Shareholders do not get to pick their directors. As we have noted often, directors are nominated by the board, with no significant shareholder input. Given the costs associated with proxy contests and the problems of collective action, shareholders rarely if ever submit their own nominees. As a result, directors seeking renomination have little incentive to act in a manner that reflects the interests of shareholders.
Given this lack of choice, shareholders theoretically have their interests protected through the presence of independent directors on the board. They may not be nominated by shareholders but because they meet a legal definition of independence they can be counted upon to watch out for the interests of shareholders.
There are many problems with this approach. For a discussion of these problems, go to the article here. One of them concerns the problem of director's fees. Both thestock exchanges and the Delaware courts take the position that the receipt of a material stream of income from the company will deprive a director of his or her independence. Yet both exclude from this analysis fees paid to directors for their service on the board. For posts on the topic, go here and here. These fees have escalated and those sitting on the board of a large public company can make as much as $500,000 a year (some examples go here and here). The law, however, takes the absurd position that directors do not care about these payments and will not be influenced by them when making decisions.
All of this brings us to Countrywide. The company has been in the center of the subprime problem, with lending volume down and employee layoffs up. It has announced pre-tax restructuring charges of approximately $125 million to $150 million. The CEO, who has been criticized in the past for "Godzilla-size pay," has apparently become the subject of an informal investigation by the Commission into possible insider trading. According to published reports, the CEO sold 3.4 million shares worth more than $130 million during the first half of 2007. Litigation involving concerns over backdating of stock options is progressing in Delaware courts and CtW Investment Group, a union affiliated advisory group. has apparently sent a letter to the board demanding his immediate resignation.
All of this suggests the need for close oversight of the CEO by the board of directors. What are the factors that suggest this has been a sleeping board? The CEO is also the Chairman, allowing him to maintain heightened control over the board. The board is staggered (ten directors, with approximately one third elected each year), making any change of control almost impossible. The directors are paid handsomely, with compensation in 2006 averaging $300,000 to $500,000. While the board held a respectable 15 meetings, ten were telephonic. Thus, the board met together physically only five times in the course of the year.
Countrywide illustrates that the current governance regime is inadequate to protect the interests of shareholders. This regime relies almost entirely on the presence of independent directors. The definition of independence used by Delaware and the stock exchanges is, however, wholly inadequate. One possibility would be to fix the definition but there is little likelihood of that ever occurring.
The most meaningful solution is to raise the risk that directors who ignore the interests of shareholders will lose the next election. This in turn requires some ability of shareholders to nominate directors. Access to the company's proxy statement would allow for this to occur in limited circumstances. Yet there is considerable speculation that the Commission will in fact deny access. An agency assigned the task of protecting shareholders and investors will merely help ensure that there will be many more Countrywides.