Charles Nathan Should Spend More Time With Investors

August 3rd, 2012
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Contributed by: Michael R. Levin, The Activist Investor
We investors have grown accustomed, nay weary, of corporate hangers-on who routinely and blithely defend entrenched directors and managers. We mostly just ignore them, knowing full well that since they make a tidy living off of corporations, they’ll go to great lengths to defend egregious, excessive behavior.

But, when they get the facts so obviously wrong, someone needs to speak up. We’ll do that here, after reading another one of the standard manifestos, this one from attorney Charles Nathan (Latham & Watkins).

His client memo, “Corporate Governance Activism: Here to Stay?”, reads like a resigned account of the inevitable and inexorable rise in power of institutional investors. Subtitles include “Corporate Governance Triumphant” and “The Expanding Universe of Corporate Governance.” Would that it were.

After the bluster and tears, and the routine criticisms of activist investing, Nathan levels a serious accusation about how institutional investors organize themselves and manage their portfolios. If true, it should prompt a similarly serious review into these investors. It’s not true, of course.

The usual suspects
What’s an essay like this without a slam against proxy advisors? Nathan repeats the usual criticism that “one-size-fits-all metrics are deeply flawed” and “ISS consistently overstates executive compensation.” He piles on “inconsistent and misapplied methodologies, factual errors, or mistaken interpretations.”

He complains further that companies that “received adverse SoP votes in 2011...rectify the situation in 2012 often by wholesale changes in their executive compensation policies.” How about that? Companies responding to shareholder votes!

And, he bemoans that the “notion of company “engagement” (frequently including personal appearances by directors)...has gained considerable traction.” Imagine, the BoD interacting with the investors that elected them!

A parallel universe
His central point bears examination. Nathan asserts:

Corporate governance activism’s fundamental structure as an alternative universe, essentially separate from the value creation function...has not changed and is not likely to do so in the future.

He states that the “parallel universe” imposes costs and inefficiencies on investors and companies alike. An arrogant cadre of corp gov bureaucrats ignores most portfolio companies:

[Some companies] have no chance for ... a hearing in the run-up to their shareholder meetings and very often find it difficult or impossible to get the attention of the corporate governance specialists at their key ... investors...

Most of all, this separate corp gov community perpetuates itself in “the all too common institutional desire for growth in size and importance.”

Spend time with actual investors?
We don’t know which investors Nathan has in mind.We can’t think of a single one, though, with a completely independent corp gov department that operates without regard to investment performance. We talked to several after reading Nathan’s piece, including corp gov staff and PMs.

Only a very few hedge funds, and most similar asset managers, even have a separate corp gov department. Portfolio managers review proxy materials all by themselves, and cast votes on their own.

Among pension and mutual funds, most of the smaller ones also lack a separate department. Yes, they usually follow proxy advisor recommendations. They do so, though, after determining that their advisor’s policies comport with that investor’s own preferences.

Most of the larger such funds do have their own corporate governance departments:

❖ In every instance, the corporate governance staff at least coordinates closely with PMs on specific voting decisions.
❖ These funds craft voting policy through a broad committee, usually headed by a PM.
❖ In more than a few, the corporate governance staff works for the PMs.
❖ At a couple of funds, the PMs overruled corporate governance staff recommendations about how to vote at a given company’s annual meeting.

As for ignoring companies, investors first have to hear from them. Aside from the occasional call from IR functionaries, PMs find they have to chase down executives, and fund corp gov staff seldom hear from them. Anyway, most companies limit or even prohibit contact between directors and investors.

Spend more time with companies, too
What about the costs of corp gov? Nathan claims the “parallel universe” imposes significant cost on companies, too (emphasis ours):

[E[fforts to influence exec comp “have come atgreat cost to the companies in terms of out-of-pocket expense and distraction for both senior management and the board.

The growth of the corporate governance universe has created a similar build-up of the corporate governance function inside public companies.While hard to measure, it seems likely that the company-based corporate governance function is far larger than the investor side. Whether or not true, there can be no doubt that the company response ... represents a largely hidden cost to shareholders...

...[W]hat has gone largely unnoticed ... is the huge amount of time, effort, and resources companies [devote] to the exec comp and corp gov engagement processes...The true cost ... includes the out-of-pocket and opportunity costs implicit in the legions of company personnel (including increasing time commitments from senior executives and board members) and outside company advisors...


In a five-page client memo with fifteen footnotes, curious (or maybe not) that Nathan can only speculate on the cost to companies of “coping with annual Say on Pay voting and other “of the moment” corporate governance initiatives...” This, from someone who probably cheered the litigation against the SEC that stopped proxy access on the basis of flawed cost-benefit analysis.

Some of his corporate clients can probably estimate the cost of their own corp gov function with precision. We speculate it’s not much, at most a couple of extra IR staff and some consulting fees - small fractions of a percent of total SG&A.

Before he accuses investors of ignoring performance for the sake of a politically-motivated corp gov agenda, and after he talks to investors about how they really handle corp gov, perhaps Nathan can also talk to some corporate clients about what these efforts really cost. And if he actually does that, he could include a fair accounting of these costs, alongside the benefits of improved corp gov, in his next polemic.
Related Article Tags: Shareholder Activists, Corporate Raiders and Proxy Battles; Hedge Fund Resources and Featured Partner News


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