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Published: February 14, 2003

 
 

Corporate Governance: Hard Facts about Soft Behaviors

Sometimes the skills needed — and absent — are painfully obvious. Frank Cahouet, retired chairman of the Mellon Bank Corporation, recalls recruiting Ira J. Gumberg when, in the late 1980s, Mellon was burdened with bad real-estate loans. Mr. Gumberg, a developer and still a Mellon director, worked directly with the company’s real-estate department to give managers hands-on advice on how to extricate the bank from its loan-portfolio mess. “Directors all have strong suits,” says Mr. Cahouet, now a director at executive recruiting firm Korn/Ferry International and Allegheny Technologies Inc. “What you do is pull on their special knowledge.”

Possessed of such business acumen and technical know-how, directors also need charm and the chutzpah to engage in debate. Again and again, when asked to describe the key activities and characteristics of a well-run board, directors we’ve interviewed say the same thing: debate, dissent, active engagement. “What you’re looking for is an open, rigorous discussion, with people challenging each other, challenging the CEO,” says Marc Epstein, a business professor and governance expert at Rice University in Houston.

Surveys conducted by Korn/Ferry support this contention. Nine out of 10 directors polled by the firm cite “willingness to challenge management” as either the most important criterion or among the most important criteria in selecting new directors.

Clearly, conflicts of interest also need far better internal policing than they now receive. Research by the New York Times discovered that at 20 percent of the 2,000 largest U.S. companies, members of the board compensation committee had business ties with the CEO. Other, seemingly more benign, relationships — such as service by a corporate CEO and a philanthropic organization head on each other’s boards — can also compromise the independence and authority of the board, and stifle debate before it can begin. We don’t advocate banning all board–CEO associations, but we certainly favor greater clarity about them.

Train the Watchdogs
Serving as a corporate director is not an honorary commitment. A director requires a thorough understanding of the company’s past, present, and potential performance to ask intelligent questions. The New York Stock Exchange recognized this when it mandated, as part of its new listing requirements, that governance principles address “director orientation and continuing education.” Yet most companies have failed to furnish that training. A survey of 300 public companies conducted by the Financial Executives Institute in 2002 found that 86 percent of the respondents did not provide a continuing program for educating board members.

In fact, a surprisingly large number of company directors have little or no background in the businesses they are monitoring. As one Australian executive director we interviewed put it, “Most of our directors have little or no real understanding of our various businesses.” Today, not all directors can even work their way through financial statements. One CEO recently asked Professor Epstein to join his board because the chief needed help figuring out his own financial statements. If the CEO isn’t fully financially literate, Professor Epstein wondered, how can the directors be expected to be? He declined the invitation.

Companies that get high marks in governance invariably devote significant time to educating their directors. Pfizer Inc., for example, subjects every new director and audit committee head to an orientation program that includes sessions with the CFO, head of research, general counsel, and corporate secretary, as well as the business unit heads. Directors are then connected to Pfizer’s senior management network and issued a directory with the home addresses and phone numbers of the top 30 to 40 Pfizer managers. “That gives directors low-tension access to information,” says Constance Horner, chair of Pfizer’s governance committee and a guest scholar at the Brookings Institution. “You don’t want to be calling the CEO all the time.” (See “Focus: How Pfizer Makes Directors Effective.”)

 
 
 
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Resources

  1. Jay A. Conger and Edward E. Lawler III, “From Meek to Mighty: Reforming the Boardroom,” s+b, Fourth Quarter 2001; Click here.
  2. Sanjai Bhagat and Bernard Black, “The Non-Correlation Between Board Independence and Long-Term Firm Performance,” Journal of Corporation Law, University of Iowa College of Law, Winter 2002
  3. Gurmeet Kaur, “The Stock Market Link,” Investors Digest (Malaysia), May 16, 2001
  4. Steve Lin, Peter Pope, and Steven Young, “Are NEDs Good for Your Wealth?” Accountancy, September 5, 2000
  5. Ira M. Millstein and Paul W. MacAvoy, “The Active Board of Directors and Improved Performance of the Large Publicly Traded Corporation,” Columbia Law Review, 1998; Click here.
  6. Dawna L. Rhoades, Paual L. Rechner, and Chamu Sundaramurthy, “Board Composition and Financial Performance: A Meta-Analysis of the Influence of Outside Directors,” Journal of Managerial Issues, Spring 2000; Click here.