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Watching the Insiders

Talk about playing hardball. Back in 1990 when Nell Minow was at Institutional Shareholder Services (ISS), a corporate governance watchdog, she was confronted with the task of having to call a board member of Aon Corp. to tell him that ISS had to recommend that he not be re-elected to his post on the board. That board member was her father, Newton Minow, a former Federal Communications Commission

Talk about playing hardball. Back in 1990 when Nell Minow was at Institutional Shareholder Services (ISS), a corporate governance watchdog, she was confronted with the task of having to call a board member of Aon Corp. to tell him that ISS had to recommend that he not be re-elected to his post on the board. That board member was her father, Newton Minow, a former Federal Communications Commission chairman.

One of ISS rules for recommending the re-election of board members was that they not miss more than 25 percent of company board meetings. ISS' analysis showed that he had missed 27 percent. Therefore, ISS would have to recommend that shareholders not re-elect Newton Minow.

“When our analyst called Aon and asked what his excuse was, we were told my dad was a busy man,” Minow recalls. “Then, I had to call my dad and explain what was about to happen to him.” Her father responded, quoting King Lear: “How sharper than a serpent's tooth it is to have a thankless child.”

That's life as a corporate gadfly: You can't play favorites, even for blood relatives. But then Minow credits her dad with inspiring her to speak out at all times. When she was growing up, she watched her dad, as head of the FCC, “stand up to broadcasters,” she recalls. “Dad told the National Association of Broadcasters that television [programming] was ‘a vast wasteland’ and that if they wanted their licenses renewed they had better be more aware of their obligation to serve the public interest. I learned never to be afraid to be different or worry about speaking out.”

Serving the investing public's interest is a good summation of what Nell Minow does for a living. Minow is editor of The Corporate Library, a Portland-based research group that evaluates corporate governance policies at 2,000 publicly held companies. “Understanding a company's corporate governance is as much a part of the risk assessment of an investment as understanding its cash flow,” Minow asserts. “We look at nontraditional indicators that are very compelling and very instructive. We must be doing something right. The primary purchasers of our services are directors and officers' liability insurers. They think we know something about risk.”

The Corporate Library started as the in-house research operation of The Lens Fund, the brainchild of veteran corporate governance reformer Robert Monks in 1990. (Lens has since been sold.) A former head of the U.S. Dept. of Labor's Employee Retirement Income Security Act (ERISA) office, Monks realized ERISA had created monstrously huge investors — employee stock ownership trusts. Monks saw that “they were becoming big, powerful and smart enough to play a meaningful role in corporate governance,” Minow says.

Shareholder activism was being born. Up to then, the “Wall Street Rule was to vote with management or sell your shares. This was never a wise rule to begin with, but as institutional investors began to take over the market it became less and less wise as a matter of economics,” Minow notes. “Why sell shares and incur the transaction costs, including finding another place to put the money, when for much less expense you could push management to increase returns?”

In 1985, Monks established ISS, the nation's first group dedicated to monitoring corporate governance. Minow, a graduate of the University of Chicago Law School, was a U.S. Office of Management and Budget (OMB) staff attorney when she met Monks. He needed OMB's approval for some proposed rules. She joined ISS a year later.

Monks left ISS in 1990 and started Lens, a fund that invested in underperforming companies, prodding them through shareholder initiatives and threatening proxy contests to adopt governance reforms to increase shareholder value. “Our stock selection began with a very traditional value assessment,” Minow says. “But, then instead of saying, ‘This stock has underlying value that will be realized some day,’ we'd say, ‘Let's see if we can get management to start unlocking it now.’”

From 1996 to 2000, Lens investments returned 34 percent annually compared to the S&P 500's 21 percent. Monks, Minow and Lens' three other principals sold the company in 2000. Minow preferred doing the research to managing money.

“I don't like managing money,” she says. “And, believe it or not, I didn't like confronting management. I only had to about one-third of the time, but that was still enough for a lifetime.”

As for her father, he was re-elected to the Aon board despite the ISS recommendation. But, says Minow, “He never missed another meeting.”

Recently, contributing editor Ann Therese Palmer caught up with Minow via telephone and email interviews.

Registered Rep.: Why should a rep consider a company's corporate governance when deciding which stocks to purchase for a client?

Minow: The very first report we did in January 2000 was about CEO employment contracts, and the one we picked as the worst was Global Crossing. The new CEO had insisted on getting 2 million options at $10 below market, plus a $10 million cash signing bonus. Also, the company was picking up first-class plane fare for his mother to visit him every month.

It appeared to us that the CEO was betting the stock would decline in value and that this was OK with the board. It had four CEOs in five years, yet it was the fastest growing stock in the NYSE's history, so no one was willing to say there was a problem.

RR: What factors do you use to evaluate a company?

NM: We focus on the board's decisions in three key areas where we think shareholders and the CEO might have a conflict: (1) CEO issues, including pay; (2) accounting; and (3) overall strategy. If a board can't resolve these issues in favor of shareholders, it's not an effective board.

I can tell you more about a board by looking at the CEO's pay plan than by reading their “principles” or looking at their resumes. We're interested in CEO pay (because CEOs don't want a lot of their pay tied to a variability like sales), succession planning and director pay.

We examine accounting and the audit committee's work. CEOs want their numbers to be smooth. Shareholders want numbers that are revealing. We want to learn whether the company is actually making money from its operations.

Finally, we evaluate a company's overall strategy. Seventy percent of acquisitions don't add value. CEOs always want to buy stuff. Investment bankers are their geishas. They laugh at a CEO's jokes. Tell the CEOs they really deserve to run a much bigger company. The job of the board is to keep a CEO looking forward. It's always more fun to buy something than to invest in research and development.

RR: What's your batting average? How accurately have your corporate governance ratings identified companies that eventually got into trouble?

NM: In addition to Global Crossing, we also highlighted the problems at Adelphia, Freddie Mac, Sprint and Enron — long before their difficulties became public.

Companies can do well for a while with bad governance, but not forever. And governance cannot be managed the way the numbers can.

RR: Do you have much contact with retail advisors?

NM: No, but we'd like to. It's a great market test. We're always interested to hear what they're interested in.

RR: Editor of The Corporate Library isn't your only job. You're also Yahoo's movie critic. Do the two have anything in common?

NM: Most people find my combination of the two careers a little odd. But for me, it is all the same set of analytic muscles. I am really fascinated by the challenges of implementation, or what you might call systems analysis.

Everyone wants things to work, whether it is a regulatory program, a company or a movie. So, when things go wrong, it's endlessly interesting to figure out why.

Why is it that you take the smartest and most honest people in the world, sit them down around a boardroom table and they lose 50 percent of their IQ and 75 percent of their courage? Why are structural reforms so ineffective? Why do people keep telling the emperor/CEO/movie star how beautiful his clothes are, and how he deserves to be paid $100 million?

RR: Do you think that New York Attorney General Eliot Spitzer's investigations into Wall Street activity will have any long-lasting impact?

NM: He's my hero. What he did with the analysts was crucial. He restored analysts' integrity. With free research, you get what you pay for.

What Spitzer did concerning Dick Grasso's pay was necessary. The NYSE wanted the best of both worlds: nondisclosure of a private organization and to have its CEO paid as if it were a public company. The NYSE is a virtual monopoly, yet Grasso wanted to be paid as if it was competing in the marketplace.

RR: What about his mutual funds investigation?

NM: There have been tremendous changes. A lot of people have been thrown out.

With late trading, rules have been changed to create a more equitable situation.

Post-Enron, the most important reform requires mutual funds to disclose how their money managers vote their proxies. That's been key for shareholder initiatives. It's led to increased opposition of CEO pay packages. The system is working better.

RR: President Bush is still promoting Social Security retirement accounts. Do you have any concerns about how this might work?

NM: The reason we set up Social Security and the pension system in the first place was because people have not been good enough at saving for retirement and managing what they have saved. Even well-educated professionals who have 401(k) plans have had a lot of trouble sorting through the options offered to them. Before we hand over investment choices to an even wider range of working people, regardless of their financial sophistication, we should remember that just as you don't play basketball against Michael Jordan, in managing your money you don't try to play against a Warren Buffett. We should not ask or expect working people to develop the expertise to play the market. There's a reason it's called Social “Security”; this is not money we want to expose to market risk or bad judgment risk.

RR: Is there any way that Social Security retirement accounts could imbalance capital markets?

NM: It could be a serious problem. The whole premise of equity markets is there's a certain tolerance for risk by people who buy equities. If you turn over more than half of the equity ownership to pension funds and other institutions that, by definition, are risk averse or actuarially based, you're going to get overinvestment in blue-chips and underinvestment in emerging companies.

RR: Why has the SEC been so reticent to get involved in governance issues? Do you predict that that will continue with the new chairman and new board?

NM: There are two reasons. Ever since 1789, corporate governance has been a matter of state law. The SEC's mandate is disclosure. They can't force directors to attend meetings. Its jurisdiction is very limited. To the extent the SEC does try to weigh in, it gets a lot of opposition from the business community and Chamber of Commerce.

RR: Earlier this year, the chairman and chief executive of an NYSE-listed company complained to me that two years ago, his company sold its $2 million corporate jet so that it could invest the funds in research and development.

He's outraged that the company's latest bill for Sarbanes-Oxley compliance from its accountants and attorneys exceeded the jet's sales proceeds.

How do you respond to criticisms that Sarbanes-Oxley compliance wastes money and is anti-competitive?

NM: It's like the bumper sticker, “Education is very expensive unless you consider the cost of ignorance.” It's like Y2K. There are a lot of upfront costs, but they're well worth it. And if a CEO had to sell the corporate jet to put the money into R&D, that's good news!

RR: What do you see as your most important accomplishment to date and why?

NM: When we first got involved, directors viewed their role as to act when there was an emergency. We believe that boards are there to prevent emergencies. There isn't a single board that isn't more involved, more alert and more independent than when we started.

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