Corporate Governance Roundtable

At this year's NAREIT Law and Accounting Conference, one of the most talked about panel discussions was on the topic of corporate governance. The panel was led by Frederick T. Caven, Jr., managing director for Lehman Brothers. The panelists were: Paul D. Lapides, professor, Kennesaw State University; Leanne Lachman, Lend Lease Rosen Real Estate Securities LLC chief portfolio strategist and executive in residence, Columbia Business School; David O'Connor, managing director, European Investors Realty Securities, Inc.; Shirley Westcott, chief policy advisor, Institutional Shareholder Services; and James J. Hanks, Jr., partner, Ballard Spahr Andrews & Ingersoll, LLP.

Below are some of the highlights of the discussion dealing with the topics of director compensation, board diversity and finding top board candidates. (An unabridged tape of the panel's comments may be obtained by contacting AVEN at 1-800-810-TAPE.)
Caven: Shirley, can you briefly give us your overview of what an ideal REIT corporate board would look like?
Westcott: Typically an independent board majority of the directors should not be employed by the company. The same is true with the standing committees: audit, compensation and nominating. Ideally these should be composed of independent directors. In terms of other governance, board related governance provisions; we like to see an annually elected board. Those are just the main points that our clients emphasize.
Caven: Leanne and Paul, there is, a sense today of needing a diverse board. How would you define diversity?
Lachman: I would define board diversity as having individuals on the board from diverse business backgrounds. And I think that it particularly important for REITs because they tended initially to be governed by almost totally real estate people.
Lapides: I would expand out to societal diversity, not just in experiences but in terms of age, skills, gender—less than four percent of board positions in the United States are held by women. Of the 80,000 positions, less than 2 percent are blacks or Hispanics.
Caven: Would you put race or age or gender, ahead of skills set? Do you feel it is that important?

We like managements that go to bed at night worrying that the stock rises as much as we do.… Ideally I would like to have directors on boards who are actually writing a check and buying stock.

Lapides: No, I wouldn't put it ahead of skills set, but let's take one of the issues that a lot of REITs can use: brand managers. When you look at industrial America, there are a tremendous number of females in brand management. Even in terms of operations issues. There are almost no operating people on the boards of real estate companies, other than a CEO of another company. We don't have COO's on the boards and we have very few CFO's on the boards. There are, particularly in the CFO area, a good percentage of women to choose from. There is no question that you can find a qualified candidate.
Caven: David, as a big shareholder of a lot of these companies, what are your views on how much ownership, if any, a director should have in order to qualify to be on a board?
O'Connor: We like managements that go to bed at night worrying that the stock rises as much as we do. If you take one step further and look at the boards of directors who were responsible for overseeing management on our behalf as shareholders, obviously the more money they have on the line the better. Ideally I would like to have directors on boards who are actually writing a check and buying stock.
Caven: Shirley, where do you find directors?
Westcott: Well, I think one thing that a lot of companies do now is hire an executive director search firm and that way they can cast a wider net of potential candidates.
Caven: The CEO is usually charged with finding the directors. Is this something that the board, the independent directors on the nominating committee, should just say, "We don't care whether it is in the budget or not. We are hiring a search firm. We want to do this right."
Westcott: Absolutely.

Consulting companies charge millions of dollars more than the typical publicly held company spends on its aggregate directors' fees and the related expenses. I think that a good publicly held board is cheap, very cheap, and that goes especially for the audit department.

Hanks: And, in fact, there are firms that specializes in finding women to serve on boards and other well-qualified people to serve on boards who would not ordinarily be in the traditional pool.
Westcott: Also, it is important to get away from the idea that the CEO's friends get placed on the board. We need to get objective people onto the board with the best experience.
O'Connor: They should start with defining whatever the biggest challenges for a company reside—where they need some level of expertise to be brought in from the outside. The last thing that 95 percent of the companies in the REIT industry need on their boards is more real estate people.

Finding some younger people for the board also is important. Older people tend to be a little bit more risk adverse, if I can generalize a little here. Younger people are sometimes a little bit more techno-savvy, and a little bit more interested in risk taking. So, having a balance can make some sense.
Hanks: There are a lot of companies these days dealing with the increased amount of government regulation. It would be highly valuable in those situations to have somebody with some relevant prior government experience.
Caven: One of the most amazing things I read recently was a blue ribbon commissions report that made the profound statement that audit committees should be include people who actually understand financial statements.

Jim, can you talk a little bit about audit committees?
Hanks: There are lots of audit committee rules. There's the new SEC rules, the new New York Stock Exchange rules, the new AMEX rules, the new NASDAQ rules. But companies generally call us regarding a handful of these. The ones of greatest interest are: you must have an audit committee of at least three members; all of the members must be independent; all of the members must be financial literate; at least one of the members must have some financial management background experience or accounting experience; the board must adopt a charter for the committee; the company must include a report from the committee in the proxy statement; and the committee must get a statement of independence each year from the independent auditors.

Also let's not forget that you may already have in existence an audit committee charter in the form of a bylaw or a board resolution. Make sure you take account of that when you adopt a new charter.

Also, I like to advise our clients who are formed in Maryland—and there are quite a few REITs that are chartered there—that you must stay away from the use of the term 'fiduciary duties' in the audit committee charters. Unlike Delaware, Maryland has very specific statute that expressly disclaims the fiduciary characterization of duties of directors as possibly imposing a higher standard of conduct on directors than is intended by the statute.
Caven: David, you're a shareholder. How much do you think directors ought to be paid? I'm looking for a dollar amount.
O'Connor: It's hard to say. If you have a small company, you can't burden it with huge board fees. If you have a large company, you have a lot more leeway. My sense is that most of the people who go on boards do so for reasons other than the financial considerations. Most have money already. Of course, there should be some remuneration tied to actually showing up for the meetings. It is hard to put an exact dollar amount. I would say at a minimum, $20,000 a year.
Hanks: Notwithstanding all of the rhetoric about directors' compensation, I think that there is a good case to be made that directors are significantly underpaid. After all, what would it cost to hire one of the big consulting firms to send in nine or thirteen or seventeen people to meet several times a year for a day, day and a half, including committee meetings, and give me their best advice on the overall strategy of the corporation, on selecting the CEO, on major initiatives by the corporation, and reviewing the business at the highest and best level?
Lapides: The Fortune 200 board members in 1998 averaged $133,000 per board member between cash and option values. The REIT boards are probably somewhere right around $20,000. But the REIT boards are certainly underpaid relative to large companies. I think the Fortune 500 is about $63,000 on the average.

You don't necessarily want board members who really need the money. You want people that are there because it is stimulating and hopefully it will help them in their business.
Caven: Time out. That is kind of a fairy tale view of the world. I mean if you have ever been in a boardroom when they have had to fire a CEO or they have had a contentious discussion over a merger or there has been some self-dealing transaction, it is not fun. If a board is doing its job and they are challenging management and they are really probing deep, I don't think it falls under the fun category. I agree with Jim. I think these boards are wildly under compensated.
Hanks: I think they are under compensated at the committee level as well. Particularly when board members on the special transaction committees or the special litigation committees can be tied up for hours, days, or weeks over the course of a transaction or a piece of litigation.
Caven: Is compensating directors simply with stock options enough or should it be a combination of stock options, restricted stock, cash, etc.
Hanks: Over the last several years there have been some well-known proponents of the idea of stock and stock option compensation solely for directors. But, I'm not sure that you want a board composed entirely of people whose exclusive compensation for their services is equity, either stock or stock options. Certainly no consultant would come in and work on that basis exclusively.

There will always be times when you want to be sure that you are getting the absolute best, independent, objective advice that you can from the people who are members of your board. You want them to call it as they see it. I think you have to worry a little bit that their views might be skewed by their personal investment in the company. In particular, what their plans are for that investment. Do they plan to be long-term holders? Do they plan to retire in six months and then sell? There is very little discussion given to that when people rhapsodize about the value and virtue of compensating directors in equity.
Caven: Okay, let's assume a board has heard our discussion today and they decide to raise their compensation. David, you are a shareholder, are you comfortable letting them set their own compensation or would you like to see a specified process?
O'Connor: I think it is up to the judgment of the board to figure out what needs to be paid to keep a good quality board intact. If it looks to be too much, it is probably too much. If it doesn't look to be too much, it is probably okay. Look at the proxy and you see the compensation. Some may be marginally different than what you see other places. But, as long as things are basically in line with what other companies in similar circumstances are doing its probably okay. I think the board members are capable of making that assessment.