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By Jason Stipp | 04-20-2012 04:00 PM

Recent Events Put Spotlight on Stewardship

Sanibel Captiva's Pat Dorsey questions whether some boards of directors can remain truly independent and make the tough decisions for the sake of shareholders.

Note: Pat Dorsey is the former director of equity research at Morningstar. He is now the president of Sanibel Captiva Investment Advisers.

Jason Stipp: I'm Jason Stipp for Morningstar. Questionable behavior in the executive suite and the boardroom is nothing new, but some recent high-profile cases might have investors wondering when they really need to sit up and take notice. Joining me here to offer some insights is president of Sanibel Captiva Investment Advisors, Pat Dorsey.

Pat, thanks for joining me.

Pat Dorsey: Always happy to be here, Jason.

Stipp: There have been a few high-profile cases from a number of companies that make you wonder is this something I really, really need to be worried about. The first one we'll talk about is really a poster child for bad corporate governance, Chesapeake Energy. The firm was in the news again recently. What was the story behind that, and why is this really important to raise some eyebrows?

Dorsey: So, it appears that CEO Aubrey McClendon had borrowed some money, about $1.5 billion from some private equity firms that Chesapeake had had other dealings with. He has a very unusual arrangement where he gets about 2.5% of revenue from every well the company drills, but he has to foot some of the costs. So, the supposition is that that's where some of the borrowing needs came from, but it appears that the board didn't know a whole lot about this.

Chesapeake, of course, has a little bit of a history of unpleasantness in terms of corporate stewardship. There was a map collection that the company bought back from McClendon during the depths of the natural gas crisis in 2008 or so, when he got a margin call on his entire Chesapeake holdings. Board members get paid about $450,000 per year, plus 40 hours in the personal jet. So, how independent are they? I report, Jason. You decide.

Stipp: So, the board potentially even if they had known about this most recent dealing, given that they're pretty captive at this point, wouldn't have necessarily made a lot of difference.

Dorsey: That will be my considered opinion, yes.

Stipp: There are a couple things there. There is certainly a compensation component there and also the related-party transactions. Would you say those are two pretty big red flags?

Dorsey: I think so. When you see companies where board members are paid way out of line with companies of similar size, $450,000 a year for directors at a business of Chesapeake's size is just out of the ballpark. And then there's the use of the personal jet. CEOs using the company jet for personal time is an issue. But board members [getting] 40 hours? It really raises questions as to how likely are those individuals to raise that tough question at the board meeting when they're just getting such lavish perks from the business.

Stipp: Another company, a household name that's been in the news recently, is Avon. It had a takeover offer from Coty that it rejected. This is a company that's kind of been in the woods a little bit recently. What would you say about the governance there?

Dorsey: The average tenure of board members is I think about 10 years there. One could argue that CEO Andrea Jung stuck around a little bit too long. The board was very reluctant to get rid of her, even though the company really has not been performing well for several years. It has undergone numerous restructurings, and now the board has rejected a takeover offer without much of a credible plan of their own frankly. So again, it's just an issue at the board level here, whereas is the board truly independent? Is the board going make difficult decisions when the rubber hits the road?

Stipp: And really as a shareholder, you're depending on the board, especially for a company that's somewhat of having a crisis moment here, to make some of those tough decisions and maximize the value of what they've got there.

Dorsey: They are your representatives.

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