Inside a glass house at Morningstar…

April 6, 2012

Over the years, we’ve taken lots of companies (and their top executives) to task for things like over-use of the corporate jet, high-priced security services and even a taste for expensive maps. So if you saw one of us, for example, at a small executive airport about to board a Gulfstream V, it might make you wonder if we really mean what we say.

We thought about this yesterday as we read the proxy statement filed by our parent company, Morningstar (MORN). That’s because for the first time since the company went public in 2005, a shareholder has filed a resolution challenging the fact that the company’s founder, chairman and primary stockholder, Joe Mansueto, is also its CEO.

As shareholder resolutions go, this one is pretty routine. Here’s a snip:

When a CEO serves as our board chairman, this arrangement can hinder our board’s ability to monitor our CEO’s performance. Many companies already have an independent Chairman. An independent Chairman is the prevailing practice in the United Kingdom and many international markets…The Corporate Library, an independent investment research firm, said there were ongoing concerns regarding our company’s board composition and its ownership profile. Five of 8 board members had 12 to 27-years tenure. This included four directors who have served for the same 12 years and CEO and Chairman Joe Mansueto, who founded the company and has served on the board since the company’s inception in 1984.

What caught our attention was Morningstar’s response. Like the many other companies that have already faced this proposal over the years, Morningstar encourages shareholders to vote against it. Here’s the main argument:

The Board believes that the company is currently best served by having Joe Mansueto, the company’s founder, occupy the positions of chairman and chief executive officer. The primary responsibility of the Board is to foster long-term success of the company. A key element in fulfilling this responsibility is to determine periodically which person or persons should serve as our chairman and chief executive officer based on the best interest of the company and its shareholders at that time. The members of the Board are in the best position to make this decision based on their knowledge of the company. At this time, the Board believes that it would be unwise to impose an inflexible requirement that the position of chairman be limited to one who is an independent director and who has not previously served as an executive officer.

And this is where things really start to get interesting. That’s because for the past 7 years, Morningstar has been issuing stewardship grades for stocks,green energy sources, and one of the key components of that grade is whether the company’s chairman and CEO is the same person. According to the grading system, companies that don’t split the role should have “a lead independent director that can actively challenge the authority of the chairman/CEO.” Morningstar does not have a lead director.

We’ve found a number of recent examples where Morningstar analysts gave companies low stewardship grades at least in part because of this dual role. For example, Moody’s (MCO) which has some overlap in terms of business with Morningstar, was given a C grade for stewardship late last year because “Ray McDaniel became CEO and chairman in 2005 and had served as president of the rating business since 2001. We’d prefer to see the roles of CEO and chairman split.”

In two recent examples where Morningstar analysts gave Amgen (AMGN) and McKesson (MCK) D ratings for stewardship, the respective analysts both cited the dual role. For Amgen, the analyst wrote “the firm loses points for Sharer’s dual role as CEO and chairman” and at McKesson, the analyst wrote that “We prefer the positions of chairman and CEO to be separate to ensure the board’s independence.”

In an email exchange with Morningstar spokeswoman Margaret Kirch Cohen, she noted that as controlling shareholder, Mansueto’s interests are closely aligned with the rest of the company’s investors, “allowing him to provide the board with a major shareholder’s perspective.” She added that the company has been in the process of changing its stewardship grades for the past year, and has never made the independent-chairman question, one of 20 items that she says analysts consider on stewardship, a hard-and-fast litmus test for stewardship.

—Our equity research team is moving away from tracking corporate governance data points that have not demonstrated value in influencing stewardship or shareholder returns,” Cohen said. —Our methodology has always taken into consideration that if a company consistently aligns its interests with shareholders and demonstrates good stewardship of shareholder capital, it can still receive an above-average stewardship grade even if it had a combined chairman and CEO. She noted that analysts have in the past given A grades for stewardship to companies where the chairman and CEO have the same role, including Berkshire Hathaway, Nucor, Lowe—s, Target and PepsiCo.

We spoke to Jim McRitchie yesterday, whose wife, Myra Young, submitted the Morningstar proposal. McRitchie is a longtime shareholder advocate who runs the site CorpGov.net. Of course, first we had to assure McRitchie that we weren’t actually a corporate spy pretending to be a journalist. Though McRitchie says he doesn’t expect the resolution to pass, given that Mansueto owns nears 50% of the outstanding shares, he thinks splitting the roles is the right thing to do. “It’s interesting that they put out one piece of information for other companies but follow another for themselves,” McRitchie said.

We also exchanged emails with Stanford Business School Professor David Larcker, whose book (co-authored with Stanford researcher Brian Tayan) on Corporate Governance is cited by Morningstar as a reason for shareholders to reject the proposal. In responding to the proposal, the company says, “(The authors) concluded that most studies regarding the impact of separating the chairman and chief executive officer roles have found little or no evidence that separation leads to improved corporate outcomes.

In our email exchange, Larcker wrote: “the evidence is extremely mixed on whether there is a positive impact on shareholder value. Our view is that this type of separation by itself does not create value. However, we believe that there are circumstances where the separation might be of value. Since many U.S. firms have a lead director that calls executive sessions among the independent directors and also serves as the communication contact between the board and management, we do not believe that it is generally necessary to separate the CEO and Chairman roles for most U.S. companies.”

As we’ve said before, writing about one’s parent company is always a little awkward, though Morningstar has been good about maintaining our editorial independence since it acquired footnoted just over two years ago. In this case, given how closely we watch the governance practices of other companies, we felt it was important to look at Morningstar’s proxy with the same skepticism we would any other company’s.

Image source: The Glass House

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Today may be a market holiday, but the SEC is open for business today, which should mean some interesting filings. We’ll be providing our best finds from today’s Good Friday filings dump to subcribers to footnotedPro. For more information, or to inquire about a trial subscription, please contact us.

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