Behind Closed Doors


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Expert Perspective by Grahall’s OmniMedia Editorial Board

Sam Mamudi’s article for MarketWatch (February 12, 2010, Mutual funds silent on banks’ pay rises Despite big payouts amid profit drop, major shareholders stay mum) reminds us that “Despite public outcry at banker pay raises during a troubled market, mutual fund firms that are among the biggest shareholders of financial companies have been mostly silent on the matter. … One recent example is the lack of reaction to investment bank Lazard Ltd” changing its compensation policy. Mamudi continues: “The issue is less about Lazard’s compensation structure but the fact that the firm’s largest shareholders refuse to even discuss the subject [except for, perhaps,] … behind closed doors.”

Pity the poor mutual fund manager who might not like the decision by the board.  What is he to do especially in this economy?  He can complain publically (and risk a decline in the share price of the company he holds and thereby a decline in the value of his fund). He can try to divest his position (but if it is a large holding that would prove difficult without some loss to the fund).  Or he can share his perspective “behind closed doors” and risk the media complaining that he is complacent or even complicit in some alleged “cover up.”

The author points to the recent announcement by Lazard as an example of this complacent complicity (or maybe complicit complacency). 

In our 2009 blog “Shareholder Lawsuits Won’t Rebalance the Boardroom” we say: “Some might hope that institutional shareholders – pension funds, mutual funds, endowments and the like – who own substantial shares will help to influence management decisions. But research shows that institutional shareholders vote with management more often than not, in fact as much as 90% of the time.”

Why is this?  Well, sadly, it may be another case of conflict.  Much like the compensation consultant conflict and the brouhaha that arose over it, many of these institutional investors have services to sell to the companies whose stocks they hold.  Think of the mutual fund company who might want to provide 401(k) services to the company, or investment banking or even just corporate banking services which can be extraordinarily profitable.

(It is also important to remember that, other than non-binding “say on pay” votes, shareholders–individual or institutional–don’t technically vote on compensation. They vote on board members, not on their decisions.)

But perhaps the institutional investor votes with management or fails to “speak out against” a decision for another reason.  Maybe they don’t understand the implications, or they don’t think their comments or their vote will make a difference. Or perhaps they think the decision is correct.

But could it be that the fund managers just think there is nothing bad to say about the Lazard decision?  In our recent blog “Bucking the Trend” we shared our point of view that it may be a gamble worth taking for Lazard because they might “attract key talent [not otherwise easily tempted] away from competitors who are weakened by the hue and cry of the media, public and government over executive pay and risk management.” 

In all these many months of haranguing about the financial crisis, the conversation has always been about how compensation strategies discouraged reasonable risk management.  But maybe, just maybe, it wasn’t compensation that was at the heart of the problem. Perhaps the management process, including business and people strategy, was the primary contributor. 

Let’s consider the following about Lazard: Their business strategy and risk management protocols prevented them from participating in and suffering from the sub prime mortgage mess. For better or worse they proved to be a more conservative management group, showing the management discipline to avoid what turned out to be a serious financial problem for many of their less cautious competitors. 
So if Lazard had, and presumably still has, the management discipline to steer clear of bad business, perhaps stringent “compensation discipline” isn’t all that necessary. 

Those companies who have focused on compensation program changes to help ensure risk adverse behaviors might want to consider this: changes to compensation programs might support proper risk taking but if they don’t change the business strategy, people strategy and perhaps even the management group itself, the compensation changes won’t be enough to secure permanent and appropriate change.
Business and people strategy are the keys to an organization’s sustainability.  Effective compensation programs can support business strategy but it is not a substitute for sound management protocols. 

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