Getting Schooled on Corporate Governance, Part 3

In recent years, boards of directors have failed to wield their clout for the benefit of shareholders, the true owners of publicly traded corporations. That doesn't mean that considerable improvement in corporate governance is difficult to achieve.

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Getting Schooled on Corporate Governance

As I mentioned in Part 1 and Part 2 of this series, providing better corporate governance isn't very complicated. It means getting back to basics. In the final installment of this series, I'll borrow a few more lessons for the benefit of directors from Robert Fulghum's book All I Really Need to Know I Learned in Kindergarten.

"Put things back where you found them."

I can't think of a better kindergarten lesson for directors to follow. Five-year-olds learn to put their toys and other "stuff" back where they found them for the benefit of the next person. Directors would better serve shareholders if they regarded themselves as transitory caretakers of an asset that, to the extent it's managed well, will easily outlive them.

Here's a simple way to get board members thinking about the long term and to better align their interests with those of shareholders: ban stock options for directors.

While Microsoft (MSFT - commentary - Cramer's Take) is doing away with options, many other companies aren't following suit. They not only continue to use options for employees, but also are giving them to directors as well. At Veritas (VRTS - commentary - Cramer's Take), for example, new nonemployee directors get a grant of 100,000 stock options (worth $1 million, by my calculations), plus another 25,000 options per year.

Sure, that's excessive, but that's not the key point. Directors should be compensated for their work -- even well compensated -- but they should be paid in a way that makes them think and act like long-term shareholders.

Paying directors with options positions them asymmetrically from shareholders in terms of both risk and reward. As option holders, directors do not have capital at risk and are incentivized to be aggressive with an eye toward driving the stock quote higher.

Compensating directors with restricted stock puts them squarely in the same position as shareholders. Options provide the potential for risk-free windfall profits, but with restricted stock, directors suffer and thrive in the same proportion as other shareholders.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.

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