Corporate boards have a new attitude. They see no problem taking the wheel to drive CEOs off the road. The last decade – especially the last two years – has seen a growing number of activist corporate boards, and the results are unmistakably apparent in the rising rate of CEO turnover.
The recent onset of high-profile corporate scandals has left CEOs such as Hank Greenberg of AIG, Harry Stonecipher of Boeing, Michael Eisner of Disney and Carly Fiorina of Hewlett-Packard in the corporate dust of board directors. With additional cases at, among others, Fannie Mae, Krispy Kreme, OfficeMax and Sony, it is evident that this is more than a passing trend.
Where are these boards getting their fuel from? The most obvious answer is fear. On the day the court settlement for WorldCom became public, the National Association of Corporate Directors (NACD) released a communication on director liability. Added to the enforced director accountability in the Enron scandal, this means directors are terrified at the reality of being held
personally liable for corporate misconduct. Paired with directors concentrating on being more accountable to shareholders, this is resulting in a new relationship between a company’s board and its CEO. Boards are being forced into activism by their charter, with shareholders requiring members of the board to be active in representing their interests, monitoring company activity and taking immediate action on under-performing management and executives.
Fall of the imperial CEO
With the mandated increase of independent directors, the traditional CEO, who had been in near-sole control, is being forced to be more collaborative. In a post Sarbanes-Oxley society, CEOs are expected to perform to higher standards and personally sign off on company financials. The new statute also requires directors to be more independent and watchful of CEO activity, creating an environment where everyone feels like Big Brother is watching.
In the past, the CEO was not a household name and when something went wrong, it went wrong with the company itself. Now, in the age of the superstar CEO, chief executives are suddenly personally accountable for anything that goes wrong within a company. The more the public identifies an organization with an individual, the stronger this accountability gets.
More may be attributed to the CEO than he or she actually has any control over. According to Matthew Rhodes-Kropf, associate professor of finance and economics at Columbia Business School, ‘it’s a very obvious physical manifestation of shareholder vigilance. If I am the board member and I want to prove to the shareholder that I am doing my job then, hey – let’s can the CEO!’
Shirley Westcott, associate managing director for policy at Proxy Governance, feels this is a construct of both changing behavior and the changing corporate environment. ‘You have gotten away from the cozier structures where the CEO would pretty much run the board and the directors would not really challenge him or her unless there was reason to think something was wrong,’ she explains. ‘What has happened since Enron, WorldCom and the current Disney situation is that directors are held personally liable. There is a fear factor for board members to make sure they have done their due diligence.’
Companies are setting new criteria for more accommodating CEOs, seeking out candidates ‘who are better able to manage an environment where information and accountability about how an organization works is far more visible,’ notes John Challenger, CEO of Challenger, Gray & Christmas.
Change in board qualifications
With the changing corporate environment, a new type of board member, armed with greater proficiency, has been born. Unlike the more compliant CEO, directors are now more outspoken. ‘The boards are no longer rubber-stamping, so people are being named to boards for ceremonial or political reasons far less than before,’ Challenger says. Instead, directors are being chosen based on ethics and aptitude.
These criteria are necessary given the newfound pressure for boards to really take the reigns in the boardroom. ‘Board members have taken a more active approach to how they interact with the CEO,’ says Westcott. ‘They are using their own advisers, whether for nomination, compensation or audit committees, and the outside auditors themselves are pre-approving all services. Boards are also more involved in succession planning. It used to be that CEOs were the designators of their own successors but nowadays boards are hiring their own search firms and taking more control over the process.’
According to Rhodes-Kropf, there is a potential problem with directors focusing exclusively on being responsive to shareholders, and taking action against CEOs for no reason other than making a symbolic gesture. Directors may be thinking, ‘How do I actually show – given that no one is going to monitor me closely – that I am actually doing what I say? A very clear, obvious statement that I am doing what I am supposed to do is getting rid of the CEO.’
At the other end of the spectrum, when the CEO really is at fault, it takes a great deal of time and effort to eject him or her. ‘You want these guys getting rid of CEOs when it is their fault, but you don’t want them simply doing that to demonstrate to the shareholders that they are active and involved. It’s like looking busy when your boss walks by,’ says Rhodes-Kropf.
Shareholders expect the dealings, workings, operations and finances of a company to be open to them, which demands greater transparency than was previously available. Part of this transparency is increased awareness of the board itself.
‘Not only are board members painfully more aware of their individual liability, they are also aware of the notion that their reputation can be smeared if they are letting the business go south, or even drift there a bit,’ notes William Crist, former Calpers president. ‘As a result, they are holding CEOs much more accountable because they are finding themselves in the press. Journalists and the media are paying attention – and the shareholders are paying attention.’
The institution of auditing is also under much heavier scrutiny now and the adjustment to this new reality has board members hot under the collar. Under the new regulations, companies get scrutinized for reporting late and for reporting incorrectly. That scrutiny can be brought to such an intense level that it becomes paralyzing; companies no longer want to report anything and feel terrified in their uncertainty of what information can be disclosed.
‘The new legislation has made everyone at every level, from private companies to major corporations, very nervous – in some sense, the pendulum has swung too far,’ Rhodes-Kropf comments. ‘People are terrified to report until they are so sure it is correct that it is dead information.’
Because any material weakness or misconduct is identified with the CEO, he or she takes the blame. According to William Strahan of Mercer Human Resource Consulting it is common for the blame of an entire company to be laid at the feet of the CEO. ‘Boards carry enormous pressure to satisfy capital markets, internal employee markets and customer markets and we see boards pushing back against CEOs, making claims primarily for the shareholder,’ he points out. ‘Not every instance of CEO turnover is necessarily an indication of failure on the part of the CEO.’
Legal bearing
Traditionally, under the so-called business judgment rule, the courts have presumed directors act in good faith with their decisions and have not disturbed these decisions, outside of conspicuous circumstances. There are now new expectations for directors, however, which are changing the way courts view the business judgment rule. ‘The courts are starting to say, Look directors, we are expecting, in view of all these rules, that you are going to be very vigilant watchdogs of what is happening in the company,’ explains Henry Blackiston, senior partner of the executive compensation and benefits group at Shearman & Sterling. He cites the liability incurred for fraudulence in the Enron case as a prime example of this.
While identifying and vocalizing problems is a crucial first step, it is necessary to take the second step of acting if matters are not corrected. With several new rounds of legislation and listing regulations in place, there are mandates for directors’ independence, outside directors having executive sessions without CEO participation, and written charters for the audit and
compensation committees. ‘Historically,’ says Blackiston, ‘this was all a matter of state law and now we’ve federalized some of the corporate governance rules, causing boards to be extremely concerned about their responsibilities. This vigilance has, in turn, filtered up to the CEOs, who can be removed.’ The legal profession certainly owns part of the responsibility for the increase in CEO turnover.
Surveillance of CEO behavior is definitely more intense but, when it comes to whether there should be any restriction of what is inspected – as in the Boeing case – the overall feeling is that everything is open game. ‘The board needs to know who is running the company and have confidence that the right thing is being done on behalf of shareholders,’ says Martha Carter, senior vice president and director of US research at Institutional Shareholder Services (ISS). ‘Whether it is a question of fraud, inappropriate accounting or ethics, the board needs to take a closer look.’
Rhodes-Kropf agrees. ‘A line is not being crossed,’ he insists. ‘We are trying to assess a leadership position. If you don’t wantthat kind of scrutiny, don’t sign up for the job.’
Boards, spurred on by their personal fears and greater regulator-granted power, are becoming far more involved in top-level corporate oversight. They are supported by shareholders’ appetite for greater representation and a general climate of mistrust and accountability. Although there is no way to make an accurate prediction of where this new-found empowerment is headed, it increasingly appears as though it might be the new standard.
