Barbarians at the gate! The fallacy of “best practices”

I. Facing the Visigoths

"We need to push the barbarians back from the city gates!" - Ted Forstmann, referencing the 1988 takeover of RJR Nabisco

Those involved in the hostile takeovers of the 1980’s were fighting for their livelihoods. As a result, they used the strongest possible terms to describe their opposition in an effort to fend them off. Though many corporate boards failed to fend off takeovers, new practices were established to stymie future hostile efforts.

Staggered elections of directors became one popular practice. Because only a third of directors might be up for election in a given year, it would take three years to turn over all directors. This made hostile takeover less attractive because raiders couldn’t take control of the company in one fell swoop. Thus, staggered elections became “best practice.”

However, recently annual elections have gained greater favor with proxy services firms. The argument is that shareholders ought to have more immediate control over the company. While supporters of this change in “best practice” might argue that other takeover defense practices have been established, such as the poison pill, adoption of these practices has been limited.

Regardless, it is right to acknowledge that the “best practice” has changed and will likely continue to do so. Perhaps these popular governance practices are better termed “market standard” since:

1. Standards regularly evolve, and
2. One size does not fit all, as we have previously argued in the case of director tenure. What is best for one company may not be the best for another.
   

II. Questionable “market standard” governance practices

Corporate governance activists have a set of rules that they insist must be followed, such as:

• The chairman and CEO ought to be separate
• At least 2/3 of directors should be independent
  
• Key committees should consist solely of independent directors
  
• Director tenure should not exceed a certain threshold (typically nine years)
  
• Elections should be annual for every director
  
• The board composition must exceed a certain diversity threshold for race and/or gender
  

Often, directors will not be supported by some proxy advisory firms if these criteria are not met.

III. Counter-Examples

While many public companies successfully generate returns for shareholders by following these market standard practices, quite a few do not. A few examples include:

• CEO and Chairman roles combined: Berkshire Hathaway, Meta, JPMorgan, Chipotle, Eli Lilly & Company, Tesla, Amazon (formerly), and Oracle (formerly)
• Multiple over-tenured directors: Berkshire Hathaway, Costco, Apple, Alphabet, Eli Lilly & Company, Coca-Cola, IBM, Caterpillar Inc., Walmart, and American International Group (AIG)
• Classified board: Eli Lilly & Company, News Corporation, and GE (until 2016)

These companies have historically exceeded average total market returns despite not adhering to “market standard” governance practices.

IV. Conclusion

Egan-Jones Wealth-Focused policy is designed to protect and enhance shareholder wealth. Using this policy, Egan-Jones will generally oppose directors who deliver poor shareholder returns, regardless of their independence, tenure, diversity, or any other characteristic. The reverse will also hold true.

For those investors interested in enhancing and protecting wealth, perhaps it is time to re-examine “market standard” or “best practice” corporate governance notions.

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