Virtue may be its own reward—but just to be safe, shareholders of Nortel Networks squeezed it into a $2.5 billion lawsuit settlement anyway.
When Nortel announced last month that it agreed to pay nearly $2.5 billion in cash and stock to resolve investor claims stemming from three years of restated financial results in the early 2000s, the telecom equipment company included another promise: good governance.
Pearce
Nortel pledged to place in the top quartile of companies ranked by Institutional Shareholder Services’ Corporate Governance Quotient, saying the board of directors “strongly believes that sound and responsible corporate governance is integral to Nortel’s future,” according to a statement by board Chairman Harry Pearce.
ISS spokesmen say the arrangement is the first time they’ve seen a company publicly promise to achieve specific governance target, especially in the context of a lawsuit.
John Coffey, partner with Bernstein Litowitz Berger & Grossmann, which represents the Ontario Teachers’ Pension Plan Board and several other plaintiffs in the Nortel settlement, says the governance promise springs from five years of institutional investors growing more adamant about governance changes. “This is the natural evolution,” he says (see related coverage in box at right).
Nortel declined to detail how it decided on the 25th percentile of the CGQ Index, saying the company is in a quiet period before releasing financial results.
Coffey
Coffey says Nortel does not want to be in the top 10 percent of the CGQ, since it still wants flexibility to run the company as necessary. “They want to be one of the best-run companies, but not enslaved to someone’s cafeteria listing to be in the top 10,” he says. Coffey also stressed that the agreement is a material condition that hasn’t been finalized yet.
Near The Bottom
And exactly what must Ontario-based Nortel do to reach the 25th percentile? Actually, nothing—Nortel is already well above that threshold, ISS says.
ISS scores companies by comparing them to a specific stock market index and to their industry peers. In Nortel’s case, the company has a 90.4 index rating, meaning it outperformed 90.4 percent of the companies in the S&P/TSX Composite. Its “industry score” is 82, meaning it outperformed 82 percent of the companies in the technology, hardware and equipment group.
Nortel’s index score is an improvement from its 89.2 score six months ago. Its industry score, however, has sagged from 91.7 in the same time. Nortel’s index score has been surging while its industry score has been declining since early 2005.
Scores are based on how companies compare to other companies in their respective groups. “Even as Nortel made positive changes that positively impacted its position relative to other Canadian companies, globally, firms in their industry group were making even more rapid improvements, resulting in a decline in their relative position within the industry,” says John Deosaran, ISS’ vice president of rating products.
CGQ uses 63 governance factors to evaluate U.S. companies and a subset of 55 factors for all other companies. Board-related issues account for 40 percent of the score, compensation and ownership issues 30 percent, anti-takeover policies 20 percent, and audit-related issues 10 percent.
Deosaran stresses that 10 factors alone have the potential for the greatest affect on scores. Topping the list is a company’s capital structure, and specifically whether it has a dual class structure with unequal voting rights between share classes.
Rankings also differ from industry to industry, so practices could be deemed top-notch for one industry but poor for another. Deosaran says Nortel’s industry group performs below average versus the other 23 industry groups. “It is near the bottom,” he says.
According to a separate analysis conducted for Compliance Week, ISS points out that in recent months, Nortel has instituted a handful of policies that enhanced its governance score.
For example, outside directors currently account for more than 90 percent of its board, versus 66.7 percent at year-end. In addition, its nominating committee is comprised solely of independent outside directors, and the board can hire its own advisers. At year-end, the nominating committee included affiliated outsiders.
This year Nortel has also prohibited the repricing of stock options. In addition, consulting fees are less than audit fees, a reversal from 2005.
On the other hand, ISS points out at least three areas where Nortel’s governance practices worsened: the board has no approved succession plan, its governance committee has not disclosed any meetings in the last year, and in just the past few months, the company went from requiring a majority vote to a supermajority vote requirement to approve mergers.
What’s more, Deosaran warns, “as other companies make positive changes, it can depress their standing. So you must watch the other companies. It may necessitate them to make a change due to the relative nature of the scores.”
Some critics sniff that Nortel’s pledge is somewhat disingenuous, since it didn’t commit to certain, specific governance practices. Says Darren Robbins, a co-founder of Lerach Coughlin Stoia Geller Rudman & Robbins, which has successfully negotiated governance changes on behalf of institutional clients in prior class-action lawsuits: “The large institutional investors I advise demand specific corporate governance improvements delineated and entered as part of a court order, so long-term interests are protected.”
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