The fight for Canadian Pacific Railway by its largest shareholder, Pershing Square Capital Management, epitomizes a growing problem with public company governance. Boards are being overrun by bureaucratic traffic cops, more preoccupied with paperwork than strategy.
Consider this: Despite the fact that CP is underperforming competitively*, CEO Fred Green, who’s held the position since 2006, met 17 of 18 objectives set by the board. Meanwhile, the cost of management has doubled, and, according to Perishing Square, there’s a lack of rail experience on the board, not to mention a lack of shareholder representation.
The problem is that once companies go public, the compliance role dominates. Value creation is increasingly ignored and shareholders become a distant memory. Indeed, Canadian corporate governance guidelines address strategy in a mere one sentence.
Contrast that with private equity governance, where directors are picked solely based on strategic requirements, where value creation is an obsession, and where the board is knowledgeable and demanding. And, perhaps most importantly, where management is held accountable for hitting targets—or replaced.
Numerous studies have been done contrasting private equity companies with public ones, notes activist investor Henry Wolfe, and with regards to performance and value creation, “the studies clearly demonstrate that private equity companies significantly outperform.”
What’s more, despite all of their tiptoeing, these so-called “compliance” boards may not be equipped to prevent another Enron. Writing for The Wall Street Journal, former Hewlett-Packard director Tom Perkins pointed out that “directors have to understand the fundamental business to understand when it is going off course.” Yet director selection is often based on independence and fame, rather than industry experience. In fact, prior to Pershing Square’s efforts, CP had no one with rail experience on its board other than the CEO. Form is being picked over substance; boards are being built to look good on paper.
At the core of this problem is the fact that shareholders have too limited a role in public company governance. Directors do not engage shareholders directly except at staged annual meetings. Shareholders cannot even propose directors in the proxy circular.
A recent proposal by a group of Canadian investors is recommending not only that shareholders select directors, but also that they—not management—compensate them. This would address incentives and accountability. Director performance reviews could also be shared with shareholders, and shareholders could have a say on board chairs.
In short, it’s not just directors who need to change—it’s also the system.
*CP recently reported first-quarter results that were much improved compared with a year ago. Pershing Square chief Bill Ackman attributed the improvement to the mild winter and a better economy.