Public Company Comp in 2012

At the April Breakfast Meeting of the New England Chapter of the National Association of Corporate Directors, a panel of public company directors faced “the Enemy” in the person of Pat McGurn, who represents the ISS.  For the uninitiated, ISS stands for Institutional Shareholder Services, the company that advises institutional shareholders in public companies as to how they might want to vote on director elections and other proxy issues.

McGurn noted that in 2011 the ISS made a favorable recommendation on “say-on-pay” votes in 88% of public companies (that is, ISS recommended that in 7 out of every 8 public companies the shareholders vote in favor of the compensation arrangements proposed by management and the board of directors in the advisory, non-binding shareholder votes mandated by Dodd-Frank).  Although it is early in the current proxy season for 2012, he noted that so far ISS has recommended favorably in 86% of the companies that have come before them.

It should also be noted that historically most companies pass the say-on-pay test with an average positive approval of over 90% of the shareholder votes; in 2011 only 41 companies, or less than 2% of the Russell 3000 Index, actually failed.  Early indications indicate that similar results will obtain in 2012.

McGurn noted that in 2013 the Dodd-Frank Act say-on-pay provisions become applicable to low cap companies for the first time, which may result in different statistics.  That is, if there is no change in the Federal administration, the suggestion being that a Republican victory might lead to a delay in implementation.  He noted that the April 5th JOBS Act signed by the President delayed many otherwise mandated compensation disclosures for newly registered companies with sales below $1,000,000,000 which is, after all, most of them.

What was the effect of a negative ISS recommendation in 2011?  According to McGurn, all but a small handful of boards receiving negative ISS recommendations, whether or not they received negative shareholder votes, responded in some fashion.  Almost all companies changed their compensation to link it better to actual performance.  Each of the three companies who received negative votes in 2011 and who have already had their 2012 annual meetings have received over 90% approval in their 2012 say-on-pay votes by the shareholders.

The key is not only changing compensation to link it to company performance; the key is also outreach to investors to understand and meet their reactions.  Disclosure is much better of course, and this facilitates communication, but some companies also have been doing formal compensation roadshows.

The problems with compensation are no longer extra perks, severance and the like, which McGurn described merely as “irritants.”  The issues now are actually tying compensation to performance, and addressing executive compensation which is a multiple of peer group mean compensation.

There is something of a contrast between this relatively self-satisfied ISS report, on the one hand, and the extensive article in this past Sunday’s New York Times Business Section concerning executive pay.  Discussing pay for the top fifty public company executives whose information has already been reported in this proxy season, the Times article concludes that while executive compensation growth may have leveled off, it has leveled off at an extremely high point in terms of absolute dollars.  Even taking Apple’s CEO out of the equation (earning something in excess of $378,000,000, although most of it was indeed in stock and not cash), CEO compensation in numerous business sectors was significant.

The panelists, chairs of compensation committees of public companies, had differing reactions.  One panelist noted that, in a highly successful company where compensation was discretionary (but it turns out not above mean), there was resistance to having ISS force mathematical metrics into the equation in order to define and calculate appropriate compensation.  There was also criticism of an over-emphasis on “total shareholder return” which is an important ISS metric; in technology companies with high potential volatility, an executive can be doing an excellent job and yet profitability can take a short term beating because of the realities of the marketplace.

The ISS response was that they have lengthened their time horizon by which they are comfortable in measuring corporate performance, to take pressure off the very short term, but McGurn did note that his clients (ISS’s clients) are long-term investors, and at some point total shareholder return on investment becomes “the” metric in which his clients have an interest.

There was also discussion of the somewhat opaque selection of peer groups in which ISS places each company (so that compensation can be measured against what are putatively the company’s peers).  McGurn noted that each company is placed in a peer group wherein that company is placed near the mean in terms of size, further noting that one of the largest determinants of absolute compensation is indeed the size of enterprise.

In 2012, ISS sees as its hot spot the payment of executive compensation above the peer mean by companies showing mediocre performance, although McGurn assured the group that ISS has no particular performance metric and that each company is entitled to have its own metrics; what he is looking for, he says, is “evidence of intelligent design” as opposed to a rote set of numbers.

Finally, the panel noted that an effort was being made to address the ratio of CEO compensation to the compensation paid to the rest of the executive team; they declared an end to “the rock star CEO.”  That announcement may come as a surprise to readers of the New York Times CEO survey.

Bentham Meets Obama (or, when Courts should shut up)

Jeffrey Toobin’s lead article in the April 9 New Yorker is a clear and convincing argument for the liberal viewpoint on the Supreme Court’s role in evaluating Romneycare – whoops, I mean Obamacare.  As befits a graduate of THE Law School, Toobin applies the power of court precedent to the debate, finds that the law should be sustained, and excoriates Court conservatives for replacing judicial process with personal bias and a lack or respect for the elected representatives of the people.

We should pause to note that Toobin, for about twenty years the legal guru at New Yorker and more recently at CNN, writes with convincing clarity and hits from the left side of the plate.  Neither of these facts make him wrong —  but neither guarantees that he is correct, either.

Toobin notes extrinsic pressures on the Court deliberations: politics.  It is hard to know the degree to which the Justices will internalize political realities in their judgments.  His analogy to the Roosevelt Supreme Court reversing in 1937 its conservative bias (most importantly expressed by the Court striking down the NRA in the 1935 “sick chicken case”), thereby reflecting an appropriate appreciation for the presumed validity of Congressional Acts passed by elected officials, seems misguided; likely, fear of Roosevelt packing the Court was a greater driver of the Supreme Court changing direction.

What is not discussed by Toobin is the role of social values underlying the debate.  The article’s suggestion that the conservatives on the Court are applying not only unprecedented standards but also their own sense of our Social Compact to the detriment of “THE LAW,” is implicit and not stated but, I suspect, can be found one layer deeper in the Toobin onion.

For example, his moral outrage over this same Court declaring corporations to be people in Citizens United is echoed in Toobin’s clear moral contempt for questions directed from conservative Justices to the Solicitor General that suggest sympathy for the insurance companies which are subject to Romney/Obamacare.

Every branch of our government reflects the sense of the electorate (that part which votes) as to the current nature of our Social Compact.  We, or some of us, elect two branches and one branch names the third; to say that Justices are not elected is true only in the technical sense.  And to suggest as does Toobin that conservative social thinking is polluting the judgment of conservative Justices is just another way of saying that people are messing with the liberal social thinking that for several decades of the 20th Century in fact dominated the content of our legal precedent.  It is not that improper social thoughts are taking over our Courts; rather, it is that social thoughts that liberals do not share are taking over our Courts.

Enter another way to think about the debate; it is a way that is not Constitutionally premised, but rather is reflective of what underlies our governance and what is (imperfectly) reflected in our voting.  What would Jeremy Bentham and John Stewart Mill, the utilitarian philosophers, do if they were on the Court?

Likely they would be blind to the Constitutional arguments although that would be a shame; the primacy of the rule of precedential law is pretty important and not often shared outside the legal profession.  I am sure they would ignore the pressure of the election.  But they would, as all people must, bring their understanding of our society’s “Deal” with itself to the deliberations.  And their understanding is neither conservative nor liberal, it is utilitarian.

Now there are various schools of utilitarianism and I am going to do disservice to all of them (and reveal no doubt a lack of deep knowledge) by reducing the whole lot to a simple proposition: best governmental decisions provide the greatest good and happiness to the greatest number.  Put another way – my way  —  we should look to weight benefit and burden.  That mathematics multiples the number of benefited by the amount of benefit, and balances it against the number of burdened multiplied by the amount of burden.  The best answer is told by the way in which the balance tips.

So who is benefited by Romney/Obamacare?  Arguably most people.  Those without current coverage?  Yes.  Those with existing coverage?  Likely so; I know that when I pay my horrendous premiums I am already paying for many who are not covered; it is implicit in the costs of the care I receive that I am covering the uninsured who by and large are being treated anyway at hospitals and by doctors that I, and others like me, do already pay for. The insurance companies?  As regulated entities, which particularly under Romney/Obamacare cannot be allowed to fail, they will get funded by premiums and governments.

Who is burdened?  Everyone who pays taxes certainly.  But query if they are paying in the long run more than they are paying now by reason of presently paying for their own care and (in an inefficient way) the care of the “uninsured.”  Individuals whose freedom is infringed by being forced to buy a product they do not want?  I find that a facially logical proposition that plays to our legitimate sense of freedom but is unconvincing.  We already are forced to “buy” an infinity of things that we may not want.  How about certain military adventures?  Farm subsidies? Pork barrel? Pick your pet peeve that your tax dollars go to.  Would Bentham much care about the argument that the government could fund universal health care by tax but cannot do so by Romney/Obamacare, when the functional result and economic costs seem roughly the same?

Our “freedoms” are impinged mightily every single day by government, and that is a wholly separate and legitimate discussion, but is not significantly addressed by saying that Romney/Obamacare should be stricken because government is forcing us to buy a commercial product.

None of the above of course reflects an independent moral judgment, which is the degree to which our society should afford medical care to people not receiving it.  There are two flavors of what is now happening in medical care: many receive it free and we are paying for it anyway and inefficiently to boot; or, some do not receive it at all, which ought to present a moral conundrum to many.   (Indeed, some people from whom I hear the argument against the law apply the moral standard privately in their charity but do not see the government as the mechanism to bring moral judgment to medical care, although our government does and must bring moral judgment to almost anything it does do, and by definition).

We will have our answers by the end of June when the Court concludes its current session and must report out its decisions on all cases it has heard.  The Court spent three days hearing arguments that I submit will not drive the decision.  The decision will be decided by preconceived notions of the Social Compact on the part of eight Justices, and some unknowable tortured process undertaken by Justice Kennedy, who so often is the “swingman” between the entrenched personal philosophies of the others.

We as observers are so politicized in the way we see things that we may miss the real battle here, but that battle also may not be express in what is expected to be multiple written decisions of the Court, as it is not express in Toobin’s New Yorker article.

And the Justices will decide,  based on whatever has happened to each of them beforehand, and which brought them to the legal, intellectual and emotional place which each now occupies.  Perhaps, as in Bob Dylan’s words, “A man hears what he wants to hear and disregards the rest.”

Jeffrey Toobin’s lead article in the April 9 New Yorker is a clear and convincing argument for the liberal viewpoint on the Supreme Court’s role in evaluating Romneycare – whoops, I mean Obamacare.  As befits a graduate of THE Law School, Toobin applies the power of court precedent to the debate, finds that the law should be sustained, and excoriates Court conservatives for replacing judicial process with personal bias and a lack or respect for the elected representatives of the people.

We should pause to note that Toobin, for about twenty years the legal guru at New Yorker and more recently at CNN, writes with convincing clarity and hits from the left side of the plate.  Neither of these facts make him wrong —  but neither guarantees that he is correct, either.

Toobin notes extrinsic pressures on the Court deliberations: politics.  It is hard to know the degree to which the Justices will internalize political realities in their judgments.  His analogy to the Roosevelt Supreme Court reversing in 1937 its conservative bias (most importantly expressed by the Court striking down the NRA in the 1935 “sick chicken case”), thereby reflecting an appropriate appreciation for the presumed validity of Congressional Acts passed by elected officials, seems misguided; likely, fear of Roosevelt packing the Court was a greater driver of the Supreme Court changing direction.

What is not discussed by Toobin is the role of social values underlying the debate.  The article’s suggestion that the conservatives on the Court are applying not only unprecedented standards but also their own sense of our Social Compact to the detriment of “THE LAW,” is implicit and not stated but, I suspect, can be found one layer deeper in the Toobin onion.

For example, his moral outrage over this same Court declaring corporations to be people in Citizens United is echoed in Toobin’s clear moral contempt for questions directed from conservative Justices to the Solicitor General that suggest sympathy for the insurance companies which are subject to Romney/Obamacare.

Every branch of our government reflects the sense of the electorate (that part which votes) as to the current nature of our Social Compact.  We, or some of us, elect two branches and one branch names the third; to say that Justices are not elected is true only in the technical sense.  And to suggest as does Toobin that conservative social thinking is polluting the judgment of conservative Justices is just another way of saying that people are messing with the liberal social thinking that for several decades of the 20th Century in fact dominated the content of our legal precedent.  It is not that improper social thoughts are taking over our Courts; rather, it is that social thoughts that liberals do not share are taking over our Courts.

Enter another way to think about the debate; it is a way that is not Constitutionally premised, but rather is reflective of what underlies our governance and what is (imperfectly) reflected in our voting.  What would Jeremy Bentham and John Stewart Mill, the utilitarian philosophers, do if they were on the Court?

Likely they would be blind to the Constitutional arguments although that would be a shame; the primacy of the rule of precedential law is pretty important and not often shared outside the legal profession.  I am sure they would ignore the pressure of the election.  But they would, as all people must, bring their understanding of our society’s “Deal” with itself to the deliberations.  And their understanding is neither conservative nor liberal, it is utilitarian.

Now there are various schools of utilitarianism and I am going to do disservice to all of them (and reveal no doubt a lack of deep knowledge) by reducing the whole lot to a simple proposition: best governmental decisions provide the greatest good and happiness to the greatest number.  Put another way – my way  —  we should look to weight benefit and burden.  That mathematics multiples the number of benefited by the amount of benefit, and balances it against the number of burdened multiplied by the amount of burden.  The best answer is told by the way in which the balance tips.

So who is benefited by Romney/Obamacare?  Arguably most people.  Those without current coverage?  Yes.  Those with existing coverage?  Likely so; I know that when I pay my horrendous premiums I am already paying for many who are not covered; it is implicit in the costs of the care I receive that I am covering the uninsured who by and large are being treated anyway at hospitals and by doctors that I, and others like me, do already pay for. The insurance companies?  As regulated entities, which particularly under Romney/Obamacare cannot be allowed to fail, they will get funded by premiums and governments.

Who is burdened?  Everyone who pays taxes certainly.  But query if they are paying in the long run more than they are paying now by reason of presently paying for their own care and (in an inefficient way) the care of the “uninsured.”  Individuals whose freedom is infringed by being forced to buy a product they do not want?  I find that a facially logical proposition that plays to our legitimate sense of freedom but is unconvincing.  We already are forced to “buy” an infinity of things that we may not want.  How about certain military adventures?  Farm subsidies? Pork barrel? Pick your pet peeve that your tax dollars go to.  Would Bentham much care about the argument that the government could fund universal health care by tax but cannot do so by Romney/Obamacare, when the functional result and economic costs seem roughly the same?

Our “freedoms” are impinged mightily every single day by government, and that is a wholly separate and legitimate discussion, but is not significantly addressed by saying that Romney/Obamacare should be stricken because government is forcing us to buy a commercial product.

None of the above of course reflects an independent moral judgment, which is the degree to which our society should afford medical care to people not receiving it.  There are two flavors of what is now happening in medical care: many receive it free and we are paying for it anyway and inefficiently to boot; or, some do not receive it at all, which ought to present a moral conundrum to many.   (Indeed, some people from whom I hear the argument against the law apply the moral standard privately in their charity but do not see the government as the mechanism to bring moral judgment to medical care, although our government does and must bring moral judgment to almost anything it does do, and by definition).

We will have our answers by the end of June when the Court concludes its current session and must report out its decisions on all cases it has heard.  The Court spent three days hearing arguments that I submit will not drive the decision.  The decision will be decided by preconceived notions of the Social Compact on the part of eight Justices, and some unknowable tortured process undertaken by Justice Kennedy, who so often is the “swingman” between the entrenched personal philosophies of the others.

We as observers are so politicized in the way we see things that we may miss the real battle here, but that battle also may not be express in what is expected to be multiple written decisions of the Court, as it is not express in Toobin’s New Yorker article.

And the Justices will decide,  based on whatever has happened to each of them beforehand, and which brought them to the legal, intellectual and emotional place which each now occupies.  Perhaps, as in Bob Dylan’s words, “A man hears what he wants to hear and disregards the rest.”

Impediments to Bio Industry Expansion

The Massachusetts Biotechnology Council meeting on The Business of Science concluded March 27, as it began: lots of discussion of the technology, interspersed with programs about the business and financial aspects of bio which all had the same themes: bio is the great wave of the future, Massachusetts is at the forefront, but other geographic bio clusters are hot on our heels and there are many ways we in Massachusetts can be overtaken and surpassed.

One interesting counterpoint came from an Indian panelist who noted that the suppositions that FDA was too slow and too conservative to the detriment of US bio in general, are simply inaccurate.  Notwithstanding the oft-recited tales of horrible delay in FDA, the timing of drug approval overseas in not faster and will not become faster because other countries rely on FDA to set the tone and the standard of review.  This assertion was not directly challenged but was, alas, simply ignored; the final speaker, who was from FDA, was asked in several ways why the FDA moved so slowly.

The FDA position, by the way, articulated by  Dr. Eric Perakslis (Informatics chief), is that they DO hurry when there is a clear unmet medical need; the FDA will be willing to incur risk if the benefit seems to balance it.  The biggest problem the FDA has these days, he noted, was in their newly established regulatory function over tobacco, where he wondered how to measure benefits against risks for a product having no benefits at all.  (My best guess is that Eric is not a big smoker.)

What is impeding Mass bio?  The state gifts ban (which kills interaction that leads to innovation); the unique Massachusetts ban on co-payment assistance which thereby imperils the payment stream; the failure of schools from elementary to Community colleges to train workers in requisite skill sets; anti-immigration laws that now overly restrict special visas; a lack of language skills among our workforce members; lack of government  funded apprenticeships in private industry thereby impeding hiring of skilled and experienced workers; the growth of viable bio clusters elsewhere with governmental support superior to that afforded in Massachusetts (citing particularly Germany and Singapore).

The attendees are all “bio people” and it is hard to separate their valid but survivable complaints from the truly existential threats to Massachusetts biotech companies; every industry has its burdens to bear, and bio is not the only industry that fairly can say that it is over-regulated, under-served by government, not supported by the educational system and, these days, denied essential capital.

The one extremely positive message that came out of the meeting, however, and one message shared by attendees from within and outside  Massachusetts, is that everyone today believes that Massachusetts has innate advantages in Higher Education and entrepreneurship and that therefore, given appropriate nurturing, bio will be an economic and social engine for the region for a very long time.

Risk, Regulation, and the American Economy: Dialogue with a Professional Director

Ernie Godshalk is a professional director currently sitting on two public boards; a director of the National Association of Corporate Directors/New England, Ernie is well known to the local director community as a thoughtful commentator on board service.

His current view of the world economy is that it is recovering slowly but subject to substantial risks, and heading the list are the precarious nature of the Euro (I parenthetically note today’s report of further weakening in the Euro countries’ employment) and the international risks created by Iran and perhaps Pakistan.  In light of this view, I asked how a board should go about enterprise risk management.

Godshalk’s view is that, while his boards discuss risk virtually every meeting and care is given to identifying who is responsible for watching which risks, there are indeed some existential exposures which cannot be controlled by the company and consequently cannot really be monitored.

Ernie expressed concern as to the impact of any Euro failure on the highly leveraged Deutsche Bank, and rejected the view that a Euro failure in the long run would not represent a substantial risk for United States businesses.  Certainly, identifying non-European markets for the purchase of parts or the sale of goods, and the shortening of lead times, can mediate the Euro risk to some extent, but substantial risk will remain given the international nature of United States business.

What are the problems most plaguing our economy, aside from major geopolitical risks?  We discussed excessive US regulation; we further debated whether over-regulation was an annoyance and a marginal expense but not an ultimate depressor of United States business.  Godshalk noted two factors in the American environment that he thought were significant: first, our high tax rate and, second, our immigration policy.

Noting the internationalization of business in general, even domestic United States companies have substantial opportunity to relocate operations and profits overseas.  Higher United States tax rates drive that flight abroad.

Immigration is an oft-cited problem, as it has become difficult to obtain visa approval for persons with requisite skills to drive technology businesses.  Even more anomalously, I suggested that we are now bringing foreign students to the United States and transferring our own sophisticated technology to them and, then, refusing to allow them to stay; it is the forced exportation of our technological advantage.

Asked about the biggest problems in serving as a director these days, Godshalk noted two: first, failure of boards properly to address CEO succession; and, second, the inordinate time which boards must apply to risk assessment, say-on-pay, proxy solicitation and the like, which diverts the board from its strategic mission of “adding value” and making the company business better.

Finally, I asked Ernie about the current state of the M&A market.  From a strategic acquisition standpoint, he believes that good deals are available.  The strategic advantage should be in either technology or in sales (for example, efficiency in marketing multiple lines).  In response to the suggestion that an improving M&A market has caused an increase in EBITDA multiples, particularly for strategic acquirors, Ernie noted that there are many companies that are for sale, there is pent up sales demand, and many enterprises with VC and PE money remain well “behind plan” by reason of the recent business recession, and consequently are favorably priced.

The issue of over-regulation of United States business is and will remain a significant discussion.  Two days before our meeting, the Congress passed and sent to the President the JOBS Act, which rolls back some of the Dodd-Frank regulatory requirements at least for businesses that are now going public with sales less than $1,000,000,000 (which is not all of them, but surely most of them).  Now that the Federal Administration identifies relationship between regulation and employment, it is possible that bi-partisan efforts (so hard to achieve in so many areas) will nonetheless continue to address these issues of over-regulation which Godshalk believes drive companies abroad and waste director time in boardrooms.

Funding Bio– MassBio Conference doesn’t know how to do it

The Massachusetts Biotechnology Council’s program entitled “2012 Annual Meeting – the Business of Science” is underway, and the kick-off keynote speech and first panel spent a good deal of time exploring why the business approach to funding bio is not working so well.

Francis Collins is the Director of the National Institutes of Health and thus a major player in the business of bio; this year he will give out $25.7  billion to about 325,000 scientists.  His speech was sprinkled with insights and great factoids, but the bottom line is that bio is in financial trouble and he is driving NIH to help meet the issues.  Only about one in every six applicants gets funded these days, and the NIH budget has declined about 20% in buying power over the last decade even though the absolute number of dollars has increased.

Most telling: a 60-year longitudinal chart showing that over that period the number of successful drugs reaching market for each $1 billion of investment has fallen 100-fold.  Although expressing himself as optimistic, citing great advances in the genomic sphere which  will speed diagnosis and specific targeted treatment of cancer and other diseases, he conceded that bio contributes wealth (as well as wellness) to our nation, and that competition in China, India, Russia and now Europe is heating up.  He intends on Wednesday to make these points to the Senate in discussing NIH funding.

(I found myself seated at a table with a representative of the UK government, who listed the UK funds established in the last few months, with many hundreds of millions of pounds to invest in bio, including a 200,000,000 government fund;  you could almost feel the breath of John Bull down the necks of the attendees.)

How to fight for U.S. supremacy in bio?  Efficient use of genomic analysis to speed drug targeting and testing, a study of failed or seldom used drugs to see if they have different applications, effective use of iPS cells which can be differentiated and then studied specifically.  And, continued NIH funding, and an additional federal fund to supplement NIH and to target major needs such as Alzheimer’s.

The panel that followed was a bit more harsh in its analysis; moderated by Juan Enriquez, Managing Director of Excel Venture Management, the panel blamed the by-now usual suspects: the FDA, the non-economic models for drug development which turn off VC investment, the greater ease to acquire drugs as compared to spending 15 years developing and testing them.  Some compared drug companies today to Procter and Gamble: more interested in marketing than in science.

One panelist noted that it is worse than feared: not only do few drugs get approved, but only 3 in 10 which are approved ever earn enough money to provide a return on investment.  Drugs being proposed these days need have not only a scientific story but also a consideration as to pricing and reimbursement issues before investors will consider them.

Growth by acquisition cannot continue, as “pharma is running out of merger partners.”  The benefits of scale will no longer be available.  Schools bear blame also, by restricting doctors from serving on company boards or taking stock.

One final question hung over the room at the end: if drugs can come to market overseas for less money and in four years, what is the future of bio in the U.S.  (There being no ready response, the program moved on to simpler things, like the cure for cancer….)

DEMOCRACY IN ACTION?

This morning’s mail has upset a part of my world view.

Universities long have been accused of being bastions of populist, liberal thought; Northeastern elite universities (along with anomalous Berkeley, the Harvard of the West) have borne the brunt of this accusation.

Such was not my experience at Harvard Law School; during my attendance (decades ago) it was the bastion of pro-corporate thinking.  Corporations should be minimally regulated so as to return greatest profit to their sole relevant constituency: the shareholders.

My 7:44 AM email today from The Harvard Law School Shareholder Rights Project reports that that group, “a clinical program through which Harvard Law School faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners,” has been working all year to force public companies to de-stagger their boards.

They have submitted proposals to over 80 of the S&P 500, and 42 (one third of the S&P 500 with staggered boards) have agreed to move to annual elections of the entire board.  The list includes Alcoa, BlackRock, Cigna, Lilly, McDonald’s and PPG.

Several aspects are fascinating.  Leave it to Harvard to apply some of its student outrage in the support of retirement funds who have invested in public companies; not exactly the poor huddled masses being dragged upwards by the power of the law.  Leave it to Harvard to take the training ground of the conservative corporate advisors and turn it towards the “democratization” of corporate governance.  Leave it to Harvard to undertake the remaking of concepts of corporate governance in a way that empowers shareholders whose interests may be short-term and inconsistent with long-term measured corporate growth.

It is not clear where they will turn next, but this kind of success is not going to do anything except further inspire Professor Bebchuck and his hearty band.  The shopping list of corporate democracy demands includes broad proxy access, greater ratchet on comp,  independent board chairs, and independent board majorities.

While no doubt entrenched boards beholden to management sometimes in the past led to failure to respond to favorable takeover bids and to over-compensation of top executives, the causes for these lapses are many and complex and cannot be made to disappear by granting greater power to shareholders.  The small shareholder is and will remain without power.  The larger shareholders have, and are legally entitled to, their own agendas; those agendas may be short term and short sighted and not consistent with healthy corporate growth or innovation.

Two lessons emerge: first, this initiative will ultimate fuel the M&A market; second, directors had better start listening more closely to Professor Bebchuck, whose message and flat presentation have not exactly made him the darling of the corporate speakers’ circuit around Boston.  He is single-handedly remaking corporate governance in America and he is doing it under many radar screens that ought to be picking up the incoming blips.

Directors and Company Founders

The March 13 breakfast meeting at National Association of Corporate Directors (New England) brought together two extremely successful business founders, together with veteran company director Ernie Godshalk, to examine the relationship between boards of directors and founders.

The two founders on the panel are atypical: each has  grown multi-billion dollar companies and has survived as both chair of the board and CEO of the enterprise.  That doesn’t mean they didn’t add executive strength below; it just means they were able successfully to stay in the saddle and have dynamic success.

Allen McKim is Chair, President and CEO of Clean Harbors, with 500 locations in the United States, Canada, Mexico and Puerto Rico and with international operations in many other places.  Josef von Rickenbach is Chairman and CEO of Parexel, a bio pharmaceutical services company.  Both companies were founded in the ‘80s and are publicly held.  Clean Harbors was founded with a loan against McKim’s house; von Rickenbach started in his basement and now has 12,000 employees.

In terms of corporate governance, their paths were diverse.  McKim with Clean Harbors had a close-knit board until the IPO; now there are nine independents and McKim.  Von Rickenbach had early VC investment, and said that this created a level of process and formality which stayed with the company.

What they both have in common is an ability to use the board as a tool.  Each noted that independent directors create a sounding board, and a learning experience, for the successful entrepreneur.

What circumstances lead to blow-outs between boards and founders?  Godshalk noted that the relationship between a founder and an independent board can be tense; the founder may even be asked to exclude himself from certain board discussions, while the founder is used to being on the top of the hierarchy.  Also, when a private equity firm becomes involved and gets board seats, the situation can become volatile because of the perhaps shorter patience of the investors.

McKim noted that his company hit a wall at around $90,000,000 in sales, and the board then guided him in finding outside management to grow the enterprise.  Von Rickenbach noted that he always treated the board as “his boss” but observed that it is necessary to be a good boss, to show up and to be prepared and to understand that a board is not hands-on with respect to execution.

While each entrepreneur remains as chairman, each board has a lead director in which substantial responsibility resides.  Each CEO indicated that he had staffed the board to track the direction of the business.  When Waste Management moved focus from the utilities industry to oil and gas, McKim added directors with knowledge in that field, and Parexel (which does a lot of work overseas) moved for geographic diversity.

A discussion of board-building, which actually has application to all boards whether or not the company is founder-run, developed several other themes:

*When asked about diversity generally, the panel noted that diversity of views of business and of science, not just gender or ethnic diversity, was desirable.

*Godshalk noted that building boards around business expertise as a company evolved tracked the desirable approach of building a board through creating a “skills matrix” and then looking for people who can fill those particular slots.

*The panel seemed to like the idea of sending a founder to serve on other boards, perhaps at larger companies, as part of the founder’s educational process.

*Suspicion of age limits and mandatory retirement was expressed; boards should retain people of merit whose board evaluations are strong, regardless of age.

*In conversation after the meeting, it was also noted (Bob Popeo from Mintz Levin) that age limits were on their way out; as companies have soured on the idea of their CEOs sitting on other boards, that role has fallen more and more to CEOs who have retired and therefore are older.

It’s Not Easy Being Green

Zaid Ashai invests money for Point Judith Capital, a private equity firm, and heads their Boston office.  On March 6th through 8th  , the Northeast Sustainable Energy Association held its Energy 12 Trade Show at the Seaport World Trade Center in Boston, and Zaid ran a seminar on the VC view of the building energy market.

Money seems to be flowing into the business of managing energy.  The companies that are getting funded address the demand side: energy efficiency, use, tracking, management.  The supply side is sluggish for investors and may well stay that way for the near term, given the low price of natural gas.  Thus, investment in wind, solar (even though solar companies were lavishly represented at the Trade Show), batteries and the like will encounter difficulties in attracting investment capital.

Point Judith looks to do Series A investments into the emerging markets, from the $500,000 to $3,000,0000 to $4,000,000 range.  What do they look for?  In order of priority: a management team with emotional self-intelligence and humility, a strong market, and thirdly the product.  Not surprisingly, they strongly recommend avoiding cold submissions to investors; it is common wisdom to try to be introduced to the money rather than simply tossing your business plan over the transom.

Energy is a regulated and structured market and consequently great care has to be given to the strategy of the business plan.  Are you going to compete with or try to partner with the big players?

Most interesting to me was the effort to apply information technology to the monitoring and management of the demand side of the energy market.  The goals are efficiency and low cost management of the energy supply.  With a tight economy, the business plan ought to aim to provide payback to customers in a shortened three year span rather than the traditional five year payback; customers also want a turnkey installation with a single installer, minimizing disruption and giving the customer “only one neck to ring.”

Energy management companies which are drawing financing not surprisingly seem to address the larger markets: office, retail, education institutions, lodging.  Of course it makes sense to offer energy management solutions to customers who have a lot of energy to manage.

Why don’t the energy suppliers, many of which are very large and sophisticated, enter into this market and blow away the emerging enterprises?  The thinking seems to be they are not fast enough or innovative enough to do this; software development in this area is being driven from the bottom up (as indeed in many other areas).

To the shock of some of the attendees, it was noted that business buyers in this marketplace don’t much care about being green (although they may say otherwise as a marketing tool); they want low cost and reliability, and investors want companies that drive that result.

The goal of United States energy policy is to provide 20% energy savings by the year 2050.  Point Judith Capital targets demand side management companies that will facilitate reaching that goal.  So while the Trade Show floor was flooded with portable toilets, triple pane windows, solar energy panel manufacturers and installers, and the like, the financial discussion was all about software solutions, and knowing when to shut down servers in data centers.  A brave new world.

(Disclosure: my lawfirm has represented Point Judith.)

MassChallenge and Entrepreneurship

Mass Challenge is a Boston-based accelerator that annually takes over one hundred emerging entrepreneurial companies through an intense mentoring program in order to build enterprises from the ground up.

Supported by private industry and the Commonwealth of Massachusetts, Mass Challenge works out of offices on the Boston waterfront.  Each year, between the 1st of March and (this year) April 11th, entrenpreneurs around the world can apply to be mentored here in Boston.  Application are available at ww.masschallenge.org.  Last year, 125 companies were selected from over 750 applicants; at least one principal from each selected company must be resident from July to September to participate in the four month accelerator program, and in October ten to twenty such companies will be awarded seed funding in the aggregate of $1,000,000.  (Disclosure: my law firm, Duane Morris, is this year, and each year has been, a Mass Challenge sponsor.)

I asked Akhil Nigam, a founding principal of Mass Challenge, to describe the niche he is attempting to fill.  Akhil is looking for teams with new ideas in any industry.  They hope to identify future high growth companies.  He characterizes the competition as a search for the very best new ideas, and for teams which can benefit (aside from access to capital resources) from the 300 or more mentors and from the peer-to-peer contact with other emerging companies.

Who wins the money?  Akhil believes that the winners share several characteristics:

  • A high impact idea.

 

  • Which is disruptive within a given industry.

 

  • Carried forward by a really good team which has the flexibility to react to feedback when the shaping force of the marketplace defines commercial strategy.

Mass Challenge is making a “bet” on people, not just on a pitch.  Can the people execute?

Mass Challenge is open to entrepreneurs from around the world, and it is “free;” Mass Challenge do not take equity and does not receive payment.  Akhil now is looking to promote the accelerator program in New York, London and perhaps Israel, but is planning for now to remain physically located on the Boston waterfront.

Beyond keeping American entrepreneurship pre-eminent, start-up companies drive American business and American employment, and put capital to work (the 2010 accelerator led to the raising of over $100,000,000 of capital and the creation of more than 500 jobs in its first year).  I inquired as to suggestions for fostering American entrepreneurship.  Certainly Mass Challenge cannot support all the disruptive ideas that will lead to high growth.  Akhil makes a societal argument: we need broad social and government efforts to support entrepreneurship, the coming together of communities to foster mentorship programs to help new ideas grow, and career options in entrepreneurship in the universities.

Government policy initiatives, perhaps through SBA or tax incentives, also are needed.  The growth of angel networks, and the possibility of “crowd funding” for start-ups, could be of help.  (This week Massachusetts Senator Scott Brown conducted a panel at Mass Challenge exploring crowd funding options.)

Akhil also noted that we are “in a different time and age” and start-ups need talented workers.  The government needs to step in with retraining programs to provide the kind of support for start-ups that will drive not just innovation but also commercial realization; this is a theme which echoes discussion at the Association for Corporate Growth’s Boston conference last week.

Made in the USA!

THE FUTURE OF U.S. MANUFACTURING

The stated theme of the recent meeting of the Association for Corporation Growth in Boston was to explore the prospects for a manufacturing resurgence in the United States, and a panel headed by MIT Professor Suzanne Berger took a pretty deep dive into that issue.

Noting that the U.S. contributes 19.4% of the world’s manufactured goods, a statistic that has remained stable for about twenty years (although the number of workers declines, we make up for it in productivity), the panel agreed that manufacturing in the United States is here to stay and indeed will see something of a resurgence.  U.S. manufacturing will take place where technology and innovation are important to production.  “Cheapest country” manufacture will continue to focus on the less technologically sophisticated products.  U.S. workers provide the greatest per-capita value-added to manufacture of any country in the world, exceeding that of Japan and other developed countries and blowing away the value added component of Chinese labor.

Manufacturing jobs are back; last month 50,000 U.S. manufacturing jobs were added and industry optimism is higher than in the last two years.

What are the drags?  A significant shortage of skilled labor, together with higher U.S. operating expenses for manufacturing even putting aside the cost of labor; it is at least 20% more expensive to manufacture in the United States than elsewhere, by reason of tax load and government regulation.

The capital providers on the panel thought there was no lack of capital to finance American production, but were worried on a couple of other fronts:

  • A foolish immigration policy that causes us to train engineers and others who can drive successful manufacture, and then making it impossible for them to stay in the United States.
  • A lack of an educational system designed to support development of the kinds of sophisticated factory labor that is required.

There are functional dynamics which drive United States manufacture.  There remains substantial distrust of the ability to protect intellectual property offshore.  This pushes low tech manufacturing offshore, or manufacture of technological products where the obsolescence is so rapid that having the technology knocked off is irrelevant (as the United States will continue to re-engineer and improve what is marketable in a given space).  Also, attenuated supply chains make it difficult to rely on production that spends six weeks on a ship coming from China, particularly when goods are destined either for the United States economy or the South American economy; as just in time gets shorter, the  attenuation and reliability of the supply chain becomes more vital (witness the disasters in Japan and the impact on U.S. business).

Perhaps the most interesting comment was related to the tax code.  Even the Obama program calls for the reduction only of corporate tax rates, but 70% of United States manufacturing is done by enterprises with flow-through tax treatment, which means that the individual tax rate is really the corporate tax rate for 70% of our domestic manufacture.  Does this matter?  Is this just a question of making sure that the rich owners of companies will have to pay their fair share of taxes?  The panel, which included one such owner, didn’t think so.  There seems to be at least anecdotal support for the proposition that lower tax rates for this population will cause greater investment in the growth of a company, and in the growth of the R&D function of a company.  Two-thirds of R&D in the United States is performed in manufacturing companies, and it is also thus essential that Congress pass a permanent R&D tax credit.

In addition to tax, immigration and education reforms, the panel noted that American manufacture would be improved by a more friendly attitude on the part of EPA and OSHA, a clear and liberal policy toward stem cell research, and the establishment of trade agreements that foster U.S. exports.

Is there an analogy between what has happened to agriculture and what has happened to manufacturing in the United States?  We have learned that 1% of the U.S. population can not only feed the United States but also create substantial exports of food stuffs.  We are a “category killer” when it comes to food.  Can American manufacturing become a “category killer” in the manufacture of technologically related goods?  The panel thinks yes.  The panel doesn’t think that a huge increase in the number of manufacturing jobs is a measure of United States manufacturing prowess.  The panel thinks that if we can get out of our own way, and educate and accept from overseas the necessary worker base, primacy of U.S. manufacturing will remain an economic fact in the world economy.