I identified 37 firms in the S&P 500 index, whose dividend adjusted returns over the last 10 years, have not even beaten the return on short term US treasuries. Has the corporate governance machinery lost sight of the most basic metric of all: chronic underperformance?
There is a lot of huffing and puffing in the world of corporate governance about board composition, ESG, executive compensation, what proxy advisors do and do not do, the Big Three institutional investors, their engagement strategies, are passive investors really passive and so on. Tens of conferences discuss each twist and turn in the legislation and norms around these topics. Undoubtedly, these conferences provide valuable insights and move the collective thinking of the field forward.
But it’s worth stepping back a bit and wondering whether all this activity misses the big picture. Ultimately, the point of corporate governance is to assess the value of managerial stewardship: has the CEO and the board delivered a reasonable return on the capital entrusted to them?
CALPERS, the Californian State Pension Fund, used to put out a list of underperformers back in the day. This list was considered a “buy” signal as the act of naming these companies, combined with implicit and explicit pressure to reform their operations, perhaps led to an improvement in performance. CALPERS stopped putting out its list of underperformers in 2010 perhaps because of political and other pressures.
In the spirit of CALPERS, and in continuation of my series on the implications of passive investing, I identified 37 members of the S&P 500, whose dividend adjusted stock performance over the last decade (June 1, 2013, to June 1, 2023, to be precise) has not even kept pace with the return on short term US treasuries of 7.5% over the whole decade. That is, an investor would have done better with the relatively poor performance on a short term treasuries-based ETF than owning these index laggards.
These 37 firms (on my website), are sorted in descending order of returns and contain several storied names: AT&T, IBM, GE, Walgreens, Wynn Resorts, Occidental Petroleum, Haliburton, Schlumberger, Citigroup, Ralph Lauren, Invesco, PG&E to name a few. For sure, each of them potentially has a reason or even mitigating circumstances to under-perform.
The question that intrigues me: without the mechanical demand generated by pension contributions for these stocks via an S&P 500 ETF or an S&P 500 index, would these firms have taken steps to restructure their operations sooner? If they had to fight harder for capital, absent passive indexer demand for their stock, would they have improved faster or even gone out of business or taken over?
To avoid making this piece exceptionally long, I intend to review one index laggard at a time in an article. Because of extensive involvement of consultants and perhaps too many regulatory guidelines and the influence of the proxy advisors, I hypothesize that governance structures have increasingly become homogenous. Before looking at the data, my expectation was that I will find no explicit “red flag.” That is because the system has evolved to avoid such “red flags.” However, the elephant in the room, which is the inability of the company and its stewards to even beat US treasuries over a 10-year period, does not get as much airtime as it deserves.
Let us begin the analysis with AT&T, the best performer on my list with a 10-year dividend adjusted return of 7.13%.
AT&T
It’s a good idea to write down prior expectations of what one would expect to observe before delving deeper into the data so that one can compare hypotheses with the evidence. So, what should the board and the compensation of an under-performing company look like?
Ideally, we would expect a bit more director turnover than usual and a strong link between CEO pay and stock returns. We would perhaps look out for dual class ownership structures, excessive compensation, supermajority voting, lack of director independence, related party transactions, classified boards and long board tenure. I pulled up AT&T’s latest proxy to take a closer look at the data.
Board
The average tenure of the 10 directors on the board is 8.1 years, 20% of the board is female and 20% of the board has people of color. More important, for our purposes, the average board member was in a stewardship role over most of the last 10 years. To be clear, the average tenure of board members in the S&P 500 is not that different from AT&T’s as per Spencer Stuart’s data: 7.8 years.
Nine of these directors are independent as per regulatory guidelines. The individual members of the board look eminently qualified. The proxy statement has the by now mandatory discussion on ESG integration and the board matrix that highlights the skills of directors.
In evaluating the suitability of candidates, the Board and the Corporate Governance and Nominating Committee say that they take into account many factors, including a candidate’s: (i) general understanding of elements relevant to the success of a large publicly traded company in the current business environment, (ii) understanding of AT&T’s business, and (iii) educational and professional background.
The Board and the Corporate Governance and Nominating Committee also say that they give consideration to a candidate’s judgment, competence, anticipated participation in Board activities, experience, geographic location and special talents or personal attributes. The composition of the Board should encompass a broad range of skills, expertise, industry knowledge, diversity, and contacts relevant to AT&T’s business.
Board committees
The board has the appropriate committees: the audit committee, the governance and policy committee, the human resources committee, corporate development and finance committee, and the executive committee. The board goes through multi-step self-evaluations. There are relatively minor related party transactions. Board compensation is in line with usual norms, ranging between $311,000 to around $688,000 for the chairman.
Proxy proposals
The Board asks shareholders to vote against two proxy proposals: (i) the first one asks the board to establish an enduring policy of separating the CEO’s job from that of the chairman of the board; and (ii) the second proposal asks for a racial equity audit.
Remarkably there is no shareholder proposal asking the most basic question: why should I hold your stock after your performance over the last 10 years? I guess the answer is: because it’s in the S&P 500 index.
Ownership
As expected in an index company, BlackRock, Vanguard and State Street collectively own approximately 20% of AT&T.
CEO pay
The statement on the philosophy behind executive compensation says all the right things about alignment with shareholders, how pay is competitive, and market based, how most of the NEO (named executive officer) pay is tied to performance, how pay balances short term and long-term pressures, and how pay is aligned with corporate governance best practices.
The proxy states that 89% of the CEO’s pay is at risk. The compensation accrued to John Stankey, the CEO since 2020, was approximately $23 million for 2022. That number barely fluctuates from $21 million in 2020 to $24.8 million in 2021, consistent with the so-called “competitive pay policy” discussed in one of my earlier pieces.
The new SEC disclosure now requires a discussion of realized pay relative to such ex-ante pay. Setting aside quibbles over such disclosure, its useful piece of information to go over. Over the years 2022, 2021 and 2020, cumulative ex-ante pay is $68.7 million relative to realized pay of $60.8 million. I am not sure why this suggests that CEO pay reflects performance.
The CEO is required to hold equity that is 6X of his base salary of $2.4 million. AT&T has an anti-hedging policy, a claw back policy and a risk mitigation policy related to executive compensation. They employ F.W. Cook as their compensation consultant.
What about other objectionable governance practices?
As per CAP IQ, AT&T does not have a classified board. But, investors need 66.67% of shareholder approval to amend the bylaws. I am not sure how unusual that is.
On the other hand, only 15% of shareholders need to approve special meetings. I did not see dual class shares. The CEO has a succession plan. The board has access to outside advisers. The non-management directors can meet in executive sessions, i.e., with no management directors or management personnel present, no less frequently than quarterly, as determined by the Chairman or, if applicable, the Lead Director, or when a director makes a request.
So what?
Precisely! I have read hundreds of proxy statements cover to cover and they are all beginning to look similar. Is it time to invoke common sense, reduce the energy devoted to minutiae associated with boards, compensation and the like and simply ask the board why AT&T is an index laggard. And, while we are at it, what is the responsibility of the S&P committee, the index maker, with respect to these 37 firms?
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