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Corporate governance: Trouble on deck

At times, regardless of economic circumstances, it can feel very secure being
on the board of a large global company. This mighty aircraft carrier beneath
your feet ploughing ever onwards, dealing with short-term issues around its
empire; launching swift strikes to lift a flagging share price here, dealing
with an under-performing director of a subsidiary there; reinforcing internal
financial systems. The strength of the structure reassures. The market provides
respect for your position. What could go wrong?

Well, there are the usual surprises that come out of nowhere, but these could
happen to anyone. Deep within your corporate culture and structure there is the
additional security of size and efficiency. But despite the board of directors’
secure position on the bridge of the great corporate ship, just beneath their
feet, things are changing.

Were we using a naval metaphor from the days of Nelson we would be talking of
rats having come on board at the last port that are now undermining the
structure by guzzling the stores and spreading pestilence and disease. But
today’s board of directors has the same threat at hand. The old certainties are
vanishing ­ and they may not have noticed.

But anyone in Mansion House, at the heart of the City of London, in early
July would know what we are talking about. Ira Millstein, senior partner at
Weil, Gotshal & Manges, sounded a serious warning that the deck beneath the
feet of senior board directors was being eaten away and was not likely to
provide much support for them in the future.

Millstein has long been a bellwether type. The audit profession never forgave
him for his warnings at the turn of the millennium that they were the weak link
in the functioning of the global capital markets. At a conference of the
International Federation of Accountants in Edinburgh, he told them fairly and
squarely that no one could rely on their audited figures in the far-flung chunks
of the global markets, and that they were a disgrace.

At Mansion House, he was looking at change in the corporate governance field.
What he was focusing on was what he sees as deep causes for concern in corporate
governance. The changing nature of the owners of companies, he said, was really
worrying. He talked of “the advent of the capital-market explosion of
organisations such as hedge funds, private equity funds, state-owned
enterprises, sovereign wealth funds, pension and mutual funds of all varieties
and combinations of them all”. He doesn’t much care for them; you could tell
that from the language he used to describe them. “This array,” he said, “has
created for corporations and their boards a ‘zoo’ of owners with different
stripes, teeth, sensors, claws, vision, strength, will and attitudes.”

But “this array” is the new breed of shareholders and a board of directors
must legally treat them all equally fairly. That was the nub of Millstein’s
argument. “Today. the board of directors, sitting amid this complex landscape
combined with extensive financial engineering, must seek to steer the
corporation in a coherent direction, somehow considering the values of its
owners and being responsive to those values,” he said.

Once upon a time, this was fine. You had a spread of institutional
shareholders, mostly with common long-term objectives. It was, by comparison to
what Millstein sees as happening in the future, an absolute breeze.

Now the capital markets are much more complex. Shareholders, aided by the
same sort of tools of technological complexity that laid the path to the credit
crunch via gullibility and a widespread false sense of security, are pushing
everything to the limits. “For instance,” Millstein points out, “due to a
combination of one or various investment techniques, such as short-selling,
share lending, hedging, or swap agreements, there is often a decoupling between
an investor’s share title and its economic interest in a corporation.” These are
not the shareholders who were traditionally a director’s legal concern. There
used to only be a few of them, dipping in and out of the stock. Now there are
many. And the lawyers, always eager for a lucrative action against directors who
have not held the interests of such shareholders paramount, have noticed.

It is this shifting in the decks of the corporate structure that has changed
everything. “Although all the new organisations may indeed be technically
defined as shareholders, what does each of them value?” asks Millstein. “What is
shareholder value between one investor who will profit from driving the share
price down, another who wants to take the company private, another looking for
instant cash and one more who is thinking about long-term growth?”

So what happens next? How does a board of directors deal with Millstein’s
disparate and wild zoo of furiously active shareholders, each pulling in a
different direction? The truth, despite overtures to the contrary, is that no
one knows. But the worrying point for directors is that they are probably now
less savvy than their shareholders. Millstein’s closing words in his lecture
were: “Quite exciting, I think.” No kidding.

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