strategy+business is published by PwC Strategy& Inc.
 
or, sign in with:
strategy and business
Published: October 1, 2001

 
 

Best Business Books: Corporate Governance

From Meek to Mighty: Reforming the Boardroom

You might remember the old story of Charles Atlas, a weak runt who grew tired of having  sand kicked in his face by muscle-bound men on the beach. Through determination and hard work, he transformed himself first into a bodybuilder and then into a muscle-marketing powerhouse.

This may seem like an odd place to start a discussion of recent books on the state of corporate boards, but there are some striking parallels. For one, it was not long ago that corporate directors were relative weaklings sitting on the equivalent of a tropical beach while receiving high pay and numerous perquisites. Although the muscle-bound CEO did not kick sand in the faces of board members, he used his insider knowledge and his personal relationships to control them. The press did the sand tossing, along with a few big institutional investors dissatisfied with their returns.

After several decades of weak boards being bullied, and a recent spate of books about making boards more effective, it seems timely to ask whether boards have gotten out of their beach chairs and begun to build some muscle. Certainly all the buzz about new governance initiatives suggests that behind those closed boardroom doors may be a group of corporate Charles Atlases who are powerful contributors to corporate performance. Ram Charan’s Boards at Work: How Corporate Boards Create Competitive Advantage (1998) optimistically shows good examples of boards that are becoming more powerful and effective.

But, as with bodybuilding, it has taken time for boards to build their strength, and motivation often waxes and wanes in the process. Moreover, the hunk in most boardrooms may still be the CEO.

Waves of Reform
The waves of reform began regularly breaking in corporate boardrooms in the 1980s. Three muscle men appeared on the beach: foreign competitors, corporate takeover artists, and institutional investors. Foreign competition exposed the flawed and outdated strategies of many major American corporations. Blame was laid squarely on the shoulders of senior managers, and ultimately on the board. The takeover movement, with significant help from leveraged-buyout firms, forced boards to choose their allegiances — were they beholden to management, or to shareholders? In most cases, the shareholders won.

The third muscle man was the institutional investor pressuring CEOs and boards to sustain performance improvements — especially the pension funds that tended to take long-term positions in firms. These investors supported initiatives to enhance board authority and make CEOs more accountable. The most popular governance initiatives included having a majority of directors be outsiders rather than insiders (a majority of insiders had been the norm), a separate compensation committee composed of independent directors, and formal performance evaluations of the CEO.

During this time of turmoil in the boardroom appeared a research-based book by Harvard professor Jay W. Lorsch and his colleague Elizabeth MacIver titled Pawns or Potentates: The Reality of America’s Corporate Boards (1989). It raised the timely question: Were the overseers of corporations doing their duty? From intensive interviews with executives and directors, the authors concluded that most boards were relatively powerless. Lorsch and MacIver’s data revealed that boards were hindered by several critical weaknesses. First, the norms of polite boardroom behavior and the pervasive presence of insiders discouraged most directors from openly challenging or questioning the CEO’s performance. Boardroom meetings were more akin to Japanese tea ceremonies than strategic debates and critical reviews of performance. Second, directors had a strong dependence on the CEO. After all, the CEO had far greater information and knowledge about the business than any director could possess. The CEO usually controlled the meeting agenda and the discussion process. He or she played a pivotal role in selecting each of the directors. In many cases, directors were also providing consulting services to the company or were subordinates to the CEO.

Finally, formal leadership of the board almost always rested in the hands of the CEO, since most held the title of board chairman. These factors gave the CEO enormous influence in the boardroom, which prevented boards from acting against the desires of the CEO.

Directors found it difficult to leverage their one strength, sheer numbers. Although the outside directors often outnumbered the CEO and insiders, there were few, if any, formal mechanisms for collective action. Outside directors were seldom a cohesive group; they met infrequently and were only casually acquainted with one another. Their strongest relationship was usually with the CEO: He or she was the hub to which the directors connected.

To make matters worse, directors had busy lives outside the boardroom, with little time to spare, so few objected to the boardroom norm discouraging contact other than at the regular meeting. Inevitably, there was no process for tapping a leader from the pool of directors in times of crisis, and boards were often ill-prepared to take quick, decisive action when it was needed.

The Lorsch and MacIver findings exposed these problems and sounded a loud alarm. Lorsch and MacIver themselves proposed several important changes. These included establishing nominating committees chaired by outside directors; limiting the number of board memberships a director could have; adding more retired CEOs as directors (they were to have more time to spend on company issues as directors); tying director pay to stock options or annual grants of stock; increasing the use of committees to govern; performing formal CEO reviews; and designating a lead or presiding director. Their most radical proposal was to choose a chairman from the ranks of outside directors who would play a strong role in setting the board’s agenda, conducting meetings, and selecting directors.

The groundwork laid by the challenges of the three muscle men of the 1980s did produce some boardroom empowerment in the 1990s. Formal CEO reviews, greater use of committees, and equity compensation for directors became popular practices among boards of the Fortune 1000. Boards showed their muscle by sacking some CEOs of well-known companies in the early 1990s — James Robinson of American Express, Rod Canion of Compaq, Ken Olsen of Digital Equipment, John Akers of IBM, and Robert Stempel of General Motors were all ousted by their boards. Lists of governance best practices emerged and were used by the press and investors to rate boards. In 1996, Business Week published its first report card on the best and the worst corporate boards.

The Long Shadow of Shareholder Value
By the mid- to late 1990s, a single metric of corporate performance, shareholder value, overshadowed all the others and became the focus of most CEOs and their boards. Judging solely by this metric, many boards were apparently doing their job well. An exuberant stock market and a few corporate stars reinforced this focus on shareholder value. There were the General Electrics, the Cisco Systems, and the Microsofts, along with the skyrocketing and then crashing stars of e-commerce like Amazon and Yahoo.

With his myth-building best-selling book Mean Business: How I Save Bad Companies and Make Good Companies Great (1996), turnaround artist Albert Dunlap, better known as Chainsaw Al, became the poster boy for shareholder value. Wherever Al worked his downsizing magic, shareholder returns skyrocketed. He also became one of the loudest advocates for paying board members purely in stock.

From the vantage point of Charles Atlas’s beach, the new muscle man on the block is now the shareholder. Indeed, research reported in our new book, Corporate Boards: New Strategies for Adding Value at the Top (2001), written with David L. Finegold, shows that today most directors see their primary role as enhancing shareholder value.

However, as we enter a new century, it is a good time to question whether the ’90s fascination with shareholder value was misplaced or perhaps overdone, and whether it has actually led to more effective boards. Al Dunlap’s star has fallen, exposing a checkered management past, because he stumbled badly at Sunbeam. A slowing economy has also raised the question of whether continuing annual eye-popping jumps in a company’s share value are feasible. Meanwhile, board intervention is often late — serious red ink or major crises have to surface before boards mobilize for action, as the example of Xerox highlights. Moreover, the formal leadership of most boards remains vested in the hands of CEOs; nonexecutive chairmen and lead directors are still rare.

Muscle-Building Ideas
Allan A. Kennedy, in The End of Shareholder Value: Corporations at the Crossroads (2000), argues that the board’s preoccupation with shareholder value has led companies to mortgage their futures for today’s higher stock price. It also has created a class of entrepreneurs who, for a brief time, were able to sell companies to a gullible investing public at unsupportable stock prices. From Kennedy’s perspective, the CEOs of large public companies deserved most of the blame.

But the story is more complicated, and here is where the boardroom enters into it. Kennedy says that the world of corporate boards has changed little in the years since Lorsch and MacIver’s book. He points out that CEOs of large companies still belong to an exclusive club, since almost two-thirds of the board members of most companies are current or former CEOs of another company. Within this snug club, favors are often exchanged. The lucrative stock-option program supported in the confines of one CEO’s boardroom is promoted at another CEO’s board meeting. And a board’s capacity to be vigilant, in Kennedy’s view, is seriously compromised by the nature of its relationship to the CEO.

Today’s boardroom, he argues, is just a more insidious version of earlier ones, because rising share values have provided opportunities for CEOs and boards seemingly to collude in order to create outrageously generous compensation packages. According to Kennedy, those puny fellows on the corporate beach are really muscle men in disguise, helping one another kick sand in the face of everyone else who has a stake in today’s corporations. While some might question the extent of purposeful collusion, CEO pay packages have, in many cases, gone through the roof. It is also clear that boards sign off on these pay packages, and, as we point out in our book, board members are dramatically improving their own compensation.

Are board members weaklings in need of muscle building, or are they wheeling-and-dealing muscle men in need of policing? Kennedy says policing is the answer. He would start by changing the membership requirements for the clubhouse. Specifically, he would ban all CEOs of large public companies from serving as directors of other large public companies. In addition, under Kennedy’s plan, board members would be selected to represent the interests of customers, suppliers, communities, and employees — not just shareholders. Any board insiders would be nonvoting members. Finally, a respected outside agency would conduct regular audits of the effectiveness of board members and the board’s overall performance. This agency, or another independent body, would also develop tough standards for boards and mandate that all new board members attend an intensive orientation program.

Ram Charan’s Boards at Work provides a dramatic contrast to Kennedy’s views. Charan starts by arguing that a handful of boards have proven themselves to be the Charles Atlases. From these role models, the rest can learn. Unlike those who see boards as either 97-pound weaklings or colluding muscle men, Charan sees board members largely as critical untapped strategic resources, potential stars who must perform. From his perspective, boards need CEOs and processes to recruit, train, and harness talented, wise strategists who can help the senior management of companies be successful.

He believes it all starts with the CEO, one who wants board members’ help and then is prepared to engage them in productive dialogues. From there, Charan argues for a simple regime. Keep committees to a minimum, have fewer but longer board meetings, and get rid of executive committees along with lead directors and nonexecutive chairmen.

Pawns and Potentates
In Corporate Boards, we say directors are potentates and pawns. The potentate role stems from the fact that board members are likely to be CEOs or retired CEOs who have a deep appreciation for the chief executive’s leadership challenges in a turbulent and complex world. Board members who are experienced CEOs are also acutely aware that micromanagement by a board can be as detrimental as a completely hands-off approach. They much prefer playing the occasional coach to playing the watchful judge. This very capacity to empathize, however, can turn them into pawns.

As Charan and Kennedy’s contrasting views show, boards must deal with the conflict between the two main roles they’re asked to play: strategic partner with top management in formulating strategy and independent overseer of management. The best way for boards to succeed in their multiple, sometimes conflicting, missions is to put structures and practices in place that make the board strong and independent. With structures to ensure careful ongoing oversight, individual directors and the board as a whole can work closely with top management to enhance strategy and organizational effectiveness. Our research suggests eight key elements to make boards more effective in their oversight roles. (See “Eight Elements of an Effective Board”.)

Eight Elements of an Effective Board

1 Independent directors (with no formal business or family ties to the firm prior to joining the board) constitute a clear majority (at least two-thirds) of all board members.

2 Each director’s knowledge and abilities are assessed regularly against the firm’s changing market and technological demands.

3 Independent directors chair and control key committees (compensation, audit, and nominating/corporate governance). The compensation committee consists solely of outside directors.

4 Chairman and CEO roles are separate; there is a lead director, and regular executive sessions are held without inside directors present. This helps outside directors bond and establishes clear leadership of the board itself.

5 Employees, customers, suppliers, and investors have direct communication channels to the board, independent of management.

6 The board’s staff and/or resources allow it to conduct its own analysis of issues (e.g., in benchmarking executive compensation); individual directors who perform significant extra duties are recognized and rewarded by the board, not by company management.

7 The CEO has specific performance targets relative to key competitors; a formal annual evaluation of the CEO includes clear written and oral feedback.

8 Succession planning reaches down several levels of management.

Source: Adapted from Corporate Boards: New Strategies for Adding Value at the Top

Independent and Accountable
Our corporate board muscle-building practices are less radical than those proposed by Kennedy, but they increase the likelihood that boards will have the knowledge, information, power, and time to provide effective oversight that serves multiple stakeholder interests. But we don’t answer the question, To whom should the board itself answer?

Corporate boards are in the relatively unusual position of assessing their own performance and setting their own rewards. Relying heavily on the firm’s top managers to hold the board accountable — the de facto solution in many companies — is, as Kennedy points out, fraught with problems, because it compromises the independence the board needs to establish.

Our research suggests boards should consider several steps to ensure that they will respond to the firm’s multiple stakeholders:

• Link a significant percentage of board members’ rewards to long-term firm performance through the use of stock grants and options.

• Conduct a regular evaluation of the board and its individual members that includes input from directors themselves, key stakeholder groups, and the firm’s managers.

• Use the results of the evaluation and benchmarking of other firms to review corporate governance procedures on a regular basis.

• Require directors to resign when they change their primary job or take on additional board memberships. This can help the board’s membership mix remain appropriate and independent.

• Have board members who can speak for stakeholders other than shareholders (e.g., employees, customers, and communities).

Once these fundamentals for an independent and accountable board are in place, directors can, as Charan suggests, concentrate their efforts on helping to identify potential threats to and opportunities for the organization, and on shaping the firm’s strategy to fit its changing environment. They can also build effective external relationships that extend the organization’s capabilities. Indeed, with the right safeguards in place, a board that is more actively involved in the strategy process and the formulation of strategic alliances can, potentially, provide more effective oversight of the organization than one that is not.

Without this involvement and the additional knowledge and information it provides to directors, boards are effectively confined to reacting to top managers’ decisions well after they have been made. In today’s rapidly changing global economy, such delays, even with the most independent and well-intended stewardship, may have dire consequences — far worse than a little sand in the face.


Authors
Jay A. Conger, jconger@marshall.usc.edu
Jay A. Conger is a professor of organizational behavior at the London Business School and a research scientist at the University of Southern California’s Center for Effective Organizations. He is the author of many books and is recognized throughout the world as an expert on leadership, organizational change, and boards of directors.

Edward E. Lawler III, elawler@marshall.usc.edu
Edward E. Lawler III is the director of the University of Southern California’s Center for Effective Organizations and a Distinguished Professor of Business at USC’s Marshall School of Business. Professor Lawler specializes in the study of human resources management, compensation, and organizational development. His previous contribution to strategy+business was “From Meek to Mighty: Reforming the Boardroom,” written with Jay A. Conger.
 
Page 1 2 3 4 5  | All
 
 
Follow Us 
Facebook Twitter LinkedIn Google Plus YouTube RSS strategy+business Digital and Mobile products App Store