HOW CAN BOARDS GET MORE 'SPINE:" AN "ECONOMIST" REVIEW.
How can company boards be given more spine?
COOTE got me in as a director of something or other. Very good
business for me nothing to do except go down into the City once or twice a year
to one of those hotel places Cannon Street or Liverpool Street and sit around
a table where they have some very nice new blotting paper. Then Coote or some
clever Johnny makes a speech simply bristling with figures, but fortunately
you needn't listen to it and I can tell you, you often get a jolly good lunch
out of it.
The blotting paper has vanished. But to judge by the crop
of scandals currently tormenting American business, little else about life in
the boardroom has changed since Agatha Christie wrote The Seven Dials Mystery
in 1929. As some of America's best-known bosses lied, swindled and defrauded
their way through hundreds of millions of shareholders' funds in the
effervescent late 1990s, boards of directors, supposedly the guardians and
protectors of shareholders' interests, appear to have snoozed through it all.
Dennis Kozlowski, recently ousted from the top of Tyco, an
ill-fitting conglomerate, stands accused of evading taxes on fine art, which
his board may have lent him the money to buy. Bernie Ebbers, former boss of
WorldCom, a telecoms firm, persuaded his board to lend him hundreds of
millions of dollars so that he could bet on his company's share price. The
board of Adelphia, a publicly owned cable company with a stock worth little,
put the company's name on $2.3 billion-worth of bank loans to the founding
family, which owns one-fifth of the shares. Not to mention Enron, whose board
rode roughshod over its own rules in order to allow Andrew Fastow, its chief
financial officer, to benefit personally from the off-balance-sheet vehicles
that he set up.
Scandal leaps from company to company with bewildering
speed, and as share prices collapse the lawsuits mount. Directors are in the
front line. PricewaterhouseCoopers, an accounting/consulting firm, has
counted almost 500 securities lawsuits filed by investors in the past year.
Marsh, an insurance firm, reports that the premiums that companies pay to insure
their directors against lawsuits have shot up by between 35% and 900%
recently, depending on the business. Companies at greatest risk, says Steve
Anderson of Marsh, could be paying $2m a year for a $10m policy if they can
find an insurer willing to underwrite the risk at all.
What to do when you become a target of the SEC is the topic
that exercises the latest issue of Directors & Boards magazine.
The SEC, meanwhile, is urging state and federal prosecutors to bring more
criminal cases against securities-law violators, and on June 12th it voted to
introduce a new rule requiring chief executives to vouch personally for their
companies' financial statements. America's boards have been in scrapes
before. Never, however, has their reputation sunk so low.
With such forces on the loose, even boards themselves have begun to
understand that something needs to be done. And not only in America.
Corporate governance is a hot topic around Europe too. The scandals there may
not have been as great as on the other side of the Atlantic, but recent
experience in America has helped to highlight an issue that has been on
Europe's corporate agenda for some time.
In Britain, a former director of the Prudential insurance company, Derek
Higgs, was appointed by the government in April to head a review into the
role and effectiveness of non-executive directors (more or less equivalent to
America's independent directors). On June 7th, Mr Higgs issued a consultative
document inviting comments on, inter alia, whether existing relationships
with shareholders need to be strengthened, and on what can be done to attract
and recruit the best people to non-executive roles. He is due to report by
the end of this year.
One person from whom he will not need to canvass views is Lord Young of
Graffham, a former trade minister in Margaret Thatcher's government. As
outgoing president of the Institute of Directors, Lord Young shocked an
audience in April by suggesting that non-executives can do more harm than
good and should be abolished. George Cox, the institute's director-general,
had to explain sheepishly that Lord Young's views did not reflect the
official views of the institute. â€œWe believe non-executives have a valuable
role to play, affirmed Mr Cox.
In Germany, where companies have two boards a supervisory board of
non-executives and a management board responsible for running the company a
government-appointed commission issued a code of corporate governance in
February. Most attention was focused on a suggestion that companies publish
top managers' pay, hitherto regarded as a private matter. But the longest
section of the code was concerned with turning supervisory boards into better
watchdogs. They should, it suggests, contain no more than two ex-members of
the management board. Their work should be delegated to small, competent
committees; and no member of a management board should sit on more than five
supervisory boards of unrelated companies.
In such countries as France and Italy, the issue of
corporate governance has yet to come to the fore. Many of the biggest public
companies in these countries from LVMH to Fiat still have large family
shareholdings, family representatives among their senior management, and
strong family representation on their boards. In France, it has been claimed
that only about one director in five on the boards of public companies is
Such a structure may help to resolve the perennial conflict between owners
and managers. But it limits the role of the board as a check on management.
It also leads to even greater cosiness among leading businessmen, who love to
appoint each other to be external directors of their boards. For example,
Bernard Arnault, chairman of LVMH, a luxury-goods group and one of the
largest companies in France, sits on the board of Vivendi Universal, a media
group that is also among the largest companies in the country. The chairman
of Vivendi Universal, Jean-Marie Messier, in turn sits on the board of LVMH.
In Italy, the high-level business and financial club of directors is known as
the salotto buono, literally the good drawing-room. It's that cosy.
East Indian origins
One reaction to the corporate scandals in America has been to seem to act
tough, in the hope of restoring investor confidence. In this spirit, the New
York Stock Exchange (NYSE) published on June 6th a set of proposals for new
boardroom standards for its listed companies. These include everything from
boardroom executive sessions without the boss to mandated orientation
programmes (including a field trip to corporate headquarters) for incoming
directors. Institutional investors, corporate-governance activists,
regulators, corporate lobbies and Congress are all jostling for position with
ideas for reform.
Working against this, meanwhile, is a countervailing impulse to protect the
best bits of the existing system from poor, or unnecessary, regulation. The
periodic worry that America may be asking too much of its boards has begun to
return. Headhunters such as Spencer Stuart and Korn/Ferry say that, as the
legal risks rise, emptying chairs around the boardroom table are getting
harder to fill. Others warn that shackling the boss with an interventionist
board may threaten America's entrepreneurial business culture.
The origins of the board lie in the 17th century among early forms of the
joint-stock company, notably the English East India Company. After merging
with a rival, it organised itself into a court of 24 directors, elected by
and reporting to a court of proprietors, or shareholders. America has dabbled
with other models of governance from time to time. In the 1920s, the chairman
of General Electric, Owen Young, pushed the idea of stakeholder boards. But
since the rise of pooled investment savings in the 1940s and 1950s, the trend
has been towards the East India Company model, with the board accountable to
shareholders. Corporate law, the courts and activist institutional investors
such as Calpers (which began publishing lists of underperforming boards in
the 1980s) have further entrenched the shareholder model.
One strand of history traces a push by shareholders for greater board
independence. In the 1970s, many shareholders became particularly upset by
public companies whose boards were beholden to powerful private interests,
often the founding family. These sorts of tension still linger. Bill Ford,
the boss of Ford, did not get his job on merit. And until last month,
Adelphia's board accommodated no fewer than four members of the Rigas family the
company founder, John Rigas, and his three sons. There should never be more
than one Rigas on any board, comments Dennis Block of Cadwalader, Wickersham
& Taft, a Wall Street law firm.
Modern problems of board independence tend to be more nuanced than this,
although not hugely so. In America, the chief executive tends to chair the
board. In good times Americans heap praise on the strong business leadership
that such a system cultivates. But during bad times, they fret about the
worrying lack of spine elsewhere around the boardroom table the nodders and
yes-men, as the author P.G. Wodehouse once called them.
This matters particularly in America, where the tyrannical corporate leader
is a well-established figure. John Patterson, once boss of NCR, a computer
company, fired an underperforming executive by removing his desk and chair,
parking it in front of the company's factory, and having it soaked in
kerosene and set alight in front of the poor man. Armand Hammer, when boss of
Occidental Petroleum, kept signed, undated letters of resignation from each
of his board directors in his desk. Among Jack Welch's top tips for bosses:
never put an academic in charge of your compensation committee. They are more
susceptible to envy than rich old men.
Sure enough, in the midst of the latest corporate-governance disasters stand
the usual feudal-baron types such as Mr Kozlowski of Tyco, Mr Ebbers of
WorldCom and Gary Winnick, the founder of Global Crossing, a bust telecoms
firm. These burly ex-sports jocks get things done quickly. But they also tend
to bully their boards into meek docility. The symptoms are clear: egomaniacal
corporate strategies and extravagant personal rewards. IBM's board recently
rewarded Lou Gerstner on his retirement from the chair not with the
stereotypical gold watch but with $100m-worth of company stock.
Most people reckon that one of the board's most important duties should be to
plan a replacement for the boss should he die or need to be jettisoned. Yet
many boards seem to lack the backbone even to raise this topic. It is
surprising and distressing how few boards have a clearly thought-out process,
says Don Gallo of Sibson Consulting Group. I think it's a huge failing in
their fiduciary duties towards shareholders.
Tyco and other companies have chosen to bring back former chief executives
when they have lost their bosses, a clear sign (if not conclusive proof) that
their boards had no plan for succession. Nell Minow of The Corporate Library,
a watchdog website, recalls talking to board directors of a public company
who got into a shouting match with the boss about succession. His policy was:
I'm not going to die', says Ms Minow.
Reformers start with the way in which directors get
elected. The CEO puts up the candidates, no one runs against them and
management counts the votes, says Ms Minow. â€œWe wouldn't deign to call this
an election in a third-world country. In theory, shareholders can put up
their own candidates, in what is known as a proxy contest. But proxy fights
are exorbitantly expensive. The recent tussle at Hewlett-Packard between its
boss, Carly Fiorina, and Walter Hewlett, a dissident board director, may have
cost the company's shareholders $150m.
As the incumbent management has the corporate coffers at its disposal, this
expense tends to make proxy fights one-sided affairs: even the smallest of
Hewlett-Packard shareholders reported receiving 20 or more calls from the
company. As a final blow to shareholder activists, the courts in Delaware,
where the majority of American companies are incorporated, found insufficient
evidence that Ms Fiorina had unfairly coerced a big shareholder, Deutsche
Bank, despite hints to the contrary. Proxy contests happen at less than 1% of
public companies each year in America.
The British and Canadian solution to the overbearing boss is to split the
role of chief executive from that of chairman of the board, a post that can
then be filled by a lead independent director. This idea has found some
support in America. Harold Williams, a former chairman of the SEC, championed
it in 1978. Institutional investors, says Roger Raber of the National
Association of Corporate Directors, are keener than ever before to split the
roles. But support among companies, says Mr Raber, is going the other way.
They say they fear conflict in the boardroom, threatening precious collegiality.
The NYSE is thought to have toyed with the idea of a separate chairman, but
it does not appear in its published proposals. The exchange is, however,
proposing new standards for director independence, along with a requirement
that all boards contain a majority of these newly defined independent
directors. (Almost all American boards already have a large majority of
non-executive directors.) The NYSE's proposed executive sessions without the
boss ought to give directors a chance to escape the perils of groupthink,
intimidation and what Victor Palmieri, a crisis-management expert in the
1980s, called a progressive loss in the collective grasp of reality.
Companies seem to hate the idea of executive sessions which might mean they
could actually work.
Some embrace these reforms as part of a creeping professionalisation of the
board. This need not mean that the job becomes full-time. But it does mean
raising and standardising the qualifications for joining a board. Part of the
NYSE's answer to the proliferation of accounting scandals among listed
companies, for instance, has been to set clearer and more detailed
qualifications for board directors who serve on audit committees.
A director's lot
To get the right people, consultants say, their pay may have to rise. Outside
the top 100 companies in America, whose directors typically earn
$250,000-300,000 a year, the rest make do on $50,000-75,000. The consultants
point out that exchanges, regulators and Congress have been heaping extra
burdens on the board for years. Boardroom committees, for instance, have
proliferated. Even audit committees were uncommon 20 years ago. Now any board
worth its salt needs a compensation committee, a nomination committee, a
finance committee, a public-policy committee and now a governance committee
This creates unrealistic expectations among investors, say critics. No
director can be expected to catch sophisticated fraud by company insiders.
The head of Enron's audit committee, Robert Jaedicke, is a professor of
accounting at Stanford University, who could hardly have been more qualified
for the job. Shit happens, says one Wall Street financier. He calls the NYSE
proposals a lot of nonsense.
The most powerful catalyst for change ought to be the big institutional
investors that have their own fiduciary duty to protect their investors.
Right now, these institutions are busily blaming boards for recent wrongs.
But this seems rather convenient. One of the more interesting features of the
assorted revelations now scandalising the market is that many of them are
hardly news. Everybody suspected that America's energy-trading companies
inflated their revenues. Software-contract accounting was an acknowledged
black art. And the fact that telecoms firms bought from each other to boost
their numbers has shocked nobody but neophytes. The big institutions knew who
the cheats were. But life was good, and they nodded and winked and chose to
go along with it. In many ways, they now have nobody to blame but themselves.
As part of its reforms, the NYSE proposes to give shareholders more
opportunity to monitor and participate in governance. This includes allowing
them to vote on stock and stock-option plans for bosses, and making companies
disclose codes of business conduct and ethics on their websites. In Delaware,
judges seem more willing to put their faith in the judgment of sophisticated
institutions, and may increasingly throw open contentious issues to a vote.
When it comes as it inevitably will the next wave of corporate scandals might
put institutions, not boards of directors, in its crosshairs.