Interview: Matt Moscardi

We are big fans of Free Float Analytics, which describes itself as moneyball for boards of directors, a system for evaluating board risk. As they say, “We put the people back in capital markets.” We strongly recommend their Business Pants podcast, with lively and entertaining conversations about the wild world of corporate governance.

Free Float’s Matt Moscardi generously answered our questions about what makes a good (and bad) board.

When did you first get interested in how public company boards perform?

In the post financial crisis years, Lloyd Blankfein once said that Goldman Sachs was doing “God’s work” — I was at MSCI doing ESG ratings on financial sector companies and I remember thinking, “who the hell let that guy have a microphone?” The governance meltdowns of the financial crisis were my first reminder that people run companies, they aren’t just amorphous ephemeral branded deities. I started asking, “who’s in charge?” a lot, and pretty soon you get to boards and the investors that elect them. There wasn’t a good way to say which directors had good track records of shutting up the Lloyd Blankfeins of the world, so we built Free Float to do that. It’s hard to hold a director accountable if you don’t know how they perform, so we built it.

Why is that important for investors?

Investors really do two things — pick a stock and vote their shares. If you’re an index investor or a massive asset owner, you don’t even really pick a stock — the only thing you do is vote. I don’t think of the vote as a democracy, I think of it as hiring and firing. Investors are capital markets’ HR department. Without the vote, capital markets are just a Vegas casino. While gambling can be fun, it’s less fun when your client’s retirement fund goes to zero because you neglected to vote on directors who were supposed to be protecting your asset but were busy paying the CEO and putting their friends on the board. Investors need to be constantly reminded that the board works for them, the board’s job is to take a long view on not screwing up. Boards are defense to management’s offense, and defense wins championships (or so they say).

We don’t know what goes on inside the boardroom, what questions are asked, whether anyone votes “no” on agenda items. What indicators are usually overlooked but meaningful?

Oh man, there are so many. The ones we have that are overlooked we used at Free Float to build an attribution model. Mostly we wanted to know who’s the loudest voice in the room — who’s the director everyone looks at when they have to make a decision. The most overlooked indicators entirely revolve around the actual people — how they got there, who they know, how much stock they own, are they insiders or outsiders, and what’s their role in the room. We know all that, but still it’s overlooked.

But the dream of any governance analyst interested in actual directors is a board meeting transcript. We want to know as much about directors as we know about professional athletes — we know LeBron James’s shoe size and favorite restaurant, we know Tom Brady’s favorite ice cream and how often he pees. For a director, I want to know who picks the types of bagels (and who complains about the bagel choices), who spends most of their time reading TMZ on their phone, who fell asleep during the audit committee report. I want a timeline of weight changes — are they stress eating this week? — and how big of a tip they leave. We’ll obviously never get any of that for a million reasons, but think of all it actually tells you.

The truth is boards are teams, whether they call themselves teams or not. They get an average tenure of seven years in the US and make millions of dollars in pay and options to make hard decisions and manage company management. And those decisions can cost investors billions, because the data suggests that directors aren’t necessarily there to generate alpha, they avoid destruction. So what would you want to know about the team of people you hire to avoid catastrophe?

How do we know if a director is “independent?”

I’ll put it this way — we built a database of director interlocks on other boards, but also increasingly non profit boards and affiliations like the Business Roundtable or Council on Foreign Relations. More than 20% of every board in the US, on average, is connected to itself. Then there’s the “soft” or cultural independence indicators, like what colleges the directors go to and what subject they got their bachelor’s in. Between the two sets of data we already have, the idea of independence is largely a joke, and exchange standards are even more laughable.

So assume that virtually no directors are “independent” — then the question becomes who the directors actually work for, management or shareholders? A director who sits on the pay committee and is connected to the CEO through another board whose kid goes to the same private school as the CEO’s kid doesn’t work for shareholders. But a director who is two steps removed from the head of the nominating committee that fills knowledge gaps on the board by adding some much needed AI experience with a track record of success is much more likely to not need to kiss the ring.

What topics do you cover in your podcast and have any of your guests surprised you? Have any inspired changes or additions in your approach?

We cover a lot of ground, but it’s all around people in business. The number of times a headline says “The CEO of XYZ Corporation” without giving their actual name might be a hate crime at this point — and forget finding out who the CEO’s bosses are on the boards. So we cover business news but with a people twist on Business Pants, replete with incredulous irreverent snark and real data, and deep people analytics for proxy voting on Proxy Countdown for investor professionals. The best stuff we get from our guests when we have them, and we’ve been judicious about it, has really been stories — you have some of the greatest stories of governance meltdowns, idiosyncrasies, and lunacy, and history repeats itself over and over. Mostly what we learn from our guests is not to forget what’s happened before and to be curious about everything.

What does CEO pay tell us about the board’s effectiveness?

That it’s not that effective?

Here’s a stat to sum up how directors and investors think of CEO pay: the majority of US company boards pay CEOs 75% of their target bonuses for performing in the BOTTOM QUARTILE of all their peers. That means the WORST CEO — the guy who ranks dead last against market peers on every metrics — still gets 75% of his BONUS target on top of his salary. Imagine that! Imagine going to your boss at a gas station and saying, “I am literally, by all metrics, your worst employee, and I deserve 75% of my bonus as a result.”

We know in the data the director who’s most connected to other directors, on average, is the CEO. We’d all love to be our own boss and set our own pay, but you know what’s just as good? Getting your friends to do it for you — and calling them independent board members.

Are boards adapting to changes in technology like AI and cyber-attacks?

Clorox would suggest they are not. And so, in fact, does the data. We used every director’s biographies, education, and industry experience against a massive database of knowledge and skills built on years of surveys to estimate what BASE KNOWLEDGE a director is likely to have. We ran it across more than 200,000 directors, and what we found is a massive and obvious skew — nearly every board is stacked with finance professionals, have one accountant and one lawyer, and nearly zero core industry experience aligned with the company. The result is a massive gap in understanding technology shifts like AI or cybersecurity. Combine that with the average age of directors at 65 years old, and it looks like the teams that are supposed to play defense for investors are almost totally ignorant of how to manage the inevitable future. And I’m not sure taking a two day educational seminar on how AI works qualifies you as a board member to make strategic decisions about AI that manifest over a decade.

What do you tell us about individual directors that is not revealed in the proxy statement?

First and foremost who has the power. It’s obvious in some cases — like Zuckerberg and his dual class shares or Musk and his classified board with his brother on it — but much less obvious in others. For instance, Roz Brewer stepping down at Walgreens was predictable given how much power Stefano Pessina has, or Bob Chapek getting fired was predictable given links of the board to Iger and the fact that Chapek had less power than Susan Arnold in our data.

But otherwise, it gives you performance indicators. Markets have short memories, but people shouldn’t — when you track a director over time, you can see how companies are influenced by them. Some directors love paying CEOs, some take accounting risks, some are great at facilitating TSR. Some behavior makes things predictable — when we looked at Microsoft’s board, the one that set the 2050 “net negative” carbon target, we found that not a single board member had experience on any board (much less Microsoft) in reducing carbon emissions or hitting targets. This year, Microsoft announced a multiyear rise in its emissions. Or take the fact that a director who was on Lehman Brothers’ risk committee didn’t just keep board seats, but now is on the risk committee at US Bancorp, which becomes frightening when US Bancorp has 55% of its deposits uninsured and 45% unrealized losses covered by tier 1 capital in the height of the Silicon Valley Bank collapse and deposit runs.

What’s the best way to evaluate “board risk?”

One person at a time. “Board risk” is the risk that people don’t do the job they’re supposed to do, which is representing investors and protecting an asset. If you think of every investment as if you’re purchasing a sports team, you want to know who the team is and whether they win. Board risk is buying a stock without knowing the people who manage it, so the best way to manage it is to know everything you can about the teams you buy.

Originally published at http://valueedgeadvisors.com on August 20, 2024.