RJR Deal May Set New Standards for Outside Directors

The stubborn independence shown by RJR Nabisco’s non-management directors may have set a standard that other corporate boards in similar situations will be judged by, according to experts on corporate management.

“People thought the board was too cozy with the management, but they did the right thing,” said Gerry Angulo, an investment banker at First Capital Partners in New York.

When the food and tobacco company’s management approached the directors with a low-ball, $75-a-share takeover offer, non-management directors responded by inviting new bidders. Ultimately, they rejected the company’s own executives, awarding the coveted prize to the Kohlberg Kravis Roberts buyout firm.

The board’s actions reflect a new independence shown by directors in just the past several years, takeover experts say. From fear of shareholder lawsuits, and at the explicit direction of the courts, many boards now work harder to observe scrupulous impartiality in judging the takeover contests that divide up billions of dollars in corporate spoils.

When Independence Counts

In contrast to a day when directors often rubber-stamped management decisions, outside board members are increasingly aware that they, too, are accountable for a company’s decisions. Nowhere is this responsibility more clear than in episodes, such as at RJR Nabisco, when managers try to buy their own firm.

“The responsibility of an outside director is at its absolute zenith when there’s a proposal for a management buyout,” declared Warren M. Christopher, chairman of the O’Melveny & Myers law firm who sits on the boards of First Interstate Bancorp, Lockheed and Southern California Edison.

“What we’re seeing now are more and more occasions for boards to exercise those responsibilities.”

Board members must avoid even the perception that they are favoring the interest of in-house managers over company shareholders.

“You do now see a marked difference in directors’ attitudes, and the RJR fight illustrates that,” says Gregg Jarrell, formerly the Securities and Exchange Commission’s top economist and now a professor at the University of Rochester.

To be sure, critics maintain there are still lots of cases where management-picked boards show a decided tilt toward their fellow occupants in the executive suite.

But a general change in attitude is acknowledged even by the shareholder activists who don’t hesitate to lambaste managements they feel haven’t done enough to increase stock-owner prosperity. “We see cases where boards don’t live up to their jobs as fiduciaries, but in general, they’re taking this job a lot more seriously,” said Sarah Teslik, executive director of the Council of Institutional Investors, a group of major pension funds.

Part of the reason is groups like hers. The huge institutional shareholders that represent hundreds of billions of dollars from pension funds, endowment funds, insurance companies and other sources are vigilant in watching for lapses in fiduciary duty. They have proven willing to sue.

Directors are also aware that they may be personally liable for their failings as fiduciaries, although some states have passed laws to protect them from this. Directors felt a chill in 1985 when a court found the directors of Transunion Corp. personally liable for $23 million for hastily approving the acquisition of their company without seeking an outside appraisal of the bid.

Courts More Demanding

They have begun to feel more vulnerable, too, as insurance companies have jacked up the price of liability coverage, or reduced or withdrawn it.

Clearly, a big reason for the new attitudes is that the courts have become more demanding about what they require of directors. Particularly important have been the decisions of the state court of Delaware, the state in which more than half of Fortune 500 companies are incorporated.

The Delaware courts have very specifically spelled out what boards must do in certain takeover situations to establish impartiality, Jarrell says. For example, boards must set up special committees of outside directors to evaluate bids, and recommend a course of action for the full board.

The committees must hire independent advisers to evaluate the merits of various takeover offers, he said. The Delaware court rulings strongly suggest boards begin an auction process with several bidders, rather than try to negotiate with a single bidder.

Jobs More Complex

RJR’s board followed each of these steps. It set up a five-member committee of directors in late October when the management-led bidding group made its initial offer. The committee then hired an independent legal team, from the firm of Skadden, Arps, Slate, Meagher & Flom. And it retained the investment banking firms of Dillon, Read & Co. and Lazard, Freres & Co. to assess the competing bids.

These new rules have made the directors’ job more time-consuming and complex. Outside directors “are being increasingly asked to be accountable for a variety of actions that in the past people rubber-stamped,” said Alfred Osborne Jr., a UCLA economist who sits on the boards of Times Mirror, Nordstrom and other companies. In contrast to a simpler past, shareholders and the public now scrutinize corporate decisions in a variety of ways, he says: “Is it maximizing the short-run value? The long-run value? What about employees and the communities?”

Some directors believe that the highly publicized example of the RJR case will cause more directors to think independently. “I know of several boards that are stacked with yes-men,” said Harvey A. Bookstein, a Los Angeles accountant who serves on three boards. But, “I think there are going to be less and less of them.”

Paul Richter reported from New York and Jonathan Peterson reported from Los Angeles.