Cozy deals corrupt many boardrooms

Nearly a third of Dow firms hired at least one relative of an executive or director

Your Money

August 28, 2005|By Andrew Countryman | Andrew Countryman,CHICAGO TRIBUNE

Just how independent are those corporate directors?

That's a question experts say investors ought to ask when they look at a company. A look at a company's annual proxy statement can determine whether it is doing business with directors or their firms, and if so, how much.

An analysis of the 30 companies that make up the Dow Jones industrial average found that at least 22 had such dealings, known as related-party transactions, with directors or executives last year; another two said they might have had such dealings but that they didn't meet disclosure thresholds.

Although these activities have been undergoing more scrutiny since the meltdown at Enron Corp. in 2001, the prevalence of the dealings within the Dow 30 has increased. Five years ago, only 18 companies reported at least one transaction.

"We all had a feeling it was going to go away after Enron," said Beth Young, senior research associate at the Corporate Library governance research group. "In fact, it has not."

Young's research suggests more than three-quarters of companies have at least one related-party transaction reported in that section of their proxy statement, though she said some are marginal.

Although companies routinely play down the importance of these dealings, saying they don't affect the directors' independent judgment, some experts said they are not necessarily benign.

"People will say these are insignificant, it doesn't compromise independence. But the reality is it's very hard to be independent when you have related-party transactions," said Paul D. Lapides, a corporate board member and the director of the Corporate Governance Center at Kennesaw State University near Atlanta.

"Related-party transactions are one of the really hot items in the boardroom right now and will continue to be," he said.

These transactions can include doing business with a director's company or law firm, hiring a board member as a consultant or having one of the director's relatives on the payroll.

"I think related-party transactions are one of the most significant red flags out there for investors," said Patrick McGurn, a corporate governance expert at the Institutional Shareholder Services proxy advisory firm in Rockville. "Certainly, when you see them in significant size or significant number.

"Investors cannot afford to avoid them as a potential risk factor."

These transactions can involve some of America's most notable business leaders. McGurn's firm recommended that shareholders withhold votes from the re-election of billionaire investor Warren E. Buffett to the Coca-Cola Co. board because of the approximately $185 million in business in 2004 between Coke and entities owned by Buffett's Berkshire Hathaway Inc.

Despite the size of these transactions, Buffett is considered an independent director. ISS objects to his membership on the audit committee. Just over 16 percent of shareholders withheld votes from Buffett.

Coke spokesman Ben Deutsch said the value of the transactions fell well under independence standards set by Coke and the New York Stock Exchange.

"Mr. Buffett's interests could not be more closely aligned with those of our shareholders, given his significant ownership stake of the company," Deutsch said. "He is a man of the highest integrity, and we are fortunate to have him on our board."

Companies employed at least one relative, including children, of an executive or director at nearly a third of the Dow firms, which troubles some experts.

"If you're on the board and you're also a parent, it has to affect you," Lapides said.

The Corporate Library's Young said, "These are big companies that have their pick of whom to hire."

Citigroup Inc. in its latest proxy disclosed that it employed seven relatives of executives and directors, paying them nearly $4 million in 2004, plus thousands of stock options.

Company spokeswoman Shannon Bell said these relationships don't affect the directors' independence.

The company employs about 300,000 people, she said, and none of the seven directly reports to any Citigroup executive officer. The employees are judged on performance, she said, and compensation decisions are not influenced by and are kept confidential from the related family member.

Traditionally, the concern comes when transactions occur with directors, with experts worrying that they will compromise their independent judgment. The fear, McGurn said, is that "you're going to be less likely to rock the boat."

Some companies declare the directors are not independent, as General Electric Co. did with racing legend Roger Penske because of substantial dealings with his businesses.

"I thought more of them would be disqualified than they are," Young said. "I saw a fair number of companies where the extent of the transactions to me raised real questions."

Experts said transactions with executives also can raise the issue of whether the company is being managed for the benefit of shareholders or the corporate insiders.

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