By Julie Gorte, SVP, Sustainable Investing, Pax World Investments
“When corporate governance operates optimally, the three key players—the executives, the board of directors, and the shareholders—provide through a system of checks and balances a system for a transparent and accountable system…”
Robert A. G. Monks and Nell Minow
Since the turn of the millennium we have lived through two extremely painful episodes of corporate governance failure, both of which were implicated as significant culprits in the recessions that followed. Something this important deserves the scrupulous attention of every publicly traded company and its shareholders. That, for all practical purposes, includes everyone.
Good governance in many ways is straightforward. It means having thoughtful directors to oversee management and bring diverse viewpoints to the decision making table. It means having management that is as concerned for the long-term health of the company they run as the shareholders who depend on its health. Managing the corporation and overseeing the management are two fundamentally different roles. There are reams of examples of how bad things can get when those roles are blurred. Robert Monks and Nell Minow, in their classic book Corporate Governance, give vignettes from the governance of Enron, Tyco, Countrywide, Chesapeake Energy, Lehman Brothers and others that serve as ample warning to other companies on the dangers of having boards too cozy with management to question things that later cost billions of dollars and robbed thousands of Americans of their pension assets, jobs, and nest eggs.
Board independence is a straightforward topic, but as an attribute of governance it is difficult—maybe impossible—to measure objectively and quantitatively. Major exchanges and the Securities and Exchange Commission all have definitions of board independence, but we have also seen that even boards that meet strict definitions of independence can be captured by management, which renders the “independent” designation meaningless.
Yet it is also true that continuing to pursue true independence among company directors is still valuable, and that diversity is a source of independence. While not all studies on board diversity reach the same conclusion, many agree that putting women on boards can be a good thing for shareholders. In particular, many studies agree that a critical mass of women on boards—variously defined, but often somewhere around three women or 30 percent of the board—is positively correlated with performance measures like return on equity, Tobin’s Q, lower cost of debt, or quality of earnings. Pension giant CalPERS noted in a 2009 report that “companies with more diverse boards…have higher performance on key financial metrics, such as return on equity, return on sales, and return on invested capital.”
Correlation is not causality, of course, but of the studies that have inquired more deeply into the mechanism behind the correlation, there is often agreement that women bring independent perspectives and greater focus on monitoring to boards, and those things are often attributes of companies that perform well financially. In short, it is not gender diversity by itself that tends to be associated with good performance, it is the qualities women often bring to boards that connects those dots. Simply adding a woman or a minority to a board isn’t guaranteed to improve its function, or the performance of the company. Good governance is about many things—boards that act independently, robust shareholder rights, accurate accounting, reasonable and fair executive compensation, and so on. No single parameter defines good governance. It takes a village.
Urban Outfitters’ recent move to nominate a woman to serve on its board is a case in point. As company that markets fashion apparel, accessories and home goods, it seems reasonable to think that the perspectives of women could be useful to its board. Many shareholders agree. A 2011 shareholder proposal requesting simply a report on board diversity won 22 percent shareholder support, and a 2012 shareholder proposal requesting that the company commit to a policy of seeking women and minority candidates for every director search won 38 percent of the shareholder vote. A vote in favor of nearly 40 percent is considered a strong signal that an issue proposed for consideration should get serious attention, and action, from directors. Nevertheless, neither proposal was adopted by the company. And, now, an action that these shareholders would normally consider positive – that is, adding a woman to the board – may be diminished by the fact that the nominee is also the spouse of the CEO, as well as a senior manager at the company.
As a whole, Urban Outfitters’ board skirts the edges of listing and regulatory requirements for independence; two of the seven directors are identified as affiliates of the company and two, if the entire slate is elected, are insiders. One of the “affiliated” directors is the brother-in-law of the co-president of one of the company’s brands, and another is a partner in a law firm that got nearly $2 million in business from the company in its most recently completed fiscal year. And now, the wife of the CEO. Is this really a company that takes board independence seriously?
It may be that this nominee is quite capable of acting independently from company management, not to mention the CEO. But, in general, we as shareholders expect that company insiders and relatives are less likely to act independently, and decades’ worth of examining company reporting for related party transactions (which often involve companies doing business with family members of managers and board members) confirms that the greater the role of families and insiders, the smaller the chances of true independence.
The value of adding women to boards of directors lies in the fact that women, who have long been excluded from boards, bring fresh perspectives to the boardroom. The chances that those fresh perspectives will come from a company insider and family member of the current management are not especially high. We still hope to be pleasantly surprised, but we aren’t expecting it.
Finally, it is also noteworthy that, while nominating a woman to its board, Urban Outfitters’ management has also recommended that shareholders vote against a shareholder resolution requesting that the company make racial and gender diversity part of every director search, just as it did in 2012. Of the 13 companies Urban Outfitters lists as peers in its 2013 proxy statement in order to benchmark executive compensation, all but one have at least one woman on their boards, and all but three have more than one woman director. The median number of women on the boards of Urban Outfitters’ self-selected peer group: three. It is past time for all companies to get serious about board diversity, and to do so in ways that comport with other parameters of good governance.