Another Red Flag

I read with interest and appreciation the article “ Corporate Governance and Client Investing ” ( JofA , Jan.04, page 43). The author’s insight that most individual investors are not focused on corporate governance when selecting a stock is indeed true and is the case for equities traders as well. Most traders do not hold an equity long enough to care about long-term governance issues, and most individuals cannot relate to the personal fallout from corporate governance lapses unless they worked directly for or held stock in the failed company.

Most individual investors own stock through mutual funds or pension funds where they depend on the professional managers to assess all opportunities and threats to a stock, including poor corporate governance. That leaves the institutional investors to lead the corporate governance charge, which they have done with greater frequency since the early 1990s.

It is now paramount that all institutional owners revisit the adequacy of their corporate governance assessments when evaluating a stock for long-term accumulation. The red flags identified in the article are indeed helpful, and I would like to suggest one more: A combined chairman and CEO position at a public company is a red flag. The chairman of the board is responsible for running the board of directors, which has a fiduciary responsibility for selecting new directors, setting executive compensation, evaluating executive performance and, through the audit committee, evaluating the company’s financial reporting and disclosures, in addition to general corporate oversight. These functions conflict with the role of the CEO who is directly affected by these board decisions.

Controlling both the board and the management functions of a company creates an “imperial CEO,” with few checks and balances to protect the shareholders that own the company. A newly published book, The Recurrent Crisis in Corporate Governance, written by the Yale economist Paul MacAvoy and corporate governance expert Ira Millstein, studies the economic impact of this red flag on our largest public companies and makes a compelling argument for having an independent chairman of the board.

The Sarbanes-Oxley Act of 2002 did not require that these roles be segregated, but this oversight was not lost on those concerned about corporate governance. Last year, the Business Roundtable, which is composed of 150 CEOs of our nation’s leading companies, reported that 55% of its members had or would have an independent chairman, independent lead director or presiding outside director by the end of 2003. As significant as this progress is, CPAs, institutional investors and other large shareholders can play an important role keeping this issue on the front burner of the remaining 45% that do not have an independent chairman or lead director. The most important tool we have to ensure change is our collective ownership in these companies, which ensures that our voices will be heard.

Scott Green, CPA
New York City