The Problem With Hewlett-Packard's Board

"May I have your attention please?
Will the real Slim Shady please stand up?
I repeat, will the real Slim Shady please stand up?
We're gonna have a problem here.."

- Eminem

Last week, I said that investors should give new Hewlett-Packard (HPQ - commentary - Trade Now) CEO Leo Apotheker a chance. I stand by that statement. But one group that doesn't deserve a second chance is the company's board of directors.

Within the past few weeks, Hewlett-Packard's board has been criticized by Oracle (ORCL -commentary - Trade Now) CEO Larry Ellison, former General Electric (GE - commentary -Trade Now) CEO Jack Welch and New York Times columnist Joe Nocera. On Friday, Ben Horowitz responded to the critics with a long blog post. Who is Ben Horowitz? He started a company called Loudcloud a couple of years ago with Marc Andreessen of Netscape fame. They later sold this start-up to Hewlett-Packard for $1.6 billion. Horowitz is now partners with Andreessen in an early-stage venture capitalist firm. Andreessen is now on Hewlett-Packard's board and played a central role in removing Mark Hurd and hiring Leo Apotheker.

Half of Horowitz's blog post is spot-on. He goes after critics who have said that the company's board was wrong to fire Mark Hurd for the small infraction of fudging expense reports and lusting after some staffer. Horowitz rightly points out: If you don't fire a CEO for lying about expenses, where do you draw the line?

If Horowitz had left his article at pointing out how silly it is for critics of Hewlett-Packard's board to mock the group for firing Hurd, it would have been fine. So what if he's clearly sticking up for his buddy Andreessen? So what if he's probably sold all his stock in the company and therefore has no skin-in-the-game basis for making this argument? I'd give him a pass, slap him on the back and say Ellison and Welch are clearly wrong on this (although I'd guess Ellison doesn't care given what Hurd's hiring has done for Oracle's stock price).

But Horowtiz didn't stop there. He goes on to pat the board on the back for being ethical, far-sighted and doing what's right for the hard-working men and women at Hewlett-Packard, because Horowitz got to know them so well from doing his time there (the way parolees have to do community service) for a couple of years as a condition of him getting his share of $1.6 billion. (I'm sure Ben really thinks he gets the struggles of the working men and women at the company from his long and protracted tenure.)

It was reading this second half of his blog post that made me immediately want to write this response. Horowitz would do well to remember that Hewlett-Packard's board is a badly governed board, which, in the case of firing Mark Hurd, made a good decision (for the reasons he spells out) but is still one of the most truly awful boards in large-cap corporate America.

Were the "ethical" directors doing right by the employees when they approved a plan to unilaterally cut all workers' pay by 5% a couple of years ago and committed that the senior executives would cut their own base salary by 10% but then doubled the total compensation (and perks) for Mark Hurd, Ann Livermore, Todd Bradley and other senior execs? Was that taking the long view?

And don't try to suggest that the board only knew about Hurd's shenanigans with this woman this past summer.

According to Hewlett-Packard, the board fired Hurd after it hired outside counsel to investigate claims of sexual misconduct. It was during the course of the investigation that the problematic expenses were uncovered that led to the firing. Yet, the company's originally filed 2008 proxy statement (which the board approved, so they either knew about it or were completely asleep when they rubber-stamped it) said that Mark Hurd charged almost $300,000 to shareholders that year for "personal meals" plus an additional $70,000 in tax gross-ups. Hmmm. Did the audit committee really think that Hurd (or even Hurd and his wife) could rack up that much in personal food expenses in a year? Even if they did, why the hell were Hewlett-Packard's shareholders paying for it? Either the members of the audit committee knew about what was going on with Hurd back then and chose to do nothing because (let's face it) Hurd was a popular CEO on Wall Street, or they were completely incompetent at their jobs of making sure all expenses are reasonable and legitimate, especially during a year of turning the screws on remaining employees with a 10% forced pay cut.

It was only after Michelle Leder of Footnoted and I complained publicly about these expenses, that Hewlett-Packard magically edited and refiled its proxy, claiming that the expenses were a clerical error.

Let me tell you, no SEC filing from a large company like Hewlett-Packard gets filed without about 15 levels of lawyers touching it first. There is never a mistake in a filing. Everything is there that's meant to be there. My belief is that this board knew stuff was going on a full two years ago -- that, at the least, warranted further investigation. Yet, they didn't act.

So don't even try to hold this board up as these thoughtful wise men doing right by shareholders.

This is a board in which no one seems to own any stock that they purchased out of their own pockets. They all have token shares that they received from options or grants. It's found money for them. If Hewlett-Packard's stock goes up, great; if it tanks (like it has since Hurd left), what do the directors care? It's not their money they lost.

Marc Andreessen (Horowitz's buddy) owns zero shares in Hewlett-Packard. Even after he sold his company to Hewlett-Packard for $1.6 billion in cash and stock a few years ago, he sold all his Hewlett-Packard shares. Even after being asked to join the board, he couldn't find the time to buy a few shares for himself. This is a guy who (conservatively) has a net worth over $1 billion. And he can't buy a few lousy shares? This is shameful. And it's not going to stop until Hewlett-Packard's shareholders (of which I am one, by the way) stand up and start screaming bloody murder.

Don't forget that this is a board with Ken Thompson sitting on it, the former CEO of Wachovia who killed his company and will never be able to work in financial services again because of it.

Hey, members of Hewlett-Packard's nominating committee, I hear that Jeff Skilling of Enron got a bad rap and deserves a second shot at being a director. Pay no mind to the fact that he's in jail. Or what about Chuck Prince or Angelo Mozillo or Dick Fuld or Stan O'Neal? So what if they all destroyed their companies? Those were all flukes. There aren't that many qualified directors around. Let's fill the board with such guys. The hard-working employees deserve these paragons of virtue representing their interests on the board. Thanks for taking such a long view for shareholders by nominating the guy who bought Golden West Financial and its mountain of California subprime mortgages for $26 billion.

I am sure that the hard-working Hewlett-Packard employees would feel much more comfortable about their board if each director committed to investing 5% of his/her net worth in open-market Hewlett-Packard stock purchases. If they believe Leo's the guy to take the company forward, great. Let's see them put their money where their mouth is.

I'm sure Horowitz supports his friend. But, next time, Ben, don't try to defend a truly awful board. Investors need investors representing their interests on the board. They don't need impartial rubber-stampers.

At the time of publication, Eric Jackson was long Hewlett-Packard.

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Best in Class: America's Top Boards

07/07/09 - 09:11 AM EDT

AMZN , JNJ , BRK-A , C , GE , IBM , GIS

Eric Jackson

It seemed an easy-enough question last week when someone asked me: What's the company in America with the best corporate governance? Yet, in trying to answer it, I was sent on a frustrating journey and a disappointing conclusion that there's no obvious winner. However, I'll name three good companies and look to address why it's so tough to answer the question.

In preparing this article, I reached out to some of the people I most respect in the world of corporate governance today: consultants, writers, bloggers, corporate secretaries and academics. Most of them were stumped by the question of what company is the best when it comes to corporate governance. It's certainly much easier to list 20 companies with bad governance for every company with good governance, which says a lot.

But three really good ones are Berkshire Hathaway(BRK.A Quote), Amazon.com (AMZN Quote) and Johnson & Johnson(JNJ Quote).

I'll revisit them later after I explain how I arrived at my conclusion.

To help spark my thinking, I searched the Web for recent corporate rankings of the best boards in corporate America. I came across a list from BusinessWeek from 2000. The top board on the list was General Electric (GE Quote), which unseated Campbell Soup(CPB Quote). Others near the top were IBM(IBM Quote), Home Depot(HD Quote), Intel (INTC Quote) and Cisco(CSCO Quote).

Since this ranking was issued, the combined stock returns of this group has been down 60% vs. negative 37% for the S&P 500. Three of the worst boards in 2000 in the rankings -- Walt Disney(DIS Quote), Rite Aid (RAD Quote) and Waste Management (WMI Quote) -- actually have slightly outperformed the best boards in the nine years since, but still returning on average negative 54% .

Ten years ago, GE's board was lauded for having a high number of outside directors who owned large amounts of stock in the company, which is worth 77% less today than it was back then. The board's largest move since 2000 was appointing Jeff Immelt as Jack Welch's successor rather than Bob Nardelli. It's hard to fault the board for that pick, given Nardelli's travails since then, but GE's shareholder base was frustrated with the stock's flat performance for the majority of this decade -- and that was before the wheels fell off last year with the concerns about GE Finance and its commercial real estate holdings.

Campbell Soup, the No. 1 corporate board of 1999 according to BusinessWeek, has lagged its peers like General Mills (GIS Quote) and Heinz(HNZ Quote) for a decade and barely treaded water with the S&P 500 over that time. Its stock is down 30% from 1999.

Finding the link between governance and performance has often vexed academics researching the link. At larger firms, with so many moving parts, it's often difficult to find the long-term performance effects of, say, separating the chairman and CEO roles.

''You are never going to be guaranteed total success,'' says Charles Elson, head of the Weinberg Governance Center at the University of Delaware. ''But good governance gives you protection when things go wrong. In the long run, that will play out.''

I spoke to Elson last week about the problem which many governance ratings have had in subsequently predicting company performance. He told me, in his view, that there were two critical governance factors which clearly showed a relationship to performance: (1) equity ownership of directors and (2) independence of directors.

I think he's right. Back in 2000, I was involved in a major research project which sought to link governance-related factors to subsequent company performance. The one factor which stood head-and-shoulders above any other was director stock ownership. And, by the way, owning stock through stock options or stock grants (the equivalent of "found money") didn't predict future company performance compared to when directors actually dug into their own pockets and purchased stock.

Board "independence" has been talked about often since the Enron and Worldcom scandals. We take it for granted that having a board stacked with family members or lawyers, accountants, and consultants who are paid by the company as directors is likely to produce more rubber-stamping boards than ones with more independent-minded people. However, there's still a lot of work to do in linking specific types of independent directors and company performance.

For example, I strongly believe having an independent director with industry experience is going to be more valuable in the long run compared with an independent director without that experience who doesn't want to speak up for fear of looking like a fool in front of the group. I also think too many boards lack diversity, in terms or ages, backgrounds or tenure on the board, which makes them collectively less independent thinkers than boards with such diversity. (However, adding a director for diversity's sake, without required business or industry experience, won't result in any new benefits for the group because such directors, again, will likely be too afraid to speak up.)

There's one more dimension I would add to the mix as being critical to finding a clear link between board governance and future company performance, and that's time to serve. If you go back and review the boards of the big failures from last year -- Lehman, AIG(AIG Quote) and Citigroup(C Quote) - all had a large number of directors who were too busy with other commitments to effectively serve as directors.

You had people like Anne Mulcahy and Andrew Liveris (CEOs of Xerox(XRX Quote) and Dow Chemical(DOW Quote), respectively) on Citi's board, who also served on Citi's audit committee, which is the most time-intensive of any board committee). When their own companies were seeing their stocks drop like stones last year, both Mulcahy and Liveris participated in 25 Citi board meetings and 12 audit committee meetings. In my view, they were stretched too thin from their day jobs to flag Citi's problems early enough.

Directors also can serve on too many other boards. Roland Hernandez who, in addition to serving on the board of Lehman and its "risk" committee (which failed if ever a board committee did), also served on the boards of MGM Mirage(MGM Quote), Ryland(RYL Quote), Vail Resorts (MTN Quote)and Wal-Mart(WMT Quote). Maybe if Hernandez hadn't been so over-committed he might have asked more questions about Dick Fuld's assumptions about Lehman's real estate

So, if equity ownership, independence, and time are the criteria for "good governance," along with evidence of sustained outperformance relative to peers, what are America's best boards? Like I mentioned earlier, the standouts are Berkshire Hathaway, Amazon.com and Johnson & Johnson.

Even as Berkshire Hathaway has taken its hits from the fall in financials and insurance companies, the stock still has beaten the S&P 500 in the last one, five and 10 years by a greater margin as you go back further in time. Investments made in Goldman Sachs(GS Quote), GE, and Harley-Davidson (HOG Quote) in the dark days of six months ago, look shrewd today. From a governance perspective, Berkshire is the gold standard for shareholder openness through its two to three-hour question-and-answer sessions at the annual stockholders' meeting and in its annual letter to shareholders. In terms of stock ownership, with the exception of Sue Decker who joined the board last year, each director owns at least $6 million in stock, with the median holding being $106 million. I also smile every year when I read how much Berkshire directors are paid to serve on the board. The majority of them get $2,700 a year, with a couple of special folks taking home $6,700, which is far less than the $300,000 to $400,000 a year some bank and tech directors take home.

The biggest problem I have with the Berkshire board is its average age. A third of the board is above the age of 80. These directors will have to face board succession issues, as well as CEO succession issues, over the next few years. They seem to recognize that they could benefit from some new perspectives on the board, judging from the most recent appointment of Sue Decker, formerly president of Yahoo!(YHOO Quote) and in her 40s.

Amazon.com also has been a standout performer for the last one, five and 10 years. Although consistently criticized by some for its sky-high valuation, it continues to succeed operationally and in its moves into new categories (most recently with the introduction of the Kindle electronic book reader). CEO Jeff Bezos gets the lion's share of the credit, but the company's board also is deserving. The stock ownership among the directors is high, with the median around $4 million.
But what I love most about this board is that every director has relevant tech or consumer experience which they bring to the group. Bezos didn't waste a seat around the table with the former ambassador to Ireland, buddies from the Seattle business community with no consumer background, former bosses, or the general manager of the Oakland A's baseball team. There's also a good range of ages and length of time served on the board across its eight members. A couple of the directors serve on two other boards besides Amazon's, and three have been on the board more than 13 years, which is getting a little long in the tooth, but these are very minor infractions when compared with most boards.

Johnson & Johnson's long-term corporate performance also has stood out compared with other "Big Pharma" players, and its governance has stood out as well. Unlike many New York-area boards of S&P 500-listed companies, J&J doesn't boast a board replete with active CEOs. In fact, it doesn't have any current CEOs (although disgraced former Citi CEO Chuck Prince was appointed to the board before he was ousted).

The board is a blend of retired CEOs and people from academia or with a specific health care background. The median stockholdings of directors is good at just under $900,000. My concerns with this board are that a few of the ex-CEO directors hold several other directorships -- including chair of JNJ's audit committee, James Cullen, who serves on four other boards. It's also odd that the finance committee didn't hold any meetings in 2008.

If I had to pick one of these as the best corporate board, I would say it's the board of Amazon.com. It's done things right on the most important governance factors of equity ownership, independence and time. Given this, I expect the company's positive stock performance to continue in the next 10 years. More importantly, Amazon's good governance means it's far less likely to suffer a Lehman-like shock that could destabilize or kill the company.

At the time of publication, Jackson had no positions in the companies mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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Was Bob Nardelli Ever Any Good?

Doug Kass wondered aloud in these pages last week about why anyone would care about what Bob Nardelli thinks, after he went on CNBC to debrief us on the Chrysler bankruptcy.

After this poor outcome, on the back of his disastrous six-year run at Home Depot (HD), it's fair to ask the question: Was Bob Nardelli ever a good manager?

Is it the case that he landed in two situations where the odds were stacked against him and anyone would have failed, or is he responsible for those two poor outcomes? If he was responsible, why was he so highly regarded coming out of General Electric (GE)? Was that high regard misplaced?

Although Chrysler dealt Nardelli a tough hand due to its size and market position, Alan Mulalley -- another outsider to the industry like Nardelli -- appears to be steering Ford (F) effectively through it.

Nardelli presided over Home Depot during the biggest housing market boom of the last century, yet it dramatically underperformed against Lowe's (LOW) over that period.

Favoritism no doubt played a role in Nardelli getting the Home Depot top job in the first place -- as Ken Langone (Home Depot cofounder and chair at the time) was also on the GE board and was very close to Jack Welch. They offered him this consolation prize days after he was passed over for Immelt. But what got Nardelli near the top rung of the ladder at GE in the first place?

Was Nardelli any good at GE and did he simply go into industries (retail and autos) in which lacked the experience to be successful, or was Jack Welch a poor judge of talent in letting him rise as far as he did at GE?

Nardelli's stumbles obviously hurt his own career prospects, but they also mar the reputations of Langone and Welch, as well as the mystique of GE's leadership funnel.

Position: None.

Originally published in RealMoney.com on 5/5/2009 9:49 AM EDT

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