On Governance, It’s Two Thumbs Down For Netflix

Posted: Jun 13, 2018 12:18 PM
On Governance, It’s Two Thumbs Down For Netflix

I've written recently about governance problems with Netflix and even discussed the issue on Fox Business Network with my friend, Neil Cavuto. However, the governance problems with this company run so deep that one column and one TV do not afford enough space to truly explore the issues, so this column (focused on the lack of shareholder rights) and a planned future column (focused on financial reporting) will tell the rest of the story.

On both governance and board practices, Netflix is near the bottom of the distribution, a worst offender. I don't know about you, but when I go to Rotten Tomatoes or IMDB to see the reviews of a new Netflix show, and it has a rating that rotten, I'm done and won't even watch the trailer (except perhaps out of some kind of morbid curiosity).

Sometimes due to politics a reviewer gives a good show a bad rating. But that's not the case here. Our screens already had Netflix at a thumbs down before the company put ex-Obama administration official Susan Rice on the board or the Obamas themselves on contract. I wouldn't care if they Jurassic Park’d Ronald Reagan and put him on the board -- this company has problems that left, right, and center should all be concerned about.

Mainly, the problem is that non-insider shareholders are treated like extras, rather than the stars of the show (which as owners, they are). Two of their directors did not even get a majority vote in past elections and were nevertheless kept on the board! The board has given itself that power. The board also ignored several proxy resolutions which would shift power to shareholders, including proposals that got a majority of votes cast.

Basically, this is a board which had the power to keep board members on board even after they have failed to get majority votes of shareholders. And, amazingly, when shareholders got together to put a change to that (and to similar abuses of power), the board refused to change the rules -- even when the measures got a majority of shareholder votes. 

That's not typical corporate behavior. That’s an outlier.

There are other serious governance problems. For example, the company has an 'entrenched board', which means very little turnover of board members, which can tend to harm independence. There are problems with 'overboarding' which means that one or more directors is on too many boards to focus adequate attention to all of them.

The board is staggered, which makes it impossible to sweep out the old guard in a timely fashion, and severely limits the ability of shareholders to take matters into their own hands through direct proxies or rule changes.

There are also issues with related party transactions: the CEO personally owns a private jet, which the company (with shareholder-owned resources) leases from him.

There are also complex interrelationships between a board member who was an original private funder of the company, and other board members.

And then, not surprisingly, there's the issue of executive pay. It's not based on performance -- at least not for top management. There's a base salary and then stock options, but stock options can be valuable just because of a general bull market, not anything specific to the company or to its managers' achievements.

The company is adopting a performance-based plan for bonuses, but not for the CEO or the CFO.

You will probably not be surprised to learn that, in the unlikely event that the shareholders get enough control to fire the CEO, he has a golden parachute, a large severance pay event triggered by a change in control.

But, some argue, the company has done very well for stockholders -- it's had great returns. That's true, but that is often the case with firms like this… They do very well, for a time. But eventually the little structural flaws and the papering over of operational problems in the financial statements (covered in the next column in this series) can tend to reassert themselves when it's not expected. If you don't believe me, ask investors in Wells Fargo, Equifax, and Tesla.