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BONDS OF PARTNERSHIP Do We Prepare Partners Adequately For Challenges?

THE AMERICAN UNIVERSITY KOGOD SCHOOL OF BUSINESS | SPRING 2012

CRASH LANDING Congress’ Attempts to Deflate Golden Parachutes

WOMEN’S WORTH Why a Token Female Board Member Cannot Add Value


FROM THE DEAN

IN THIS ISSUE 1 FROM THE DEAN 2 THE RISK-RETURN PARADOX 4 O PARTNER, WHERE ART THOU? COVER STORY 8 Blood in Business 13 Relative Leaders KOGOD TAX CENTER 18 Golden Parachutes Get a Lift From Congress 22 RUSSIA’S CORRUPT FREE MARKET 24 DUX FEMINA FACTI Women and Board Leadership 32 KOGOD STANDOUT Adventures in Silicon Valley 34 THE FRAGILE NATURE OF SUPPLY CHAINS 39 SUSTAINABILITY’S SPLINTER EFFECTS

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PRACTITIONER PERSPECTIVE When Succession Planning Goes Beyond the Family Barry Dewberry, Chairman, Dewberry, Inc. The Business Case for Sustainability Linda Fisher, Chief Sustainability Officer, DuPont

47 REGULATING INDEPENDENCE 48 WEB EXCLUSIVES Beyond the Page

Across the board, our faculty are pushing past the accepted thinking in finance, accounting, taxation, management, and more. Through their collaborations with private- and public-sector businesses, government agencies, and a bevy of nonprofit organizations, new knowledge is being created to shape the markets of today and tomorrow. Creating sustainable value for shareholders, now and in the future, is a complicated endeavor and a key concern of Kogod School of Business faculty. The carnage wrought by short-term thinking peppers daily headlines and fills congressional committee dockets. Market perceptions formed around “greening” core business functions, like supply chain management, are being reconsidered by Professor Bruce Hartman and Assistant Professor Ayman Omar. And DuPont’s chief sustainability officer, Linda Fisher, weighs in on how the global science giant helps its clients consider sustainability as a business priority. Vilifying corporations, and their leaders who “make too much” and “think too little,” has become a national pastime—one that will certainly remain an undercurrent in the unfolding presidential race. Yet the long-term value that business generates cannot be distilled into a single number. For our part, we’ll keep digging deeper into the multifaceted concept of value creation, and examine how a little perspective may help bridge the seemingly insurmountable divide between K Street and Main Street.

LETTER BY MICHAEL J. GINZBERG DEAN, KOGOD SCHOOL OF BUSINESS

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Nowhere is this more true than in the case of family firms. By exploring this nuance, Professor Ronald Anderson zeroes in on the unique forces at play in family firms that impact corporate governance decisions. His groundbreaking research has opened up entirely new avenues of thought on what family ties do to, and for, businesses. His collaborations with Associate Professors Parthiban David and Augustine Duru have revealed that the closely held firms with the most market value are also the most transparent; he has also uncovered that Great-Aunt Tilly just might be trading a little too early on that undisclosed quarterly earnings report. Barry Dewberry, MS ’82, provides a captivating first-person perspective on the tough choices family members who double as managers must make when planning for the future of the firm. CEO compensation decisions create an intriguing quandary for the boards of family and publicly held firms alike. Assistant Professor Yijiang Zhao joins his colleagues David and Duru to consider why a handsomely rewarded chief executive, hired to steer a company into new seas of opportunity, may be taking major risks that yield little return. Ready to raid the external audit team for financially savvy leadership? Take heed, warns Assistant Professor Yinqi Zhang: negative investor perception, along with regulation—including the SarbanesOxley Act—encourages greater distance between former auditors, auditing firms’ extraneous business services, and their clients.

KOGOD NOW SPRING 2012 | kogodnow.com

40 FINDING FEDERAL SAVINGS IN THE STRATOSPHERE

Few would argue that good corporate governance is not important to the longterm success of businesses and our entire financial system. There is, however, much less agreement on exactly what constitutes good governance.


THE RISK-RETURN PARADOX

Ever since young Jack traded his cow for some magic beans, society has bought into the concept that greater risk promises greater reward. The relationship is taken for granted as fact; empirically, researchers have shown it is fiction. ARTICLE BY JACKIE SAUTER

• Institutional ownership • Blockholder ownership (concentrated owners) • External corporate governance (measured through firms’ antitakeover provisions) • Board of directors’ monitoring • CEO ownership • CEO stock options • Product market competition Using regression analysis, the professors simulated the effect of each mechanism on the riskreturn relationship. They controlled for other factors that might affect performance, such as firm size, leverage, and diversification, as well as the possibility that risk taking can arise from within—say, in firms operating in high-performance industries (like the high-tech sector). They found that Bowman’s paradox is direr for companies that are not subject to efficient

IT STOPS AT THE TOP There was one notable exception to the market’s influence, in the realm of CEO compensation. As a corporate governance measure, compensation should help to ensure that managers take risks only when they are sure to be followed by a return. When motivated correctly, executives should swing for the fences with shareholders’ returns in mind, rather than their own payoffs. But the researchers point out that this does not hold true when the compensation structure isn’t working. Certainly, CEO compensation has been heavily scrutinized and hotly debated. But the risk-return paradox has never before been considered in terms of the influence of market mechanisms, compensation being one. CEOs are compensated in a myriad of ways, but often the majority percentage of their salary is dependent on performance. A typical compensation package includes a mix of total cash compensation (salary, bonuses), long-term incentives (restricted stock, stock options), benefits, and perks. Two compensation methods that the professors focused on were CEO ownership and stock options. They found that these two components behaved quite differently when analyzed. Fundamentally, an ownership stake exposes CEOs to both the upside and downside of a risk.

NO MAGIC SOLUTION The professors’ research clearly indicates that strong market mechanisms provide some relief for the risk-return relationship. But the larger question remains to be answered: Can the market truly mitigate managers’ actions as they seek to climb mythical beanstalks? Without the ability to isolate the market’s individual influences, the remedy to the problem could remain as elusive as Jack himself. David, Duru, and Zhao expect to submit their paper to journals this year.

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CHECKS AND BALANCES For the first time, the Kogod professors looked at the perplexing risk-return relationship in the context of market mechanisms. They wanted to unearth whether the market’s role could help explain the paradox.

Is the market, left to its own devices, capable of correcting managers’ mistakes? “Market mechanisms might be the reason that the risk-return relationship is not working well,” said Associate Professor Augustine Duru, who had previously studied CEO compensation in the context of accounting. In theory, these mechanisms should constrain the managers from taking excessive risks. For example, the labor market could act as a constraint to an overzealous CEO; if he takes unwise risks and is fired, he may not be able to find another job. David, Duru, and their colleague, Assistant Professor Yijiang Zhao, undertook the project. Zhao’s research background in corporate governance (in particular, takeover markets) and financial reporting primed him for the effort. The researchers studied how two broad types of mechanisms—corporate governance measures and product market competition—would affect the risk-return relationship. With a sample of more than 2,100 firms from the S&P 1500, the authors studied performance over a 12-year period and tested the interaction between the relationship and each of these market mechanisms:

Their regression showed that CEO ownership, like the other market mechanisms they studied, helped alleviate the risk-return paradox. Not so with CEO stock options. That’s not too surprising; if stock options are never exercised, the CEO is not any worse for the wear (even though the shareholders suffer). Let’s say that CEO Barney Johnson is given the rights to buy 10,000 shares of Cheap ’N’ Quick Restaurant Chain for $100 a share in January 2013. If the company’s stock is trading at $120 a share at that point in time, Barney’s made a cool $200,000—without investing a personal cent. And if the company’s stock is only trading at $75 a share at the time, well, he simply won’t exercise his options. At that point the options are called “out of the money.” “The stock options shield the manager from the downside, so there is a tendency to take excessive risks; that is what we are seeing,” Duru said. “All we’re trying to point out is that stock options could lead to distorted incentives.”

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There is a negative relationship: firms that take bigger risks get lower returns. “This flies in the face of what we would expect to find,” said Associate Professor Parthiban David, who holds the Collins Chair in Strategic Management. His expertise is in corporate governance. The risk-return contradiction, known as Bowman’s paradox, has befuddled management scholars for years. It’s unavoidable that firms must undertake risk—each time they enter a new market, launch a new product, or look for creative ways to cut costs. But they should do so only when rational decision making is at work. Here’s the conflict: managers, not shareholders, are the ones making the decisions. And their biases and behaviors can cause excessive risk taking in two common ways, agree like-minded researchers. In Framing, managers categorize performance as either a gain or a loss. When they see a clear point for the “Win” column, risk taking seems like a threat. But when a project is seen as a loss, then risks are suddenly viewed in a new light: as potential salvation. Simply classifying a project as a loss prompts the manager to take an excessive risk to get it back on track. Overconfidence is easier to relate to. By overestimating their own competence or the firm’s future prospects (or by underestimating their competition), prideful managers are led astray. They buoy their own belief in the likelihood of a positive return. Aligning risk and return is a riddle worth solving, because there are deep consequences for the company when a risk doesn’t pay off. Beyond the direct financial hit to the firm, risks can lead a firm to grow its personnel or reallocate its resources gratuitously. They can also negatively affect consumers’ confidence in the firms’ products. No one is arguing that risks should never be taken. On the contrary, “managers must be induced to take risks,” the authors write, “but only those that are likely to produce gains.”

market discipline. In almost every case, the market measures tempered the paradox. In the presence of weak market mechanisms, the risk-return relationship was negative, as the paradox predicts. However, as the market mechanisms gained influence, the relationship between risk and return became less negative. This relationship even became positive as the market mechanisms, such as monitoring by dedicated institutional owners, grew stronger. “The returns to risk taking are increasingly positive as the firm faces stronger market forces,” Zhao said. This was what they had hoped. And in the context of manager incentives, it’s clear what led to these results. A vigilant board of directors, for example, offers a powerful defense against brash business plans. Board members hold many trump cards; they sign off on executives’ compensation plans, and they also approve—or disapprove—proposals. The presence of more outsiders on a board, frequent board meetings, and the separation of duties on the board have all proved to take the edge off excessive risk taking.


O PARTNER, WHERE ART THOU? Contrary to the romantic notion of a passionate dreamer going it alone, most start-ups are founded by partners, not solo entrepreneurs. Think of some of the high-tech companies that have risen to fame and stunning capitalization in almost no time: Google, Facebook, LivingSocial. All started by partners.

DAVID GAGE, PHD, IS A CLINICAL PSYCHOLOGIST AND MEDIATOR, COFOUNDER OF BMC ASSOCIATES, AND ADJUNCT PROFESSOR AT THE KOGOD SCHOOL OF BUSINESS. HIS BOOK ON EFFECTIVE PARTNERSHIPS, THE PARTNERSHIP CHARTER: HOW TO START OUT RIGHT WITH YOUR NEW BUSINESS PARTNERSHIP (OR FIX THE ONE YOU’RE IN), WAS PUBLISHED IN 2004.

The trend isn’t limited to cutting-edge tech firms. Partners also founded some of the best-known companies of the 20th century: Black & Decker, Warner Bros., Hewlett-Packard. And then there are 3M, Costco, Microsoft, Intel, and Apple. Partners, too, founded them.

ABSENCE OF ATTENTION If we are going to improve our performance in teaching about partnership, it will be important to create a sound base of research for the lessons we convey. To date, there is very little scholarship available on this subject.

One reason for this is the complexity of the field. How many times have you heard the famous line, “It’s not personal, it’s just business” from “The Godfather”? For partners, family business owners, and even mafiosi, it couldn’t be further from the truth. Almost everything that occurs among partners in closely held companies is both personal and business. Co-owners constantly describe their partner relationship as a marriage, but hasten to add, “Except I spend more time with my business partner!” Recognizing the duality is advantageous. Researchers need to develop a realistic conceptualization of the challenges that partners face, one that fully appreciates the interpersonal-business pairing of partnerships. Anything less will be too simplistic to be helpful. The focus has to be on the individuals who do business together, not on the business itself. Unfortunately, researchers who want to study partners often feel slightly out of their element. They are typically experts in one discipline—psychology or business—but not both. Researchers from different disciplines may need to collaborate—as partners!—to study this topic effectively. Another hurdle is the fact that closely held businesses are truly closely held. They are private, which is an advantage for co-owners but a barrier for researchers. Researchers will need to provide partners with an incentive to share private information. Without a reason to open up, partners will likely remain something of a mystery. MEDIATION AS AN ACADEMIC RESOURCE As the founder of a firm that specializes in preventing and resolving co-owner disputes, I have learned that mediation is not only a process that partners usually agree on when they have serious differences. It is also a process that opens the door to the private, inner workings of partners. I discovered that the confidentiality of mediation helps partners open up and discuss things

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UNDENIABLE RISKS So why wouldn’t all start-ups begin with co-owners at the helm? Because there is also a dark side to the partner story. There are no hard numbers that spell out how many companies die premature deaths as a result

PREPARATION FOR SUCCESS Reviewing the curricula of our peer business schools reveals that very few offer courses for entrepreneurs who want to learn how to set up healthy business-partner relationships. Courses on leadership, managing teams, choosing among legal entities, and identifying funding are valuable to entrepreneurs, but miss the mark when it comes to having partners. Developing and maintaining good relationships with partners is not the same as leading an executive team or managing a company of a thousand employees. The intimate dynamics among partners are quite different from the dynamics of any employer-employee relationship. True co-owners tie their futures and fortunes together in a unique way. Partners have a fiduciary duty, and a loyalty, to one another that employers do not have to their employees, even if they give them honorific “partner” or “associate” titles. Business schools aren’t the only ones behind the partner curve. Incubation labs, economic development centers, the Small Business Association, venture funds, and even other private organizations focused on helping entrepreneurs seem to miss the importance—and the challenges—of having partners. To address some of these deficiencies, I developed and have taught a graduate course at Kogod for the past 10 years on managing private and family businesses. It covers the range of partner issues described above, delves into the value of co-ownership, and gives students concrete strategies to minimize the risks. In my view, more schools need to experiment with courses to help students understand partnerships.

THE INTIMATE DYNAMICS AMONG PARTNERS ARE QUITE DIFFERENT FROM THE DYNAMICS OF ANY EMPLOYEREMPLOYEE RELATIONSHIP.

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PARTNER ADVANTAGES Partners—whether they are family members or not—are extremely important because their presence boosts the chance of success. It seems like common sense; after all, there is strength in numbers. Generally speaking, partners mean greater resources: more skills, energy, capital, psychological support, networking capabilities. Need further proof? A study published last year by the National Bureau of Economic Research tried to determine whether having partners is really an advantageous strategy for entrepreneurs trying to commercialize inventions. The results were impressive. Projects run by partners were five times more likely to reach commercialization, and their average revenues were approximately 10 times greater than projects run by solo entrepreneurs. Research from Marquette University backs that up. The researchers investigated a sample of nearly 2,000 companies, categorizing the top performers as “hypergrowth” companies. Solo entrepreneurs founded only 6 percent of the hypergrowth companies. Partners founded an amazing 94 percent. One for all and all for one! Even Alexandre Dumas knew there needed to be three Musketeers—not one.

of partner difficulties. Private companies are not obliged to undergo a postmortem, but estimates often run to more than 50 percent failure within a few years. We know that many business advisers regularly warn entrepreneurs not to start businesses with partners, offering horror stories from past clients. “There are too many risks involved, and it’s extremely difficult to extract yourself from partners,” they warn. The risks are numerous. Many would-be business owners are under the dangerous misconception that completing certain legal documents fully prepares them for partnership. If anything, these legalities give partners a false sense of security that they have done all they need to do to protect themselves. If we accept that partner problems are a leading cause of start-up failure, we have to ask: Why aren’t we doing more to educate and train entrepreneurs to maximize the benefits and minimize the risks of co-ownership? Why aren’t organizations that fund entrepreneurial research helping start-ups prepare better for the challenges of having partners? Why aren’t VCs asking start-ups to do more to ensure their survival? As advisers to entrepreneurs and business students, we are not guiding them out of harm’s way. We are not teaching them sufficiently about either the risks of having partners—turf battles, personality clashes, values conflicts, money disputes, distrust—or how to minimize them. The box office hit “The Social Network” helped bring this issue to light in 2010, when moviegoers turned out en masse to watch the story of Mark Zuckerberg and his ill-fated Facebook co-founder Eduardo Saverin unfold on the big screen. A highprofile multimillion-dollar lawsuit between the two was eventually settled out of court. And Saverin wasn’t the only one to haul the Facebook co-founder to court. How do we prepare

entrepreneurs for the Winklevoss twins of the world—those who publicly allege they hold partner status, even though they may not? But helping future Mark Zuckerbergs mitigate their risks is not sufficient either. We need to also teach them how to proactively create healthy partnerships.


WHAT IF? they would otherwise never reveal to a stranger, from plans to sell the company to “creative” and sometimes ill-conceived methods for taking money from the business. Behind this shield of confidentiality, partners in mediation quickly realize that they only hurt themselves if they play their cards too close to the chest. Mediators, like myself, strive to convince the parties that to be effective, we must know everything that has transpired. We need to understand how their partnership works. Part of the conflict resolution process involves separate, individual caucus sessions in which each partner has a chance to lay his or her story completely on the table. They are often quick to seize this opportunity, because they believe that if they don’t disclose something, another partner almost certainly will—and no one wants to be seen as withholding key information, or appear to have something to hide. Partner mediations have thus been fertile ground for learning about what makes partners tick—and stop ticking.

PARTNER MEDIATIONS HAVE BEEN FERTILE GROUND FOR LEARNING ABOUT WHAT MAKES PARTNERS TICK AND STOP TICKING.

THE BOOK—AND BEYOND The lessons I learned from scores of mediation clients became the blueprint for The Partnership Charter. The book talks on the interpersonal side about personalities, values, expectations, and fairness. On the business side are roles and responsibilities, decision making, governance, money, and ownership. Partners also have to decide how they will handle differences. A scenario-planning process forces partners to prepare for the uncharted waters that lie in front of them. Some of the what-ifs they need to prepare for are unique to having partners:

WHAT HAPPENS IF A PARTNER HIRES A KEY EMPLOYEE WHOM THE OTHER PARTNER(S) DISLIKE(S)?

• What happens if a partner hires a key employee whom the other partner(s) dislike(s)? • How will you decide how to respond to an unsolicited buyout offer from a competitor? • What if the partners decide to close the business and the company has nothing but debt? Though mediation has taught us a great deal, we need to investigate the inner world of partners with more typical research paradigms and techniques. The research topics are many, but could include the importance of financial transparency, whether establishing a governing board mitigates conflict, and whether a partnership with a best friend improves, or lessens, the chance of success. Despite the gap in partnership know-how, we have learned a significant amount about what causes partners to “fall out” with one another. While there are numerous topics partners must address, the most important step they can take is to engage in a comprehensive planning process. To get the ball rolling, my business partner and I have also set up a website for The Business Partner Institute, an organization that can help people to share research ideas and explore interdisciplinary collaboration. By joining efforts—as partners do—I have no doubt that we can dramatically improve the shortand long-term success rate of start-ups.

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HOW WILL YOU DECIDE HOW TO RESPOND TO AN UNSOLICITED BUYOUT OFFER FROM A COMPETITOR?

WHAT IF THE PARTNERS DECIDE TO CLOSE THE BUSINESS AND THE COMPANY HAS NOTHING BUT DEBT?

KOGOD NOW SPRING 2012 | kogodnow.com

KOGOD NOW SPRING 2012 | kogodnow.com

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CASE IN POINT Here’s one example, from more than two decades of mediating business partnerships, that illustrates one of the common challenges partners face and for which they are ill prepared: determining ownership percentages. These partners, who ran a company in an emerging medical device industry, were not neophytes by any stretch of the imagination. Numbering five in total, they included a successful CEO from a regional consulting firm, an attorney, a seasoned marketer, a physician-investor, and an established medical researcher. As all partners must do, they had to determine their respective percentages of ownership. From the starting gate, each began jockeying for as large an interest as possible. Like forty-niners staking their gold rush claims, each of the five fought for

his share of equity. Eventually they followed the conventional advice of their advisers and “filled in the blanks” of an operating agreement. The storm appeared to pass. Exactly one year later, the consulting firm CEO (now the CEO of the new company) and the researcher claimed that they had all agreed to review everyone’s performance after a year’s operation, and then adjust their percentages accordingly. The lawyer and the marketing director disagreed vehemently, claiming that the idea of revising the percentages had been raised but then dismissed. The physician-investor, a friend of both the marketing director and the CEO, demurred, saying he was unable to remember the decision. The resulting deadlock took a toll on their relationships, their motivation, and their productivity. Worse, their employees were becoming aware of the disagreement. With threats of lawsuits hanging in the air, the partners agreed to try mediation. The convoluted dynamics among the partners quickly became apparent in individual discussions with mediators. The mediation was an in-depth study of the complexity of determining ownership percentages, and it revealed how tightly the partners’ egos were wrapped around these percentages. Since they were united around the goal of growing and selling the company in a few years, they were acutely aware of the value of every percentage point. With the help of the mediators, the owners eventually resolved the equity battle. In brief, some of the partners agreed to reduce their percentages to free up equity for certain key employees, and they shifted certain management responsibilities to resolve underperformance issues. The details can be found in my book on having partners, The Partnership Charter: How to Start Out Right With Your New Business Partnership (or Fix the One You’re In). Four things are important about this case study. First, mediation provided an opening to better understand how partners operate. Second, the plot line is very common: some variation of this true story occurs in most partnerships. Third, despite it being a common problem, there is almost nothing written to help entrepreneurs with a more rational process for determining equity percentages. And finally, this story describes but one of the many challenges partners may face.


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If "The Godfather" truly provided the answer to any business question, there would be a lot less angst about how to motivate employees. It’s not a stretch to contend that business was simpler under the Mob’s thumb. Processes and procedures were understood: family came first. The appearance of propriety was paramount. No Sicilian could refuse a request on his daughter’s wedding day. And if gambling debts aren’t paying the bills, it’s time to diversify the business. Why not try an emerging market?

KOGOD NOW SPRING 2012 | kogodnow.com

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COVER STORY BLOOD IN BUSINESS

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But imagine how turbulent the markets would be if a violation of respect resulted in literal bloodshed. It would make 2008 look like a banner year. The key was that in the gangster-ridden world of Old New York, everyone in the “organization” had aligned goals: preserve pride, profit, and a pulse. The same can’t be said for modern-day firms. This indisputable fact has given rise to the field of corporate governance, which endeavors to mitigate the myriad conflicts between managers and shareholders. It all boils down to a matter of diverging interests. Shareholders’ first priority is to maximize their own wealth: stock prices should go up, dividends should be paid. “Shareholders are often thousands of miles away; they generally don’t want to know about the day-to-day operations…there is a separation between management and ownership,” said Professor Ronald Anderson, who has spent the last decade researching corporate governance, particularly in family firms. Anderson holds the Gary D. Cohn Professorship in Finance. On the other hand, no one is entirely sure what company managers hold sacred. “They should be focused on maximizing shareholder wealth, but they have a natural tendency to protect themselves and maximize their own utility,” Anderson said, citing examples like the implosion of Enron and scandal at Tyco. “It’s a problem that has reared its head a lot over the last 10 to 12 years.”

JUST AS OVERBEARING FAMILIES TEND TO WEIGH IN ON DECISIONS “FOR OUR OWN GOOD,” FIRMS WITH ACTIVELY ENGAGED FAMILY OWNERS GENERALLY OUTPERFORMED FIRMS WITHOUT AN ACTIVE FAMILY MEMBER.

NOW YOU SEE ME… In their recent article in the Journal of Financial Economics, the pair invited Associate Professor Augustine Duru to study the effects of corporate transparency on family firms. Thanks to his prior research on the use of accounting information in CEO compensation, Duru had expertise in measuring transparency through an accounting lens. Like many others, Duru had initially assumed that family firms would be less valuable than diffusely owned firms. “But my colleagues’ empirical work showed that, certainly, family firms were more valuable. It seemed counterintuitive,” Duru said. Past research has demonstrated that corporate transparency is crucial in order to protect shareholders and mitigate conflict between large and small investors. But no one had studied transparency specifically within the context of family firms. “When they decided to bring in the accounting perspective,” Duru noted, “the question became: If we believe that accounting information is important to firm performance, what would happen if there was a lack of information?” While all publicly traded firms must comply with mandatory accounting disclosures, the authors acknowledge that there is still substantial variation in what firms choose to reveal—as well as in the amount of outside scrutiny they receive. Firms can also elect to engage in voluntary disclosures. “Transparency is clearly a choice; there are public companies that are not as transparent as they could be,” Anderson said. “But some of it is market-driven, and some of it is shareholderdriven as well.”

“THERE APPEARS TO BE A LOT MORE INFORMED TRADING GOING ON IN FAMILY FIRMS; GIVEN THE MAGNITUDE OF IT, SOME OF IT IS LIKELY ILLEGAL.” RONALD ANDERSON, PROFESSOR

To test their theories, the researchers built an index that ranked the opacity of the largest 2,000 US firms. Family involvement was defined as firms in which the founders or heirs maintain influence, usually through an equity stake. About 22 percent of the firms in the sample were founder-controlled, and another 25 percent heir-controlled. Opacity was categorized using four factors that indicated the levels of both internal and external opacity: • Trading volume and bid-ask spread, which lend insight into the amount of information uncertainty • Analyst following and analyst forecast errors, which help explain the availability of firms’ information The researchers determined that both types of family firms are significantly more opaque (by about five percent) than diffuse shareholder firms. “Their shares trade less than those in diffuse shareholder firms and exhibit significantly less analyst following,” they wrote. Analysts are important because they play a monitoring role. Large, publicly traded multinational firms are subjected to scrutiny; “multiple monitoring” keeps controlling families on their best behavior, just as the looming threat of the Five Families did in the Godfather’s world. How does opacity impact other shareholders’ wealth, beyond the family? Since family firms are more valuable—and tend to be more opaque—then was opacity more valuable? The opposite was true.

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FAMILY FIRST In hindsight, families should have gotten acclaim beyond the box office for their business skills. After all, family owners are highly incentivized to pay attention: on average, family owners have held their shares for more than 78 years, and have 69 percent of their personal wealth invested in the firm. They have a vested interest in ensuring that the managers running their companies are protecting their assets. Anderson and Reeb proved that despite their bumbling portrayal in the media (see: the Bluths of HBO’s Arrested Development), family firms are more valuable than diffusely owned firms, which are held by a large number of shareholders and investors. Family businesses are also highly prevalent. Thirty-five percent of Fortune 500 companies and 60 percent of publicly held companies in the US are family-controlled, according to the advocacy group Family Enterprise USA. It turns out family presence cannot be ignored. Just as overbearing families tend to weigh in on decisions “for our own good,” firms with actively engaged

family owners generally outperformed firms without an active family member. Decades after public firms’ initial offerings, many family members continue to hold hands-on positions in day-to-day operations. The findings ignited a flurry of attention from academic and mainstream media, including a Businessweek cover story. For Anderson, the next questions quickly took shape: Why are these firms more valuable—and under what circumstances?

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KOGOD NOW SPRING 2012 | kogodnow.com

IT’S NOT PERSONAL A company’s ownership structure should be a superfluous ingredient in its success, but Anderson and his colleagues have proved that family owners are of a unique flavor. Firms with controlling family owners (those who wield sufficient power to enforce decisions) are singularly motivated. Though the family members may not be as hands-on as Vito Corleone, their firms make distinctive investment choices, and flourish—or flounder—in certain circumstances. Spurred by the lack of research on family firms, Anderson and colleague David M. Reeb, now at the National University of Singapore, began in the late

1990s to evaluate family ownership and its connection to firm performance. Their findings changed the way academics and practitioners view this previously underrated demographic. Further research at Kogod has investigated family firms’ transparency, proclivity for insider trading, investment choices, and the impact of “family-style” debt. The surprising findings serve as indicators of how this inimitable slice of the business world stands apart.


COVER STORY BLOOD IN BUSINESS

Where a positive relationship existed between family ownership and performance, it was limited to firms with a high level of corporate transparency. When the corporate information environment was opaque, however, family firms ceased to be as valuable as firms without family owners. “When it’s harder to see what’s going on inside the company, it is much harder for the market to monitor the family, and as a consequence maybe the family can misbehave,” Anderson said. Opacity reduces the ability of outsiders to police opportunism by family firms. Simply put, the top-performing family firms are also the most transparent. Think Walmart. The Walton family’s massive multinational is currently followed by 36 analysts, all of whom are listed on the Walmart website, along with extensive stock information, historical pricing, and governance documents. The world’s largest retailer is also covered widely in the news media. For Walmart, there is no escape from scrutiny. The researchers also looked at CEO types in these transparent top performers. In their sample • the original founders held the top spot 37.7 percent of the time; • outsiders, like Campbell Soup Co.’s Denise Morrison, 34.2 percent; and • heirs, such as Nordstrom Inc.’s Blake Nordstrom, 28.1 percent.

KOGOD NOW SPRING 2012 | kogodnow.com

Transparent family firms led by an outsider performed best, followed by those led by founders and then heirs. Yet all three types of these transparent family firms still outperformed transparent, diffusely owned firms. In the absence of a highly transparent environment, there was no evidence of a benefit attributable to family ownership. In fact, in more opaque family firms, there was a negative relationship: as opacity increased, performance fell. Opaque family firms performed worse than any other type of firm. In those muddy waters, families can exploit control to extract private benefits at the expense of smaller investors. It’s clear that shareholders—and thus the S&P—value founder or heir involvement only when those family values include financial transparency.

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TAKE THE CANNOLI As it turns out, informed trading may also be a family affair. And when there are short sales, there’s gonna be trouble. Anderson’s latest project, with coauthors Reeb and Wanli Zhao of Worcester Polytechnic Institute, finds that family firms boast “substantially higher” volume of abnormal short sales, where traders bet on a company’s poor performance. “There appears to be a lot more informed trading going on in family firms; given the magnitude of it, some of it is likely illegal,” Anderson explained.

RELATIVE LEADERS Prior studies have found that family owners are among the best informed of shareholders. Anderson postulates that this is attributable to a few factors. For instance, they are likely to know about skeletons in the family closet. Also, family members who do not serve in senior management at the firm can fly under regulators’ radar more easily, and potentially avoid detection. Of course, outside investors could play a role in these antics by gleaning information from a family member and using it for personal benefit. Or perhaps the short sales are a product of disgruntled employees who perceive family domination as hurting the firm. Take the case of Robert Chestman, a stockbroker convicted on insider trading charges following the 1986 takeover of Waldbaum Inc., a New Yorkbased grocery chain now owned by the Great Atlantic and Pacific Tea Company. The Securities and Exchange Commission (SEC) asserted that Mr. Chestman had received nonpublic information from a member of the Waldbaum family, which he used to trade 11,000 shares of company stock. But Chestman was by no means the only one selling. In the days before the company’s announcement, the trading volume in Waldbaum stock skyrocketed. In two days, trading climbed from 2,300 shares to more than 77,000 shares traded daily, according to The New York Times and the SEC. Insider trading hardly capped in the 1980s. In 2005, former senator Bill Frist, heir to the forprofit hospital chain HCA, raised the SEC’s ire. The commission conducted an 18-month investigation into Frist’s sale of his blind trust of HCA shares, but ultimately did not press charges. Frist ordered the sale during a peak in the stock’s trading; weeks later, a less than stellar earnings report drove the share price down by nine percent, according to USA Today. THE VALUE OF DISCRETION Information leakage was at the center of Anderson’s study. At the root of short sales is the spread of nonpublic information. By identifying and homing in on the times when short sales preceded negative earnings surprises, the researchers made the issue empirical. The question: Does family presence aid or impede informed trading? They analyzed short sales that occurred prior to earnings surprises, merging the SEC’s shortsales database with their own information on family ownership in the largest US firms. The resulting sample was 1,571 strong, with family firms making up more than one-third of the sample. Rather than focusing on the motivation of the sellers, the researchers simply sought to uncover whether insider trading was more prevalent in family firms. It was. “Family firms experienced almost 17 times more abnormal short selling preceding nega-

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Founder CEO Michael Dell, Dell Inc. NASDAQ: DELL

Heir CEO Micky Arison, Carnival Cruises NYSE: CCL

Professional Manager CEO Denise Morrison, Campbell Soup Company NYSE: CPB

Mark Zuckerberg wasn’t the first tech entrepreneur to start a billion-dollar enterprise from a dorm room. Dell began his computer business at the University of Texas in 1984. By 1992, the then-27-yearold had become the youngest CEO of a Fortune 500 company.

Micky Arison is the CEO of Carnival Cruises CCL, the cruise operator that owns brands such as AIDA, Seabourn, Carnival, Ibero, and a series of others. His father, Ted, founded the business in 1972. Micky joined in 1974 and worked his way up to the chairman role in 1990; he became known for acquisitions, including the purchase of Holland America Line in 1989 and P&O Princess Cruises in 2002. The Israeli American also owns the NBA’s Miami Heat.

Denise Morrison, president and CEO of Campbell Soup Company, hails from a family of successful businesswomen. Perhaps, then, it’s appropriate that she took over leadership of the family-rooted company in August 2011. Morrison is only the 12th CEO in Campbell’s 140-year history, and its first female leader; she joined the company in 2003.

Dell has since racked up accolades, written a book on his success, and served on the US President’s Council of Advisors on Science and Technology. Though he stepped down as CEO in 2004, he returned to the position in 2007 at the request of the board of directors. The Texan has four teenage children; perhaps a successor is in their midst? In the meantime, Dell Inc. announced plans to launch its first consumer tablet late this year.

Compiled by Nicole Federica and Jackie Sauter

He’s no stranger to controversy; early this year, the partial sinking of cruise ship Costa Concordia in Italy claimed at least 17 lives, with many more injured or missing. The company said it expected a $175 million hit against net income in fiscal 2012 as a result of the disaster, according to Reuters.

With 35 years’ experience in the packaged goods industry, Morrison started in the sales department of Procter & Gamble, and previously served at Pepsi-Cola, Nestlé USA, Nabisco Inc., and Kraft Foods. Campbell’s has projected net sales growth between 0 and 2 percent in 2012.


COVER STORY BLOOD IN BUSINESS

ON ITS FACE, GROWTH IS A NOBLE GOAL— BUT THERE CAN BE TOO MUCH OF A GOOD THING. EXCESSIVE GROWTH CAN HARM PROFITS IF MANAGERS DON’T SHARE THE RESULTING WEALTH WITH INVESTORS... DEBT HELPS TO KEEP MANAGERS IN CHECK.

tive earnings shocks than nonfamily firms,” the authors wrote. These firms also had marginally fewer abnormal short sales before positive surprises— indicating that more sellers were hanging on to their stock in anticipation of good news. This was no coincidence. The presence of family members as managers or board members increased the likelihood of short sales. The researchers contrasted family ownership with that of hedge funds, private equity funds, and other large-block shareholders, but did not find the same results. There are regulatory implications. Despite the researchers’ findings, the SEC’s enforcement actions of late have focused on hedge funds, with 22 enforcements between 2006 and 2008 against the funds, and zero filed against family owners. Further investigation reveals zero enforcements filed against family owners through early 2012. Certainly, the SEC takes abuse of short sales seriously. The commission has held numerous public hearings, enacted new rules on “naked” short sales, and required more transparency about the short-selling process. The focus on short sales is warranted: the SEC says that short selling comprised almost half of US equities volume, based on data provided by exchanges for June 2010. “Our analysis suggests that regulations to reduce informed trading, while potentially limiting such activity in nonfamily firms, appear substantially less effective in family firms,” Anderson concluded.

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SO WHAT’S THE RUB? There is no question that relational debts are beneficial to firms that invest substantially in R&D. The long-term relationship between lender and borrower allows continuity of investment; the bank can step in more easily if the firm were to default. Transactional debt was more effective in preventing overinvestment in firm growth than relational debt. While relational debt may lead to more growth, the growth may hurt profits, David and O’Brien concluded. This may be best understood with an example— one that’s all too familiar. In 1980s Japan, stock and real estate markets peaked, and real estate was all the rage. Many firms that previously had never invested in real estate were tempted to get in on the action.

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DO ME THIS FAVOR Of course, in order for earnings surprises to occur, firms have to play a role in the action. That could mean an acquisition or investing in a new business venture. And the latter often requires firms, and their managers, to borrow money. Debt can be a tricky business, and all debt is not equal—now that debt is no longer traded in Mafia-style personal favors, that is. No one knows this better than Associate Professor Parthiban David, whose expertise focuses on the impact of corporate governance on firm performance. David holds the Collins Chair in Strategic Management. David, along with coauthor Jonathan O’Brien of Rensselaer Polytechnic Institute, examined how the type of firm debt is related to growth. The pair chose Japanese firms to make up the sample, due to their predilection for growth. On its face, growth is a noble goal—but there can be too much of a good thing. Excessive growth can harm profits if managers don’t share the resulting wealth with investors, and instead funnel it back into the firm. Debt helps to keep managers in check: they have to make interest payments, repay the balance at the end of a contract, and face the threat of default. Just as family-owned firms are inherently anchored in relationships, forms of debt can also have a relational quality. And debt plays an impor-

tant, pseudo-parental role in corporate governance. Exhibit A: Bank loans are built on relationships. Business owners have a rapport with the bankers who invest in the growth of their businesses. Loans are not merely dollars and cents to the bank (or so they would have us believe); rather, banks assess the complete picture of the borrower and company. They also consider the possibility of ancillary business relationships that might form down the line; loans could be a foot in the door to a more robust, potentially lucrative relationship. Often bank representatives will hold seats on the firm’s board of directors, provide other business services beyond lending, and have relationships with the firms’ customers and suppliers. “Bank loans are long term,” David said, explaining that both sides build trust and may act as partners. “Banks have business relationships; growth is important to them, because more growth means more business.” In contrast, bonds are transactional, impersonal forms of debt. Bonds allow lenders to keep their borrowers at arm’s length. These securities are diffusely held, and lenders are focused solely on the returns they earn. Consider the case of Columbia Sportswear Co., a family-owned business that began selling hats in 1938. After the 1970 death of the family patriarch, the near-insolvent company struggled to stay afloat; it had already taken a $150,000 loan from the Small Business Administration. Within two years the company racked up a negative net worth of $300,000, according to Funding Universe. Yet the Boyle family was able to draw more credit from its bank; bank officers even suggested the family consult an adviser, which was the “first step on a path toward stability and then growth,” the owners told Family Business magazine. The infusion of credit happened to pay off; Columbia has come a long way since then, projecting revenues of $1.7 billion in 2011.


COVER STORY BLOOD IN BUSINESS

As Northwestern’s I. Serdar Dinc discovered, firms that had relational debt were more likely than those with transactional debt to make real estate investments. When the bubble burst less than 10 years later, they were hurt badly. Parthiban David’s work implies that the “leniency” of those relational lenders led to that overinvestment, which ultimately weakened the firms. If debt is to be used effectively for corporate governance, then managers—and shareholders, family or otherwise—need to understand the vast differences provided by these two diverging forms of debt.

“WHAT WE FOUND IS THAT WHEN THERE IS MORE RELATIONAL OWNERSHIP, THE FIRMS WERE LESS LIKELY TO CUT THEIR WAGES OR LAY OFF PEOPLE, EVEN WHEN PERFORMANCE GOES DOWN. ” PARTHIBAN DAVID, ASSOCIATE PROFESSOR

Academic papers that gave rise to the cover story Ronald C. Anderson, Augustine Duru, and David M. Reeb, “Investment Policy in Family Controlled Firms,” Journal of Banking and Finance (forthcoming). Ronald C. Anderson, Augustine Duru, and David M. Reeb, “Founders, Heirs, and Corporate Opacity in the US,” Journal of Financial Economics (2009). Ronald C. Anderson and David M. Reeb, “FoundingFamily Ownership and Firm Performance: Evidence From the S&P 500,” The Journal of Finance (2003). Ronald C. Anderson, David M. Reeb, and Wanli Zhao, “Family Controlled Firms and Informed Trading: Evidence From Short Sales,” The Journal of Finance (forthcoming). Parthiban David, Andrew Delios, Jonathan Paul O’Brien, and Toru Yoshikawa, “Do Shareholders or Stakeholders Appropriate the Rents From Corporate Diversification? The Influence of Ownership Structure,” Academy of Management (2010). Parthiban David and Jonathan Paul O’Brien, “Firm Growth and Type of Debt: The Paradox of Discretion,” Industrial and Corporate Change (2010).

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TIMES HAVE CHANGED Efficiency is something that Richard Lenny, the first outsider to serve as CEO of Hershey Foods Company, understood. Lenny increased company profits by closing six underperforming plants in the US and Canada in 2007, cutting 3,000 workers, and outsourcing the production of cocoa. It was a far cry from the utopian community that Milton Hershey envisioned for his employees and their families. When the Great Depression hit and sales plummeted 50 percent, Hershey did not lay off a single worker, but instead used employees to pursue growth opportunities. His ideals were as popular as his company’s sweets; more than a century later, the town’s identity is still tightly wrapped in silver foil with a tidy bow. Milton Hershey’s focus on protecting employees was not the norm for corporate America, but it is representative of many Japanese firms, which often increase their investments in growth when demand for their products falls. “Given a choice between cutting dividends or workers, CEOs there generally say their employees and suppliers are the most important stakeholders,” David said. “It’s almost a family situation.” The reason behind firms’ diversification—and whether the motivation differed by the identity of its owners—was the focus of David’s recent study. In the same way that types of debt can be considered either relational or transactional, domestic and foreign owners also display these characteristics. Prior research on corporate diversification and its implications for firm performance had treated all owners as if they had the same end goal: profit. Not so, David and his colleagues found, in a paper published by the Academy of Management

in 2010. Diversification is also a means to other ends, such as career advancement opportunities for employees, higher compensation, and lower employment risk. Using data from four sources, and excluding small firms and those in highly regulated sectors, their sample resulted in 1,180 unique firms. It turns out that relational owners emphasize growth, while transactional owners emphasize profit for shareholders. The differences are considerable: on a share-per-share basis, transactional owners “are over three times more effective than relational owners in pressuring managers to improve profit.” “What we found is that when there is more relational ownership, the firms are less likely to cut their wages or lay off people, even when performance goes down,” David said. “But with transactional ownership, they are more likely to do so.” For domestic owners, he believes, it all comes down to stakeholder relationships. Firm growth means new business, which keeps firm employees and their suppliers working. But firms with foreign ownership are more likely to diversify the business in order to collect more profits. David was quick to point out that domestic owners are not blindly making poor business decisions. “There is a self-interest here also,” he said. “It is not irrational altruism. There is an economic incentive for domestic owners to support growth; once again, more growth means more business.” The project helped to reframe a central question about firm performance, which previously had been viewed only through the profit lens. Like his colleagues’ work, the findings from David’s team had significant implications for governance literature. Taken together, the emphasis that Kogod’s faculty have placed on researching the value of family firms has highlighted the firms’ critical value to the US economy. Beyond their profitability, family businesses also employ 63 percent of the US workforce. As regulators look ahead to a November election in which the key issue is jobs, they should pay a visit to these firms for counsel on how policy will impact expansion and job creation, said Ann Kinkade, CEO of Family Enterprise USA, in Forbes. Questions remain. Will the SEC step up its focus on short-sale trading in these valuable firms? Can larger firms in the US gain access to relational funding to fuel firm growth, traditionally a more popular investment choice for small businesses? How can family businesses be encouraged to add jobs? As Clemenza argued to Michael Corleone, “At least give me the chance to recruit some new men.”

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GO TO THE MATTRESSES Debt was something that J. Willard Marriott detested. When the founder of Marriott International wanted to focus on growing Hot Shoppes, the family’s modest restaurant chain, his heir saw the promise of hotels. Getting into bed with the hospitality industry meant going into debt, something the elder Marriott avoided at all costs. “Debt was something that [my father] didn’t understand, and he hated it…he didn’t want anything to do with it,” Bill Marriott once told The Washington Post. Luckily for travelers, J. Willard’s son went to the mattresses for the company, now valued at around $10 billion. In the first six years after Bill took over the presidency, the company quadrupled in size, surpassing Howard Johnson and Hilton Hotels in both revenue and profits. The younger Marriott acquired Big Boy and Roy Rogers restaurant chains, and made the company international with an acquisition in Venezuela. He also invested heavily in research, which informed the decision in 1983 to target the mid-priced hotel market with Courtyard by Marriott. Still, J. Willard’s conservative business strategies are consistent with Anderson, Duru, and Reeb’s findings from a recent study of the ties that bind family ownership and investment decisions. The authors examined dueling potential motivations behind investment decisions: an aversion to risk was one possibility, or an extended “investment horizon.” With Duru’s help, the team focused on accounting disclosures required by regulators, including R&D and capital expenditures. What was the family’s biggest influence? The researchers discovered that family firms preferred to construct their future in physical assets,

like new restaurants, as opposed to riskier ventures— such as expanding into a new industry segment. “We found that family firms invested less in R&D; they are more risk averse,” Duru said, explaining that family firms devote less capital to long-term investments than do diffusely owned firms. Compared to their peers, family firms also receive fewer patents per dollar of R&D investment. Rather, they seem to prefer doubling down on reinforcements that strengthen their core business. Take Carnival Corporation, which has 101 ships among its brands and 10 new ships on order, focusing on expansion into Europe, Australia, and Asia. The Arison family retains 35 percent of company stock in the world’s largest cruise ship operator. The reluctance to pony up for long-term investments may be counterintuitive. Tales of family business owners often hinge on the notion of their far-reaching view of the future and their financial sacrifices, made to prop up the business. It is possible that there is less spending on R&D in family firms simply because family oversight makes firms more efficient.

CREATING THE COVER STORY


KOGOD TAX CENTER

GOLDEN PARACHUTES GET A LIFT FROM CONGRESS In our country’s recent history, Congress has tried at times to solve problems on its own, spurred by corporate governance issues that (it felt) were not sufficiently addressed by state laws. Nowhere is this more evident than in executive compensation.

ARTICLE BY DAVID J. KAUTTER & ANDREW R. ZANK THE KOGOD TAX CENTER IS A NONPARTISAN CENTER THAT PROMOTES INDEPENDENT RESEARCH ON TAX POLICY, PLANNING, AND COMPLIANCE ISSUES IMPACTING SMALL BUSINESSES, ENTREPRENEURS, AND MIDDLE-INCOME TAXPAYERS.

In two very visible situations, Congress used the Internal Revenue Code to deal with this growing concern. Both times, these provisions were controversial; after all, executive compensation has typically been considered a matter to be resolved by corporate boards and executives. As the debate over tax reform rages on, it is imperative to consider the effectiveness of this approach. The question is, has using the federal tax law to deal with corporate governance issues solved the problem Congress was trying to remedy? We think not.

PLAN DEPLOYED Congress decided to deal with the problem by discouraging transactions that would reduce amounts that might otherwise be paid to company shareholders, according to a report by the Joint Committee on Taxation at the time. How did congressional representatives set about discouraging these arrangements? By providing that “excess parachute payments” would be nondeductible to the corporation and imposing a 20 percent excise tax on the executive. What qualified as an “excess” parachute payment? One that was 1. in the nature of compensation (including a non-compete agreement); 2. paid to an officer, shareholder, or highly compensated individual; and 3. deployed only with a change in control of a corporation—but only to the extent that the payment exceeded three times the average amount of compensation the individual had earned in the five years preceding the acquisition.

• First, those with payments that were less than three times their base amount sought, and often received, an increase in the amount of their payments to 2.99 times their base amount. They pointed out that at that level, the payments would still be fully deductible by the corporation (and no excise tax would be imposed on the recipients). • Those who had parachute payment agreements in excess of three times their base amount sought, and often received, “tax gross up” payments. This means that after the gross up payment was received, included in income, and the 20 percent excise tax paid on the gross up amount, the executive received the amount he would otherwise have been left with had there been no excise tax on the underlying payment (see Figure 1). CRASH LANDING Golden parachute agreements remain to this day a common part of executive contracts, ensuring about two to three years of salary and bonus, according to a recent Wall Street Journal article. Despite Congress’s effort, golden parachutes are continually being deployed. In 2011, at least four CEOs of target companies were in line for a payout of more than $50 million, including $100 million to former Nabor Industries CEO Eugene Isenberg; four more CEOs were in line for payouts of more than $30 million; and many more executives expected payouts in the tens of millions. It seems pretty clear that Congress’s attempt to implement a change in corporate governance to reduce the trend 25 years ago has not discouraged the practice. If anything, these arrangements are more widespread today—and more generous in their terms—than they were when the legislation was enacted. POLITICAL AIRS If at first Congress didn’t succeed, it tried again… this time by limiting the deductibility of compensation paid to executives. In the early 1990s, information on the lack of correlation between executive compensation and economic performance became increasingly available, thanks to the introduction of United Share-

There are 21 CEOs who received “walk-away” packages greater than $100 million, according to a recent report from corporate governance consulting firm GMI. Collectively, the top dogs’ total earnings exceeded almost $4 billion. “Too many golden parachutes and too many retirement packages are of a size that clearly seems only in the interest of the departing executive,” the report postulated. Below are a sample of five such payouts in a variety of industry segments: health care, retail, digital, oil & gas, and banking.

Company Pfizer Inc. Executive Hank A. McKinnell Jr. Term 2001-2006 Payout $188,329,553

Company Target Corporation Executive Robert J. Ulrich Term 1994-2008 Payout $164,162,612

Company eBay Inc. Executive Margaret C. Whitman Term 1998-2008 Payout $120,427,360

Company ExxonMobil Corp. Executive Lee R. Raymond Term 1993-2005 Payout $320,599,861

Company Merrill Lynch & Co. Inc. Executive E. Stanley O’Neal Term 2002-2007 Payout $161,500,000

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The effect? An almost immediate increase in parachute arrangements, which until then were still rare—and the introduction of “gross up” clauses, under which companies pay the 20 percent excise tax on behalf of the executives. Executives who did not have parachute arrangements argued that their pay should be consistent with that of their peers. They sought to have parachute payments added to their compensation arrangements, and many boards agreed.

Meanwhile, executives who already had golden parachute arrangements fell into two categories:

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A BALLOONING PROBLEM In the late 1970s, high-profile executive severance packages, known as golden parachutes, began to unfold. The so-called parachutes triggered substantial payments in the event of a corporate acquisition. One of the first corporations to adopt a parachute-type arrangement was Hammermill Paper. According to a study on the origins of golden parachutes by Peer Fiss, Mark Kennedy, and Gerald Davis, the provisions stated that, upon “a change of control,” the executives’ employment by the company shall continue “for at least three years, at an annual rate of compensation equal to his total compensation for 12 months preceding the change.” In other words, Hammermill’s senior executives were guaranteed three full years of salary in the event of a company acquisition. By the early 1980s, high inflation rates and a depressed stock market led to a wave of corporate acquisitions. Economic conditions simply made it more attractive for companies to grow through acquisition rather than organically. As the acquisition wave grew, the golden parachute trend continued to pick up steam. By 1981, “15 percent of the 250 largest US corporations had such plans in place,” according to Organization Science. Congress became increasingly concerned over some of these arrangements. Members of Congress worried that, in some situations, these arrangements—although boardapproved—were hindering corporate acquisitions by increasing the cost of acquisitions and dissuading

interested buyers. Other times, these payments tended to encourage the executives involved to favor a takeover that might not be in the best interests of the company’s shareholders—the very group they were hired to serve. In either event, Congress was concerned that payments to shareholders were being reduced.

WALK-AWAY PACKAGES


KOGOD TAX CENTER

EXAMPLE OF PARACHUTE PAYMENT WITH GROSS UP $4,000,000

FIG 1

TOTAL COMPENSATION PAID DURING PERIOD

$1.2M

$1M

$800K

$750,000

$700,000

$800,000

$850,000

$900,000

$800,000

AVERAGE COMPENSATION PAID DURING PERIOD (BASE AMOUNT / 5)

$600K

$3,000,000

$400K

PARACHUTE PAYMENT

$200K

0

2008

2007

2009

2010

EXCESS PARACHUTE PAYMENT

2011

$3,000,000

PARACHUTE PAYMENT

ASSUME Federal Tax 35% State Tax 7% Fed Excise Tax 20% Total Tax Rate 62%

Excise Tax: 20% x $600,000

3X BASE AMOUNT

$120,000

Gross Up Payment Calculation: $120,000 ÷ (1 - 62%) $316,000 TAX ON GROSS UP PAYMENT: Fed (35%) (110,600) State (7%) (22,120) Excise (20%) (63,200) Total (196,000) $316,000 – $196,000

$120,000

EXCISE TAX (20%)

BAG IT? As these experiences illustrate, trying to implement corporate governance policies through the Internal Revenue Code has, at best, a mixed record. Using the tax law to encourage (or discourage) behavior has worked effectively in some parts of the economy. For example, enactment of the Research and Development tax credit has been considered successful in encouraging greater research. On the other hand, corporate governance does not appear to lend itself to a federal tax solution. Yet despite the uneven results with respect to past efforts, when Congress sees other corporate governance issues it believes are not being addressed adequately, it is likely to continue taking matters into its own hands. An election year in which taxation is a paramount issue, and former CEOs are vying for the country’s top spot, presents the opportunity to make a choice to stop legislating through changes to the tax code. It has only made the tax law more complicated, interposed the IRS between executives on the one hand and corporate boards and shareholders on the other, and failed to solve any of the problems with which Congress was concerned.

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$120,000 (amount needed to pay excise tax)

EXCESS PARACHUTE PAYMENT

CHANGING AIM In 1993, Congress responded by enacting Section 162(m) of the Internal Revenue Code. Under this provision, the corporate tax deduction for compensation paid to the CEO and the four other highest-paid executives of a publicly held corporation was limited to $1 million each. An exception was made for performance-based compensation: to the extent that payments in excess of $1 million in one year meet goals set by the Board Compensation Committee, and are approved by a majority of the shareholders in a separate vote, then the compensation is fully deductible. The House Ways and Means Committee stated its belief very clearly that excessive compensation would be reduced following this action. With the new restraints on deductions in place, Congress believed it had taken an important step toward pushing domestic corporations to adopt more responsible, performance-based executive compensation systems. Section 162(m) also attempted to introduce a level of accountability that had been missing, by providing opportunity for more shareholder input. So what happened? A study of the effects of Section 162(m) calculated that between 1992 and 1997, the median compensation for covered executives increased 17 percent, and executive bonus and long-term incentive plans (as well as grants of restricted stock) nearly doubled. The study, by Tod Perry and Marc Zenner, also showed that many executives with compensation

below $1 million saw pay raises; 75 percent to 84 percent of executives earning $900,000 or below got a salary bump following the implementation of Section 162(m). Perry and Zenner determined that many others, with pay already above $1 million, saw no change at all. Quite simply, in response to Section 162(m), many corporations locked in fixed compensation for executives right around the $1 million mark and created performance-based bonuses to further compensate executives beyond their fixed salaries. Congress wasn’t the only injured party. A 2006 study by the Joint Committee on Taxation found that Section 162(m) eliminated millions of dollars in deductions, reducing profits and, in many cases, adversely affecting company shareholders. The study concluded that, by making performance-based pay an exception to the $1 million cap, there was a resulting increase in executive compensation, and the provision led to more executives looking to manipulate earnings to demonstrate a better earnings pattern and, in turn, earn higher pay. Although the consequences of the $1 million cap were far from the results Congress had anticipated, the legislation has increased executive accountability to corporate shareholders.

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$2,400,000

GROSS UP PAYMENT:

holder Association Compensation Surveys and increasingly active corporate shareholders. As more data on executive compensation came to light, public outrage began to sweep the country; by 1992, CEO compensation had become a key presidential campaign issue, as then-candidate Bill Clinton debated incumbent George H. W. Bush for the country’s attention. As more citizens voiced concern over the continuously rising compensation for top executives, and politicians looked to take action, heated debates began in Washington. Some critics argued that certain executives were increasing their own salaries without input from shareholders, and without ties to the company’s economic performance. The high pay, they argued, was unearned. Others believed that the large disparity in pay between the executives and lower-level employees, as well as a similar disparity between US executives and foreign executives, was inexcusable and clear evidence of the need for federal intervention.


RUSSIA’S CORRUPT FREE MARKET

“THERE IS A RUSSIAN SAYING: A FISH STARTS ROTTING FROM THE HEAD. IF CORRUPTION WASN’T SANCTIONED AT THE TOP, THEN IT WOULDN’T BE ACCEPTED AT LOWER LEVELS AS WELL.” VALERIY FILATOV, BSBA ’12

ARTICLE BY ANNA MIARS

In Russia, corporate raiding is simply the latest incarnation of property redistribution. The tactics have modernized over time: the use of hired muscle in the days of racketeering has been replaced by exploitation of legal loopholes and loose regulations. But the participation of government officials, which makes the whole system possible, remains intact. that have valuable assets in the form of fixed capital or real estate, are at the greatest risk of raiding. Certainly, capital accumulation after the fall of the Soviet Union was uneven; some benefited more than others. But that's not why such great disparity between the haves and have-nots exists. Without clear rules of competition and a mechanism for transferring property to more efficient owners, the system never evolved. Instead, a process of negative selection has emerged, where the strongest and most profitable businesses are picked off, stifling growth and damaging the larger economy. In Vladimir Putin's Russia, where the power hungry politician was recently elected to a third presidential term, the clout of the bureaucrat—not the wealth of the owner—guaranteed ownership of an asset. “It’s difficult to change duplicitous legal and political systems in an environment that rewards those who exploit it,” said Filatov.

• Letter of the Law. Raiders uncover and expose regulatory infractions in order to destabilize the company and prime it for the taking. • By Force. Raiders use administrative sanctions or fabricate criminal cases to facilitate takeovers. • Hit ’Em Where it Hurts. Bankruptcy schemes are effective ways to undermine a business. • Dispute Ownership. By manipulating the stockholder registry, raiders can call the very ownership of the company into question. In general, information-based businesses and service providers are at a lesser risk of raiding than those in the finance, retail, dining, construction, and agriculture industries. However, there are risk factors that cut across all industries. For example, the dispersal of stockholder ownership affects whether raiders will be able to abuse rules at stockholder meetings. The presence of fixed capital investments—such as valuable land, or factories—also establishes the potential for raiders’ profit. Finally, a company’s level of debt plays a role: firms with a high debt burden are more vulnerable to bankruptcy tactics. “There are a lot of interested parties,” said Filatov. “The raiders themselves; those who know about the raid but look the other way; and the individuals that commissioned the raid.”

COLLECTIVE RESPONSIBILITY Although Russian governmental agencies are supposed to function in a way that ensures checks and balances, in reality, officials are reluctant to incriminate their colleagues. “People advance by helping one another in small groups,” Filatov said. “It’s known as krugovaya poruka, which translates to ‘solidarity’ or ‘collective responsibility.’” This is particularly prevalent within industry sectors. The arrangement of mutual assistance, a cultural carryover from Soviet rule, provides raiders who already have a motive with the means and opportunity. The environment is ripe for corruption. Government support is essential to a company’s survival. “One Russian corporate lawyer concludes, ‘The only real protective measure is to have very good political connections,’” Filatov wrote. Change will have to come from the top, he believes. Corporate raiding was defined in legal terms only in 2009. Outgoing president Dmitry Medvedev signed a series of antiraiding laws into power in the summer of 2010 as part of his anti-corruption campaign, but the jury is still out on whether they will have an effect. Only with sound leadership in the public and private sectors, and an overhauled system, will the connection between political power and property that drives corporate raiding truly be broken.

Filatov’s paper was voted best in his session at the Association for Global Business’s Annual Meeting in November 2011 and was published in the Proceedings of the Annual Meeting.

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SYSTEMIC RISK In 2009, Evgeniy Konovalov, the owner of an agricultural company in southern Russia, found himself in pretrial detention. Though the charges were fabricated—it was eventually proved in court that forged documents were used to purchase his firm—he spent a year under arrest. During this time he fought the raid executed by his long-time business associate and was eventually named the rightful owner. His business was returned to him in 2011. “Despite overwhelming evidence of

violations of Russian law by [Konovalov’s business associate], his accomplices, and complicit government officials, none of the parties have been punished,” Filatov wrote in his award-winning paper. Similar stories abound. “It used to be gangsters who ran rackets, and now it’s consultants and lawyers wearing ties, who are civilized on the surface but carry out the same blackmail,” Andrei Girev, the general director of a Russian cell phone company, told Bloomberg Businessweek. One in six Russian businessmen has been prosecuted for an alleged economic crime over the past decade, according to The Economist—most at the hands of corrupt police, prosecutors, and courts. “The Russian legal system is extremely complex and full of contradictions,” Filatov said. “Almost everyone in business is breaking the law on a daily basis, so it’s easy to leverage the law in support of illicit activities.” While Russian law no longer allows for pretrial sentencing in economic cases, as in Konovalov’s case—this changed in 2010—the surprise element hinders business owners’ ability to fight wellorganized, authority-backed raids. Filatov believes that corporate raiding is under-reported and unaddressed for a slew of reasons: law enforcement doesn’t want to appear incompetent, the media attempts to remain impartial, and the government is disinterested or too corrupt to seek reform. Another reason the Russian government is not focused on creating good conditions for private businesses? The

HOW RAIDING WORKS “There is a Russian saying: a fish starts rotting from the head,” said Filatov. “If corruption wasn’t sanctioned at the top, then it wouldn’t be accepted at lower levels as well.” Financial compensation is a strong incentive for participation, or at least passive tolerance. Everyone from police officers to judges and governors stands to benefit by collecting a performance bonus, accepting a bribe, or pocketing a future favor. “I think, increasingly, people who are doing the dirty work have been co-opted by government officials who are often the end benefactor of the scheme,” said Filatov. Each of the three types of raiding requires an “inside man,” a government official who can provide the necessary leverage to accomplish a raid. So-called black raids are what movies are made of: violence, including coercion, threats, and kidnapping. Gray raids call for a mixture of legal and quasi-legal means, such as calling legitimate shareholder meetings using forged documents. Finally, white raids are performed to the letter of the law, though they often violate its spirit, according to Filatov. Capitalizing on regulation violations is a common method associated with white raiding. An anonymous report submitted to the court system can indicate complicity and result in the removal of executives or financial damage such as fines or suspension of business activities, causing internal instability and devaluing the company’s shares. Although violent acts against businessmen, or black raids, have largely subsided, administrative methods that

achieve the same ends are still prevalent. “Raiding is more damaging to businesses than racketeering because of its goal to acquire complete ownership, rather than just ‘capture’ a portion of the profit,” Filatov said. Filatov identified the four most common approaches to raiding in Russia:

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Of course, the days of overt KGB control are long gone; in today’s Russia, order seemingly prevails over the repression of an earlier era. And yet, more than 20 years after the fall of the Soviet Union, intimidation and corruption against business owners is rampant. Media reports estimate that up to 70,000 cases of corporate raiding— reiderstvo in Russian— occur each year. The sophisticated form of whitecollar crime involves the seizure and rapid resale of a company or its liquid assets: private firms and businesses are dismembered, and the parts sold to the highest bidder. Valeriy Filatov, a Russian-born US citizen and BSBA ’12, coauthored a research article analyzing the phenomenon with Claudio Carpano, a former executive-in-residence. His research discovered that the annual financial gains made from Russian raids were estimated at a whopping $4 billion in 2010. “Raiding is mainly performed by bureaucrats and mid-size-business owners—those who didn’t do it in time for the first divvying up of the pie during the 1990s,” Filatov asserted, referring to the privatization of state assets after the breakup of the Soviet Union. In countries with well-established institutions, such as the United States, corporate raids (also known as hostile takeovers) are usually carried out in accordance with strict guidelines. They are used to restore stability and competitive advantage to fledgling companies. In Russia, the reverse is true: the most successful businesses, or those

profit gap between state-run oil and natural gas companies and other industries. High tax rates on oil and natural gas provide a majority of the country’s budget revenue, making the independent business community a distant second priority.


ARTICLE BY LINDSEY ANDERSON

“Working well as a team member…We hardly even notice she’s a girl anymore,” remarked a reviewer of Victoria Harker’s performance at the end of her first year on the board of directors at a publicly traded company.

*From Virgil's Aeneid: Dux Femina Facti, or "A woman was leader of the exploit." A rare example in Latin verse of a feminine noun paired with a masculine verb.


DUX FEMINA FACTI

PERCENTAGE OF FEMALE REPRESENTATION AT THE TABLE ON CORPORATE BOARDS

Harker, MBA ’90, is executive vice president and chief financial officer for global power company AES Corporation, and one of two women on the boards of Xylem, a global water technology provider, and Darden Restaurants Inc., the parent company of restaurants such as Capital Grille and Olive Garden. She does not fit the profile of a typical board member; most are white males. Harker and the reviewer’s comments exemplify a recurring theme on boards of publicly traded companies: there are few female board members, and where they do exist, they tend to make up only one or two of the 12 seats at the table. As a result, they may be invisible, pointed out, or stereotyped as representing all women.

“I DON’T THINK DC AND VIRGINIA ARE NECESSARILY OUT OF SYNC WITH THE REST OF THE COUNTRY IN TERMS OF HAVING FEW WOMEN ON CORPORATE BOARDS…IT’S SORT OF A NATIONAL PLAGUE.” JILL KLEIN EXECUTIVE-IN-RESIDENCE

NO WOMEN MEMBERS: 53.75%

ONE WOMAN MEMBER: 33.75%

TWO WOMEN MEMBERS: 9.38%

THREE WOMEN MEMBERS: 2.5%

FOUR WOMEN MEMBERS: 0%

FIVE WOMEN MEMBERS: 0.63%

NO WOMEN MEMBERS: 25%

ONE WOMAN MEMBER: 41.67%

TWO WOMEN MEMBERS: 25%

WASHINGTON, DC

THREE WOMEN MEMBERS: 8.33%

PERCENTAGE OF COMPANIES WITH ANY FEMALE BOARD MEMBERS

VIRGINIA: 7.7%

WASHINGTON DC: 12.8%

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A CRITICAL MASS Klein also stressed the importance of obtaining a “critical mass” of three or more women, which allows more diverse opinions to be heard and represented on the board.

VIRGINIA

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“There are adequate numbers of women and minorities in organizations, but they’re just not represented in upper echelons,” said Assistant Professor Caren Goldberg, whose research focuses on gender and diversity in human resources. “If you look at where they are, most are at the lowest two rungs of the ladder.” Yet female board members have been shown to have a positive impact on company performance. Women make up nearly half the labor force—about 47 percent in 2009—meaning that companies who do not employ female board members may forfeit their comparative advantage. When there are more diverse voices in the boardroom, then more of the stakeholders’ broad perspectives are represented, decision making improves, and the board is more open and collaborative. Scholars, politicians, and business people alike have begun to realize the benefit of having women on corporate boards. So why do women hold only 15.7 percent of board seats at Fortune 500 companies, according to Catalyst’s 2010 Census? And what can be done to ensure that more female executives earn those top spots?

WOMEN IN THE BOARDROOM To get a glimpse into the situation in the Washington metropolitan area, the professional group Women in Technology commissioned a study from Kogod on female board membership in Washington, DC, and Virginia. Graduate students Susanne Barakat, MA/MBA ’12, and Julie Bloecher, MBA ’11, looked at 172 publicly traded companies headquartered in the District and Virginia that are listed on the major stock exchanges (AMEX, NY, and NASDAQ). Their 2010 report, conducted with the help of Information Technology Executive-in-Residence Jill Klein, did not reveal a rosy picture. Women hold only 101 (7.7 percent) of the 1,318 board seats at 160 Virginia-based publicly traded companies. In Washington, women hold 14 (12.9 percent) of 109 board seats at 12 District-based public companies. “DC can look pretty good because it’s strictly an urban space, and urban America tends to be a little bit more forward-thinking,” Klein said, cautioning that the small number of DC companies means a small sample size. “Virginia is probably much more representative of what we see across the country. I don’t think DC and Virginia are necessarily out of sync with the rest of the country in terms of having few women on corporate boards…it’s sort of a national plague.” Fortune 500 companies often have more female members, said Vicki Warker, chair of WIT’s corporate board committee, who commissioned the report when WIT started thinking about creating a program on board membership. “I think we were all a little shocked that the numbers were that low,” Warker said. “But when you think about it, the numbers that are typically reported are for the Fortune 500 companies, which tend to have a higher profile, and I think they understand it could be a PR disaster for them to have no women on their board. The study that we did covered all publicly traded companies headquartered in DC and Virginia; they’re smaller companies and probably less high-profile than the Fortune 500 companies.”

The black dots represent the number of seats that are held by a woman on a company’s board of directors. The pie charts represent the percentage of boards that have a specific number of female members, as signified by the number of black dots around each chart. There are 12 dots on each chart to represent the average 12 members of a company’s board. This information comes from the 2010 Executive Summary of Key Findings commissioned by the Women in Technology and Leadership Foundry (p. 6).


DUX FEMINA FACTI

FEMALE BOARD MEMBERS ACCORDING TO INDUSTRY

INDUSTRY

This table displays the breakdown of female board members accord to industry in both VA & DC. The white circles represent the percentage of women on boards of that particular industry. This information comes from the 2010 Executive Summary of Key Findings commissioned by the Women in Technology and Leadership Foundry. (pages 7 & 9)

NO. OF WOMEN DIRECTORS IN

Mining 3 VA companies 0 DC companies

0

Utilities 2 VA companies 2 DC companies

4

5

Construction 2 VA companies 0 DC companies

0

Manufacturing 25 VA companies 1 DC company

13

4

Retail Trade 7 VA companies 0 DC companies

7

1

Information 25 VA companies 4 DC companies

13

Finance & Insurance 48 VA companies 3 DC companies

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DC

VA

Real Estate & Rental & Leasing 5 VA companies 0 DC companies

0

Professional, Scientific, & Technical Services 21 VA companies 1 DC company

9

1

Management of Companies & Enterprises 2 VA companies 0 DC companies

1

Administrative & Support & Waste management & Remediation Services 8 VA companies 1 DC company

2

0

Educational Services 3 VA companies 0 DC companies

3

1

3

4

Health Care & Social Assistance 2 VA companies 0 DC companies

Arts, Entertainment, & Recreation 1 VA companies 0 DC companies

2

2

If there is a solitary female member, she may not be willing to participate or speak up as an outsider. “When you achieve the critical mass, then there’s a little bit more comfort for the women on the board to participate as equals with the men,” Bloecher explained. More women also means women are less likely to be stereotyped and seen as the “token” female who represents the opinions of all women. “It’s not just getting women on the board, it’s getting a critical mass so their voice is not lost or misrepresented,” Klein said. “One woman can’t speak for all women. Nor can three women, but you start to get a better consensus on things that women are thinking about.” Nearly all of the Virginia- and DC-based companies—97 percent—failed to achieve a critical mass. ADDING VALUE Although there has not been a large amount of academic research conducted on gender diversity among corporate boards, and existing studies are certainly not cast-iron, scholars have come to a few conclusions about the benefits women bring to boards. Bloecher and Barakat’s report pointed out a few of the benefits that result when a board reaches a critical mass of women: • Discussions are more likely to include the perspective of multiple stakeholders, from employees to customers to suppliers to the community at large, who all affect—and are affected by—company performance. • With more women, the board is much less likely to ignore or brush aside difficult issues and problems, leading to better decision making. • A diverse boardroom is also more dynamic, open, and collaborative, helping managers listen to the board’s concerns and take them to heart without being defensive. It also comes down to simple comparative advantage: boards have few women. Women make up nearly half the workforce. By focusing on only one half of that workforce, boards lose out on hiring possible talent. “If appointing women to boards results in positive financial benefits, the fact that Virginia and DC

companies report lower than Fortune 500 averages in female board membership suggests that local companies may be forfeiting their comparative advantage,” states the WIT report. While the initial transition to diversity may be uncomfortable for some and members’ attitudes will need to adjust, research has shown that the advantages of diversity will outweigh the downsides within about two months, Goldberg said. “Beyond that time, diversity tends to pay dividends in terms of performance and productivity,” she explained. DETRACTING VALUE One research study that Goldberg coauthored determined that not only are there positives to having women in a company’s top spots, but there also are negatives to not having them there. The study, published in the journal Human Relations in 2010, examined gender composition and perceived reward and social outcomes. Researchers asked participants to answer questions about their workplaces’ perceived fairness, discrimination, organizational support, exclusion, and gender harassment. Though the sample comprised male and female medical doctors in Sweden, the findings could apply to a wider population. Goldberg and her colleagues, Alison Konrad at the University of Western Ontario in Canada and Kathleen Cannings of Uppsala University in Sweden, found that • women who worked in medical units with a larger percentage of men reported more gender harassment; • women who had a male supervisor reported less organizational support; and • women who worked in an organization with a male head reported more gender discrimination. “Gender of the top organizational leader is likely to have both material and symbolic effect on the organization’s climate for gender diversity,” the authors write, giving the example of President Barack Obama and racism. Many Americans saw Obama’s election as a sign that the United States may be moving past racism. Similarly, employees and shareholders could perceive that a company with top-level female managers, like women board members, does not engage in gender discrimination.

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Transportation & Warehousing 1 VA company 0 DC companies

NO. OF WOMEN DIRECTORS IN

DC

VA

Wholesale Trade 4 VA companies 0 DC companies

INDUSTRY

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DUX FEMINA FACTI

Goldberg agrees. “We, as the United States, lag behind dozens and dozens and dozens of countries in terms of family-friendly policies. Even countries that are clearly less economically developed than the United States offer a great deal more to new parents than the US does,” she said.

“FRANKLY, THERE ARE A LOT OF WOMEN WHO ARE READY, AND COMPANIES ARE JUST NOT AWARE THAT THERE ARE WOMEN WHO ARE READY.” VICKI WARKER, WOMEN IN TECHNOLOGY

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POSSIBLE REMEDIES The solutions for getting more women onto corporate boards are far from simple. More family-friendly policies, including more leave and flexible hours for women and men, may allow women to continue their careers, move up in the corporate world, and grab a few of those coveted board seats. But also key is providing training and networking for top-level women so they can one day become prospective board candidates. “Men have always felt comfortable enough to network with other men and make contacts, and it should be the same for women,” Bloecher said. The WIT report led to the creation of The Leadership Foundry in January 2011, a networking and mentoring program for a handful of senior-level female executives who are interested in joining a board of directors. “It’s probably as much about increasing the conversation as it is about producing more women who are ready for board membership. Frankly, there are a lot of women who are ready, and companies are just not aware that there are women who are ready,” said Vicki Warker, a civil engineer by training. But while training, networking opportunities, and family-friendly policies may ensure that more women are adequately prepared for board membership, they do not address the fact that people still often select people similar to them—men selecting men—for board membership. In 2005, Norway mandated that all corporate boards be at least 40 percent women. A dozen other European countries have followed suit, and, in 2010, Britain’s prime minister David Cameron called on companies to appoint more women directors. Proponents of Norway’s legislation, including the female head of its Centre for Corporate Diversity, say the new female board members are more highly educated, more international, and younger than their male colleagues. Critics say such laws promote “window dressing” as corporations add female board members who are less qualified in order to meet quotas.

Harker expressed similar concerns. “I’m not always sure that they end up with the best slate of qualified board members. They may be checking the box in order to say, ‘We have XYZ number of women,’” she said. Instead, she encouraged diversity as an internal focus for boards and an external demand from investors. “As investors have taken more of a lead in terms of demanding things like transparency in corporate governance, for example, the composition of the board should be something shareholders are asking for,” Harker said. “More transparency around a board’s plans for adding diversity, just like they [disclose] age, tenure, and that list of things shareholders or individuals ask for.” Shareholders could ask for diversity among board members, soliciting a board’s yearly plan for how to include more diverse voices, for example. “On our side of the pond, we’re looking at these European laws with great interest,” Klein said. “We may have to legislate it, but I’m hoping we’re smart enough to look at what other countries are imposing and saying, ‘We can get there without legislating it.’” Goldberg agrees that incentives—whether playing up the benefits women bring to boards or providing incentives to boards that hire women—are key to promoting diversity, but that similar legislation in the United States might serve a purpose. “I do think legislation helps in the long term,” Goldberg said. “If you look at what happens in the short term, it creates tokens out of women and minorities who perceive, either rightly or wrongly, that they were only put into a position because of their gender or race. But I think that, in the long term, that sort of exposure is needed for people to feel more comfortable working with women or minorities in top-level positions.” Goldberg believes legislation can help break that cycle, although it may take time for a new cycle, one that values diversity of all kinds, to be instated. In the meantime, Harker takes the two female board members and the female members of her team from her own company, AES, out to lunch sometimes, creating an informal network and showcasing the up-and-coming women. “That’s what the good ol’ boys do, after all,” she said. She now laughs about the gender-biased review she received. “Hopefully I’m bringing value whether I’m wearing pantyhose or not.”

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SO WHY ARE THERE SO FEW FEMALE BOARD MEMBERS? If female board members bring both symbolic and actual value to a company, why do so few boards achieve the critical mass of female membership? Historically, women entered the workforce later then men, and mostly not until the 1960s, when the 1963 Equal Pay Act required men and women who perform equal work to receive equal compensation, and when Title VII of the 1964 Civil Rights Act prevented employment discrimination based on sex, race, religion, or national origin. In 1972, the Equal Rights Amendment passed out of Congress but is still three states short of the requirement for ratification to become part of the US Constitution. But that decades-long head start does not fully explain why men still dominate corporate boards. “It’s been really glacial progress adding women to boards,” Harker said. “I’ve watched the selection process take place as a board member, and my perception would be that, because a lot of boards are not that diverse to begin with—which is to say largely white males—they tend to tee up those that they know and have worked with in the past, which by definition becomes a replicating model. “There is a tendency to nominate within the search process those they are most familiar with, which is their own background and experience.” So board members look for potential members who are like them, creating a cycle of men who select men who select men: a “good ol’ boys” club of sorts. Goldberg describes it as a catch-22: There are fewer senior-level women in the workplace, therefore certain positions are not seen as not appropriate for women, and thus women are not given those positions. Men are also more likely to network with other men, bonding over, say, beer and football and perhaps leaving out their equally qualified female colleagues. Others argue that it is not a problem of board members not choosing women, but of women not choosing boards. Many women put their careers on hold for a decade or more while they raise children. “That’s clearly going to keep people out of the running for corporate boards,” Klein said. “The reality is that you have to raise families, so you’re going to have to make some of those really hard choices.” Klein, who is also the adviser for the Kogod Women in Business student organization, said the women in the group often discuss the challenges they will face in the first five years of their careers, including starting a family.


KOGOD STANDOUT

ADVENTURES IN SILICON VALLEY

Nick O’Neill is no stranger to a challenge. In 2007, the serial entrepreneur launched a blog, AllFacebook, which sprouted into an online publishing and event business. It was acquired in late 2009 by WebMediaBrands Inc. Less than six months later, O’Neill, BSBA ’05, departed the nation’s capital—where he’d resided since enrolling at American University—for sunny Silicon Valley.

KOGOD NOW SPRING 2012 | kogodnow.com

He’s now juggling two projects, with help from a small number of collaborators and contractors. The first, Holler, is a location-based mobile application that connects people online for offline activities. O’Neill taught himself to develop an iOS app and launched the product last year; his team is currently working on updates to enrich the community. “It’s a pretty challenging space,” said O’Neill. “We’re testing things right now to see what works best.” Meanwhile, his other endeavor, Startup Stats, offers a data dashboard that allows investors to survey the early-stage startup ecosystem. It’s intended for venture capitalists and angel investors, but, as O’Neill points out, it also serves entrepreneurs who want to monitor their competitors. And he should know. Go online for an exclusive video interview with Nick at kogodnow.com/nick

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Photographer: Vance Jacobs


THE FRAGILE NATURE OF SUPPLY CHAINS

A global supply chain—which begins with raw materials and progresses through manufacturing, packaging, transportation and distribution, and returns management—is a bit like a spiderweb. Both delicate and complex, the network is so interdependent that if you touch one place, reverberations emanate. And like a spiderweb, the chain is often invisible to the consumer: hard to see until it’s right in front of you. ARTICLE BY AMY BURROUGHS

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While many company leaders are on board philosophically, they lack the time, resources, and knowledge to implement changes. Figuring out where to begin is not easy, according to Assistant Professor Ayman Omar, the Marvin Fair Faculty Fellow in International Business. How do you gauge how “green” a supplier is? How do you guarantee that a sub-supplier in a far-off country isn’t using forced labor? How do you control whether a manufacturer properly disposes of hazardous waste? Some companies keep an eye on European regulations for signs of what’s to come, since Europe’s more stringent regulations sometimes predict US policies. Europe’s 2003 WEEE (Waste Electrical and Electronic Equipment) Directive, for example,

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As thought leaders recognize the importance of the “triple bottom line,” the resources demanded by a global economy are under increased scrutiny. The new paradigm is to set a standard—for environmental, social, and economic stability—for every player in the supply chain. Achieving supply chain sustainability sounds like a perfect complement to popular “green” branding. But taking on an entire network of suppliers stretching from Cleveland to China, through laws, cultures, economies, and regulatory environments far different from those of the United States, is considerably more difficult than meeting LEED standards for a new building, or convincing paperjunkie coworkers to save trees by not printing every last email.


sets criteria for manufacturers, importers, retailers, and consumers to recycle electrical and electronic goods. Seeing the burden put on their European counterparts has been a wake-up call for some US companies, Omar said. “Companies have been realizing…if it’s now in Europe, it’s going to catch up in the US at some point, or other areas we’re working in, and we might as well be ahead of the curve.” The United Nations Global Compact provides a framework for companies that want to address human rights, labor, the environment, and anticorruption efforts. Launched in 2000, the guidelines are based on the principle that since business is the driver of globalization, business can push improvements that benefit economies and communities. “This is the next competitive advantage,” Omar said. “But [companies] still have issues of how to achieve this, how to implement, at an operational level.”

“A LOT OF PEOPLE THINK IT’S ALWAYS A TRADE-OFF BETWEEN MONEY SPENT VERSUS SOCIAL RESPONSIBILITY OR ENVIRONMENTAL IMPACT... SOMETIMES IT’S THE OTHER WAY AROUND.” AYMAN OMAR, ASSISTANT PROFESSOR

THE REAL BOTTOM LINE The give-and-take among costs, savings, investments, and returns—tangible and intangible alike— is a persistent tension. A company employs cheap Chinese labor, but loses those savings to higher shipping costs and longer inventory cycles. But being sustainable doesn’t have to mean taking a financial hit. “A lot of people think it’s always a trade-off between money spent versus social responsibility or environmental impact. ‘We can be good to the environment or socially responsible, but it’s going to cost us more money,’” Omar said. “Sometimes it’s the other way around. It can be good for the environment and socially responsible, and save money by using less resources and raw materials.” However, like most things, sustainability strategy does come down to money. Until managers believe sustainability is good for the bottom line, he predicts, companies will have little motivation to be proactive. Even so, corporate giants could wield significant power in raising supply chain standards, he noted: if Walmart tells suppliers to cut raw materials by 10 percent next year, they’re going to figure out a way. Omar has researched behind-the-scenes processes at two major US companies, Dell and Hewlett-Packard; the resulting research paper is under review at the Journal of Operations Management.

REGULATORY ENVIRONMENT In March, Omar and Assistant Professor Jon Kirchoff of East Carolina University presented a paper at the 20th annual North American Research and Teaching Symposium on Purchasing and Supply Chain Management in Arizona. Their study, “The Influence of Environmental Regulation on Global Sourcing Decisions,” will examine how companies evaluate cost versus regulation when making purchasing decisions. The professors are determining which countries and companies they will use to collect data.

JUST AS BUSINESSES DECIDE WHETHER TO PRIORITIZE LOW COST OR SOCIAL RESPONSIBILITY, GOVERNMENTS ALSO FACE A TRADE-OFF IN SEEKING FOREIGN INVESTMENT: THE QUESTION IS, WHO DO YOU WANT TO ATTRACT? Research has shown that purchasing managers play a significant role in the supply chain process, and low cost is the primary factor in purchasing decisions. Where Omar and Kirchoff plan to contribute is in studying the influence of environmental laws. Just as businesses decide whether to prioritize low cost or social responsibility, governments also face a trade-off in seeking foreign investment: “The question is, ‘Who do you want to attract?’” Omar predicts a wide disparity between countries still doing business in “pollution havens” and those that have pulled out because they value environmental concerns. His goal is to tease out the return on that value and the process by which companies make such decisions. The professors will study nations at both ends of the spectrum, from more heavily regulated Europe to the generally more permissive African countries. They also may examine new emerging markets, like Colombia and Argentina, where cost parities have allowed companies to move operations from China and Malaysia. “There are many, many interesting countries to think about,” Omar said. “The reality is, where can we go and where can we collect data.” WHO’S BEHIND THE CURTAIN? From companies’ perspective, having suppliers in multiple countries raises numerous implications for sustainability. One deceptively simple concern is knowing whom you’re doing business with. That may not be as easy as it sounds, according to Alexandra Wrage. She is the founder and president of Annapolis, Maryland-based TRACE International, a nonprofit that helps companies achieve antibribery compliance. She describes one company that for 10 years did business with a supplier it believed to be located in Jordan, based on invoices and shipping addresses. Eventually, the company discovered the supplier was actually an Iranian company, masking its nationality with a Jordanian freight-forwarding office.

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“RETURNS” ON INVESTMENT Getting goods to consumers is one thing. But what about the vast numbers of products that flow back

to companies because they are damaged, unsold, or otherwise unwanted? In 2002, this “reverse supply chain” was estimated at more than $100 billion a year globally. Managing such massive and unpredictable inventory is tricky. For help, Dell, Hewlett-Packard, and more than 150 other corporations use GENCO Supply Chain Solutions, which specializes in reverse logistics. Headquartered in Pittsburgh, the company helps businesses decrease return cycles, streamline processes, and “remarket” products to increase liquidation values. According to its website, GENCO manages more than $1.5 billion in freight annually with more than 10,000 employees and 37 million square feet of warehouse space. Omar visited GENCO’s Columbus, Ohio, and Nashville, Tennessee, facilities to study its longterm relationships with Dell and Hewlett-Packard. Although previous research focused on operational issues, he was interested in companies’ strategic decision making: Do we keep reverse supply chain management in-house or outsource it? Do we keep it in the US or move it overseas? What decisions and innovations are made to squeeze profitability from the reverse flow? “Our focus became, ‘How is this process being managed, what are the decisions being made, what kind of value is added from this external company?’” Omar said. Among his findings are that trust and corporate compatibility are crucial for an effective partnership. For Dell and HP to gain the most value from GENCO, they must share operational and strategic information that most businesses keep close to the vest. But when the relationship works, Omar said, it can get goods back to consumers in the least amount of time, over the shortest distance—which reduces fuel and transportation costs, saving the company money and making it more sustainable. Omar has shared his expertise as an adviser to the Sustainable Logistics Study Group, convened by the DC-based Japan International Transport Institute last October.

KOGOD NOW SPRING 2012 | kogodnow.com

KOGOD NOW SPRING 2012 | kogodnow.com

WHERE TO BEGIN? Even if a company is on board, how does it get its global suppliers and distributors there, too? Many managers are scratching their heads trying to translate lofty goals like “fight slave labor” and “cut pollution” into concrete, measurable numbers. Omar described the difficulty of setting benchmarks: If eliminating carbon emissions is unlikely, is a 10 percent reduction acceptable? Twenty percent? Thirty percent? Does every supplier have to meet the same standard? One solution that’s being watched carefully, he said, comes from Procter & Gamble. It is evaluating suppliers’ year-to-year improvements using a Supplier Environmental Sustainability Scorecard, posted online as an Excel spreadsheet. Each partner in P&G’s supply chain reports on 17 categories such as electricity, fuel, and water usage; hazardous waste disposal; compliance with Kyoto Protocol greenhouse gas emissions; use of recycled material; and fines. Companies are rated 1 to 5, from Far Below Expectations to Far Exceeds Expectations. Other companies use the 80-20 rule: if 80 percent of your purchases come from 20 percent of your suppliers, start working with that 20 percent.

Regardless of strategy, any effort raises the question of how much change is enough. “That’s still very subjective, but at least companies are starting to try to track this down,” Omar said. Companies also must decide how much to engage with suppliers. As outlined in the UN’s Global Compact guidelines, engagement can be as simple as setting expectations, or can range from monitoring and auditing suppliers’ compliance, to helping them improve deficiencies, to forming true partnerships. Even if companies hit on perfect metrics, supply chains fluctuate. The Brazilian factory you use this year might change ownership or close down next year. A new market opens up. International conflicts increase the likelihood of using unethically sourced materials. It all has implications for supply chain sustainability. “It’s not something where you can say, ‘By 2013, we’re going to achieve this goal and everybody is going to be doing an excellent job,’” Omar explained. “It’s an ongoing process.”


SUSTAINABILITY’S SPLINTER EFFECTS HOW WELL-MEANING LEGISLATION BACKFIRED IN THE CITY OF LOS ANGELES

ARTICLE BY AMY BURROUGHS

“IT’S SOMETHING OUR COMPANIES WERE VERY INSISTENT THERE WAS A NEED FOR. THESE COMPANIES HAVE TO OPERATE SOMETIMES WITH 150 OR MORE COUNTRIES AND IT’S REALLY HARD TO KEEP TRACK OF WHO THEIR SUPPLY CHAIN IS.” ALEXANDRA WRAGE, FOUNDER AND PRESIDENT OF TRACE INTERNATIONAL

Professor Bruce Hartman’s research demonstrates the complexities of the global economy, especially when it comes to instigating change. help trucks make the conversion. The program also required trucking companies to phase out independent drivers, relying instead on drivers employed by the companies. Negative reactions erupted. Opponents called the plan unconstitutional, a violation of the Interstate Commerce Act, and a Teamsters Union ploy to gain a foothold at the ports. National and local groups fought the costs of retrofitting trucks and feared that new regulations would drive business to more lenient cities. It wasn’t long before American Trucking Associations filed a lawsuit and the matter went to court, where it remains stuck in the US Court of Appeals for the 9th Circuit. According to Hartman, the case eventually may be appealed to the US Supreme Court because of the unconstitutionality claim. The litigation was focused on the right to work as an independent rather than an employee. In the meantime, the environmental provisions of the law went into effect. “This is a great example of a conflict between environmental goals and economic goals and social goals,” Hartman said. “That’s one of the big lessons of this case. You can sign up to implement environmental improvement measures, but the details matter, and different parties consider different things important so you’re likely to get objections.” At stake is the question: Who has the right to decide how to create a sustainable supply chain? Hartman’s paper articulated this complexity: “Each port must be careful to set pollution standards high enough to capture supply chains that have sustainability as a choice criterion, high enough

to satisfy regional interest groups, and low enough to assure that there will be trucks to handle the number of units they expect to move.” The professors used a game theory model to show that incentives don’t always work as intended. While drivers were offered a subsidy to upgrade their trucks, it didn’t automatically compel them to do so, although it did factor into their overall assessment of future risks and benefits. In trying to understand each side’s strategic interests, Hartman and his coauthor focused on bargaining positions. What they learned was that as each party took into account the other’s actions, both decided it wasn’t in their best interest to make any more improvements than they had to. The challenge of managing port traffic is unlikely to decrease. As Hartman pointed out, every product imaginable arrives from overseas in a large, rectangular shipping container. Their standard size makes them cheap to use in bulk, and container ships are getting larger to handle more capacity. As the numbers grow, companies and governments will have to figure out how to simultaneously reduce social and environmental impacts. “When people talk about sustainability, I’m always asking, ‘How do you measure that? How do you measure progress in any of these dimensions?’” Hartman said. “I think that we’re just beginning to explore how to measure those things and therefore how to improve them— because, basically, you get what you measure.”

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His study, coauthored with Associate Professor Christopher Clott of the University of St. Francis, examines the Port of Los Angeles’s controversial Clean Truck Program, which attempted to limit the use of drayage trucks hauling goods to and from the port. Their paper will be published in the International Journal of Shipping and Transport Logistics this year. “Sustainability means three things— economic, environmental, and social stability—and when you try to improve one of them, you may well impinge on what somebody believes about one of the others. That’s what happened here,” Hartman said. As the authors explain, burgeoning international trade and two decades of improved supply chain management have resulted in “mega ports” handling thousands of shipping containers daily. In 2005, about 70 percent of shipping containers from Asia arrived in the US through the West Coast, most via Los Angeles and Long Beach. But there was a price for that intense volume: the ports were the biggest source of diesel pollution in the Los Angeles Basin, regional air quality was terrible, and nearby residents had higher levels of asthma and disease. “The evidence was strong that rates of cancer were higher for people living in the neighborhood of the ports,” Hartman said. “There wasn’t really any scientific doubt about that.” Spurred by regulations approved by California’s clean air agency in 2007, the Port of Los Angeles instituted the Clean Truck Program in 2008; the program banned pre-1989 trucks and required newer trucks to meet stricter emissions standards. A subsidy was offered to

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KOGOD NOW SPRING 2012 | kogodnow.com

“Which meant,” Wrage noted, “this good and well-run company unknowingly bought Iranian goods for 10 years.” She pointed out that when it comes to doing business with sanctioned countries, ignorance isn’t a legal defense against a criminal violation. In her experience, companies are either fully committed to supply chain sustainability, perhaps even dedicating an entire internal department to it, or they are completely tuned out to potential risks. “Every company has the potential of a supply chain train wreck, but the amount of work they have to do to bring it into good order will vary, depending upon their industry and their supply model,” Wrage said. To help companies vet suppliers, TRACE recently launched the first uniform system for identifying overseas partners. “It’s something our companies were very insistent there was a need for,” Wrage explained. “These companies have to operate sometimes with 150 or more countries, and it’s really hard to keep track of who their supply chain is.” The service is free to companies. Starting June 1, suppliers will pay $80 and recertify annually. Suppliers complete questionnaires tailored to their business category, upload documents verifying ownership, corporate status, and similar facts, and answer compliance questions documenting previous bribery investigations, use of metals from certain countries, and the like. Wrage expanded the questionnaire in response to the California Transparency in Supply Chains Act of 2010, which took effect January 1 of this year. It requires retailers and manufacturers doing business in California to disclose their efforts to eliminate forced labor and human trafficking from

their supply chains. The law applies to companies with at least $100 million in gross annual receipts worldwide and, according to Wrage, is catching many companies off-guard. She also added screening questions for conflict minerals, like those used to make cell phones. Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires companies to disclose if their products incorporate conflict minerals originating in the Democratic Republic of the Congo or an adjoining country. Companies that use such minerals must report their due diligence on the minerals’ source and chain of custody. Wrage acknowledged that suppliers could misrepresent themselves. But, she said, the incentive is stronger to adapt to changing standards. “They’re going to take away from that question that they can enhance their reputation and will be a more valuable member of the supply chain if they keep clean on that issue,” she said. “We’re sending the message that companies prefer to work with entities that don’t do those things.” While TRACE’s self-reporting mechanism provides a much-needed starting point, future supply chain measurements may require “spot checks” or other techniques to ensure compliance and accuracy. After all, suppliers could be spinning attractive threads to catch new clients.


FINDING FEDERAL SAVINGS IN THE STRATOSPHERE ARTICLE BY ANNA MIARS

Imagine a large cruise ship. Passengers use the same communal space and infrastructure—restaurants, swimming pools, exercise facilities—but also have their own private cabins. Most people can’t afford to buy a ship, so this shared arrangement offers the maximum return with minimal investment. This is how cloud computing works for the federal government: it can do more with less by jumping on board.

SAVINGS IN THE SKY The technology necessary to support its daily operations, including governance risk and compliance, cost the federal government more than $88 billion in 2011—up $8 billion from the previous year. Shifting to the cloud is slowly, but steadily, lowering that figure. Vendors are replacing in-house experts who install, configure, and run—plus develop, test, and troubleshoot—programs. They also assume responsibility for the physical space to house servers and databases. Consulting firm Booz Allen Hamilton estimates that cloud computing costs are 65 percent lower than traditional IT costs were. In 2010, Vivek Kundra, the United States’ first chief information officer, mandated a “cloud-first” approach to IT. His Federal Cloud Computing Strategy

is now driving the government’s push toward implementation of the cloud. By 2015, the federal government plans to shutter 800 data centers, saving more than $3 billion annually. “Using cloud and similar technologies, we can now deliver systems and processes at an affordable price,” said Bhagat. “Hardware and software expenses of the past are no longer barriers to efficient operations.” Bhavesh’s firm, Confident Governance, combines the back-end work of governance experts with front-end customization. Risk, security, privacy, and auditing specialists weigh in on the back end to guarantee that the front end is a comfortable user interface that’s aligned with an organization’s needs. “There is no reason for federal agencies to continue to use so many different HR, accounting, and e-mail systems,” Lamoureux said. “It only creates incompatibility and confusion.” Agencies like the Labor Relations Authority have transitioned to cloud computing and seen promising outcomes. The agency switched from a case management system that used database software to a cloud-based system, eliminating up-front licensing costs of $273,000 and reducing annual maintenance from $77,000 to $16,800. The US Army, which moved its recruitment tracking system to the cloud, has reduced licensing costs from $83 million to $8 million and increased productivity by 33 percent, according to Info.Apps.gov. The cloud’s scalability also introduces financial flexibility. Usage-based pricing allows agencies to pay for exactly what they use, without the burden of a contract if and when needs change. Just

IMPROVED GOVERNANCE Reining in fragmented data and infrastructure also aids federal agencies in carrying out successful governance initiatives. Before the cloud’s arrival, a compliance office or hired contractor had to supervise complex initiatives across an entire organization. Lacking more effectual alternatives, it was difficult to create informed procedures that reflected realtime needs. Using cloud technology allows organizations to be better custodians of data, more aligned with regulations, and less susceptible to fraudulent acts. While no one can entirely account for human error—intentional or accidental—the cloud can ensure higher levels of accuracy and transparency. Accessed exclusively over the Internet, applications deliver important business information at the click of a mouse: analytics, fraud detection and prevention, investigation, receivables management, and screening. “Everyone is using the same software and looking at the same data,” said Associate Professor Gwanhoo Lee. “Rather than loosely connected silos, the cloud is a common repository.” Organizations can monitor their compliance with specific security standards, industry regulations, and corporate policies through technology rather than people. Data is largely safe from manipulation, since it is collected and housed beyond the four walls of the company; unintended redundancy is also eliminated.

IN IT WE TRUST As agencies develop and execute plans to migrate to cloud computing services, protecting how information is accessed and stored is the next major hurdle. The cloud’s widespread adoption has already placed increased emphasis on the field of cybersecurity. As the government’s strategy has progressed, Kundra—who stepped down in August 2011—has suggested the development of standards in the areas of security, interoperability, and data portability to ensure that information is protected. The standards would also verify that clouds and the computer applications they support are compatible, and that content can be moved from cloud to cloud without jeopardizing access to or integrity of the data. But while the security apprehensions associated with the cloud are widely known, the potential security benefits are less so. They include the ability to focus

resources on areas of high concern as more general security services are assumed by the cloud provider; greater uniformity; and improved backup and recovery. Bhagat recognized the need to support secure cloud computing when he founded the Cloud Security Alliance Federal Center of Excellence in 2009. Members of the DC-based chapter of the global not-for-profit seek to promote education, research, and development by hosting conferences and workshops, and granting training certificates to those who complete the workshops. In three years, the alliance has attracted more than 100 members. Beyond building a secure environment, the federal government’s “cloud first” policy seeks to streamline implementation. To that end, the federal government will adopt an “approve once and use often” approach. Once vetted, a vendor will be added to an approved list for future use by agencies that require its services. The General Services Administration uses 12 approved cloud vendors to serve 28 distinct offices. So is it smooth sailing from here? Perhaps; the horizon looks promising. Cloud computing has the potential to establish greater transparency and efficiency at a lower cost, leading to better governance and, ultimately, a more responsive government. And that charts a course we can all agree on.

Jackie Sauter contributed to this story.

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MAKING THE CLOUD’S CASE The federal government can be slow to embrace technological advancements. With more than 2 million non-military federal employees, 15 executive agencies, and numerous centers, offices, and divisions, it’s understandable: the benefits must be proven before a change is made. Yet centralizing desktop computer management has become extremely

difficult in recent years. Workers increasingly require access to their office files and network from multiple locations and devices. More than 85 percent of federal employees work outside the Washington, DC, metropolitan area, according to the Bureau of Labor Statistics, and telework programs are growing. “Instead of acquiring and maintaining resources separately, agencies— and centers within agencies—are able to share basic services in the cloud,” said Michael Lamoureux, MBA ’09, an associate at the management and technology consulting firm Octo Consulting Group.“Outsourcing infrastructure allows internal talent to work on projects of greater value.” Simply put, the cloud allows agencies to concentrate on their core competencies, rather than worrying about the technical complexities behind their execution.

Figuratively speaking, the cloud delivers actionable intelligence that previously took weeks or months to generate and relied on a variety of sources. One of the major goals associated with cloud adoption is democratizing public-sector information and embracing openness in government. President Obama’s Open Government Directive, issued in 2009, calls for transparency— one of three tenets—to help the public understand the government’s actions and hold it accountable. Enabled by cloud-based hosting, information is now directly uploaded to the cloud, whereas previously links were provided to data hosted on agency servers. The Federal IT Dashboard—a website that lets agencies, industry, the general public and others view details of federal IT investments—is an example of cloud infrastructure that makes it possible for agencies to provide and host data in a centralized location. Through standardization and consolidation, the cloud “establishes a framework that allows a degree of insight that was previously unattainable,” Bhagat said.

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KOGOD NOW SPRING 2012 | kogodnow.com

“Cloud computing is revolutionizing how we implement information technology,” said Bhavesh Bhagat, MBA ’97. “It is transforming how agencies and organizations assess and manage their risks.” As co-founder and CEO of the firm Confident Governance, Bhagat is an expert in this growing domain. He helps government agencies of all sizes govern their operations better by offering high-level strategy and nuts-and-bolts technical design as subscription-based services through the cloud. It appears that more agencies want to make that jump. A survey conducted by MeriTalk last year revealed that 64 percent of federal CIOs thought the cloud will help them reduce costs and improve services. Forty-two percent of IT managers said using cloud services will help them overcome the stormy budget climate. At a time when the bottom line is driving operational decisions, cloud computing offers an alternative that not only is more cost-effective, but also affords greater transparency in terms of how data is stored and monitored. Going forward, the federal Office of E-Government and Information Technology is requiring that agencies default to cloudbased solutions whenever a secure and reliable cloud option exists.

like electricity, natural gas, and other utility services, the total cost reflects precise usage. “Managing data is expensive and time-consuming,” said Lamoureux, who recently completed a project on using cloud storage for research needs at the National Institutes of Health. “The cloud has unending capacity and can facilitate data sorting that is not possible on in-house machines. Ultimately, it gives us a smarter way to look at data.”


PRACTITIONER PERSPECTIVE

WHEN SUCCESSION PLANNING GOES BEYOND THE FAMILY My family’s company was founded in Arlington, Virginia, in 1956, as construction of the Capital Beltway began. Alongside the communities that were forming in the expanding metropolitan area, Dewberry built its reputation for civil engineering, architecture, and consulting services. BARRY DEWBERRY, MS ’82, IS CHAIRMAN OF THE BOARD AT DEWBERRY, WHERE HE HAS SERVED FOR ALMOST FOUR DECADES. THE FAMILYOWNED FIRM, WHICH IS HEADQUARTERED IN VIRGINIA AND HAS A NATIONWIDE PRESENCE, PROVIDES ARCHITECTURAL, ENGINEERING, MANAGEMENT, AND CONSULTING SERVICES TO PUBLIC AND PRIVATE CLIENTS.

Sid and his four children are whole owners in equal shares of the company. I am Sid’s oldest child, and the only one working in the business. We are focused on the infrastructure for the places where we live and work—most of what you see and everything you don’t. We serve both public- and private-sector clients, the latter being our roots. Dewberry has grown to 40 offices across the country and 1,800 employees. Our growth is guided with a steady hand: decisions are made conservatively, in the context of how they will impact us decades on. Our company has momentum and clear goals. Words like passion, perseverance, integrity, and intellectual honesty are cornerstones to our employees. We run lean; in 56 years, we have never lost money. It should come as no surprise that change is accepted only in small doses. That has worked for us; the company is thriving, and we do not have debt. This cautious temperament is why it came as a shock to me when, in 1997, the ground shifted irrevocably—without warning, like an earthquake.

CONSTRUCTIVE TENSION There have been some bumps along the road. One is that management needs its own space. When tough-minded independent management meets tough-minded owners, who were the hands-on managers just yesterday, there can be friction. As owners, we absolutely need for them to succeed. They have our support, and we do not interfere with their chain of command. But we also want management to play ball according to the Dewberry playbook, and therein lies the rub. You hire people who are strong and have vision of their own. Then you ask them to see the world through your glasses. Eighty percent of the time, we think alike or easily smooth over our differences. It’s that other 20 percent that weighs heavily on their minds. I like to call this “constructive tension.” Adopting a more open and democratic style of management has also brought opinions out of the woodwork. My siblings are now speaking up at board meetings; I don’t always like what they have to say. Independent directors don’t always see eye to eye with each other, the owners, or management. There is more paper flying around. There are more meetings, with more people at them. The pace of making decisions has slowed down to the speed of sound. I never figured more voices and layers of approval to be inherently better, but I tell myself it’s OK. Maybe our management and decision-making hierarchy was flatter than it should have been.

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IF IT AIN’T BROKE… It was traumatic for me to rewrite the future without myself as boss. Intellectually, I understood that it made perfect sense to get the succession plan under way, while both Sid and I were still around to guide it. But that did not make it easy. I still had so many questions: How would a board and nonfamily members as managers work as well as what we had previously had in place? What would happen to our culture and mission now? What made us believe this would promote, or even protect, the family’s interests? There were no reassuring answers…only a plan to move forward. The plan was detailed and tough-minded. For me, it started with accepting that planning for future Dewberrys—those not even born yet—was becoming my responsibility. We could not predict the family’s future ability to successfully manage, or even oversee, the company for generations to come. What to do? Our answer was to develop and test a system of management and governance that did not rely on a Dewberry. First, this meant a board of directors consisting of family owners and independents, with the latter being equal or greater in number. All members had an equal vote, with two exceptions: owners reserved the decisions to sell shares and choose independent board members. The board was charged with ensuring that Dewberry was being managed from a 30,000-feet perspective, in a way that would guarantee its health and longevity as a family-owned business. For the board, we chose successful practitioners from our world, all of them retired. All previously had run companies like ours, and they came from a similar culture. At Dewberry, our people get warm feelings knowing that they had a hand in building

WE’RE NOT DONE YET Ten years on, with these three items in place and working, the dust had settled enough for us to see that our work was not done. We were finally getting accustomed to the idea of a future where control could pass out of our hands—but our original questions were not yet completely answered. How will Dewberry retain its culture and mission if there are not successive family members in the key role of CEO? Through the generations, as board members come and go, how will we keep company oversight consistent? In 2010 we started a family council, where owners and their children could regularly gather to discuss company business in an open forum. We realize now that in order to keep our business in the family, to remember and respect the original mission, and to ultimately maximize value, we need a strong, united family. If the family is not close-knit, this can be tricky. But you must have a place to test the interests and mettle of the successors, and to identify which of them will lead and what support they might expect. For the family council we retained a consultant who specializes in organizing and keeping the council on track for the long haul. I believe that one day the family will generate its own momentum… but today, we need somebody to keep us collectively focused on the goal. We know that the original culture and mission may need to change with time and the interests of future family owners. That will be their decision to make. In our case, the next generation is still young, and only time will tell of their successes. Our hope is to give them a structure to support them as they work through these complex issues. I can finally say that I am glad we got started while I was young.

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KOGOD NOW SPRING 2012 | kogodnow.com

OUR STORY In 1997, my father was 70. For him, the notion of retirement was still an abstraction, as it remains even today. I was then CEO, and had served the company for 22 years. At 47, I was focused on my future. Management succession planning in my mind was simple: Sid was the boss until I was the boss. I was about to get a lesson in just how quickly the world could change. Unbeknownst to me, Sid had been thinking about how to preserve the company as a family business for another century. That year, I did all I could to dissuade Sid from changing the way we ran the firm and, most importantly, from changing the future I had planned for myself. When that failed, I did all I could to help develop the vision and put it in motion.

Three years later, we had agreed to sweeping changes. Sid kicked himself upstairs to the newly formed board of directors. I resigned as CEO, and we promoted our best man to become the new manager.

and strategizing for the future of their communities. Clients are neighbors. Our bet was that these members would be sympathetic to our business model and values, and anxious to preserve them. And so, a closed system of values remained closed. But this was only the first step. The second part of our new strategy was hiring independent managers to run the firm and report to the board. Management’s job is clear: to see that the mission and culture, agreed on by the board, is adhered to. This has to be done on the ground, every day, minding the details. Next, a comprehensive owner’s agreement spelled out the limits of authority for owners, the board, and management, and thereby the relationship between all three bodies.


PRACTITIONER PERSPECTIVE

THE BUSINESS CASE FOR SUSTAINABILITY

As a regulator and as a corporate executive, I have a unique perspective in the burgeoning world of sustainability because I’ve looked at this issue from both sides. Many would suggest that those two perspectives are like night and day, yet I believe the regulator and the regulated community have much in common.

LINDA FISHER IS CHIEF SUSTAINABILITY OFFICER AND VICE PRESIDENT—DUPONT SAFETY, HEALTH & ENVIRONMENT, WHERE SHE HAS SERVED SINCE 2004. AN ATTORNEY, FISHER WAS PREVIOUSLY A SENIOR LEADER AT THE ENVIRONMENTAL PROTECTION AGENCY AND IS A BOARD MEMBER OF SEVERAL NOT-FOR-PROFIT ORGANIZATIONS.

our customers improve their environmental and product performance. We are currently focused on developing sustainable solutions for three global challenges: feeding the world, decreasing our dependence on fossil fuels, and protecting people and the environment. Society is demanding high-performance, sustainable innovations to address these issues, and it’s through such innovation that we will have to develop new products and services if we are to achieve our market-facing goals by 2015.

GOAL NO. 2: INTRODUCE SAFETY PRODUCTS Our second market-facing goal was to introduce at least 1,000 new products or services that help make people safer globally. To date, we have introduced 928. Worker safety has traditionally been included as part of the social aspect of sustainability. To that end, DuPont is committed to protecting our protectors—military personnel, law enforcement officers, firefighters, and first responders—with things that help them perform their jobs as safely as possible. Products such as DuPont™ Kevlar® and Nomex® advanced fibers and DuPont™ Tyvek® nonwovens are used in body armor, helmets, turnout gear, vehicle armoring, and other protective equipment. GOAL NO. 3: GROW REVENUES THROUGH SUSTAINABLE PRODUCTS By 2015, we plan to grow our annual revenues by at least $2 billion from products that create

“TWO-THIRDS OF OUR CUSTOMERS BELIEVE ENVIRONMENTAL BENEFITS IN PRODUCTS WILL CONTINUE TO HAVE A POSITIVE IMPACT ON JOB CREATION IN THE NEXT FIVE YEARS. THIS TREND OFFERS SIGNIFICANT GROWTH OPPORTUNITIES FOR COMPANIES THAT CAN DELIVER SUSTAINABLE SOLUTIONS.” energy efficiency or significantly reduce greenhouse gas emissions. We are getting there; in 2010, we generated revenue of $1.6 billion from products that help our customers, or the final consumer, reduce their greenhouse gas emissions. Much of the increase was from revenue growth in key areas like PVs and from engineering polymers used in safely lightweighting vehicles. One example of how we operationalize this charge is through cars. It’s no surprise that automobiles are a significant source of carbon dioxide emissions. But high-performance, lightweight DuPont-engineered plastics can replace heavier metal parts and components inside cars, thereby reducing their weight and contributing to fuel savings and reductions in carbon dioxide emissions. We have also developed next-generation refrigerants for automobile air conditioning that have a 97 percent lower global warming potential than the substances currently in use. We estimate that our products have reduced greenhouse gas emissions in our supply chains by

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GOAL NO. 1: R&D INVESTMENT Our first goal was to double our investment in R&D programs with direct, quantifiable environmental benefits for our customers and consumers to $640 million per year. In 2010, we surpassed our goal, investing $667 million in total. Our investment is paying off. A key example is DuPont’s critical role in the solar industry. DuPont materials continue to set new photovoltaic (PV) industry standards around the world. Highly durable and efficient photovoltaic modules, widely known as solar panels, permit the reliable production of low-carbon electricity. The generation and storage of renewable energy will be the fastest-growing sector in the energy market for the next 20 years. With more than three decades of experience in PV materials development, applications know-how, manufacturing expertise, and global market access, our extensive (and growing) portfolio of solar solutions is key to both crystalline silicon and thin-film solar cells and modules. Our materials increase their lifetime and efficiency, thus reducing overall system costs.

We have invested hundreds of millions of dollars across all of our businesses that sell into the solar photovoltaic market. We collaborate with PV cell and module manufacturers, equipment suppliers, academic institutions, industry associations, and government entities. We have expanded our global capabilities for product R&D, bringing testing and application support closer to customers in every region. In the end, we want to reduce the cost of solar energy to bring it in line with other forms of power generation, and therefore encourage faster and broader adoption of solar energy to reduce fossilfuel dependence. We are close. We expect to reach that goal mid-decade.

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KOGOD NOW SPRING 2012 | kogodnow.com

In my view, sensible, science-based regulation protects the public health and the environment, but it also creates regulatory certainty. Regulation can provide the industry with the market incentives and time it takes to develop new solutions to pressing problems. At DuPont, our vision is to be the world’s most dynamic science company, creating sustainable solutions essential to a better, safer, healthier life for people everywhere. As often as we repeat these words, we need to remind ourselves that they are more than an inspirational goal: they inform our everyday reality and are an integral part of the way we conduct ourselves. Our mission of sustainable growth can be traced back to decisions and commitments we made decades ago. In the ’70s and ’80s, our sustainability focus was on internal safety and meeting environmental regulations. In the late ’80s and through the ’90s, we added voluntary environmental footprint reductions, going beyond the current regulatory requirements. Next, we began thinking more deeply about our products and how they could help our customers reduce their impact on the environment. In 2006, we made sustainability commitments that placed more focus on the types of products we brought to the market, and not just on how we made them. These “market-facing sustainability goals” addressed all stages of product development, from R&D efforts through marketing and sales. They also marked a turning point in our corporate thinking around sustainability, from an internal focus to one that looked outward. Sustainability had become a key part of our growth strategy, as we established goals that recognized an opportunity in helping


PRACTITIONER PERSPECTIVE

REGULATING INDEPENDENCE HOW THE PERCEPTION OF VIRTUE IMPACTS THE BOTTOM LINE

ARTICLE BY AMY BURROUGHS

Suppose that Betty Miller is a well-respected auditor working for an esteemed Big Four firm. Betty led the firm’s audit of Massive Multinational for years, before taking early retirement. Exactly 365 days later, Massive Multinational hires her for a high-profile, well-paid senior position. Analysts nationwide get a queasy feeling in their stomachs. more than 6.5 million metric tons between 2007 and 2010. GOAL NO. 4: NON-DEPLETABLE RESOURCES Our final market-facing goal was to nearly double revenue from products produced from non-depletable resources, to at least $8 billion. Last year, we grew to $7.7 billion in revenue. Our customers and their consumers are demanding more sustainable and environmentally friendly products—now. They want products that are better for the environment because they are made with better materials. DuPont is delivering high-performance, biobased materials made from renewable sources that reduce fossil-fuel dependence. Using common crops, such as corn or soybeans, as well as nonfood crops, like switchgrass and corn stover, to make renewably sourced building-block chemicals and fuels reduces the need for petroleum as a raw material. It also reduces carbon emissions from the processing stages. Renewably sourced products cross numerous industries and markets. They are used in everything from carpeting to fabrics to personal care products to liquid detergents and antifreeze.

It happens more often than you’d think. And while new regulations have been implemented in recent years to ensure that auditing firms are suitably independent from their clients, the most important aspect of the relationship cannot be regulated: the perception of integrity and independence. That’s one of the major research findings by Assistant Professor Yinqi Zhang. In one of her research streams, Zhang examines the financial consequences for investors when a company hires a former auditor as a financial executive. Specifically, she examines whether investors and analysts will continue to trust the integrity of that company’s earnings reports, or choose to seek additional sources of information. Zhang’s research shows that investors likely consider the new executive to be less impartial than someone with no previous company affiliation. Investors’ hesitancy stems from a complex set of concerns, which could number any—or all—of the following: • The newly minted leader has inside knowledge of auditing procedures—in other words, she knows the tricks of the trade and how to circumvent them. • Audit firm staff may be reluctant to question the accounting practices of their former colleagueturned-client. • An auditor with her eye on a plum position at a client’s firm may be disinclined to push back against a prospective employer with whom she wants to curry favor.

REGULATORY IMPLICATIONS In another research stream, Zhang has used regulations, such as the SarbanesOxley Act of 2002 (SOX), to study changes in companies’ behavior and the implications for their accounting practices. SOX prohibits auditing firms from providing many types of business services other than the traditional assurance services—such as certain kinds of tax advice and consulting, which used to offer them a lucrative additional revenue stream. One of the purposes of SOX is to temper earnings management—a deliberate misdirection intended to make firms seem more stable. Earnings management boils down to this: In a good year, a company keeps money in reserve, so that if a bad year follows, those earnings can be released and give the impression that the company is even-keeled. The controversial practice, which investors consider objectionable, results in companies adjusting reports in order to appear less volatile than they actually are. Zhang found that, after SOX was enacted, companies on average had a significant reduction in purchasing nonaudit business services from their auditors. And firms that had a greater decline in these harmful purchases were more likely to practice the earnings management sleight of hand. “The findings support the SEC’s rule, because we proved that companies that excessively purchased non-auditor services had higher earnings management—which, of course, investors don’t want,” Zhang said. The ensuing article was published last year in Auditing: A Journal of Practice & Theory.

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The bottom line is, “It’s crucial to create the perception that you are inde-

pendent to investors and regulators,” Zhang said. “If auditing independence is challenged, then investors resort to alternative sources of data and may not trust your firm anymore.” Her research indicates that investors’ use of quarterly earnings information declines after an affiliated auditor is hired. And for companies that want to issue new stock or access capital markets, the perception of independence is even more crucial. While the US Securities and Exchange Commission has set the bar high for everyone, Zhang said, companies in this position have the most to lose. Past research has established that firms with independence violations face a much higher cost of raising capital. The SEC has established a one-year “cooling off” period before an auditor can safely join a former client’s staff. This is so investors have reason to believe that the former auditor has had enough time and distance to remain objective. Some factors can mitigate concerns about auditor independence, according to Zhang, such as a strong, independent audit committee. Committees that lack a financial expert or are too close to management, on the other hand, are likely to make investors nervous. To be sure, there are above-board reasons why hiring a former auditor can be beneficial to the company. That person knows the industry inside and out, and is familiar with company issues. He or she also has existing relationships with key company staff, such as the comptroller and treasurer. But in the long run, perception is paramount. Zhang’s research paper is being considered by the Review of Accounting Studies.

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THE RESULTS The market seems to agree with our direction. According to 89 percent of DuPont customers surveyed, delivering products with environmental benefits is a long-term market opportunity. Our customers said that among their most important environmental benefits are products that deliver inherently safer materials, reduced air and water pollution, and improved energy efficiency. Moreover, two-thirds of our customers believe environmental benefits in products will continue to have a positive impact on job creation in the next five years. This trend offers significant growth opportunities for companies that can deliver sustainable solutions.

WHAT’S NEXT? We view DuPont’s role as making the direct link between our customers and the markets they serve. It’s the key to truly integrating sustainability as a growth strategy. We see sustainability broadening to include human safety as well as environmental protection, and continuing be a key driver of our business priorities throughout the value chains we serve. The transition to products that meet the definition of “sustainable” will happen over time. But the pace will quicken as the synergistic effects of market demand, societal expectations, and product innovation create collaborations up and down the value chain. We believe the global companies that succeed in responding successfully and sustainably to 21st century challenges will be those that master the art of collaboration. That’s why we are building alliances around the world in an effort to address needs sustainably at the local level. We’ve adopted a new model that we call “inclusive innovation.” It means solving problems by designing their solutions in cooperation with those who will benefit directly from the product. We invite others to join us in this endeavor as we uncover unmet needs and respond to them. Together, we can accomplish what no one can do alone.


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BEHIND THE SCENES

VIDEO FEATURE

Kogod Now editor Jackie Sauter explains how the content of the Corporate Governance issue came together and reveals her own family crest in this special editor’s note.

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HOW CAN YOUNG BUSINESSWOMEN PRESENT THEMSELVES AS AUTHORITATIVE LEADERS—AND FUTURE BOARD MEMBERS? Despite their mounting educational achievements, women still hold only about 15 percent of top corporate positions, according to The Atlantic. Amanda Cardinale, MBA ’12, explores the ways in which female employees tend to speak and debate in the workplace, and the potentially unfavorable consequences. See what she has to say at kogodnow.com/women.

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Kogod Now - Spring 2012