All On Board
All On BoardReaction to the Sarbanes-Oxley Act has helped determine the best and worst gaming boards of directors of 2003 HVS International
For the typical investor, corporate governance has always been cloaked in mystery and backroom intrigue. However, recent corporate scandals have prompted the Securities and Exchange Commission to launch new corporate reporting legislation, including the Sarbanes-Oxley Act. Welcome to the world of corporate governance.
In the afterglow of these scandals, we set out to evaluate the performance of gaming boards of directors. Already among the most scrutinized businesses in the land, will the gaming industry react to this new legislation and scrutiny quickly and efficiently? To answer this, and other questions regarding the practices of gaming companies' bodies of governance, we studied the public documents of 48 publicly traded gaming companies, and compared findings with other experts on corporate governance. We then rated each company in four key areas:
• The size, makeup, and independence of the board.
• Their committee structure, and its effectiveness.
• The prevalence of interlocks, insider participation, or other related transactions.
• Commitment to pay per performance-particularly for the CEO.
By the numbersOur goal in this is to acknowledge the efforts of those companies who make a real commitment to quality governance, while also identifying those who need to reexamine their purpose. As in other years, we noted a number of trends worth commenting on. Of the companies surveyed:
• 56 percent have independent consultants, brokers, attorneys, or other professionals on their board who are also paid a fee for their professional services. This insider participation is down from 64 percent a year ago.
• 21 percent allow interlocks. Exactly the same number as in last year's survey.
• 21 percent provided some form of actual director attendance record, above and beyond the ubiquitous boilerplate assertion that "all directors attend at least 75 percent of the meetings of the board, and subcommittees in which they participate." This is up from 13 percent last year, and we once again compliment this trend.
• 58 percent of the firms CEO's also serve as chairman of the board. This is down from 64 percent last year, but still
surprisingly high considering the modern climate of board scrutiny.
• As we note every year, there is still no company that has established criteria for monitoring, and evaluating director performance/contribution.
• 81 percent pay some portion of director compensation in the companies' stock-exactly the same percentage as last year.
• 92 percent have a standing compensation committee compared to 94 percent a year ago. However, 27 percent of those committees met only once or not at all in the course of the year. We feel that it is necessary for a committee to meet to be effective.
• 40 percent have established governance, or executive committees. However, 42 percent of these committees conducted one, or no meetings.
Board size, makeup and independenceWe feel that a board must be measured against a clearly articulated set of best practices. In regard to board size, that would be not fewer than five, or greater than fifteen members. In practice, too small a board has a narrower than desired perspective, and too few members to appropriately staff its requisite subcommittees.
As a case in point, the four-member board at Global Payment Technologies has three of its four members (including the CEO) as its compensation committee, and shuttles in the fourth member instead of the CEO as its audit committee. This hardly qualifies as subcommittee structure since there is little or no distinction between the full board and its committees.
On the other hand, too large a board can simply be overly difficult to convene in a manner allowing for making timely decisions.
Consider the eighteen-member board of MGM Mirage whose notably prestigious members often sit on numerous other boards as well. Their full board conducted four meetings last year, while their executive committee convened twelve times. We are not chastising the active role of the executive committee, but rather suggesting a smaller board would allow for striking a more even balance between that group, and the entire board.
An odd number of board members also seems an obvious choice, and is recommended by all corporate governance experts as it allows for a quorum on all issues put to a vote. Yet in our study, just over half, or 54 percent, of gaming company boards were comprised of an odd number of members. We also look for a greater number of wholly independent members, or company outsiders. For example, Harrah's Entertainment had 11 independent directors and only two company insiders on the board. On the other side of the coin, at Interactive Systems Worldwide, only two of its five-member board are company outsiders.
Attendance and participation in meetings is absolutely crucial to evaluating director performance and the performance of the board. That is why it is very pleasing to see a growing number of companies who are providing some record of attendance. Many of the world's most effective boards have established systems of evaluating director performance, so shareholders can vote for or against a returning director based
on some knowledge of their performance. Though every year we encourage this model being adapted in the gaming industry, there is still no gaming
company that makes this information available to their shareholders.
Independence, as noted previously, is the final key area of the makeup of the best performing boards. Directors who are in no way beholden to the firm or its executives are better able to serve the shareholders. Furthermore each director should have expertise and experience that brings value to the board they serve. At Harrah's, directors include the CEO of a prominent retailer, the former CEO of a major entertainment studio and the CEO of the Joint Center for Political, and Economic Studies.
We feel that the most commonly abused area of director independence is seen in the choice of the board's chairman. As we noted earlier, a company's CEO- obviously an insider-is also the board's chairman in 56 percent of the firms studied. Like most experts in corporate governance we prefer to see this role held by a company outsider, yet only 12 percent of the companies in gaming follow that principle.
Committee structure and effectivenessAn infrastructure of subcommittees is a hallmark of effective board performance. The gaming companies we analyzed had as many as six standing committees, but the "must-haves" are audit, compensation, nominating and governance/executive committees. With the exception of the executive committee, these must be composed entirely of independent outsiders who have knowledge or expertise in the relevant subject matter. New definitions have been adapted by all the exchanges as to what constitutes an independent director.
With the advent of Sarbanes-Oxley, the audit committee has undergone the most restructuring. Most companies now clearly address the issue of independence where their audit committee members are concerned. In fact, we noted last year that Edson R. Arneault, CEO of MTR Gaming, was then a member of the company's audit committee. This year, we are pleased to report that Arneault no longer sits on that committee. At Argosy Gaming, whose board was our top performer for the past two years, their audit committee report clearly states the committee met seven times just to monitor the effectiveness of the audit effort and internal controls.
This year, the number of companies who report having nominating committees rose to 29 percent, from 19 percent last year. However, 63 percent reported that the committee did not hold a meeting. Again this would indicate the committee exists in name only.
Many of the companies commented that the nominating committee did not have to meet because no new directors were being nominated. Bad excuse. If directors only held their positions for a one-year term and were being formally evaluated, we guarantee that more nominating would need to be done. Furthermore, we feel it is extremely important to have independent directors reviewing and making recommendations of future board nominees to prevent the board from inbreeding and developing a monocular perspective.
Interlocks and insider participationIn this very critical area of business ethics, public gaming companies have made no real strides. Twenty one percent of the companies in this year's survey allow board interlocks. This instance of "you sit on my board, and I'll sit on yours" presents the clearest potential for conflict of interest, and should really be entirely eliminated.
Insider participation also continues to thrive in gaming company boards with 56 percent of the companies in our survey engaging in some form of this practice. These occurrences of fees, rent, or professional payments made to otherwise seemingly independent directors are generally stated in the companies' public documents with a disclaimer that the price paid to their director, or their company, is no more than fair market value. That may be true, but it is an obvious conflict of interest. Can a director who views the firm-and its CEO-as a valued client and income source be truly impartial? We don't think so.
Commitment to pay per performanceCorporate governance experts agree that the best boards closely link compensation for the firms' CEO and other senior executives to specifically defined performance goals. The gaming industry has clearly embraced this philosophy at least in form, if not in fact.
This year, 92 percent of the companies we studied reported having a standing compensation committee, compared to 94 percent last year. As recently as 2001 however, only 59 percent of public gaming companies could make that claim. Unfortunately, as we noted last year, the compensation philosophy stated by many of those companies is vague boilerplate talk about attracting, and retaining the best and brightest, blah, blah, blah.
The best performing boards in the gaming industry, like other industries, utilize outside sources to obtain competitive compensation information, and very clearly state the criteria by which bonuses and long-term incentives are granted.
The same experts contend that there should be criteria by which the contributions and performance of directors are evaluated. We also believe this is essential, or else a shareholder is really only able to cast their proxy vote blindly or on the chairman's assertion in the proxy statement that the company encourages a vote for the nominated directors approval.
The evaluation should be published in the company's public documents and made available to its shareholders. Furthermore, we feel that directors should be required to own a significant amount of company stock, to ensure their focus on long-term strategies as well as short-term operating needs. There is still no gaming company that requires stock ownership of their directors, though as we noted earlier 81 percent do pay some portion of the director compensation in stock options.
Top performersThis year's top performing board has been in the top five every year we have conducted this survey, and has been acknowledged as best performing board in gaming three of the last five years.
Harrah's Entertainment has shown a commitment to being a leader in best practices where corporate governance is concerned, and they continue in that tradition.
In this year's proxy statement, the firm published pictures of their board members-both nominee and existing. Though a seemingly very small thing, this allows a shareholder to "humanize" the board, rather than knowing them only as a short bio that tends to be an intimidating list of accomplishments. While it is not as good as a performance evaluation, it shows an effort to make the board more accessible to the shareholders.
The list of top performing boards doesn't change much from year to year as good board practices can be repeated. Once established, they tend to be self-renewing. This is the same group it was last year with some small changes in the order of their ranking. Among the best boards, we have to look very closely to separate the best from the best.
Worst performersUnfortunately bad corporate governance is just as repeatable as good, and this list is also little changed from last year's. Boards of two members (Bingo.com), boards whose committees don't meet (Florida Gaming), boards that have the company CEO on the compensation committee (MDI Entertainment) all definitely need to reexamine their practices.
Gone from the list of worst performers this year is Trump Hotels & Casino Resorts who took a number of great steps to eradicate bad governance. Significantly, they announced that they were disbanding their executive committee of one member, Donald Trump, who acted with the power of the full board. It is possible to change bad practices.
As in every year, this study produced much that has stayed the same, as well as some interesting new twists. Considering the drastic changes in the country's-and the world's-attitude toward corporate governance, the public gaming companies stayed pretty much the same.
Perhaps next year the news will have reached boardrooms everywhere. CJ