the deal.
One would have expected BCE’s board to have established a special committee prior to the company’s announcing its decision to explore a going private transaction —not after. This gives rise to the impression that the decision announced on April 17th was not entirely thought through. Given the scale of the potential transaction and BCE’s prominence in Canada’s capital market, this is less than encouraging.
The fact that management appears to be leading the process, and has selected partners it feels comfortable with, is also troubling. In these kinds of situations, management typically wants to do what is in the best short-term interests of management and not necessarily what is in the long-term interests of shareholders. BCE’s board has a history of being overly deferential to management, as the costly fiasco involving the company’s purchase of Teleglobe, at former CEO Jean Monty’s insistence, illustrates.
It is the board that needs to be carefully and undeniably setting the tone for these discussions. That voice is too faint and its timing has been unimpressive thus far.