Aficionados of good corporate governance shouldn’t get too excited about the fact that two Hewlett-Packard directors are leaving the board and a third, Raymond J. Lane, is stepping down as chairman.
The reason is that directors are still rarely if ever held responsible for their poor conduct.
The latest evidence comes from a study of bank directors and whether shareholders held them accountable for their - let’s face it - horrific performance after the financial crisis.
The study, co-authored by me, Andrew Lund of Pace University School of Law and Robert Schonlau of Brigham Young University‘s Marriott School of Management, analyzed director turnover at financial institutions in the Standard & Poor’s 1,500-stock index from 2006 to 2010. The idea is that the financial crisis was particularly salient â€" and if anything would ever push directors to act, it was likely the financial crisis.
Financial institutions are also unique; the possibility of shareholder activism is quite limited because Federal Reserve regulations serve to entrench boards of directors and damp activism in this arena. According to Factset Sharkrepellent, only seven national commercial banks in the S.&P. 1,500 were the focus of activist campaigns in the period covered by the study. Not surprisingly, these were the largest institutions, including Bank of America, Citigroup, JPMorgan Chase, Wachovia and Wells Fargo.
If directors are going to be unseated or pushed out at financial institutions, it is going to have to be because of market pressure and not direct shareholder action. In other words, shareholders will have to express their disapproval of directors by cutting their investments rather than actively seeking to unseat them. Banks are also highly regulated, and the government can urge the firms to overhaul boards in times of trouble, as the government did with Bank of America and Citigroup.
But despite some notable changes, bank directors faced little consequences for their poor decisions, before and after the financial crisis. Director turnover at financial institutions was 5.6 percent a year from 2006 to 2007 and 6.27 percent from 2008 to 2010, the postcrisis period. This means that director turnover increased by less than a percentage point during this time.
Director turnover is also not materially higher if the financial institution performs particularly poorly. For directors at most financial firms, the chance of being replaced is only about 1 percent greater than for their counterparts at better performing firms. This is an almost negligible amount and means that even during the financial crisis, directors faced little penalty for poor performance.
In fact, the biggest determination of director turnover at banks during this time was age. Directors who reached the age of 70 left their positions because of mandatory retirement policies.
The study also examined those financial institutions that received help from the Troubled Asset Relief Program. It found that receiving a bailout from the program did not increase director turnover. Again, the biggest driver of turnover at banks in the program was reaching the mandatory retirement age of 70.
At the same, the compensation of directors in this period â€" an average of $134,000 in cash and incentives a year â€" appeared to be unrelated to the performance of the company. Instead, compensation for directors appeared to be largely a function of the size of the bank. The bigger the bank, the larger the compensation package, regardless of performance.
For those who were hoping that financial institutions were an outlier, the study also examined nonfinancial companies in the S.&P. 1,500. The results were largely the same. For directors at those companies, the chance of being replaced for poor performance was only 0.6 percent, or approximately three-fifths the probability at banks and financial firms. In either case, this is very small. As with banks, the largest driver of director turnover appears to be age.
For those who advocate consequences for poor performance, the results are head-shaking. Last week, James B. Stewart, a columnist for The New York Times, wrote about the few consequences for the Hewlett-Packard directors and the reasoning.
Shareholders did not succeed in ousting the two H.P. directors and demoting Mr. Lane, the chairman, at the shareholder meeting, but were able to exert pressure that eventually led to this outcome. These types of campaigns typically work only in the most egregious and visible circumstances, as happened at Yahoo and H.P. And even then it can take years.
But as this study and the H.P. experience shows, it’s rare that shareholders or chief executives push directors out. Even in the most extreme circumstances - like the financial crisis â€" directors bore little consequence for their poor decisions. As it stands, directors have more to fear about getting old than about doing a lousy job.
For those who ascribe to kindergarten principles, this is disheartening. These principles would say that if you do something wrong, there should be consequences. But these basic rules we all are taught in childhood don’t appear to apply in the boardroom.
