Jamie Dimon Faces His Critics in Crucial Shareholder Vote

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Jamie Dimon

The six best math students at the all-boys Browning School on Manhattan's East Side were given bad news, and then worse news. Their math teacher had suffered a heart attack and would not be returning to teach—that was the bad news. The worse news was that her replacement did not know calculus.

If the students wanted to continue to study calculus, they would have to teach it to themselves.

Three of the students decided the task was hopeless. The other three stuck it out. They'd go to class each day and work through the problems in their textbooks. There was no teacher in the classroom at all. Just the three students, trying to teach themselves one of the most bedeviling subjects a high school student ever faces.

One of the students who kept up with calculus was Jamie Dimon, the guy who would eventually become the chief executive officer and chairman of the board of the largest bank in the country, JPMorgan Chase. At the time, math was not even his favorite subject—that was history—but it was his strongest.

You might think that the administrators and teachers at Browning would be deeply impressed by this academic dedication. But you would be wrong about that. Even though he graduated fourth in his class, Dimon was rejected by Brown University—in part because of a backhanded recommendation letter written by the assistant headmistress of the school.

"His lack of manners, due to his habits of making quick judgments and contradicting others, is greatly improved," the assistant headmistress wrote, according to Duff McDonald's biography of Dimon, Last Man Standing (from which this school days tale is lifted).

She praised Dimon's "keen, analytical mind" and his "dedication and seriousness of purpose." But she could not avoid mentioning what she saw as his problem with authority. Dimon was too headstrong to win her unqualified praise.

Forty years later, Dimon once again finds himself pitted against the corporate governance equivalent of a legion of assistant headmistresses. A pair of influential shareholder advisory groups, Institutional Shareholder Services (ISS) and Glass Lewis, have recommended that shareholders vote to split Dimon's role as chairman and chief executive. The AFSCME Employees Pension Plan, the Connecticut Retirement Plans & Trust Funds, Hermes Equity Ownership Services and various New York City pension funds have issued a shareholder proposal calling on JPMorgan Chase to name an independent chairman.

JPMorgan will announce the outcome of the shareholder vote on Tuesday at the bank's annual meeting in Tampa, Florida. The vote is only advisory—the board could still name Dimon to both posts even if the shareholders vote for a split—but it is being watched very closely on Wall Street, by investors, and by corporate chiefs across the U.S.

A trend toward separation

Efforts to separate the roles of chairman and chief executive at public companies in the U.S. have been underway for years. The share of companies in the S&P 500 with a split structure has risen to 41 percent in 2011 (the most recent figures available) from 23 percent in 2003, according to a report put out by Deloitte last year.

Splitting the roles is much more common outside the United States.The Deloitte report said that in Canada, 55 percent of companies in the Toronto Stock Exchange have independent board chairs. In Germany, 50 percent of companies in the Deutscher Aktien Index (DAX 30) have independent board chairs. In the United Kingdom, 76 percent of companies in the Financial Times Stock Exchange (FTSE) 100 Index split the roles.

Advocates of the split structure claim that this model best positions companies for strong performance and better, more shareholder-friendly governance. A 2009 study by the Corporate Library, a research firm based in Portland, Maine that has since become part of GMIRatings, said businesses with unified CEO-chairmen tend to be less "shareholder friendly."

"A board that retains the dual role out of reluctance to challenge a powerful chief executive may not be a strong protector of shareholder interests in other respects," the research firm said.

"The two most authoritative positions in a boardroom are the CEO and the chairman. However, when these roles are combined, all the authority is vested in one individual; there are no checks and balances, and no balance of power," Paul Hodgson of GMI wrote in a different, more recent report.

The evidence on the governance count is strong, so long as you define "shareholder friendly" as adopting structures approved of by self-styled shareholder advocates. But it remains an open question whether such firms actually perform better in ways that matter most to shareholders, including the performance of the company's stock.

There is in fact no strong evidence demonstrating the companies that split the roles of chairman and CEO perform better than other companies. Most academic research shows evidence that splitting the roles improves long-term performance of the company to be weak or nonexistent.

Last year, however, a paper by GMI challenged this consensus. That paper showed that while the median shareholder returns for over a one-year period and a three-year period were superior for companies that combined the roles. The returns over a five-year period were better for companies that separated the chair and CEO. The authors of the study conclude that this indicates that separated roles are better for long-term, diversified shareholders. This, however, might be an artifact of the study's timing, since the five-year period included the financial crisis in which many financial companies with unified roles suffered tremendous losses.

One reason that splitting the chair and CEO might not perform as well as advocates expect is that board structures in general—the number of independent directors, staggered voting, and so on—do not appear to have any consistent effect on financial performance. Boards may matter for company performance but the formal structures seem to matter less than is commonly supposed.

What's more, separate chairs are not necessarily independent. Many of the companies that have separated the roles wind up chosing ex-chief executives or other retired officers to lead the board. The Deloitte study found that only 21 percent of companies on the S&P 500 have truly independent, non-executive chairs (up from just 9 percent in 2004).

Even truly independent chairs may not be the blessing they seem to be. Even if splitting the roles makes it easier for a board to monitor the chief executive, the board must now also monitor another powerful individual—the chairman.

"The board now must expend effort to ensure that such a chairman doesn't use the position to extract rents from the company and, moreover, that the chairman expends the effort necessary to carry out the post's duties effectively. The board also must ensure that a dysfunctional rivalry does not arise between the chairman and the CEO, both of whom presumably will be ambitious and highly capable individuals," UCLA law professor Stephen Bainbridge has written.

Unsurprisingly, not all companies experience the split of the CEO from board leadership the same way. Some companies, particularly those whose stock has been under-performing for long periods, seem to see a boost in stock performance when the roles are split. For others, it makes no difference at all. And at least one study has found that in very complex companies—such as JPMorgan—the effect is very small to non-existent.

Companies that have the most to benefit from splitting the roles are those that operate outside the spotlight or lack strong directors. It would be hard to imagine a company more in the spotlight lately than JPMorgan. And the board has a strong and independent lead director, Lee Raymond, the former chief executive and chairman of ExxonMobil.

This Time, It's Personal

But if the evidence in favor of splitting the roles is so weak in general, and weaker still in the case of JPMorgan, why is this year's proxy contest considered to be a close run thing? And why did forty percent of the shares vote for splitting the roles at the last meeting?

To answer that, it helps to remember that Browning assistant headmistress who noted Dimon's "lack of manners." Even though he is obviously far more polished now, Dimon still has—as McDonald put it in his biography—a "reputation for being somewhat difficult in the presence of anyone else's authority." He's been a vocal critic of financial reform, directly challenging Fed Chairman Ben Bernanke in a public forum for instance. He's bristled at criticism from Wall Street analysts. And, of course, he initially swatted away questions about the London Whale as a "tempest in a teapot."

Dimon and JPMorgan have also become synecdoches for Wall Street, much the way Lloyd Blankfein and Goldman Sachs were a few years ago. The bank and its chief serve as a focus for public ire against the financial sector. In an odd repetition of the aquatic theme, the London Whale is the new Vampire Squid. Taking the chairmanship away from Dimon is seen as a way of showing Wall Street that this time the public means business.

In a post titled "Jamie Dimon Needs A Boss," Felix Salmon of Reuters last week tried to make the case for splitting the roles turn on specific critiques of Dimon's chairmanship.

Even if Dimon is a great CEO, there's really no evidence at all that he's a great chairman, and JP Morgan's shareholders have the right to install the best possible officeholder in each of those roles.

How do we know that Dimon is a bad chairman? Well, there's the fact that there's no good succession planning, for starters. And then there's the board itself, which is basically a bunch of supine muppets, who do as they're told rather than actually representing shareholders and holding the CEO to account.

The problem with Salmon's argument, however, is that succession planning isn't just the job of the chairman. It's the job of the board as a whole. If they're failing now—if they're "a bunch of supine muppets"—why would anyone think installing a powerful non-executive chairman change things around? In point of fact, the board currently enjoys an extensive array of powers that truly controlled boards do not, such as the ability of the independent lead director to call special meetings of the board and of shareholders.

Simon Johnson, writing in the Economix blog of the New York Times, cites the London Whale fiasco, in which JPMorgan lost billions by bungling trading and risk-management in a previously unknown division of its Treasury Department, as evidence that JPMorgan has "a serious problem from a shareholder perspective that needs to be addressed through strengthening board oversight."

But this is effectively rebutted by Steven Davidoff's piece in the Dealbook section of the New York Times.

This is important in the case of JPMorgan, because some have argued that the move is justified in this case for risk management purposes. Included in this group are the funds proposing this resolution, stating that "we believe that independent board leadership would be particularly constructive at JPM," and that the firm's $6 billion trading loss last year had "tainted Mr. Dimon's reputation."

But does anyone really think that the JPMorgan board sits with complex spreadsheets looking at the bank's risk positions? Does anyone think it should?

Instead, the boards of sophisticated banks control risk by picking the right management. Up until the multibillion-dollar trading blowup last year, Mr. Dimon had a stellar record on risk management. Would an independent chairman really have prevented such a trading debacle?

Better risk management is just not one of the things that splitting the chair and chief executive is going to accomplish.

In any case, the biggest problem at JPMorgan is really just that the bank remains too big to fail. This status distorts management decisions, blurs the lens through which it views its own risk, scrambles market signals, and ultimately hurts long-term shareholders by encouraging the company to take on too much debt. But that's also not a problem that an independent, non-executive chairmanship is going to solve.

A time for testing

Voting on the issue is already underway. Several large shareholders have already cast their votes—although only JPMorgan and the firm they've hired to count the shareholder vote know where the tally stands. The rest of the world will not find out until Tuesday.

A clue to how things are likely to go, however, can be seen by looking at a chart by Matt Levine of Dealbreaker. Levine took a look at the governance structure of JPMorgan's twenty largest institutional shareholders, who together control around 38 percent of the company.

The majority of the largest shareholders—representing more than 26 percent of the voting power in the company—have unified executive chairman. Each of the five biggest shareholders—Blackrock, Vanguard, State Street, Wellington, and FMR—have chief executives who are also chairman.

This is what we might call a revealed preference. The top shareholders apparently think that having CEO chairman is a good idea. They are very likely to vote not to split the roles.

Around 45 percent of the top holders, however, reveal the opposite preference. They divide the roles. Together they control around 11 percent of the voting power.

This is where the weird role of a mostly unknown organization called Governance for Owners comes into play. The organization is a self-styled shareholder activist—although not in a loud and pushy sort of way. Governance for Owners says on its website that its activism is "constructive and discrete."

Although Governance for Owners runs a small fund of its own, that's not why it is important here. What makes it important is that Blackrock, the largest holder of JPMorgan stock, has delegated its voting power to Governance for Owners, according to the New York Times. It had to do so because of a provision in the Bank Holding Company Act, which applies to Blackrock because of PNC Financial's 21 percent stake in the asset manager.

Last year, Governance for Owners voted against the proposal to divide the chairman and chief executive roles. But because shareholder advocate types are really enthusiastic about having splitting the roles, there is at least some chance it will vote with other shareholder adviser groups.

Governance for Owners is holding its cards pretty close to its vest, refusing to say how it will vote. But if its task is to represent the interest of Blackrock here, you'd think Blackrock's entrusting the chairmanship to its chief executive Larry Fink would count in favor of letting Dimon hold on to both roles.

Calpers—another large institutional holder—Is expected to vote in favor of splitting the chair and CEO. The California public pension voted in 2011 to split them. And then, of course, there are the AFSCME Employees Pension Plan, the Connecticut Retirement Plans & Trust Funds, Hermes Equity Ownership Services and the New York City pension funds that have already indicated support for a split.

The last time around, 40 percent of the shareholder vote went for splitting the roles. If a smaller share votes for the split this time, that will be a major victory for Dimon. If a significantly larger share votes to split, Dimon will at least have suffered a setback. Which means that if Governance for Owners changes the Blackrock vote and all others remain the same, Dimon will be seen as having been rebuked.

A majority vote against Dimon would almost certainly spur the board to reconsider the current structure, despite the fact that the vote is only advisory.

When asked what the biggest downside to splitting the roles would be, Dimon replied that it might result in him leaving the company. That wasn't really a threat. It was more of a prediction by someone who understands himself very well. Dimon does not need the money he gets from running JPMorgan—he's been paid quite enough over the years to have amassed a fortune larger than he or his progeny will ever need. So if shareholders rebuke him too strongly, he may well decide they'll have to make do without him.

At this point in his life, he doesn't need to put up with a scolding by the assistant headmistress.

_By CNBC's John Carney. Follow him on Twitter at @carney.