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HP Directors Lack Skin in Game: Opinion

The outside directors need to assume a significant stake in the company in order to effective monitor and discipline its managers.

By the time this article appears, we will likely know the next CEO of


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And leading the committee who selected the new CEO is Silicon Valley wunderkind Marc Andreessen. Andreessen was the public face of HP when it ousted former CEO Mark Hurd in August (after granting Hurd an estimated $35 million severance package to get him through in between jobs).

When HP and


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crossed legal swords after Hurd became Oracle's next co-president 30 days after leaving HP, it was apparently Andreessen who called Larry Ellison to smooth things over.

HP shareholders might be surprised to learn, however, that Marc Andreessen owns exactly zero shares in HP. As an HP shareholder, I'm very disappointed that Andreessen and most of his colleagues on the HP board haven't dug into their own (deep) pockets to buy some HP stock.

I'd prefer feeling that my representatives on the board feel the same pain that I do when the stock tanks. For this reason, I've recently filed a shareholder resolution with HP to adopt high stock ownership requirements for all directors. I hope that HP will allow its shareholders to vote on this matter at the spring annual meeting.

Long-term shareholders have been disappointed in HP's stock returns relative to the

S&P 500

index return over the last decade. As of Sept. 22, 2010, HP's 10-year stock return was 25.14% vs. -22.64% for the S&P 500.

Over that time period, HP's board has been criticized for lax governance practices, including (1) the recent decision to oust Mark Hurd for questionable behavior, while still paying him a rich severance package, (2) the decision to use "pretexting" to gather information on a

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reporter and some of HP's own directors in 2006, and (3) the decision to pay Hurd $98 million in total compensation (before severance) for the three years prior his departure even though HP's stock return for the three years prior to Aug. 6, 2010, was -2.33%.

The Corporate Library, a corporate governance ratings firm, has consistently rated HP's board as "high risk" for its inability to manage incentive compensation. Nell Minow, co-founder and executive editor of The Corporate Library, has called HP's board "a serial corporate governance offender."

I believe that HP's outside directors would be more vigilant and effective monitors of management, as well as better judges of effective compensation packages (including executive perks such as personal use of corporate aircraft, personal travel and meals expenses, and gross-ups at the expense of shareholders for these executive taxable benefits), if all of them owned a significant equity stake in HP which they had to dig into their own pockets to buy, rather than being granted stock or stock options.

As of HP's last proxy statement filed in the spring 2010, the outside directors' HP shareholdings were as follows:

  • Lawrence T. Babbio Jr., former Verizon (VZ) - Get Verizon Communications Inc. Report executive (who has been on the HP board since 2002) owns 36,836 shares (not including stock options)
  • Lucille S. Salhany, CEO of JHMedia (who has been on the HP board since 2002) owns 34,406 shares (not including stock options)
  • Robert L. Ryan, former Medtronic (MDT) - Get Medtronic Plc Report CFO (who has been on the HP board since 2004) owns 16,152 shares (not including stock options)
  • Sari M. Baldauf, former Nokia (NOK) - Get Nokia Oyj Report executive (who has been on the HP board since 2006) owns 14,130 shares (not including stock options)
  • Joel Z. Hyatt, former CEO of Hyatt Legal Plans (who has been on the HP board since 2007) owns 9,725 shares (not including stock options)
  • G. Kennedy Thompson, former Wachovia CEO, who made the decision in 2006 for Wachovia to buy Golden West Financial for just under $25.5 billion calling it a "crown jewel" for Wachovia (who has been on the HP board since 2006) owns 9,360 shares (not including stock options)
  • John H. Hammergren, McKesson (MCK) - Get McKesson Corporation Report CEO (who has been on the HP board since 2005) owns 7,198 shares (not including stock options)
  • John R. Joyce, former IBM (IBM) - Get International Business Machines Corporation Report executive (who has been on the HP board since 2007) owns 6,426 shares (not including stock options)
  • Rajiv L. Gupta, former CEO of Rohm & Haas (ROH) (who has been on the HP board since 2009) owns 306 shares (not including stock options)
  • Marc L. Andreessen, Netscape founder (who has been on the HP board since 2009) owns zero HP shares.

As of Sept. 24, 2010, a majority of the HP outside directors each owned less than $500,000 stock - even though that amount would be pocket change compared to their personal net worth.

And remember that, of these stock holdings, it is unclear how much each director acquired through open market purchases versus from stock grants or past exercising of stock options. In my view, this is an insufficient level of outside director "skin in the game" to ensure an adequate level of motivation for proper oversight.

Several academic studies have concluded that significant equity holdings by outside directors lead to them more vigorously representing the firm's owners - because they are owners, not just on the company dole.

As Harvard Business School Professor Michael Jensen has argued: "the idea that outside directors with little or no equity stake in the company could effectively monitor and discipline the managers who selected them has proven to be hollow at best."

Furthermore, these empirical studies show a clear link between boards filled with outside directors with significant equity stakes and long-term stock price appreciation.

Yet, studies have only found this link when the outside directors put their own money at risk and not when they're given a lot of stock or stock options. The reasons are obvious: As humans, we pay more attention when it's our own hard-earned money at risk versus "found money" or "other peoples' money" at risk. This isn't rocket science.

Therefore, I'm calling on HP to immediately adopt a clear policy requiring all outside directors to purchase a minimum of the lesser of $500,000 or 5% of their personal net worth in open market purchases of HP stock within six months of being elected to the board of directors.

In other words, everyone serving on this board should experience the same joy and pain as other shareholders when the stock price moves. They should have a minimum of $500,000 of their own money at risk. But, let's face it, $500,000 doesn't mean as much to someone like Marc Andreessen when his net worth was estimated at being $500 million 10 years ago - it's likely much more today.

For most of us, if we had 5% of our net worth on the line with a particular investment, we'd pay attention. Whether our net worth is similar to

George Soros'

or a recently laid off construction worker in Florida, we don't want to lose money on 5% of our net worth.

I think Marc Andreesen is eminently qualified with his extensive tech experience to sit on the HP board and he is not over-committed with other boards so he has sufficient time to give to the job at hand.

He has his professional reputation at risk in serving on the HP board and I'm sure that he takes his director responsibilities seriously. Yet, that's enough. If Andreessen's net worth is $1 billion today, he should put $50 million of that at risk in HP stock. I'm sure Andreessen would say he'll do just as good a job whether or not he invests in HP. Empirical research says otherwise.

Jensen is right: Until outside directors put their own skin in the game for owning stock in the boards they sit on, they are no better than the talking heads who come on TV with market predictions when they have none of their money at risk if they're wrong.

Everyone needs to be an owner inside the boardroom. The talking heads can go home.

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

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. You can follow Jackson on Twitter at or @ericjackson