NEWS ABOUT CORPORATE GOVERNANCE - March-April/2003

Year IV – No. 27

Corporate Governance News

Editor: Luciano Carvalho Ventura

 Editorial

The risky and complex business of transition of the CEO.

- The CEO occupies an important niche in any Corporate Governance structure.  It is he or she who is the chief link between the regulating body, the board of directors and the regulated body, senior management, and the remainder of the organization.  The CEO is also first on the ladder of liability for the company’s operating performance and for striving to maintain one of Corporate Governance’s most important values, transparency. Thus, given the importance of the role of the CEO, in his/her capacity as a part of the company’s Corporate Governance structure, his/her transition is a risky undertaking for any company, regardless of whether it is foreseen or unforeseen.  A poor choice of successor or an inefficiently conducted process places any company at risk and undermines its market image.  In the words of the financial director of a large corporation, who witnessed its CEO transition process, “a badly handled succession blocks the flow of the changeover, creates uncertainties. undermines energy, causes resentments, encourages in-house politicking, and drives good executives to seek opportunities elsewhere.” Possibly due to this, boards of directors of US companies with a high level of Corporate Governance, always have a constantly updated CEO substitution plan.

For obvious reasons, the unforeseen transition process is significantly riskier than a planned succession. Among the main reasons for an unexpected transition are sudden death or resignation, the latter representing more obstacles when a CEO accepts a proposal from the competition.  Despite being highly unethical, this occurs more frequently than commonly imagined.  The only means for effectively dealing with an unforeseen transition is to have a second person duly groomed to permanently take over the CEO’s job and, if this does not work, for the shortest period of time possible until a new CEO is contracted.

In turn, despite being less risky, efficient methods must be applied to a planned transition to ensure a successful outcome, to the extent this is possible.  These include prerequisites, stages, and mainly, well defined timing.  The two main prerequisites are: a) the board of directors, which is the group with the greatest responsibility for conducting the transition process, must have full confidence in the cooperation of competent consulting services when necessary; and b) the company must have the updated analyses of all senior officers who are natural candidates in the succession process.  It is interesting to note that, in his recently published book “Good to Great”, Jim Collins noted that, in his research work, ten out of eleven CEO’s of “born to succeed” companies rose from the ranks of these same companies.  With these two prerequisites met, the following stages should be an essential part of the process: 1) Explanation or review of the desired corporate strategy by the Board of Directors; 2) Preparation of the profile of the executive capable of implementing the corporate strategy that has been approved or is being modified; 3) By using updated evaluations, identification of a suitable executive within the company, who meets the profile required by the corporate strategy.  In this event, a review of the organizational structure becomes essential and/or the succession process must be carried out with the intent of substituting the executive who was promoted to the position of CEO. If the company does not have an officer with the desired profile, the alternative would be to seek a new CEO outside the company, which would require the aid of specialized executive search consultants. 4) Once an ideal candidate has been selected, a short period of active command of the company jointly with the resigning CEO is recommended. During this stage, close monitoring by the Board of Directors is absolutely essential, to ensure that the change in the chain of command is completed within the pre-established period of time.  5) The final stage of the process is training the new CEO to prepare him/her to rapidly discharge the new duties at a level compatible with the importance of the CEO role in the company.

Some closing comments on this transition process in family businesses. Despite the methods being very similar, some additional ones must be considered here.  Depending on the company’s level of professionalism, one family member among several others will be selected to lead the company.  Obviously, this involves supplanting the other family members involved in the process and, thus requires additional care in administering sensitive political aspects. On the other hand, the need to train the new CEO would be more pressing if not many options were considered in the selection process.  And, lastly, since in almost all planned family business transitions, the resigning CEO becomes a member of the board of directors, this individual requires training both to be a member of the board and behavioral coaching, to make space to enable the new CEO, frequently his/her child, brother/sister, nephew/niece, or cousin to be free to carry out his/her new duties. 

IBGC – Brazilian Institute of Corporate Governance

During its Annual General Meeting that took place on March 31, the IBGC held its first fully democratic election of the Board of Directors, where any member could become a candidate under equal conditions, and no longer proposed by the Nomination Committee, which was extinguished during the last statutory review.  The following members were elected for a one (1) year term of office: Adhemar Magon, Eliane Lustosa, Fernando Alves, José Guimarães Monforte, Maria Helena Santana, Mauro Rodrigues Da Cunha, Miguel Sampol Pou, Paulo Diederichsen Villares, and Ronaldo Camargo Veirano.

The Board elected Paulo Diederichsen Villares as Chairman and Ronaldo Camargo Veirano and José Guimarães Monforte as deputy chairmen.  It is worth noting that, despite the facilitated voting methods available, including faxed votes, only a small number of members voted, and the abstention level was high enough to be a poor example of corporate governance to the market.

ANIMEC – National Association of Capital Market Investors

This Association that consistently strives for a transparent and equitable Brazilian capital market, has issued a twenty-two (22) point handbook that, in the opinion of minority shareholders, adds value to publicly traded company shares in Brazil.  In an interesting article that includes this handbook, Gregório Mancebo Rodrigues, vice-president of  Animec, discusses the Corporate Governance topic in the context of the distance between words and action and states that “it is not enough for companies to adopt transparency and Corporate Governance rules – governance must be imposed”.  The full text may be found in the Technical Material of the LCV site (www.lcvco.com.br).

IP - Participações celebrates ten successful and profitable years.

The IP – Participações Fund was founded ten years ago by Christiano Fonseca and Roberto Vinhaes and today is managed by Investidor Profissional partner, Pedro Chermont.  The Fund’s objective is to prioritize the quality of company management, mainly in relation to Corporate Governance and the company’s business potential, in the process of selecting assets in the market, without excess concern with other traditional analytical indices, among them low share liquidity.  Thanks to this strategy, inspired by the track record of mega-investor, Warren Buffet, IP – Participações boasts an unprecedented success rate in the history of Brazilian share funds.

Recently, in Rio de Janeiro, Investidor Profissional, the asset manager, celebrated ten years of incontestable leadership in Brazil, in terms of the profitability of its share fund, IP - Participações. This leadership was attested by no less than São Paulo’s revered Fundação Getúlio Vargas, that recorded the company’s accumulated profitability of 347% in US dollars for the period under analysis.  To give the reader an idea of the undisputed leadership position of IP – Participações, the other two share funds sharing the podium recorded accumulated profits of 198.6% and 61.2% respectively, for the period considered and analyzed in accordance with the same criteria.    

Corporate conflict results in the demise of yet another Brazilian family business.

The corporate conflict risk is now viewed worldwide as an additional risk for any company, particularly family businesses. Good Corporate Governance practices have gone far to minimize this risk, although many family firms, possibly due to ignorance or lack of interest, do not implement these principles practices, and for this, often pay too high a price.  The most recent example is the Corretora de Valores Souza Barros, one of Brazil’s oldest securities brokerage houses.  Due to failure to engage the services of arbitration council, which are so helpful, particularly for family firms, the decision to dissolve the organization was legalized in court, and hit the headlines of the major Brazilian newspapers.  It all began in the 2002 annual shareholders’ meeting when, after many years, the controlling shareholder dismissed his brother, a minority shareholder from his position as CEO, to permit the controlling shareholder’s son to succeed to this position. The aggrieved minority shareholder took legal action in the courts of justice, which ordered the partial dissolution of the brokerage house and complete dissolution of the family’s holding company.  The verdict also found in favor of the minority shareholder’s rights over the traditional Souza Barros trademark.  Due to the absence of good Corporate Governance practices, the size of yet another family business has been reduced, by being split into two smaller companies.  This leaves them significantly more vulnerable in today’s increasingly competitive market.

Meanwhile, other family businesses are shining examples of good Corporate Governance.

Santher, a leading Brazilian toilet paper manufacturer that, in 2002, billed R$ 520 million (US$180 million), formally implemented its Corporate Governance with the installation of a board of directors in October 1996. Since then, this family firm of 65 years of business activities, which has gradually been applying good Corporate Governance practices, is now undergoing an experience that would be crucial for any family business. The controlling shareholders, all of them members of the Haidar family, are withdrawing from operational management and will become members of the board of directors and the financial and management committees to monitor the performance of the company’s new CEO, Philippe Olivier Boutaud (44), an independent executive. In the words of the retiring CEO, Ruy Haidar, who will chair the board of directors, “The arrival of Philippe Boutaud is the culmination of Santher’s restructuring and professionalization. From today onwards, our organization is no longer a family firm but a company belonging to the family”.

Another excellent example is that of the Mesquita family, that has controlled the hundred-year old organization, the newspaper company, S.A. O Estado de São Paulo.  The decision was taken that all shareholders should relinquish their executive roles and become institutionally responsible for the organization’s editorial and corporate guidance, as members of the Board of Directors and the recently formed Editorial Committee and the Supervision and Strategy Committee.

Ethics and Corporate Liability continue to be the Order of the Day

At a recent seminar in São Paulo, entitled “Corporate Liability and the New Corporate Ethics”, a large number of entrepreneurs and executives dedicated an entire day to the values that are the cornerstone of Corporate Governance.  These are ethics and corporate liability.  An article by the technical coordinator of the seminar, Rafic Ayoub, lists the group of practices that can undermine corporate management in the context of ethics and liability.  Given their close link with Corporate Governance it is worth listing them.  According to Ayoub, these are: 1) external auditor ethics; 2) the integrity of accountants; 3) board of director independence; 4) quality of financial information; 5) supervision by regulating bodies; 6) watchfulness of minority shareholders; 7) analysts’ rigor and technical knowledge; 8) the end of conflicts of independence between audit and consulting areas; 9) transparency policy in disclosing economic and financial data; 10) downfall of illicit gains and of the hypocrisy of senior corporate officers. The full text of Ayoub’s article may be found in the Technical Material of the LCV site (www.lcvco.com.br).

Penalization of conflicts of interest

Conflicts of interest have received special attention in the business world, particularly in the context of Corporate Governance.  However, it is no easy task to avoid this, especially in its many subtle disguises.  Through its regulating and monitoring bodies, the US capital market has put in place all possible mechanisms to prevent conflict of interest situations.  However, this is still insufficient, and now offenders are being “punished”.  The larger US financial groups are paying out US$ 1.4 billion to elude accusations that they misled clients with inaccurate share analyses.  Among the larger fines meted by  the SEC (expressed in millions of US dollars) are Citigroup (400), CSFB (200), Merrill Lynch (200) Morgan Stanley (125), and Goldman Sachs (110). On announcing a billion-dollar agreement at the New York Stock Exchange, Secretary of State for Justice, Eliot Spitzer, who commenced his investigations while still Attorney General, stated “The aim of this procedure was to guarantee justice to the small investor.  Our citizens must be able to trust Wall Street, and this agreement will re-establish this confidence”.     

High salaries remain in the sights of shareholders of large US corporations

Over recent years, critics of the remuneration of major US corporation senior officers have grown in number. The motive has been mainly stock market crises and financial scandals involving groups such as Enron, Tyco, and Global Crossing, among a number of others. Some corporations, among them Coca-Cola and General Electric, are pre-empting the increasing pressure applied by organized shareholder groups, and have already announced progressive benefits cuts for their top executives, such as pension funds and extraordinary salaries. Specifically, in the case of GE, the cut impacted the salaries of its five highest paid officers, while Coca-Cola plans to eliminate the pension plan of its three chief executives. Further evidence of victory in the arm-wrestling competition with top executive management.

Despite probably being involuntary, a decision that will be a good example to follow

The CEO, Thomas Schmidheiny (grandson of the founder), of Holcim, a prominent Swiss family business, the world’s second largest cement producer, present in 70 countries and with over 50 thousand employees, recently announced that the family will relinquish control of the company.  Under its antiquated dual shareholder structure, where the family held only 26.6% of capital, it controls 56.3% of voting shares.  As from now, the “one share, one vote” system will prevail.  The Schmidheiny family will receive no special payment for relinquishing share control but the company will now have greater ease of access to the financial markets that are increasingly exacting on the question of voting powers.  Financial market access is an important matter for Holcim, since it operates  in a very wide-ranging capital segment.  This could have had significant influence on the family’s decision, although Thomas Schmidheiny has stated his desire “to create an opening in the world’s most important cement producer, in order to transform it into a modern and future-oriented organization”.

Holcim was one of the last great Swiss corporations to relinquish the dual share structure.  All eyes are now on the pharmaceutical giant, Roche, which is controlled by the founder’s descendants with a mere 10% of its capital.

In a context such as this, what can be said of the Brazilian capital market where a company can be controlled by a holder of a little less than 17% of capital?

CVM (Brazilian Securities Commission)

- Quote from “CVM Recommendations on Corporate Governance”.

II. STRUCTURE AND RESPONSIBILITIES OF THE BOARD OF DIRECTORS (cont.)

Preferred Shareholders’ Membership of the Board of Directors

II.3       The company should immediately allow holders of preferred shares to elect a representative to the board of directors, to be nominated and chosen solely by the preferred shareholders.

The Corporate Law establishes that until 2006 preferred shareholders can choose a member of the board of directors from a list of three names appointed by the controlling shareholders . But such a measure is not justified in light of the best corporate governance practices, and therefore the company should include in its by-laws a rule that ensures right away that holders of preferred shares who are not part of the controlling group may freely nominate and elect a member and its surrogate to the board of directors.

Chairman of the Board and Chief Executive Officer

II.4       The chairman of the board and the chief executive officer shall not be the same person.

The board of directors supervises management. Therefore, in order to avoid conflicts of interests, the chairman of the board should not also be the chief executive officer.

Best Corporate Governance Practices

- Quote from the Best Corporate Governance Practices Code – Brazil.

The Board of Directors (cont.)

2.17. The Chairman of the Board of Directors

The Chairman is responsible for the performance of the Board of Directors, for establishing its objectives and programs and for chairing its meetings. He has to make sure that the Board of Directors complies with the Company Law, the by-laws and internal instructions.

2.18. The Chairman of the Board and the CEO

The Chairman of the Board and the Chief Executive Officer should be two separate people.

The logic is the same as in avoiding the election of the CEO, Officers and other Management personnel to the Board of Directors. It is a conflict of interest to supervise yourself.

2.19. Independent Board leadership (Lead Director)

If the Chairman of the Board and the CEO is the same person, it is important that the Board have a particularly influential member, someone who is highly regarded by his/her fellow executives and the business community in general, capable of balancing the power of that executive who is both Chairman and CEO.

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