Welcome! This web conference will begin at 12 noon Eastern time.

1. Welcome! • This web conference will begin at 12 noon Eastern • time. • If you have not already done so, please “sync” • your telephone and computer as detailed in the • “voice connection” tab at the bottom right-hand • corner of your screen.

2. Corporate Governance in the Current Economic Climate • Speakers • Jonathan Koppell, Associate Professor of Politics and Management, Yale School of Management • Gerald Davis, Wilbur K. Pierpont Collegiate Professor of Management, Stephen M. Ross School of Business, University of Michigan • Moderator • Mary C. Gentile, Ph.D., Giving Voice to Values and Babson College

3. Corporate Governance and the Financial Crisis Aspen Institute Web Conference October 27, 2009 Jonathan GS Koppell

4. Bad corporate governance was (in part) responsible for the financial crisis Better corporate governance would have reduced likelihood of financial crisis Response to financial crisis ought to include improved corporate governance Future financial crises will be prevented (or much less likely) due to improved corporate governance A caricature of crisis-governance syllogism Few would actually say this but many – both friends and enemies of governance reform – have an interest in turning this from caricature into catechism.

5. “The administration and regulators at the Federal Reserve have been preparing new guidelines to align executive pay scales at banks with appropriate risk-taking. But the White House, which has come under attack from conservatives for giving the government what they consider too large and intrusive a role in the economy, has also made clear that it has no intention of seeking to impose any broad-based caps on executive pay. Instead the administration is seeking to influence pay decisions through several changes in the way corporations govern themselves. The White House has proposed, for instance, giving shareholders a nonbinding vote on the pay of top executives. It has also proposed that compensation committees of boards, as well as compensation consultants, be more independent. And it will propose that the companies under review divide the function of chairman and chief executive between two executives.” New York Times, October 23, 2009 Example of the “governance solution”

6. Can corporate governance actually do that which it is expected to do? Protect the public Protect investors Protect stakeholders Probably not. And that is a fairly narrow (very “negative”) reading of what we expect from corporate governance…

7. At least two big meanings of corporate governance dominate conversation… The rules and processes by which traded companies are governed: Director elections Proxy contests Anti-takeover provisions (i.e., poison pills) “Say on pay” Independence requirements Boards Rules • The way in which directors and senior managers oversee the affairs of corporation: • Boardroom dynamics • Interpretation of fiduciary obligation • Consultation with shareholders • Requisite directorial expertise and engagement

8. Corporate governance also properly refers to the web of institutions of which the corporation is a part. This includes: Intermediaries (including pension funds, mutual funds, hedge funds, etc.) Ratings agencies Investment banks Regulators Investors And one aspect is generally under-emphasized… Interests

9. To the extent “corporate governance” was a significant causal factor in the financial crisis, it involved all three dimensions And yet reforms are focused almost entirely on the “rules” with relatively limited attention to other elements. This does not mean that changing the rules is irrelevant, trivial or futile. But expectations are almost certainly too high. Way too high.

10. Not negative enough for you? Has the nature of the corporation outlived the plausibility of the assumptions underlying the corporate governance model? • Boards/directors oversee and advise management • Owners ensure that the board protects their investment "Actually, I'm probably close to 20 years beyond which I had a granular knowledge [of financial details]. Conceptually I can fully understand what Libor's doing versus three-year swaps. But if you say, 'How do you design a "swaption"?' that goes beyond where I am today." Robert Rubin, Newsweek, November 28, 2008

11. What directors are supposed to do Independent judgment Active board involvement Regular face-to-face, comprehensive meetings of directors Regular evaluation of CEO Regular “executive” sessions of independent directors Careful review of disclosure documents Effective law compliance programs monitored by the board (Based on “Seven Board Practices to Avoid Liability” Chief Justice E. Norman Veasey (Retired) Delaware Supreme Court) • Attend meetings, prepared to participate actively and skeptically • Assess management integrity, tone at the top • Understand: business & strategy, proposed transactions, disclosures, internal controls, legal obligations & consequences, interested party transactions & conflicts, anything directors are asked to sign • Review meeting materials, disclosure documents, minutes • Rely on experts as appropriate • Resist complacency • Embrace best practice re board structure & process • Focus on Management Performance re Strategy and Risk Is this feasible with respect to a massive financial conglomerate like Bank of America or Citigroup?

12. A new wrinkle • The surprising reality of publicly-traded companies introduces a set of novel (in the United States) governance issues. • Defining engaged ownership? • Pursuit of policy through corporation? • Role of independent directors?

13. Corporate governance and the financial crisisJerry DavisAspen Institute webinarOctober 27, 2009

14. Punchlines for this discussion Better corporate governance of financial institutions would not have prevented the financial crisis Corporate ownership in the US is more concentrated than at any time since WWI But: conflicts of interest among financial institutions prevent ownership from mattering the way it could 14

15. Financial institutions are highly diverse in their corporate governance The most troubled players in the recent crisis were in highly diverse industries Commercial banking (Citi, Wachovia) Savings and loans (WaMu, IndyMac) Investment banking (Bear, Merrill) Mortgage banking (Countrywide, New Century) Insurance (AIG) GSEs (Fannie, Freddie) Corporate governance has very different histories across these industries 15

16. What does good corporate governance look like (according to reformers)? Boards are comprised primarily of truly independent directors Outside directors have relevant expertise and resources The CEO does not serve as Chairman of the Board Directors are elected annually Directors’ and top executives’ wealth is tied to the company via share ownership [Optional] The firm has a large institutional blockholder to hold its board accountable 16

17. Board composition in 2006 17

18. Ownership structure in 2006 18

19. AIG after Greenberg: A model of governance reform Substantial turnover among former “Greenberg directors” (7/15) between 2004-2006 Structural changes: Retained Arthur Levitt to advise on reforms, nominees Director candidates not receiving a majority vote must resign 2/3 of directors must be independent (strictly defined) By-laws require independent (non-executive) Chairman, who is evaluated annually Former AIG CEOs cannot serve as directors Directors limited to 4 other corporate boards All employees must complete formal ethics training Audit committee met 21 times in 2005! 19

20. Fannie after Raines: A model of governance reform Substantial turnover among former “Raines directors” (7/13) between 2004-2007 Structural changes: By-law requires separate CEO and Chairman of the Board All directors but one are independent Majority vote required for director election Stock ownership requirements for executives and directors 20

21. Conclusion I Even a perfect board, annual director elections, aligned incentives, etc. can’t address the internal problems of firms like AIG 21

22. American employers moved from DB to DC pensions… 22

23. …so households became increasingly invested in the stock market during the 1980s and 1990s Source: Federal Reserve Survey of Consumer Finances (various years) 23

24. Specifically: investors in mutual funds Source: Investment Company Institute 2008 Investment Company Fact Book 24

25. There are many more US mutual funds now Source: Investment Company Institute 2008 Investment Company Fact Book 25

26. And they gathered a lot of assets Source: Investment Company Institute 2008 Investment Company Fact Book 26

27. But ‘name brand’ funds got most of the benefit Source: Investment Company Institute 2008 Investment Company Fact Book 27

28. Leaving US corporate ownership largely ‘intermediated’ by a few mutual funds • Corporate ownership by mutual funds • 1950: 3% • 1990: 8% • 2005: 28% Source: Spectrum 13F database, various years 28

29. Fidelity is now the largest shareholder of one in ten US corporations # of listed firms in US 3833 5187 5828 4423 Source: Spectrum 13F and 13G databases, various years 29

30. Conclusion II Ownership in US corporations is more concentrated than at any time since the days of JP Morgan and Other Peoples’ Money 30

31. Mutual funds’ support for governance reform is almost perfectly (-) correlated with their pension business 31

32. Conclusion III Mutual funds have the potential clout to fix corporate governance, but conflicts of interest limit their enthusiasm 32

33. And now, a word from our sponsor Papers documenting much of this stuff are available at www.managedbythemarkets.com See in particular: Gerald F. Davis, 2009. “The rise and fall of finance and the end of the society of organizations.” Academy of Management Perspectives23(3): 27-44. Gerald F. Davis, 2008. “A new finance capitalism? Mutual funds and ownership re-concentration in the United States.” European Management Review5(1): 11-21. Gerald F. Davis and E. Han Kim, 2007. “Business ties and proxy voting by mutual funds.” Journal of Financial Economics85: 552-570. 33

34. Corporate Governance in the Current Economic Climate • Speakers • Jonathan Koppell, Associate Professor of Politics and Management, Yale School of Management • Gerald Davis, Wilbur K. Pierpont Collegiate Professor of Management, Stephen M. Ross School of Business, University of Michigan • Moderator • Mary C. Gentile, Ph.D., Giving Voice to Values and Babson College