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What’s Ahead for CEOs

The year is 2017, and the past decade has been a bruiser for Corporate America on the governance and regulatory …

The year is 2017, and the past decade has been a bruiser for Corporate America on the governance and regulatory fronts. Shareholders now have unprecedented access to proxies, and regularly nominate their own candidates for director seats, giving annual elections-staggered board terms are obsolete-a circus-like feel.

With a new cadre of hostile directors -each representing his or her own special interests-some boards look and act more like a fractured Congress than professional decision- making bodies. There are advisory boards that provide nonbinding “guidance” to managements in areas like workplace safety and the environment.

Investors also have won the right to insert themselves into parts of the business that once were considered the province of management, such as setting dividends and other capital- management tasks. And in a few notable situations, companies have been forced from lucrative businesses, such as nuclear power, thanks to shareholder-orchestrated votes. With oversight taking on an initiative- and-referendum-style political look, some wonder, why even have a board?

The regulatory climate isn’t much better. A new accounting convention now requires that companies provide daily-not quarterly-financial updates via the Internet to all investors. That’s significantly increased reporting costs, and more than a few CEOs have complained, allowing competitors to pick up on subtle strategy shifts.

Over the past decade, companies have been forced, via legislation or regulation, to slash carbon emissions and invest 10 percent of profits in energy-conserving, “green” facilities and technologies. They now must divulge political contributions in minute detail-both those of the corporation directly and of any political action committees to which employees contribute. The new protectionism that wreaked havoc with trade agreements has been matched by stiff new limits on the outsourcing of core functions.

In a nod to the pay scandals of the early 2000s, the Executive Compensation Reform Act of 2009 now requires that chief executives’ total pay be limited either to 40 times that of the average employee or 100 times what the lowest-paid worker receives-take your pick.

Add up the various pieces-the contentious board relations, the higher levels of scrutiny, the required disclosures and compromised strategies, the increased costs and lower pay- and it’s small wonder that being the CEO of a public company has lost much of its luster. In short, the “decade of the shareholder,” as some pundits call it, has spawned its losers, too-and they’re often found in the executive suite.

                                        

The Future’s So €¦ Dark?

Far-fetched? Perhaps. Then again, 10 years ago not many folks gave the kind of changes since codified by the Sarbanes-Oxley Act and the Securities and Exchange Commission’s new compensation disclosure rules much of a chance either. Nor did many foresee the emergence of hedge funds and other activist investors, all of which have brought more scrutiny and pressure to chief executives, and to their boards and companies.

The Present’s So €¦ Prescient?

s we enter 2007, some business groups, heartened by what appears to be Washington’s grudging recognition of the hardships and risks spawned by new regulations, are betting that they can make the climate more business-friendly. Even so, it’s important to note that there’s nothing in the above scenario that isn’t presently being discussed on some level or another.

No one is going to argue against the virtues of greater accountability. Boards today are more independent and more responsive to shareholder concerns than a decade ago. Financial statements and other shareholder communications are cleaner, clearer and offer more detail than in the past.

Boosting transparency and responsiveness even more doesn’t sound like a bad idea. And few would dispute the important role corporations can play in promoting the broader social good, via responsible workplace and environmental practices.

The question is, what is the proper balance? To many eyes, a world filled with strident shareholders, overzealous regulators and a raft of new laws, all aimed at holding corporate feet to the fire, promises to stifle the kind of creativity and risk-taking required to set companies apart from the pack- and ultimately generate superior shareholder returns.

“If you try to solve all of society’s problems by imposing solutions on business, it could lead to an adverse impact on the very people you’re trying to help,” says Robert Mittelstaedt Jr., dean of the Arizona State University‘s W.P. Carey School of Business. Mittelstaedt worries that excessive outside mandates could lead to decision- making gridlock, lower corporate profits and employment levels, and eventually push more companies to become private-slashing the alternatives available to investors. “You could create a downward spiral that has a very dark scenario attached to it.”

Game-Changing Scenarios

What changes are most likely? Movements on the corporate governance front provide an apt barometer of the public mood. Most expect shareholders to gain greater and more regular access to proxies, including director nominations. Staggered board terms will fall by the wayside, replaced by annual elections for all board members. And it will require a majority of shareholder votes to elect someone to the board.

“We’re going to see a lot more targeting of individual directors,” promises Nell Minow, head of The Corporate Library, a governance research group in Portland, Me. “People won’t be permitted to serve on boards if they don’t get majority support from shareholders.”

Turning the boardroom into a `battleground could have some unexpected consequences. John Castellani, president of the Business Roundtable, argues that outside stakeholders-labor unions, hedge and pension funds, proxy advisers, environmental activists and lawmakers among them-are all jockeying to alter the very mission and purpose of the corporation.

“The concern is that, under the guise of corporate governance, we’re opening the process to people who have a different vision of the corporate model, from one where the board oversees things on behalf of all shareholders, to one that represents the specific interests of small groups of shareholders,” he explains.

Castellani predicts a future where some boards are comprised of “one director who’s there because he curried favor with labor, one who’s there because of her views on global warming, and another whose main mission is to boost short-term returns.

“To the extent that you balkanize the board in this way, you diminish the way it works best-as a collegial, cohesive group that provides oversight and comes to consensus on the direction that most benefits shareholders,” Castellani adds.

Already, the interests of various activist financial shareholders, once viewed as a more or less cohesive group, are splitting between short- and long-term orientations. With greater access to the decision-making process, it isn’t hard to envision hedge funds regularly pressuring boards and managements to forego long-term investments and simply pay out a big dividend to shareholders-or sell.

Just ask Jay Sidhu, who as chairman and chief executive grew once-tiny Sovereign Bancorp in Philadelphia into a regional powerhouse, but was pushed out last fall by an investor group led by Relational Investors, a FSan Diego fund that was unhappy with Sidhu’s unwillingness to consider a sale.

Some even predict that shareholders could win the right to vote on key strategic decisions, such as investment levels or asset sales. Injecting shareholders so directly into the debate threatens to hamstring management’s flexibility to adjust to changing market conditions. “The more things shareholders are allowed to vote on, the more it will slow down management’s ability to act quickly and manage risk,” Mittelstaedt warns.

If these things come to pass, they won’t occur in a vacuum. The environmentalists, the labor groups, the advocates for privacy protection, animal rights or you name it are entering the corporate governance process in part because they’ve been frustrated in the public policy arena. That doesn’t mean, however, that they’ll stop pushing on that front.

Picking on Pay

Take executive pay. While lawmakers are unlikely to set firm guidelines linking an executive’s compensation to that of employees, they very well could mandate direct shareholder approvals of those packages-à la a bill sponsored by Rep. Barney Frank (D-Mass.), incoming chairman of the House Financial Services Committee.

If so, it’ll be rooted in political demagoguery -a reaction to both Americans’ general outrage over CEO pay and their own economic frustrations. As Frank told reporters recently, “A handful of people are getting very wealthy, and a lot of people aren’t getting anything.” In other words, Minow says, CEOs have no one but themselves to blame.

“If boards and managements don’t get control of this executive pay problem soon, we’ll have the government helping us,” warns Richard Koppes, a corporate attorney with Jones Day, San Francisco, and a former general counsel with the California Public Employees’ Retirement System (CalPERS), a big institutional investor. Minow says that means arriving at total compensation figures that aren’t offensive, and capping severance payouts in particular. “If you’re willing to bet on your own performance-not your departure-shareholders will beton you, too.”

At the same time, don’t be surprised if the executive compensation disclosure regime, which the SEC is requiring this year for the first time, expands to include such things as greater detail on what metrics go into performance based pay calculations.

These kinds of changes could be painful for several reasons, not the least of which is the strategic insight they could reveal to rivals. Thomas Mac Mahon, chairman and CEO of Laboratory Corporation of America, says he’s perfectly comfortable with his board’s compensation committeedebating the merits of his performance- based pay behind closed doors. However, “we’re treading on dangerous ground if my target bonus is put out there, and it’s related to how many new accounts we open or retain, or our strategy for pricing or penetrating a particular market,” he says. “That’s too much detail for competitors to see.”

In the worst case, forcing CEOs to shoulder greater liability without the same financial rewards could scare off qualified people. “The risk reward equation could get out of whack” and create a leadership void, Mac Mahon says.

To be sure, not all companies will be impacted in the exact same way, and absent a government mandate many might resist significant change, with their shareholders’ approval. The CEO of one large high-tech firm, for instance, says his company is so dependent upon having a stable board to guide long-term research and development investments that he’s simply unwilling to go along with the nascent trend toward annual director elections. “This is a cyclical business. We have bad years,” this executive says, explaining that he can’t risk losing seasoned board members over such hiccups.

Globalization could render some of these efforts moot, as well. On the plus side, today’s outsourcing debate, for instance, could become a non issue as businesses continue to generate more profits abroad. Overall, we could see more global markets not only for products but also in talent and regulation. Already, the International Accounting Standards Board is discussing a shift to real-time financial reporting, as opposed to today’s quarterly system-something that, if adopted in Europe, would likely be matched in the U.S.

Either way, the future could present myriad distractions to make it more difficult for CEOs to plot and execute corporate strategies. “Fundamentally, all this stuff will leave us with less time to talk about the business operations,” says Harris Simmons, chairman and CEO of Zions Bancorporation in Salt Lake City, Utah, and outgoing chairman of the American Bankers Association. “In a thousand little ways, it threatens to throw a wet blanket over our innovative impulses and make companies a lot more risk-averse.”

If added costs and scrutiny progress far enough, don’t be surprised to see more companies head for the gates, gladly opting for private- equity buyouts, where shareholder and regulatory pressures are, if not lessened, at least more manageable. For the rest, CEOs will need to adjust their strategies and tactics to deal with the new reality.

Managing Outward

Like many chief executives, Robert Kelly, chairman and CEO of Mellon Financial, a big asset-management and servicing firm in Pittsburgh, fears that shareholder and regulatory pressures already are conspiring to make it more difficult for U.S. companies to compete globally.

U.S. executives are more risk-averse than they were five years ago, Kelly says, due to the threat of personal liability imposed by Sarbanes-Oxley’s reporting requirements and to competition between various regulators-the SEC, state attorneys general and the like-all vying to score political points.

Kelly, who foresees such trends continuing, says smart CEOs need to be proactive in terms of “stakeholder management,” viewing external relations as part of their overall risk-management duties and seizing the initiative to blunt outside critics. Since being named as Mellon’s CEO last February, he has held numerous meetings with investors and recently began eliminating the company’s takeover defenses, including a classified board structure and supermajority voting requirements on by-law amendments and director removal.

Such moves, executed well, can leave outside critics a step behind. Wells Fargo & Co., the San Francisco-based banking company, recently created an environmental advisory board in response to shareholder demands that it halt lending to “environmentally destructive projects.” Time Warner recently began exploring ways to reduce greenhouse gas emissions in its magazine printing operations.

Kelly also says CEOs must respond to shareholders’ short-term aggressiveness by setting-and achieving- “bite-sized” financial goals. “Instead of saying you want to turn around the company in six years, you might have three periods of two years, each with its own set of goals,” he says. “You’re really going to have to change the way you communicate with shareholders if you want to keep your job.”

No one can say for sure what’s coming next. We live in a reactive society, where the actions of a few bad apples can generate over-the-top responses from well-intentioned enforcers. For CEOs who must navigate their companies through such minefields, the best advice is to have a strong, independent board, stay alert and be ready to ride whatever wave comes next.


2017 Prediction: Expect Emissions Standards

The politics of climate change will add to company compliance burdens.

For a good example of how external pressure could impact corporate managements in the next decade, consider the highly charged climate change debate. More than 80 percent of large companies recently surveyed by the Pew Center on Global Climate Change expect federal emissions standards by 2015. “Most companies believe we’ll soon be living in a carbon constrained world,” says Eileen Claussen, the Pew Center‘s president.

New regulations would make running a company more complicated and costly. Most proposals would require market-based “cap-and-trade” systems, which place hard limits on companies’ emissions and permit those that beat their targets to sell leftover capacity to those that don’t. That means large companies will need to seek more outside help, in the form of consultants and auditors, and to hire people to staff internal “carbon trading desks” to manage those permits.

Andrew Hoffman, a professor of corporate environmental strategies at the University of Michigan, says that the regulations will hike risks for corporations. A company’s ability, or lack thereof, to limit emissions will be “material” under Sarbanes-Oxley. “Your shareholders are going to have the right to know your carbon exposure,” he explains. “And if they believe you’re too exposed, you might see an impact on your share price.”

Already, some large investors, including CalPERS, are evaluating companies on their emissions performance. A growing number of lenders, such as Wells Fargo & Co., have begun assessing the environmental impact of clients’ projects before financing them. Insurers won’t be far behind in weighing compliance efforts when they set premiums. The chief goal of this outside scrutiny would be to cut energy usage. In the worst case, some companies-or even entire industries-that rely on outdated gas-belching plants, could eventually die under the weight of the regulations, “similar to the typewriter being wiped out by the computer,” Hoffman says.

The movement is well-intentioned. In 2005, some 28 billion metric tons of greenhouse emissions were poured into the atmosphere, with the United States contributing about a quarter of the total. Claussen says those emissions are causing the Earth’s temperature to rise, leading to rising sea levels, more-intense floods and droughts and more-violent storms.

Even so, critics of emissions standards say they’re just another set of burdensome rules that could make businesses less efficient. “We’re moving toward a European model of a stakeholder corporate structure,” where corporations are tagged with helping achieve all sorts of societal goals, says James Glassman, a resident fellow at the American Enterprise Institute. “To be torn in all these directions makes business less efficient.” Like it or not, an emissions crackdown awaits. “It’s going to take public policy to get the job done,” Claussen says. Smart managements would do well to prepare for it.

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