From the Knowledge@Wharton today blog.

In the wake of President Barack Obama’s victory over challenger Mitt Romney in the 2012 presidential election, KnowledgeToday asked Wharton faculty for their perspective on a number of issues that will take center stage in the days and months ahead.

We posed a number of questions, including:

1. What do you think was the biggest reason for Romney’s loss? What should he have done differently?
2. What was the biggest reason for Obama’s victory?
3. An editorial in The Wall Street Journal suggested that Obama got a big boost in the election from two men: Ben Bernanke and his quantitative easing, and John Roberts, who joined four other Supreme Court justices in upholding Obamacare. Do you agree?
4. The election raised interesting demographic questions. Romney appealed to many white males, while Obama appealed to many Hispanics, Asians, women and African Americans. Does this suggest that Republicans need a better strategy to attract these groups going forward?
5. What should Obama’s strategy be for dealing with the key issues of unemployment, the fiscal cliff and the deficit?
6. Is there any reason to think that the Republicans, who control the House of Representatives, will be more willing to work with Obama to get some of these issues resolved? Can the two parties hope to work together?

Here is what we heard:

Peter Cappelli, director of Wharton’s Center for Human Resources:

“Aside from the tactical issues, the fundamental issue in the election was the role of government. The vote was basically split between those who did not think government did much for them economically and those who thought government either did, or should do, something for them. The Democrat/Republican divide always reflects this issue, but it was much starker this time because the Republican position was more extreme, particularly in the proposed cuts for social services.

“The Romney campaign suffered because its proposals seemed to frighten too many voters who feel they need government protection. The Romney ticket also could not shed the baggage from the primaries on social issues – women’s rights and immigration, in particular – that hurt them with those voters.

“The biggest reason for the Obama victory in my mind was that Governor Romney’s various gaffes shifted the contest from being a referendum on President Obama and the poor state of the U.S. economy to being more of a referendum on Governor Romney. Much of the energy on the Democratic side seemed to be [directed] to voting against the Romney ticket.

“There are a hundred things that made a difference to the election. Certainly if Obamacare had been turned down by the Supreme Court, things would have been bad for the President, but then it was bad for the Democrats when the Supreme Court upheld Citizens United. Quantitative easing appears to be helping the economy, but it has been bad news for the President that none of the other treatments before helped much. A lot of other things could have gone differently that would have affected the outcome….

“The big question seems to be how the Republican party, especially in the House of Representatives, will see their effort over the last four years to obstruct anything that would appear to give the President a legislative victory. The goal of that approach was to prevent the President’s reelection. That did not work. So what do they do now?”

Mark V. Pauly, professor of health care management:

On why Romney lost: “The economy recovered enough to take away his main argument for change.”

On The Wall Street Journal editorial: “I do not see that the court decision on health care reform meant more votes for the President. It kept an issue alive — you need to vote Republicans [into office] to get rid of Obamacare — but that was obviously not an important enough issue, nor should it have been since in the short run, relatively few people gain or lose from health care reform.”  

On dealing with the issues of unemployment, the fiscal cliff and the deficit: “Republican control of the House of Representatives will keep us at the same point in discussing these issues as we were before the election.”

On whether the two parties can work together: “Now that the House knows it will have to deal with the President, I expect they will try to get some things resolved that were held hostage to the election. I think the President has used most of the ammunition he has in terms of executive orders and the like, so I expect the House will pull things their way. We will have some tax increase on millionaires and billionaires, but of course we do not have enough [of them], so that will not help the deficit that much. It will just make Democrats feel better.

“I am hoping this will set the stage for bipartisan tax reform along the lines of the Rivlin-Domenici or Bowles-Simpson [debt reduction plans]. Both have big health care parts to them. I think the election gives cover to Republicans to go along a little.”

Kent Smetters, professor of business economics and public policy:

On why Romney lost and Obama won: “Obama had a better ground game — more regional offices, more effort to get out the vote. Romney also focused solely on jobs without painting a broader picture. He should have channeled Reagan a bit more.”

On The Wall Street Journal editorial: “I don’t agree with it. Money injected by [the third round of quantitative easing] is basically just sitting on bank balance sheets. I think that the [Supreme Court decision on health care], if anything, helped mobilize conservatives behind Romney.”

On the demographics question about Obama’s popularity with minorities: “The election raised interesting demographic questions. Romney appealed to many white males, Obama to Hispanics, Asians, women, African Americans and other ‘minorities.’ Does this suggest that Republicans need a better strategy to appeal to these groups going forward? Romney also appealed to married females. But, yes, the Democrats are effective at class war politics. Republicans need to do a better job of explaining how prosperity is better than envy.”

On a strategy for dealing with unemployment, the fiscal cliff and the deficit: “The ‘fiscal cliff’ is a horrible term. Minus five for Bernanke for coming up with it; minus 10 for still being an old school Keynesian. Otherwise, I like him.

“The real cliff is if we keep focusing on the short run without also addressing the huge budget deficit. The problem with the U.S. economy is not the lack of consumption. We have plenty of it. The problem is the lack of investment. We need to address the fiscal cliff by removing some of the uncertainty about future tax rates and returns to investment. Any proposed solution to the fiscal cliff can’t be short-term and [can’t work without] comprehensive reform of the tax code and spending side that improves the long-run situation as well.”

On whether the two parties can work together: ”No, they will continue to play chicken. Hopefully, however, it will lead to a grand compromise, like the 1986 Tax Reform Act where Reagan and the House Democrats hammered out a deal that was tenable to both sides.”

Mark Duggan, professor of business economics and public policy:

On why Romney lost and Obama won: “A key reason for Obama’s victory is that the economy has been gaining more momentum over the last few months, with unemployment falling below 8% and job creation relatively strong. This may have given voters more confidence that his policies, such as his help for the auto industry — an important issue in arguably the most important state of Ohio — were working. His handling of Hurricane Sandy also probably helped to give him just a bit more support so that he pulled out wins in pretty much all of the states that were deemed battlegrounds.

“While Florida has still not been called, the races in states like Ohio, Virginia and Colorado were sufficiently close that even a small boost might have helped lead him to victory. Plus his victory margins in Wisconsin, Iowa, New Hampshire and Nevada were somewhat bigger than expected. On the foreign policy front, I think most people felt he won the third debate; that may have helped to tip the balance for many voters, too.”

On issues like the fiscal cliff, taxes and unemployment: “As for big things that are coming down the pike, the President will be negotiating with Congress on what to do about the upcoming fiscal cliff. Effective January 1, 2013, there are a set of spending cuts and tax increases taking effect that will lower the deficit by about $600 billion, which is close to 4% of GDP. While reducing the deficit is important, many think that a change in government policy of this magnitude could put the economy back into recession. Thus, it will be very important for Obama to work with Congress to make the right tradeoff between starting to tackle the deficit and stimulating economic growth.

“Certain parts of the fiscal cliff, like the payroll tax holiday (a 2 percentage point cut in this tax for all workers on their first $115,000 in earnings), are very unlikely to be renewed, but others — like the spending cuts and increases in income taxes — are likely to be negotiated. Long-term deficit reduction is also hugely important, with changes needed to the tax code and to entitlement programs.

“The fact that Obama will now be a second-term President may make it easier for him to confront these challenges as he does not need to worry about being re-elected. Indeed, that is why many support term limits.”

From the Knowledge@Wharton today blog.

Austerity in Spain and most of Europe has failed, according to Wharton management professor Mauro Guillen.

Further proof came this week with the announcement that the Spanish economy’s downward spiral continued, with GDP shrinking by 0.4% in the third quarter — the fifth-straight quarterly decline — and unemployment hitting a record 25%.

Despite the government’s attempt to put off a eurozone-led bailout of public debt, expect Spain to accept terms within two to three months, says Guillen.

In this video, he addresses the question: Have attempts at economic reform in Spain worked on any level?

This post was previously posted in Knowledge@Wharton today blog: Spain Sputters as a Bail-out Moves Closer

From the Knowledge@Wharton today blog.

China’s economy may be bottoming out in the face of a weak third-quarter GDP growth rate of 7.4%. It was the seventh straight quarterly decline. Although this and some other recently released indicators look gloomy, they have been partially offset by more positive economic news, all of which suggests that the hoped-for soft landing for China’s economy may be underway.

But for the Chinese economy to revive in a sustainable way, the household consumption portion of GDP “has to reverse course and start going north,” says Wharton management professor Marshall W. Meyer. Given China’s stage of development, “household consumption is extremely low, about 34%. Neither exports, given the parlous state of the EU and, to some extent, the U.S., nor capital formation, given there has been so much of it, can provide the path to sustainable growth at this point.”

China has relied on investment activity to grow more than any economy in modern history. The country’s disappointing third-quarter numbers were foreshadowed earlier in the month when the World Bank cut its growth forecast announced just five months ago from 8.2% to 7.7% for all of 2012. Still, the Bank now projects GDP growth next year will tick upward to 8.1%, albeit a bit below its May forecast of 8.6%. Holding economic growth above 8% will be possible next year because of additional liquidity injections and higher spending by the government, World Bank economists say.

Local Chinese governments have been spending heavily to grow local industry. Various reports note that some 7 trillion yuan in spending has been set loose since July.

“When you throw a trillion dollars into the Chinese economy something is bound to happen,” says Meyer. “Whether it’s a good thing is another matter.”

Already there are signs that, despite the third-quarter’s overall letdown from the second quarter’s growth rate of 7.6%, other indicators are starting to turn around. For example, China also reported this week that exports unexpectedly jumped 9.9% in September compared with a year ago. There were additional reports that retail sales, industrial production and investment all rose toward the end of the quarterly reporting period, which prevented the numbers from deteriorating even further.

But as Meyer suggests, the short-term challenge to China’s economy seems to be one of stopping the bleeding rather than offering hope of resuming the robust growth of recent years. As he notes, the Baltic Dry Index (a measure of prices for shipping basic materials and commodities) is still far below its all-time high in May 2008, and HSBC’s China purchasing managers index “was pretty low, 47.9, at the end of September.” (A number below 50 typically suggests economic contraction, while a number above 50 suggests expansion.) The August consumer confidence level, meantime, was below that of August 2011.

The World Bank also cut its forecast for the whole of East Asia this week from 7.6% to 7.2%, acknowledging the drag China’s economy is exerting on the region. That outlook marked the lowest level of GDP there in more than 10 years.

This post was previously posted in Knowledge@Wharton today blog: China’s Third Quarter Turns Down — Again

Gina Anderson| CSI Blog

We often talk about the role of philanthropy as ‘venture capital for the not for profit sector,’ able to take risks on new ideas, innovation and social change. However for many in the not-for-profit arena, the problem with philanthropy is the lack of ambition and lack of purpose.

A fascinating new report by The Resource Alliance, supported by the Rockefeller Foundation, entitled  ’Risk and Philanthropy‘ examines how risks in international development philanthropy are defined, assessed and managed. It reports the conclusions from a series of 27 interviews conducted with development philanthropists, philanthropic intermediaries, grant makers from leading international foundations and sector academics in April 2012.

The report argues that philanthropy needs to become better at understanding the relationship between risk and opportunity, cognisant of the distinctive contribution that effective risk strategies can play in creative solutions to the most intractable development and social problems. It also argues that philanthropists need to be much more accepting of failure and recognise that to achieve large-scale change much of the resource may be ‘wasted’ along the way. Occasional failure should be seen as the acceptable cost of innovation.

In the report they seek to understand more about why so many individuals and foundations are seemingly risk averse with their philanthropy. While the focus of the report is on international development philanthropy, their examination of risk assessment, risk management and how philanthropists and philanthropic institutions use different decision rules depending on categories of risks experienced, is very useful for understanding all types of philanthropy.

The report defines the two main risks that are of primary concern to philanthropists engaged in international development:  Impact Risk and Operational Risk.

Impact Risk is most often cited as the critical risk and is defined as the risk of not achieving the required impact given a specified level of philanthropic investment – in short, is the money making a difference? There appears to be three drivers of impact risk in international development:

• It is often difficult for philanthropists to articulate how they define impact
• It is often difficult for philanthropists to decide a priori how to design an effective social innovation system to achieve the desired impact
• It can be difficult to establish meaningful metrics to measure success and/or to encourage those being funded to report on the impact achieved in a meaningful way.

Operational Risk often goes hand in hand with impact risk and is defined as not having the right operational approach to support sustainable impact – in other words, is the money being spent appropriately? As part of the discussion of operational risk, I particularly enjoyed their examination of the selection of appropriate business models and of the importance of developing a diversified risk profile, an organisational learning culture and adequate control mechanisms.

Other risks identified in their interviews were financial, reputational, political and personal risks. However, these were rarely considered as important and typically only became a concern when they were perceived as increasing either impact or operational risk.

The report also highlights the importance of trust on the part of both beneficiaries and funders.  So much of risk is subject to trust with the corollary that little trust often means big risk.  In most cases, the perception of risk is based on the philanthropist’s past experience. In reality the risk in philanthropy is often a lot less than imagined and the possibility of failure not as great as imagined. The onus falls to the not-for-profit organisation to manage and mitigate risks, while understanding the philanthropist’s biases and educating the philanthropist on the field of endeavour.

However, as learning begets learning, the pragmatists among us plead:  don’t over intellectualise philanthropy – just do it!

Gina Anderson is a member of The George Institute Board and was Executive Director and Chief Executive Officer of Philanthropy Australia from 2005- 2010. This article first appeared on the CSI Blog.

 Jeffrey Knapp

Largege Australian companies which have previously complied with all disclosure requirements in accounting standards are now claiming that they do not have public accountability and are doing less disclosure.

The auditors of these companies are going along with this treatment. The reduced disclosures under AASCB 1053 include the removal of information about remuneration for key management, financial risk management, and audit firm remuneration.

The new Australian Accounting Standards for ‘Reduced Disclosure Requirements’ , or AASB 1053, remove the requirement to publish much of the detail about a company, if they have no ‘public accountability’.  It does not officially commence until July 1, 2013, however some companies have already implemented the new standards.

I do not understand how a public company complying with all accounting standards overnight becomes an entity with no public accountability, thereby reducing its disclosures. It’s not a good look when the management of a public company is responsible for reduced disclosures of management remuneration or an audit firm agrees that the disclosure of audit firm remuneration should be removed from the accounts.

Under AASCB 1053 a company must have no ‘public accountability’ to take advantage of the new reduced disclosure requirements. Public accountability is defined to mean “accountability to existing and potential resource providers and others external to the entity who make economic decisions but are not in a position to demand reports tailored to meet their information needs.”

A large Australian company that is economically significant employing hundreds of employees or with hundreds of creditors has public accountability because those stakeholders and resource providers cannot command specific financial information from the company. Employees and creditors of such a company are entitled to information about how the company is managing financial risks, especially given the current economic environment.

I will issue a challenge to the big audit firms to show leadership when interpreting the meaning of “public accountability” for the purpose of accounting standards disclosures. 

The accounting profession must act in the public interest and it fails in this regard when it reads down definitions in accounting standards and meekly concedes to fee-paying clients. If the big audit firms are weak when interpreting the meaning of ‘public accountability’, then they make the case for less professional judgment and more hard and fast rules like audit firm rotation.

Jeffrey Knapp is a lecturer in financial accounting at the Australian School of Business.

Professor John Piggott

All around the world, governments are trying to get workers to work longer. Australia is no exception.

Population ageing – increasing longevity combined with lower fertility – will generate massive increases in the per worker fiscal cost of supporting people in retirement and old age, unless we work for longer. This is a calculus most governments now appreciate, at least in theory.

By 2050, the 65-plus population of Australia will have doubled, and the 85-plus group will have increased by a factor of four.

So how is it that the average Australian retirement age, according to figures from the Organisation for Economic Co-operation and Development (OECD), is lower by three years compared with 40 years ago? It now stands at 23 years for 60-year-old males, and 26 years for females, among the world’s highest, and our healthy life expectancy’s been going up too.

International experience indicates, and Australian experience supports, the idea that the single most important determinant of retirement age is the age you can access your retirement income. The OECD estimates that Australian labour force participation moves from a highly respectable 82 per cent for the 50-54 age group to 53 per cent for those aged 55-64, and then plummets to 25 per cent for ages 65 to 69.

Australia has three access ages: 55 (about to start moving to 60) for superannuation access; 65 (about to move to 67) for age pension access; and 60 for tax-free superannuation benefits. Two sticks and a carrot.

This alignment between access age and falling labour force participation is no coincidence.

To take just one cross-country comparison, New Zealand’s mature labour force participation rate climbed rapidly over the last 20 years, to 76 per cent for ages 55-64, as age pension access there increased from 60 to 65, with no widespread superannuation to buttress it. It is now higher than Australia’s, whereas 20 years ago it was lower, at least for males.

Australia is adjusting the access ages for the two sticks. But the access age for tax-free superannuation is stuck at 60. Once the standard superannuation age reaches 60, in 2024, the carrot will have lost its crunch.

The social cost of this policy paralysis is very high. Professor John Piggott from the ARC Centre for Excellence in Population Ageing Research and Senior research fellow Rafal Chomik calculate that GDP would be 4 per cent higher if our mature age participation rates were like New Zealand’s.

But there are other costs too. Mature age unemployment is lower than among the young, but duration in unemployment is much longer. Nearly half of the unemployed in their early 60s have been unemployed more than a year.

It follows that once you leave the labour force at a mature age, re-entry is likely to be difficult.

These hazards will occur much more frequently when there is a seven-year gap between tax-free superannuation and the age pension, which is where we’re heading on current settings.

Relative to 40 years ago, current mature age workers are healthier and can expect to live much longer. And for the most part, the work they do is less physically demanding. Retiring should be happening later, not earlier. And we should use the policy levers we have to make this happen.

John Piggott is Director of the ARC Centre of Excellence in Population Ageing Research (CEPAR), and Scientia Professor of Economics at the University of New South Wales.  A version of this article was previously published in The Australian Financial Review.

From the Knowledge@Wharton today blog.

Anyone who has ever sat through a commencement address, read a self-help book or sought input from a friend when making a tough decision has probably heard this seemingly straightforward piece of advice: “Do what makes you happy.”

But the connection between doing what’s best for you and being content with that decision is more tenuous than most of us might think. According to Wharton marketing professor Deborah Small and PhD student Jonathan Berman, the conflict inherent in making a decision – and guilt about choosing oneself over the chance to help others – often makes looking out for your own self-interest seem downright miserable.

“Context is critical – people make very different choices based on the background. When the context is right, self-interest can feel quite pleasurable,” Small says, noting that people make numerous choices every day without thinking of them in moral terms. “But when self-interest is directly pitted against the needs of others, it makes self-interest feel selfish.”

Some people are psychologically hard-wired to think everything they do is selfish, Berman points out, while “others are oriented to think that nothing they do in their own self-interest is selfish.” Berman and Small decided to see what happened when the choice was taken out of people’s hands. In a recent paper, “Self-Interest without Selfishness: The Hedonic Benefit of Imposed Self-Interest,” which is forthcoming in the journal Psychological Science, they show that people who had a self-interested outcome imposed on them were able to enjoy it without the burden of feeling “selfish” – and were happier on average than those who got to make the choice on their own.

In the first of three experiments, 216 people were told that they were either going to be given US$3 to spend on themselves, or would donate that money to UNICEF. Some participants got to choose between the two options; the others had no choice – they were forced forced to either keep the money or give it to charity.

After the first study, participants were asked was asked to rate on a scale of one to seven how much enjoyment they got from the experience. The happiest group of people by a significant margin were those who were simply told they could keep the money, rather than being told to donate it to charity or to decide between the two options. (Credit: Deborah Small and Jonathan Berman)

Afterward, the entire group was asked to rate on a scale of one to seven how much enjoyment they got from the experience. The happiest group of people by a significant margin, the researchers found, were those who were simply told they could keep the money.

“The idea is to make it feel less and less like a choice,” Berman says. “The less something feels like a choice, the less tension people feel and the better they feel as a result.”

In the next experiment, 132 people were asked either to choose between accepting one of two gift cards, to pick one of two charities to give a $5 donation to or to decide whether to take a gift card or give the equivalent amount to charity. Once again, those who were only presented with gift cards(self-interested options) proved to be the happiest with the outcome.

Finally, Berman and Small conducted a third experiment designed to study whether people’s perceived level of control over a decision impacted their level of happiness with that choice. They recruited 252 people through Amazon Mechanical Turk and told the group that each would receive a monetary bonus in exchange for their work or would be asked to donate the same amount to UNICEF.

Participants were asked to give their preference between the two options and then told that either they would get to make the choice, or the computer would make it for them. (Unbeknownst to the group, however, the computer “picked” whatever option the participant said he or she wanted.) Once again, the group was asked how happy they were – and once again, those who got to keep the money were happier when they believed the decision was imposed on them.

According to Small and Berman, the research shows the danger inherent in giving people too many choices, and how giving moral undertones to a particular decision could put at risk the happiness that consumers associate with a particular store or product.

As an example, Berman points to programs in which supermarkets give customers a choice at checkout of whether to keep a refund for bringing their own reusable grocery bags, or to give that money to charity instead. “Companies tend to think about the people who would want that option, not about the people who don’t want to take it,” he notes. “Maybe if they just gave everyone the money as a refund, everyone would feel better off.”

“Or they could impose the choice to donate to charity,” Small adds. “Lots of companies do. For example, they say that for every dollar you spend, a portion of that is given to charity. Cause marketing is very effective if it is done well. Consumers like the idea of doing good. But the potential downside is that putting the customer in the position of deciding whether or not to do good might make him or her feel less satisfied.”

However, Berman notes, that feeling selfish isn’t necessarily a bad thing. “In some sense, the feeling of selfishness is a good thing for morality because people who don’t want to feel selfish end up doing good deeds,” Berman says. “Maybe there is a trade-off between your own happiness and doing good deeds, but it’s also doing good for the world.”

This post was previously posted in Knowledge@Wharton today blog: Do Something Nice for Yourself — Without Feeling Selfish

Peter Swan

Common sense suggests company boards are best composed of directors who hold shares in the business because any poor performance is effectively ‘skin in the game’ as a cost to the director as well as to shareholders. Director’s interests align with shareholders. Directors who mismanage pay a severe price. Evidence also implies this is the case.

During the global financial crisis when the ASX200 index tumbled nearly 40%, incentivised boards suffered fewer relative stock price falls. Yet this advantage can be lost if a company’s board has too many outside directors or if the board members are too compliant to the chief executive. They fail to ask the tough questions. The size of boards is also an issue. Having executive board members who share ownership directly benefits firm performance and lowers CEO pay – but less so when ownership is combined with large boards. It seems when a firm performs poorly, too many independent directors can impede critical action – such as firing an underperforming CEO. A ‘smallish’ board of five or six highly incentivised directors, with a low proportion of outside directors who are prepared to monitor and not just advise management, is optimal, according to my research done in conjunction with Serkan Honaine.

Poor governance can squander a firm’s wealth and our study into how well the interests of independent board members and shareholders are aligned in larger Australian companies suggests large boards of eight-plus members can be very destructive for shareholder value. The average market-to-book ratio of companies with smaller boards of seven or less directors is 50% higher than those with eight or more, and nearly 40% higher when debt-financed assets are included.Our research based on an analysis 284 major Australian listed companies over the decade to 2010 shows that if businesses with large boards behaved like firms with fewer directors, they would improve their performance substantially. Reducing the size of the average large board (nine directors) of Australia’s top 200 firms in 2010, to the size of the average small board (six directors), could boost an individual company’s performance by as much as 50%.

In all likelihood, a large board indicates that management is in control with little effective supervision by shareholder representatives. Naturally, management is reluctant to give up its privileges and drastically reduce board size despite huge cost savings. Poor board monitoring and weak decision-making is collectively costing shareholders hundreds of millions of dollars. Part of the solution is to replace large boards with smaller boards that do not try to usurp the role of management by micromanaging and to focus on the important task of hiring and firing the CEO.

Risk Aversion and Big Boards

Larger boards appear to substantially drag on overall firm performance through a variety of mechanisms, such as reducing non-executive director (NED) incentive pay and raising base pay for outside directors. Such actions encourage a board, dominated by outside directors who have no incentives, to entrench poorly performing CEOs. Large boards are also more cautious because they can have more difficulty reaching a collective decision. This constrained risk-taking results in slow responses to new circumstances and slower release of new information. The resulting reduced stock price volatility appears harmful to shareholder value.

Bigger boards, dominated by outsiders unlikely to be informed of company affairs, have a tendency to keep growing. Large, externally dominated boards appoint more and more directors like themselves with little or no regard for the wishes of shareholders, who are then hit twice. Shareholders not only pay for the salaries of surplus directors but also suffer performance decline into the bargain.

Our research measured performance by comparing companies’ market values to book values. (The market-to-book ratio attempts to identify undervalued or overvalued securities by taking the market value and dividing it by book value. As a rule, the more the ratio exceeds 1, the better the performance while those below 1 are considered undervalued or poorly performing.)

We find that, based on 2010 values, property group Westfield and National Australia Bank (NAB) had below-average market-to-book ratios of 1.34 and 1.39, respectively, and 13 board members each. Publisher Fairfax Media, with 11 board members, carried a very depressed ratio of 0.58, which is well below 1 (and far lower still in 2012). National airline Qantas had 10 members on its board and its value ratio was less than 1 (at 0.83) with its ratio continuing to deteriorate.

Investment and financial services provider Macquarie Group had 10 members with a ratio of 1.03. In contrast, with only five directors on their boards, investment fund Platinum Asset Management and high technology company, Silex Systems, had ratios of 11.7 and 9, respectively.

Meanwhile travel brand group, Wotif, and electronics retailer JB Hi-Fi, each with six directors, had ratios of 13.2 and 7, respectively.

Challenging Independent Director Dominance

In theory, Australian boards appear to be wide open to influence by outside directors. Unlike the US corporate landscape, no chief executive was chairman of a big Australian publicly listed company board. As a result, non-executive directors have a greater ability to intervene in a firm’s activities.

Shareholders have greater power too. Only 40% of Australian shareholders vote at company meetings on proposals from the directors – half the rate of the US. So large shareholders of Australian companies may not need as much stock to maintain control and can make critical decisions, which puts the onus on independent directors to apply greater scrutiny.

We suggest the findings on the harmful effects of outside directors’ dominance and large boards are directly contrary to the views held by regulators, which have been shaped by big corporate collapses. Virtually every country in the world has mandated a majority of independent directors based on little more than what may be simply a coincidence: the failed US energy company, Enron, happened to have a majority of executives on their board.

We challenge the trend for corporate governance councils around the world to introduce policies for a majority of independent directors on boards. Full-time executives, especially those with shares providing skin in the game, know a great deal more about the company and where it is heading than do outside directors. Moreover, typically they stand to lose a great deal more than do part-time directors if the company fails. This may include their jobs and livelihood.

Part-time, outside directors typically have little background in the industry. If the company fails, they may lose their director’s pay that in some cases is little more than a sinecure for turning up to board meetings. If prominent in the community, they may also suffer reputational loss.

We also question the regulators’ decision – in Australia and other countries – to make share ownership a barrier to independence. The Australian Securities Exchange’s (ASX) listing rules require the majority of directors to be ‘independent’, which is defined as not being a substantial shareholder (by holding less than 5% of stock in the company) or not having worked in an executive capacity for the company or another group member for at least three years. This seems counter intuitive because large shareholders have the most to lose from bad managers. They therefore have an economic incentive to gather information and actively monitor the chief executive.

If protecting shareholder interests is the task non-executive directors are facing, then surely alignment with, and not independence from, shareholders is ideal. The New York Stock Exchange (NYSE) and NASDAQ listing rules adopt a neutral stance: stock ownership per se is not a barrier to independence, and they set the barrier at 10% of stock for directors taking on an audit committee role because of the Sarbanes Oxley Act.

It would seem that regulators, in their quest to free management of burdensome shareholder concerns, have taken Australia way out of the mainstream at a huge cost to investors and forno apparent reason other than to appease the privileged managerial class at the big end of town.

Regulators’ Response

The ASX does not see this as a burning issue. When the ASX Corporate Governance Council recently reviewed its Corporate Governance Principles, roundtable discussions were held throughout the country with representatives of directors, management, institutional and retail shareholders, proxy advisers and others with an interest in how corporate governance practices are developing, no change was recommended.

The council chair, Malcolm Starr, said the consensus view was to leave well alone because the present system was working well. He acknowledged the viewpoint that it was counter intuitive to limit non-executive directors’ shareholdings because ownership should encourage better monitoring of company management. Yet there was another opinion that complete independence (through no shareholdings in a company) was the better way to go, Starr insisted.

The Australian Institute of Company Directors agrees. “Non-executive (or independent) directors are seen as ‘custodians of the governance process. While they govern an organisation on behalf of the shareholders or members by whom they are elected, their role is to act in the long-term interests of the company, not shareholders per se, and certainly not particular shareholders,” says spokesman Steve Burrell.

We say independence is undermined by other factors – such as by the old boys’ network that traditionally has appointed directors in the first place. In theory, outside directors should confront management and champion shareholder concerns, but in practice, their motivation is suggested to be more about behaving in ways that will bring more lucrative directorships.

Non-executive directors who are often appointed through friends on the board would be more partial to showing allegiance to their friends and overlook activities by management to expropriate the wealth of shareholders. Directors who do ask questions of management are likely to be either ignored or ostracised. They face the prospect of being denied the right to stand for reelection.

Paper independence aside, high levels of fixed compensation for attending scheduled meetings, along with the barriers to equity ownership provide for little incentive for non-executive directors to exert the extra effort that would add value to the firm. Likewise, the low level of variable forms of compensation to non-executive directors provides little incentive for them to seek and endorse strategies that add value to a company, as the non-executive directors would receive little in the way of the fruits for their labour.

Yet there could still be an incentive for non-executive directors, who may be motivated to perform their role more effectively by both the lure of new directorships from other boards and the financial incentive of being a corporate insider.

Why board size counts

We show that company performance diminishes with reduced monitoring of management by directors, while future firm performance increases when executive and non-executive directors own shares in the company – but not when the board is big. Weak monitoring by large boards, in combination with a high proportion of non-executive members who do not effectively own or take responsibility for decisions – the ‘free rider’ problem – was also found, particularly when boards consisted largely of non-executive directors without shares in the company.

A standard justification for large boards may be the need for these knowledgeable or well-connected outside directors to act as advisers – particularly in big complex companies. Yet it has been long believed that companies with larger boards suffer in performance because of their difficulty reaching consensus on decisions.

Greg Medcraft, the new chairman of the Australian Securities & Investments Commission (ASIC), has warned boards they will be held to account. “For instance, in the Centro case, Mr Medcraft has said publicly that ASIC acted where it believed directors’ behaviour did not meet the expectations of the law,” emphasises an ASIC spokesman. The Federal Court recently found directors of the Centro property group breached their duties when they failed to notice multi-billion dollar errors in the property group’s accounts.

Medcraft, who was appointed in May 2011 for a five-year term, says directors play an important role and they must not uncritically adopt the work of management on major issues for which they are responsible. “The key elements of the financial position of the company are things that directors should understand,” he says.

Conclusions

Our findings are a challenge to the ASX and ASIC, which discourage outside directors from owning shares in companies they hold board roles on for fear it undermines their independence. Ownership can be a tool to help align shareholder and manager interests and is linked to a firm’s positive performance. It is only likely to be fully effective if the board size is restricted to no more than about five or six. If management needs advice then it should simply hire consultants, not create large unwieldy structures made up of so-called ‘advisors’ kowtowing to management.

Before accepting a board role, a prospective director needs to signal his believe in the board’s monitoring role either by substantial personal shareholdings or taking his pay in the form of escrowed shares during his tenure. He may also need to negotiate funds set aside to assist board members in their monitoring role as boards need access to resources independent of day- to-day managerial control, especially when dissatisfied with the CEO’s performance.

Professor Peter Swan AM FASSA is a Professor of Finance, Australian School of Business, The University of New South Wales. This opinion piece was previously published on the ASA Magazine.

From the Knowledge@Wharton today blog.

What will a “Kodak moment” be without Kodak? In late August, Eastman Kodak Company announced that it plans to sell its flagship film business as part of a fundraising plan to emerge from Chapter 11 bankruptcy next year. The firm is looking to spin off its personal- and document-imaging businesses, which include film, photo developing kiosks, scanners and other divisions — a move that would render it a company focused mostly on inkjet printing and commercial services.

This “new” Kodak would be vastly different from the company that helped coin the phrase “Kodak moment” to indicate a one-of-a-kind opportunity that begs to be captured on film. “Whoever buys the film business from Kodak stands to gain access to a very valuable asset,” says Wharton management professor Emilie Feldman. “Much of Kodak’s value derives from its film business, so the future acquirer will need to manage that brand equity carefully.”

For Kodak, the key challenge will be that its name is so closely associated with film, not with any of its remaining businesses, according to Feldman. “Once Kodak exits film, the operations left behind will not have a concrete and well-established image on which the company can rely,” she says. “This will be problematic for Kodak vis-à-vis its external stakeholders — particularly investors and securities analysts, who will have to make sense of the new company.”

Until the mid-1970s, Kodak commanded 90% of the market for photographic film in the U.S. But it lost that dominance rapidly in the digital age. “Digital technology has all but done in the iconic filmmaker,” notes a Knowledge@Wharton article that traces Kodak’s slide over the years. Should the firm have chosen an earlier time to sell its consumer film business? “A company should divest its ‘legacy’ business when the value of its remaining businesses plus the value of the payment it receives for the legacy business exceed the value of continuing to run the legacy business within the existing company,” says Feldman. Kodak would have benefited more had it sold the film business when it was on top of the market, she points out. But now, given the company’s financial distress, the need to repay its creditors is dominating its strategy, she adds.

In the latest quarter ending in June, Kodak reported losses of $299 million on revenues of a little more than $1 billion. Since 2003, the company has closed 13 manufacturing plants and 130 processing labs, and reduced its workforce from 63,900 less than a decade ago to about 17,000 worldwide. After eliminating 2,700 jobs since the beginning of this year, the firm announced it would cut another 1,000 before 2013. Kodak also has seen some turnover at its top level: On Monday, the firm announced that its president and chief financial officer are stepping down.

Letting go of the consumer film business may not be painless for Kodak because of the branding halo it lends its other, lesser-known business operations. “Because legacy businesses constitute companies’ historical cores, the synergies between the legacy business and other parts of the company are likely to be particularly strong,” Feldman noted in another Knowledge@Wharton article, based on her research of legacy divestitures by diversified U.S. companies between 1980 and 2000.

In addition, companies are prone to miscalculating how their consumers will react to drastic changes in the way they do business. For example, Los Gatos, Calif.-based Netflix last September announced its intention to split its DVD rental and streaming media businesses, only to drop that plan a month later. Netflix’s consumers reacted badly to the idea of having to sign up for two different services. The plan to split the businesses “may be a harmful strategy,” Feldman had toldKnowledge@Wharton Today at the time.

In a statement, Kodak acknowledged that consumer photography “has been the core of our business” for most of its history. “It is also important to note, however, that our brand is strong in commercial markets.” The company’s commercial services business now represents more than two-thirds of its sales, the firm added. Its reorganization plans include the sale of 105,000 retail kiosks and efforts to monetize its litigation-ridden portfolio of digital imaging patents. In early August, Kodak won a partial victory over Apple in a battle over digital imaging patents. It may either sell that portfolio or leave it as an alternative source of recovery for creditors, Kodak has said.

Professor Renée Adams

There’s support across the globe for increased female participation at leadership levels. In Norway, it’s a legislative requirement that at least 40% of the board members of listed companies are women. Spain, Italy, Belgium and The Netherlands also have mandated quotas. Firms and organisations in other countries, including Australia, are voluntarily adopting gender targets.

Of the many reasons put forward to promote gender diversity in workplaces, a call for general fairness is one of the more effective and is easily understood. But the debate becomes illogical when diversity advocates claim that company performance will automatically lift if there are more women involved in executive-level decisions.

In fact, it does women a disservice to raise such unrealistic expectations. The findings of a range of diversity research projects that I have been involved with, using data from a number of countries and from different periods starting in 1996, make it evident that there is no actual business case for gender targets. Some companies may do better with more women, but others may not.

If it really were clear that simply adding a woman to the board would increase shareholder value by a significant amount, you can be sure that firms would already be doing it. This is business, after all.

Of course, there is a fairly large literature arguing that such a business case exists. In essence, such claims point to a correlation between firm performance and gender diversity on the board. That correlation is always positive if you only look at it as a correlation. But what the literature completely ignores is the question of whether this correlation is causal. As soon as you try to address the causality question, you don’t find this positive relationship anymore.

But the news is not all bad. Our research has revealed benefits that women bring to boards, notably conscientiousness, better corporate governance and performance accountability. Women appear to be tougher monitors of management and the likelihood that the CEO gets fired if performance goes down is higher when you have more women on the board.

Whether a tough board is always a good thing is contestable. If you have a board that’s constantly looking over the CEO’s shoulder and nitpicking, the CEO is less likely to share much information with it and this may be less than ideal for decision-making. In the female participation debate nothing is black and white.

But we do know that women are more likely to turn up to board meetings than men and that men show up for more meetings when there are more women on the board. Also, when it comes to directors’ pay, women are more aligned with shareholders by having a greater portion of equity in their compensation. These are likely positives.

And contrary to their counterparts in the wider population, women on boards are less tradition-bound and less averse to risk than men. It raises the idea that if women were able to implement or to have an effect on boardroom decisions so that their values were reflected, they could facilitate innovation. Another possible positive.

I’m a big advocate of diversity and like working in diverse groups but don’t believe who we work with should be mandated. Some senior managers may decide they are happier working with guys. Perhaps they enjoy going off to football games after board meetings and believe that women wouldn’t enjoy that sort of bonding. Sometimes people just work better with particular types of people and if that means men, and the company is operating well, then that’s a perfectly valid approach, if regrettable from an equal opportunity point of view.

Yes, there are demonstrable effects and arguable benefits in having the participation of more women. But it’s foolish to claim their input will automatically improve company performance, or even that at the very least it won’t make it any worse. It’s simply not true and has the unintended consequence of setting women up for a fall.

Professor Renee Adams is The Commonwealth Bank Chair in Finance at the Australian School of Business. Professor Adams will discuss her research at the Australian Graduate School of Management’s 35^th anniversary conference on 11^th of September 2012. This article was previously posted on The Conversation.