Allen Sykes
29 The Mount
Fetcham, Leatherhead
Surrey KT22 9EB
Tel: 0044 1372 375851
Fax: 0044 1372 362693
e-mail: c/o

1 July 2003

Jonathan G Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington DC 20549-0609

Re: No S7-10-03

Dear Mr Katz


The current SEC Enquiry is timely and important. I hope it justifies consideration of this unavoidably late letter setting out the perspective and experience of an Englishman who has been a senior executive and non-executive director of major international companies over the last three decades, including working in partnership with major American companies. I should add that I am a long-term collaborator and co-author with Robert A G Monks. I support the views in his 2nd June letter to you, and this letter complements it.

The problem of securing sufficient non-executive directors who are both truly independent and have the relevant business expertise has not yet been solved in your country or mine. I therefore believe you and your colleagues should consider the analysis of Anglo-American shareholder capitalism in Bob Monks' and my November 2002 short booklet published simultaneously in New York and London, "CAPITALISM WITHOUT OWNERSHIP WILL FAIL - A Policymaker's Guide to Reform", published by the Centre for the Study of Financial Innovation (CSFI). It is a deliberately short booklet of a mere 32 pages of text which can be read in 1-1/2 hours. (It comprises Appendix A to this letter as it did to Bob Monks'. The table of contents is included as Appendix B for ease of reference.) To the best of our knowledge it is the only comprehensive analysis of all the contemporary serious and malignly reinforcing weaknesses of Anglo-American shareholder capitalism. (This booklet's analysis and conclusions are endorsed in the just published, well argued major survey on "Capitalism and Democracy" in the 160th Anniversary edition (28th June - 4th July) of The Economist, especially pages 9 to 11.)

The SEC is engaged on a major enquiry into whether there is a case for shareholders to have the right and effective means to appoint some non-executive directors. The difficulty for you, as for any single issue enquiry, is that the focus may be too narrow to comprehend all the relevant complexities and their interactions. It risks sub-optimal or even unintentionally damaging conclusions. For this reason our wider enquiry, which led us to four interdependent integrated remedies which address all the major corporate governance weaknesses, including the provision of truly independent directors, may be particularly relevant for you. I set out below the very briefest summary of our analysis in the context of the SEC's concerns.


The unintended and unforeseen consequence of channelling a major part of individuals" savings invested in equities into institutions, encouraged by government tax incentives, has been to neuter the effective ownership of shares. (On investment grounds it is of course entirely sensible for investors to pool their savings to gain expertise and to spread risk.) Major powers have been passed to corporate managements (our page 9). They choose their non-executive directors and the auditors (i.e. the monitored appoint both of the shareholders" main monitors with no shareholder involvement). They choose the remuneration consultants who advise board remuneration committees, and unsurprisingly the consultants are primarily loyal to their paymasters, as are non-executives and auditors. Managements also effectively choose the fund managers who run their corporate pension schemes even when employees can choose from a slate of advisers. So the fund managers also depend heavily on corporate patronage.

This represents a huge concentration of power in the hands of CEOs who are not effectively accountable to their shareholders. All economic thinkers from Adam Smith to Milton Friedman, all political scientists and indeed commonsense, tell us that when those to whom power is entrusted are not effectively accountable to those whom they serve a greater or less abuse of that power is inevitable. And so it has proved in your country and mine. Never since the Great Crash of 1929 and its aftermath have corporate managements in general incurred so much public distrust. Yet economic growth and rising living standards primarily depend on effective shareholder capitalism. We neglect reform at our peril. Governments date not stand aside when trust in shareholder capitalism is so damaged. The need for wise, well considered reform has never been greater.

The long held fundamental tenet of and justification for shareholder capitalism is that it is run in the long-term interests of shareholders, both the direct individual shareholders and the indirect beneficial shareholders whose investments are held collectively by investment institutions - 50% each in your country. Decent retirement incomes depend on the success of corporations meeting these objectives. Yet average CEO tenure in major companies is now only 3-4 years and falling, and their primary incentive is 2-3 year stock options. Optimum, sustainable, long-term corporate performance can hardly result from a series of necessarily short-term oriented CEOs. CEOs (absent the fraudsters) are not to be blamed for such incentives. They are imposed by the demands of institutional intermediaries whose own tenure is equally short-term and who put inevitable pressure for short-term performance on corporate managements to preserve their own tenures.

This is evidence of a systemic fault. Neither managements nor investment institutions are able to play to their undoubted longer-term strengths for sustainable, longer-term performance. And all individual and beneficial shareholders pay the price. Investment institutions lack the necessary incentives and preconditions to behave like long-term owners yet the evidence from the few who go in for small, long-term ownership portfolios is that they can outperform the conventional approach, often by a considerable margin (e.g. Warren Buffett and Berkshire-Hathaway). As long as investment institutions lack the security of tenure to take the long view this weakness will persist. But there is now strong worldwide evidence (our pages 25 to 28) that well governed companies with committed, knowledgeable shareholders and some truly independent directors are worth 20% or so more than conventionally governed and owned companies, and more again if the Monks/Sykes proposals are implemented. These are huge potential gains. But the institutions, owning typically 1% or less of the major American corporations, lack the necessary individual incentives to try to hold managements to account (our pages 13 to 14). To do so is to incur all the costs of successful actions for only 1% or less of any reward, with 99% going to one's passive competitors. Further, even if they succeed occasionally - and it can only be occasionally because no-one institution can take on more than a few companies a year - they get the reputation of an "activist troublemaker" and put their future business at risk being dependent on corporate patronage. It is a no-win situation for activist institutions and a no-lose situation for passive ones. In sum, passivity pays. At present the ownership risk goes by default - yet it is incontestable that no-one looks after assets as well as the owners. The fundamental governance requirement is to make effective ownership worthwhile to realise the well attested very substantial prizes for shareholders in particular and the economy in general.

Our four integrated reforms address this wide problem - and the provision of some shareholder elected directors is a key part of this - but only a part. It is not sufficient on its own. It is important, however, to consider the general case for some shareholder elected directors (our page 14) because it is bitterly opposed by the great majority of CEOs. Yet CEOs are meant to be appointed by the board, not, as at present, the other way round. Up until half a century or so ago boards were commonly appointed by their shareholders to hold managements directly accountable to shareholders" interests. But now shareholders are virtually totally disenfranchised. The board (more commonly the CEOs who exercise an effective veto even with nomination committees) chooses its own candidates for succession and only one candidate per vacancy. Shareholders may have the formal vote but with no choice of candidates they are powerless. The vote is in effect "coerced ratification". It bears an uncanny resemblance to elections in the former Soviet Union or Saddam Hussein's Iraq. (It is equivalent to your President having the sole right to nominate a single candidate for every vacancy in the Senate and House of Representatives.) It should have no place in either of our countries who pride themselves on being the champions of democracy and accountability. Further, the general record of board performance - see Subsection 3 below - is deeply flawed. The need for truly accountable boards to raise long-term corporate performance is undeniable. And that means more independent non-executives including some chosen directly by shareholders.

I turn next to our proposals. The four proposed remedies in barest outline (see pages 30 to 35 of our booklet) are as follows


  1. Governments should affirm, in support of the principle that there should be no power without accountability, that creating an effective shareholder presence in all companies is in the national interest - and that it is public policy to encourage effective shareholder involvement in the governance of publicly-owned corporations. A national level Council should be created to ensure that this policy is applied by all executive and judicial branch agencies, competition authorities, stock exchanges and other entities.

  2. All pension fund trustees and other fiduciaries (insurance companies, mutual funds, etc.) holding shares must act solely in the long term interests of their beneficiaries, and for the exclusive purpose of providing them with benefits - i.e. the existing law governing trustees and fiduciaries must be strictly enforced.

  3. To give full effect to the first two proposals, institutional shareholders should be made accountable for exercising their votes in an informed and sensible manner above some sensibly determined minimum holding (say US$15m). Votes are an asset; accordingly, they should be used to further beneficiaries" interests at all times. In effect, the voting of most institutionally-held shares would be virtually compulsory.

  4. To reinforce the other three proposals, shareholders should have the exclusive right and obligation to nominate at least three non-executive directors per major quoted company. (Such Wall Street figures as the financier and former Ambassador Felix Rohatyn and the much respect governance counsellor Ira Millsten have recently suggested that direct nomination of at least a single director should be considered.)

  5. ..


1 Need for All Four Remedies

The first and fundamental point to emphasise about our proposal for a minimum of three shareholder selected directors is that it is only one of four integrated proposals. (They are all uniquely based on our comprehensive analysis of shareholder capital in the two main countries concerned.) It will not work well, if at all, without all of the other three. Without the government affirmation that a shareholder presence on major company boards is in the public interest it will lack support, respectability, any imperatives to act, and will not influence regulators such as yourselves. Without enforcing existing trust and fiduciary law, investment institutions will not act (witness the ERISA failure) nor will they be able to overcome their massive conflicts of interest (mostly by delegating to new investment intermediaries who would be free to act solely for shareholders - see our pages 34 to 36). Without being made accountable for their votes investment institutions could take refuge in allegedly putting pressure on companies "àbehind closed doors" - which we know seldom works. Our starting point therefore is to make the justification for all four integrated reforms. None can stand alone.

I turn now to the detailed supporting arguments.

2 Owners" Interests Should Prevail

Companies should be run ultimately in the long-term interests of shareholders. When they are, they are run also in the long-term interests of all other stakeholders. Further shares (including those held individually for retirement) are the main category of personal wealth in both countries. It cannot be disputed that no-one looks after other people's assets as well as their own. Yet manifestly, the real shareholders (individual and beneficial alike) are disenfranchised. Once those to whom power is entrusted are not effectively accountable to those whom they serve, self interest takes over to a greater or lesser extent. And the longer this goes on without check, the more benefits special interest groups divert to themselves. As we have seen, especially in the 1990s, every one of the participants in corporate life have rewarded themselves handsomely without looking after shareholders" best interests - and often when shareholders were losing value massively. This cannot be defended as the working of market forces - whereby all profit or suffer together. Rather it represents the exercise of monopoly power, especially CEO monopoly power. Corporate managements, auditors and consultants, investment institutions and their fund managers, lawyers, investment banks and their analysts, etc have all grown rich without serving shareholders" best long-term interests. (Nor have regulators done their job well.) This is not liberal capitalism doing its key job of being one of the main bulwarks of liberal democracy. Shareholder capitalism needs one of its periodic reforms to re-assert the primacy and validity of its long-held fundamental tenets.

3 Boards" Poor Stewardship Record

The general record of boards in aggregate in both countries does not support the view that most companies have been well governed, and that only in a relatively small number of cases has there been fraud - the "àfew rotten apples in the barrel". The evidence on two main matters is stark. There is no correlation between sustainable corporate performance and senior executive remuneration - and often negative correlation over a whole economic cycle. Second, 60% plus of mergers and acquisitions actually destroy shareholder value, but lead to major increases in senior executive remuneration which correlates closely to corporate size. (Most value destroying companies in both countries have been serial acquirers.) In the limit there has been fraud, even massive fraud, but non-fraudulent value destroying action has been far more widespread (high tech companies, companies, telecommunications, etc.). It cannot be argued that most boards under the present regime have delivered acceptable value for shareholders.

4 Misplaced Collegiality

Boards prize collegiality highly, but if boards are supposed to be run in shareholders" interests, one could argue instead for a majority of non-executive directors to be shareholder selected! All too often collegiality has meant not rocking the boat, giving way to CEOs, etc., enjoying the prestigious and useful contacts of board membership while enjoying the quiet life. (See Warren Buffett's early March trenchant denouncement of misplaced collegiality.) Undoubtedly most non-executive directors have no real appreciation of their complicity in not protecting shareholders" long-term interests, particularly in the long 1990's share price boom. ("àa financial reputation is a rising market and a short memory.") All this will continue unabated as long as Chairmen/CEOs effectively select their non-executive colleagues, or retain an effective veto over a nominally independent nomination committee. Every expert and every investigation in both our countries affirm that "independent" directors are essential to good governance, but none have yet led to directors of the necessary independence. Always the CEO retains a veto. How can self-perpetuating boards be fully and sufficiently independent? The time has surely come to get real accountability into the heart of the boardrooms of all major quoted companies. Our proposals alone can achieve this - and our integrated interdependent reform proposals alone are based on a fully comprehensive analysis of all the serious corporate governance weaknesses, and thus avoid unintentioned damage elsewhere. Finally, it needs to be remembered that on several major matters the interests of senior executives and shareholders frequently diverge - notably over executive remuneration and mergers and acquisitions (see above). Full collegiality, what has prevailed almost universally up till now, has failed to deal with these problems. Only if some genuinely independent directors are chosen by those most concerned, shareholders (or rather their properly motivated agents, the investment institutions), can any worthwhile improvement result.

5 Divided Boards? - A Misplaced Worry

The key point to emphasise is that shareholder selected and elected directors will be from the same pool of experienced businessmen and women as now. As all individual and institutional shareholders would have a vote only such people would be elected. The only difference is they would not be neutralised by CEOs to whom they would no longer owe their appointment or reappointment. Further it would be a competitive process whereby more candidates might well be put forward than the 3 or so available directorships - a further and welcome major safeguard which no democrat should fear.

Second, and speaking from personal experience, in normal times no-one would be able to identify which non-executives were shareholder chosen and which conventionally chosen. Only in a crisis does behaviour change. Then independent shareholder directors are freer to do their job - and this soon encourages the independence of the others. (It also lessens the risk of shareholder suits, since companies with independent directors are less likely to allow wrong conduct, and so are less risky for all concerned. As importantly, well governed companies are much more successful - see above.) The attraction of board membership thus increases because real independence of thought and action is contagious, and the job is more interesting, worthwhile and achievable. And boards thus strengthened would give CEOs the longer-term incentives which would truly align their interests with all shareholders. Effective CEOs have nothing to fear and everything to gain. The same applies to investment institutions and their fund managers.


I hope I have now strengthened the case for having shareholders elect a minimum of three non-executive directors per major company. As importantly I have tried to put this reform in the context of the three other necessary integrated reforms for which Bob Monks and I have argued. Without these complementary reforms a few shareholder directors, while highly desirably, will be largely ineffective.

Respectfully submitted.

Allen Sykes


Appendix B: Table of Contents to Appendix A.

Appendix B:

CAPITALISM WITHOUT OWNERS WITH FAIL: A policymaker's guide to reform
PREFACE - Andrew Hilton, Director CSFI 1
FOREWORD - Sir Brian Pearse 2
FOREWORD - Henry Kaufman 3
    Threat to equity culture 7
    Damaged investor trust 7
    The gathering storm 7
    Increasing unease 7
    Crisis reactions 8
    The major inappropriate powers of corporate management 9
    Deeply entrenched short-termism 9
    Absentee ownership, the double deficit 10
      The investment institutions 10
      The fund managers 12
    The systemic fault 13
    Board composition and accountability - the reality 14
      The misconceptions 15
      A window on the Enron board 15
    Management remuneration abuse 16
      Transparency is insufficient for reform 17
      Examples of excess 17
    Too many poor value mergers and takeovers 19
    Auditors, consultants etc. Too close to management 20
      General audit considerations 20
      Auditing remedies 21
      Remuneration consultants 21
      The need for relationship-driven investment bankers 22
    The dangerous obsession with maximising shareholder value 22
    The need to realign interests with shareholders 23
    Britain equally needs corporate governance reform 24
    The weaknesses in perspective 25
    Avoidable massive value destruction 25
    Reducing avoidable corporate waste 26
    Benefits of committed ownership 26
    Positive evidence 27
    The main British initiatives 28
    The main American initiatives 29
    A four point reform programme 30
      Crucial interdependence of the proposals 31
    Immediate benefits from implementation 32
    Effective change 33
    Possible market responses 34
      Special purpose trust companies 35
      Specialist investors and relationship investors 35