Red Flags

Sometime ago, I was helping recruit speakers for a NIRI-Chicago program and a friend recommended a recently “retired” CEO of a small-cap industrial manufacturing company.  I did a little background research on this person – let’s call him John – to determine if he would be a good fit for our panel discussion.  While we never connected, I tell this story because its illustrative of some of the red flags of poor governance practices.

This company was formed in 2000 when it split off from a larger conglomerate.  At the time, prospects appeared poor as the company competed in the global industrial, energy and heavy equipment industries and was saddled with significant debt.  John joined the company shortly after the split and served as division president for multiple business units, eventually becoming Chief Operating Officer.  For roughly five years as COO, John partnered with the company’s first and only Chairman and CEO to grow the company organically (think energy/fracking) and via acquisition (10 acquisitions collectively costing over $525 million in five years).

The board was comprised of eight people, including the Chair/CEO, another 30-plus year C-Suite executive (not John) plus 6 independent directors. By the early 20-teens, about half the board had served for more than 10 years and the shortest director tenure was five years.  Tellingly, around this time, the company failed to get a majority affirmative say-on-pay vote.  So, the following year the board took action:

  • The compensation program was revised.
  • The Chairman/CEO relinquished his role as CEO but retained his role as Chairman.
  • The other employee-director left the board and a new independent director was elected.
  • John became CEO and was appointed to the Board.

I’m sure you can see the warning signals:

  • Board composition and lack of refreshment: With two employee-directors, representing 25% of the board, perspectives could easily be skewed.  In addition, even though long board tenure isn’t always indicative of a lack of objectivity or engagement, it does raise questions given how the company and competitive environment had changed
  • Executive compensation: Executive compensation is often considered a litmus test for board independence.  So, the say-on-pay vote points to a failure of independent thought on the board
  • Chairman/lead director: Allowing the first and only Chairman/CEO to retain the Chairman role is not considered a best practice.  It likely seeded confusion within the company and the boardroom.

From an outsider perspective, John’s position was precarious given these governance red flags. The macro environment didn’t help either. During John’s short tenure, oil prices dropped by about half, causing contraction in the U.S. energy industry as active rig counts fell. Over the same time period, China’s growth slowed and its currency devalued, dampening global demand for industrial equipment.  The company keenly felt these pressures as did most other U.S. industrial manufacturers.  The company’s stock price fell approximately 35% since the previous year’s peak (other companies in the same sector saw stock declines ranging from 15% to 40%).

After roughly 18 months John was out as CEO, replaced by the company’s former first and only Chairman and CEO. Interestingly, a few months after this change, a known activist announced they had accumulated a more than 5% position.  I suspect this activist pressured the board to look at the company more carefully.  Today, a new external-hire CEO is leading the business; the lead independent director is the non-executive Chair and two new directors replaced two retiring directors.  The former first and only Chairman/CEO left the company and board.

Lisa Ciota
Lead-IR Advisors, Inc.

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