Beware of these 5 Deadly Corporate Sins

By Russ Banham

Chief Executive

Dubious corporate tactics that were once considered arcane business shenanigans are now consumed and broadcast on social networks as widely as the latest celebrity scandal.

The public’s sudden interest in corporate mischief is driven by a confluence of emergent populism, growing mistrust of institutions and the bully pulpit of social media messaging. People who were indifferent or oblivious in the past now take notice.

Behaviors that smack of irresponsibility or hubris—like the unimaginably rich CEO of a ride-sharing company who recently belittled an employee in a video that went viral—can have immediate and far-reaching negative consequences.

“Business news is no longer just business news,” says Edgar Baum, CEO of the brand measurement firm Strata Insights. “If CEOs are perceived as doing something fishy, the public knows about it immediately, even if the underlying business details are beyond comprehension. The problem is one of hyperbole, sensationalism and speed.”

“Fishy” is not necessarily illegal. Much of the public has raised the bar when it comes to the standards to which they expect both CEOs and the companies they lead to adhere. Small wonder at a time when a whopping 63% of the population does not trust CEOs, according to Edelman’s 2017 “Trust Barometer” survey. Do something with a whiff of impropriety, and people become hashtag activists, instantly expressing their protests or echoing others’ complaints across large swaths of the global population. This information then finds its way into apps like DoneGood, aVOID, Glia and BuyPartisan, which were created to steer
consumers away from “objectionable” companies.

How bad is it for companies portrayed as sinners? “The forest of rhetoric is so thick right now that corporate actions that are not illegal, but appear to be deceptive or unfair, can ignite a brushfire that’s not easy to put out,” says Hampton Bridwell, CEO and managing partner at brand and marketing consultancy Tenet Partners.

In addition to personal and corporate risk, bad behavior is undoubtedly tarnishing the overall reputation of capitalism: a 2016 Harvard survey showed that 51% of millennials do not support capitalism, while just 42% said they support it.

We’ve compiled five corporate “sins” that CEOs should do their best to avoid committing—not because they’re illicit per se, but because the short-term gain may not be worth the long-term pain.

1. Dual Shares, Double Trouble

Dual-class shares are a great way for a visionary founder of a company with voting rights to guide its long-term strategy, without the quarterly short-termism views that more ordinary shareholders might exact. But the structure, which on average calls for giving 10 votes to insiders versus one vote to public shareholders, has its share of detractors.

“Some CEOs think they know better than anyone else what is best for the business, but this is a very shortsighted view,” says Thomas Quinlan, chairman and CEO of LSC Communications, a global provider of digital and traditional print-related services and office products. “A poorly performing CEO should not be immune
to disciplinary actions that may even include the person’s ouster.”

Absent the threat of external discipline from institutional investors and other stakeholders, a CEO’s omnipotence can result in incautious decisions, like voting down a takeover offer that would provide a significant premium for shareholders, Quinlan adds. “Personally, I believe it is unconscionable for a company to sell shares to the public but keep voting control through dual-class shares.”

He is far from alone in that view. “By not listening to outside investor viewpoints, you run a big risk of destroying long-term value,” says Rahki Kumar, managing director and head of ESG (environmental, social and governance) investments and asset stewardship at State Street Global Advisors.

Peter Kimball, head of advisory services at governance consultancy ISS Corporate Solutions, agrees: “By definition, you’re creating an insular environment with less accountability to shareholders, which can increase risk.”

Kimball raises the example of SnapChat parent Snap’s recent IPO, which took dual-class shares to a new extreme—offering no voting rights at all to shareholders. “It’s resulted in the rare move by the Council of Institutional Investors to request that S&P Dow Jones Indices and other index builders exclude the company from their indexes,” he explains. “Otherwise big stock portfolio managers would be obliged to buy Snap’s shares, without having any say in its direction.”

Kumar also questions the Snap voting structure. “Companies with dual-class shares argue that it allows for more long-term focus,” he says. “But what if the focus is wrong?”

Such leadership arrogance can backfire, as it suggests a company that has no interest in the concerns of others. “Shareholders have ownership of something, but no ability to protect their interests,” says Baum, a former investment banker. “Meanwhile, those with voting powers are not held accountable to anyone but themselves. That’s not exactly a comforting message.”

Perhaps worst of all, such structures do not necessarily enhance shareholder returns. “All else being equal, shares that have dual voting rights generally are less valuable,” says Chris Ruggeri, national managing partner of strategic risk and brand management at Deloitte. “Ordinary shares often trade at a discount to their theoretical value, the spread tending to narrow in bull markets.”

2. Rigging CEO Compensation

Public outcry over CEO compensation has been around for a while, resulting in the widespread use of peer groups by board compensation committees to justify high pay packages. But what if the peer groups were judiciously selected to artificially inflate the pay of senior executive leaders?

Jun Yang, an associate professor of finance at Indiana University’s Kelley School of Business, and Michael Faulkender, an associate professor of finance from the University of Maryland’s R.H. Smith School of Business, collaborated on a report in 2010 demonstrating that many board compensation committees had benchmarked their CEO pay to that of higher-paying peers. “Needless to say, we were surprised,” Yang says.

The eye-opening study was a factor in changing the rules to require boards to disclose the names of the CEOs they had benchmarked against. Nevertheless, Yang, who continues to study the subject, says the problem has not gone away. “It’s just not as severe as it was in the past,” she explains.

“Boards are more careful, given the heightened risk of discovery and revelation. But some peer selection bias still exists.”

Kimball affirms that peer group “cherry-picking” continues. “Compensation committees select what I call ‘aspirational’ peer groups composed of CEOs from companies that are much larger, have rising total shareholder returns and a more successful mix of businesses,” he asserts. “Such companies simply tend to pay [their CEOs] more, which can lead to inflated compensation.”

Yang’s current research has opened up another can of worms—a possible nexus between the charitable donations a company makes to nonprofit organizations and the compensation of its CEO. “We found that 5% of Fortune 500 companies donate to the charities of their independent directors,” she explains. “It appears that when such donations occur in a company, the compensation of the CEO is higher by about 10%.”

The donations are not disclosed in the annual report or the 10-K, Yang notes. “They’re pretty much under the carpet,” she says. “Obviously, this brings into question the directors’ ‘independence.’”

Yang and Kimball agree that high CEO compensation is not inherently wrong—so long as an outsized pay package is based on provable performance and market value. But when very wealthy people become even richer based upon manipulated data, the public is more likely to condemn the person and the employing organization.

3. Inverting Corporate Inversions

Corporate tax inversions are another dubious tactic worth a reappraisal. Last year, U.S. companies avoided paying nearly $135 billion in corporate taxes by registering their profits overseas. Yet they continue to derive the benefits of American “citizenship” by claiming that their operations are headquartered
in the U.S.

If American citizens pursued the same practices, the IRS would go after them for tax avoidance. “Corporate tax inversions produce the most significant brand and reputation risks for U.S. companies,” says Bridwell. “To ordinary people, it’s a clear statement that a company doesn’t want to pay its fair share, even though the U.S. helped make it what it is.”

Despite an anti-inversion bill passed by Congress in 2004, many companies deftly find workarounds. When portrayed negatively in the press, they blame the migrations on the country’s 35% corporate tax rate, griping that it puts them at a competitive disadvantage with businesses in areas with lower tax locations. President Trump has pledged to indirectly end inversions by decreasing the tax rate to 15 percent at home. Until then, tread lightly. “If an iconic national brand is considering an inversion to better their tax situation, expect substantial blowback,” Bridwell says.

“Just because you can doesn’t mean you should,” chimes in Jonathan Knowles, CEO of Type2 Consulting, a B2B consultancy. “Legality is different than legitimacy,” he explains. “In the short-term, it may result in lower effective tax rates and an uptick in the stock price, but in the long-term, it can erode the company’s trust, legacy and reputation. I’d be very cautious. You simply cannot get around how unfair and unethical it looks.”

4. Restricting Stock Access to Pandering Analysts

It’s hard to believe in this era of increased corporate transparency that a company would restrict its management team’s access to stock analysts who have and will most likely continue to provide favorable “buy” recommendations. Yet this shady practice was unveiled recently by The Wall Street Journal. Much of the fault lies with the analysts: they earn business from institutional investors by helping them access a company’s leadership. This results in undeserved fawning, flattery and recommendation “inflation” by analysts.

One study that looked at more than 16,000 earnings conference calls, indicated that analysts had uttered the phrase “great quarter” approximately 3,000 times.
One Wall Street analyst, Dan Davies, skewered the typical earnings call with this spoof: Analyst: “Great quarter, guys! I’d like to drone on for a bit, and make it perfectly obvious that I had a meeting with you before the close to discuss my numbers. I’d also like to remind all the other analysts on this call that I’m the most experienced analyst with a ‘buy’ recommendation, which is why you took my question first. So my question is, what do you think about how the quarter went?”

Management: “We thought it went pretty good, Jim! Thanks! See you at the conference in Boca!” As for those analysts less likely to provide a “buy” recommendation, they experience greater difficulty accessing company management teams—to their investors’ chagrin. Certainly, this is no way to build confidence in the investment community.

“Companies should have a very cohesive way of describing how they are going to create value for shareholders over the long term, and should be proud to tell that story and support it with facts,” says Ruggeri. “You either push the envelope of transparency in your narrative by opening access to all analysts, or you end up ignoring relevant stakeholders to your long-term peril.”

5. Abusing the Patent System to Restrict Competition

Companies that file overly broad patents or acquire patent rights merely to restrict competition are guilty of committing our fifth and final sin. Such “patent trolls” used to roam the backwaters of business until President Obama outed them in his 2014 State of the Union address as “phony patent filers” costing “some of our best innovators tons of money in court.”

While thousands of legitimate patent infringement lawsuits are recorded each year, a few are filed solely to limit competitors in their development of innovative products. “Some companies have asserted patents pretty blatantly to restrict competition,” says Josh Becker, CEO of Lex Machina, a provider of legal analytics to companies and law firms. He pointed to giant Honeywell’s 2012 patent complaint against tiny thermostat-maker Nest, claiming the startup’s smart thermostat violated its intellectual property.

After Google acquired Nest in 2014, the two businesses settled the dispute out of court, reaching a cross-license agreement. Was it worth it for Honeywell to be perceived as a Goliath picking on a David, particularly one with a highly innovative product? “It was pretty obvious that Honeywell sued with the purpose of putting the young punk startup out of business,” says Becker. “I understand when a company files a patent infringement complaint for defensive purposes—it would be a dereliction of duty not to do that. But if the public perceived you doing it with the purpose of restricting competition, you’re in for a backlash.”

Beware these 5 corporate sins as they can be deadly, corporate reputation experts warn. “Negative news travels fast, meaning you better have a credible
response ready if you’re caught with your pants down,” says Knowles. “It’s so easy now [for customers] to quickly switch to a competitor.”

Thanks to hashtag activism, when people turn their backs on a business they are likely to do so in droves, posing an immediate threat to the organization’s revenue stream. “Companies have to be more careful in their rhetoric and decisions, particularly in this era of rising populism and instant social messaging,” says Bridwell. To deter the risk of poisonous tactics infecting the workforce, he advises that CEOs establish, disseminate and champion permissible behaviors. “Clarify your organization’s purpose and values, and communicate these tenets aggressively,” Bridwell says. “Your reputation and brand depend on it.”

Quinlan provides a similar perspective, which rings especially true in light of United Airlines’ April fiasco: “One of the quickest ways to destroy market value is an incident that causes consumers not to trust you,” he says. “You only have one reputation. Protect it at all costs.”

As the embattled CEO of the aforementioned ride-sharing company would attest, removing the tarnish that attaches to a reputation is hard work. Better to
keep it sterling.

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