Setting a New Agenda for Directors : Investment: The cozy, rubber-stamp corporate board comes under attack by reformers and shareholder activists.
The criticism and discontent so evident in this election year is pushing rudely into corporate boardrooms.
Just as populist Ross Perot barged onto the political scene to challenge the validity of the two-party system, an influential group of corporate-governance experts and shareholder activists is demanding a shake-up in corporate oversight that would retire the good-ole-boy network of passive, rubber-stamp directors in favor of committed and involved stewards of corporate affairs.
The revisionists include consultants, academics, lawyers, regulators and shareholder activists who hope to replace what they view as an outmoded, discredited model. They seek to redesign a system that will turn out independent, better-informed “superdirectors” whose scope will range beyond today’s narrow focus.
Last week’s forced resignation of Robert C. Stempel as CEO of General Motors is but the latest example of growing boardroom power. Previously, Sears, Roebuck directors orchestrated the sale or spinoff of several divisions to focus management’s efforts on its long-neglected retailing core. And at Digital Equipment, directors recently persuaded founder Kenneth Olsen to step aside.
At the same time, shareholders are agitating for a greater voice in management at troubled giants such as International Business Machines. The new ranks of corporate reformers, however, advocate more sweeping--and fundamental--change in the boardroom.
They would expand new-age directors’ responsiveness beyond business constituencies such as managers, lenders, shareholders and suppliers to public constituencies such as employees, communities, the environment and the economy. Ideally, their goal is to ensure that corporate money and talent are employed efficiently toward an overall economic and social good.
Some envision a future that more closely resembles well-coordinated European and Japanese economies, in which investors work closely with management and government when companies run into trouble.
Jay W. Lorsch, professor at Harvard Business School and author of a book on boards titled “Pawns or Potentates,” sums up the new mandate: “Directors would become stewards of important national assets. (The reform movement) is about the failure of great corporations. The issue is the same thing the election is about: loss of jobs. American management is being held accountable.”
In this era of accelerated change--which management expert Peter F. Drucker calls “one of those great historical periods that occur every 200 or 300 years when people don’t understand the world anymore”--it’s hardly surprising that corporate governance has come under closer scrutiny.
The sickening roll call of layoffs and plant closings and the economy’s stubborn stall have frayed nerves across the country. People don’t have far to look for culprits, and corporate directors haven’t helped their image by approving fat pay packages for poorly performing executives in recent years.
But corporate-governance experts believe the present system can be rescued and revitalized. Says Michael Useem, professor at the University of Pennsylvania’s Wharton School, “I think the whole governance debate will result in empowered boards working more closely with investors and top management to determine a better way of presiding over assets of the firm.”
Many experts envision a vast oversight network capable of intervening more quickly when corporations begin to drift. The goal: Long-term corporate health to protect against a repeat of the past decade’s contractions and help maintain the nation’s economic strength as well as its internationally competitive edge.
Lorsch and New York attorney Martin Lipton lay out steps they believe can accomplish such a change in an article to be published in the November issue of The Business Lawyer. The authors warn that the current system no longer works: “The most obvious sign of failure is in the gradual decline of many once great American companies.”
They insist no changes in laws or regulations are required for what they call their “modest proposal.” They advocate:
* The shrinking of boards to no more than 10 members, each with a term limit, and separating the duties of the chairman and chief executive. Also, they call for the establishment of independent audit, compensation and nominating committees.
* Bimonthly board meetings of a full day each; one annual two or three-day strategy session; a full day’s preparation for each meeting, for a total of at least 100 hours annually.
* A carefully focused agenda that covers strategic planning, capital allocation, long-range goals, performance appraisal and manpower planning. And, they advocate establishment of a lead director to work with the CEO in creating an agenda, a concept used by many European companies.
* An annual evaluation of the CEO and an annual assessment of how the board is functioning.
* An annual board meeting with 5 to 10 of the company’s largest investors. If a company has under-performed three of the last five years, provisions should be made for outside directors to comment in the annual report on causes and remedial actions undertaken. Large shareholders should be allowed to comment in proxy materials for the annual meeting.
Joining Lorsch and Lipon on the reform bandwagon is Chancellor William Allen of the Delaware Court system. Allen, a noted scholar on corporate law, calls for outside directors to function as “active monitors of corporate management, not just in crisis, but continually.”
In an influential speech at Northwestern University last spring, Allen recommended that directors play an active role in formulating and approving long-term strategic, financial, and organizational goals, and he called on them to review performance and press for change when needed.
The notion of reforming corporate governance is also gaining momentum overseas. Oxford Analytica, an international consulting firm based in Oxford, England, predicts that increasing internationalization of business will lead to major change in boardrooms around the world throughout the rest of this decade.
In a report on corporate-governance trends in seven industrial nations sponsored by four U.S. legal, accounting and investment banking firms--Russell Reynolds Associates, Price Waterhouse, Goldman Sachs International and Gibson, Dunn & Crutcher--Oxford Analytica predicts that boards in the United Kingdom, Canada, Germany, France, Italy and Spain will tighten management accountability, widen representation of various stake-holder groups and deepen involvement in strategic direction.
The British researchers expect the greatest change, however, to occur in the United States, where boards already possess more independence than their brethren abroad.
To be effective, Oxford Analytica says, future board members must steep themselves in the fine points of finance, production, research and international markets as well as maintain strict ethical standards.
All this theory raises the obvious question: How will tomorrow’s superdirectors, especially those from non-business sectors, develop sufficient knowledge and skill to carry out the new directives?
Advocates of change contend they must sever their dependence on corporate managers for information and turn increasingly to independent counsel for advice on issues such as how better to monitor financial performance and how to tie executive compensation more effectively to performance.
Understandably, all this proposed meddling alarms CEOs of the blue-chip companies that make up the Business Roundtable. They aren’t keen to don a shorter leash, but whether they like it or not, the evolution is already apparent in fits and starts.
So far, the most potent catalyst for change has been pressure exerted on directors by institutional investors concerned by strategic drift at troubled companies. Today those investors represent about 60% of total equity in the United States, and their growth is transforming U.S. capital markets.
Because institutional investors such as pension funds, insurance companies and mutual funds move money around in search of short-term gains, many analysts worry that the U.S. system of allocating capital threatens the competitiveness of American firms.
These analysts favor an expanded partnership between big investors and companies--which many refer to as “relationship investing”--that encourages long-term, or permanent, ownership. Adoption of this model would move the U.S. closer to European and Japanese systems, where big stockholders play a role in running corporations.
A two-year project sponsored by a privately funded council on competitiveness and the Harvard Business School, headed by Harvard’s Michael E. Porter, recently called for comprehensive reform in the way America invests in industry.
Its report concludes that companies with permanent family ownership, such as computer maker Hewlett-Packard, and those whose outside investors become essentially permanent owners, such as Warren Buffett’s Berkshire Hathaway holding company, enjoy competitive investment advantages.
The council warns that effective reform will require coordinated efforts and concessions by policy-makers, investors, corporations and managers.
Specifically, “Institutional investors . . . should not expect to gain greater influence over management without giving up some of their current trading flexibility, while management should not expect informed and committed owners without giving them a real voice in decisions.”
Among other recommendations, the council advocates loosening restrictions on institutional board membership and regularizing the flow of more comprehensive information to investors, such as assessments of a firm’s competitive position.
The debate will move to center stage next spring at a conference on relationship investing to be held at Columbia University. New York attorney Ira Millstein--an ardent reformer who has long advised the GM board and promoted its recent intervention in management--helped establish and is chairman of Columbia’s Institutional Investor Project, a think tank for study of the role of big pension funds in corporate affairs.
Says Nell Minow, principal at LENS, Inc., the shareholder-activist group headed by Robert A.G. Monks: “From all directions different groups seem to be converging on the boardroom. The board is the place where the competing interests of shareholders and management must be balanced.”
Many analysts agree with Minow’s contention that for some time directors may have wanted to do the right thing, but they have lacked sufficient information or independence to act. Says Minow, “Shareholder focus on the boardroom has given directors the ability to do what perhaps they have wanted to all along.”
New York City Finance Commissioner Carol O’Cleireacain, who oversees New York City’s pension funds, concludes: “Shareholders have woken up and made directors understand they have got to do their jobs. The combination of the growing corporate-governance movement and the bad economy means there is no long any veil to hide behind.”
