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Chipotle Board Is Back in the Spotlight with Ackman Stake

Bill Ackman discusses Chipotle's future.Bill Ackman discusses Chipotle's future.
Bill Ackman discusses Chipotle's future.Photos by Keith Srakocic—AP & Andrew Harrer—Bloomberg via Getty Images

Chipotle is in the spotlight again this week after activist investor Bill Ackman revealed a nearly 10% stake in the burrito chain. The investment community expects Ackman to agitate for change to the company’s board, which has previously been under fire for everything from its insular composition to CEO compensation.

The following, from a piece I published in April called “Chipotle’s Board Feel the Heat from Agitating Shareholders,” takes a closer look at the company’s directors. At the time, CtW Investment Group was calling for changes to the Chipotle board after the company had endured a series of food safety issues. The company’s financial and stock performance has continued to suffer as a result, making it a target for Ackman.

Chipotle (CMG) has a new problem—and this one has nothing to do with the company’s food.

CtW Investment Group, which works with union-backed pension funds that hold some 55,000 Chipotle shares, wants the fast-casual Mexican-food chain to shake up its board in the wake of the company’s food safety crisis.

In a letter to shareholders, CtW called Chipotle’s group of directors “one of the least diverse, least independent boards among the S&P 500.”

CtW’s funds hold a relatively negligible stake, but CtW has a history of agitating for governance reforms. It was a vocal player in pushing for compensation reform at Chipotle in 2014 (more on that later).

[Chipotle did not respond to Fortune‘s requests for comment at the time of the original publication but today offered the following from spokesman Chris Arnold: “All of our directors were re-elected in last year’s shareholder vote. We are currently interviewing for one additional board member, and are considering additional changes to our board to accommodate longer-term needs. I might also add that we are in the process of adopting proxy access provisions based on the results of last year’s vote.”]

Here are a few of the key issues CtW called out in the letter to shareholders that it made public:

  • “Excessively long director tenure.” The median tenure for a Chipotle director is 17 years, with six directors having served for more than a decade, the letter said. Four of the seven outside directors were appointed while the company was private, which CtW calls a “management-dominated process.” Two directors are former McDonald’s (MCD) executives and have been on the board since the fast food giant owned Chipotle. (Read this for more on McDonald’s governance issues.)
  • “A shocking dearth of racial and gender diversity.” The letter notes that 100% of the directors are white and only one is a woman.
  • Three of Chipotle’s seven outside directors have ties to Denver and Boulder, Colo., where the company is headquartered and the co-CEOs attended college.

To sum it up, the letter charges that Chipotle has outgrown its board. “They replicated the mom and pop recipe, and that’s probably what contributed a lot to their success,” says Jim Neale, a partner with law firm McGuireWoods, who specializes in food safety defense. “But there’s a level of sophistication that you need if you’re going to do things on a large scale so you can respond to large-scale problems.”

Larry Fauver of the University of Tennessee’s Corporate Governance Center said of the board, which has only one independent director who is currently a Fortune 500 executive: “You would expect a little more fire power.”

In addition to two directors who had stints at McDonald’s, another company popped up more than once: Syntex Corporation, which was acquired by Roche in the mid-1990s. Both Neil Flanzraich (a Chipotle director since 2007) and Darlene Friedman (a director since 1995) worked for the pharmaceutical company at one time. Founder and co-CEO Steve Ells’s father, Bob Ells, was once a senior executive at Syntex and was the first financial backer of Chipotle. A 2015 oral history of the company from Bloomberg noted that in the early days the board was made up of almost entirely of family friends.

Chipotle lists only two directors as not being independent—co-CEOs Ells and Monty Moran. But the Syntex connection is an example of what governance experts call “soft” ties. “When I think about independence, there are two flavors,” explains Hillary Sale, a professor of law and management at Washington University’s law school. “One is financial and one is state of mind. The state of mind standard is what we call a ‘beholdenness standard’—can they think independently? It’s much harder to measure and is not regulated by the federal government.”

Until September, Friedman and Patrick Flynn—a director since 1998 and one of the two former McDonald’s executive—had been the only two members of the compensation committee and also held the distinction of being among the longest-serving directors. CtW in its letter specifically called for shareholders to “withhold support” for the reelection of Friedman and Flynn.

“The longer you are on the board, the more comfortable you become with management and what management is doing,” says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “Where you see oversight failures, you will oftentimes see folks who have been there a long time and have soft or hard ties to management.” Elson says that Chipotle situation seems to be of that flavor.

Chipotle’s pay structure has been under scrutiny since CtW pushed for shareholders to vote against the company’s executive compensation in 2014. Equilar, in collaboration with The New York Times, rated Ells the No. 27 highest-paid CEO in 2014, with Moran coming in at No. 31. If you added their compensation together as co-CEOs, they would have ranked No. 10.

Ultimately, 77% of shareholders who voted opposed the compensation plan that year.

“That only happens in extreme cases,” says corporate governance expert Nell Minow. “It sends a serious message. It’s an indicator of a weak board.” Elson noted that it “symbolized a board that seems to be a little out of touch.”

In September 2015, a third director, Flanzraich, was added to the compensation committee and became its chair. The company also hired two compensation consulting firms and later announced big pay cuts for the co-CEOs in the wake of negative financial results caused by the food-borne illness issues.

Chipotle has made two additions to its board in recent years, adding Stephen Gillett, a senior executive at Google[x] and a former Starbucks CIO last year, and in 2013 entrepreneur Kimbal Musk (the brother of Tesla founder Elon Musk) joined the board. Musk does not sit on any committees.

The company disclosed in its proxy that Chipotle’s charitable foundation gave a non-profit organization founded by Musk a grant of $250,000. It also said that it had a “business relationship” with Google Inc., where Gillett works.