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Published: February 14, 2003

 
 

Corporate Governance: Hard Facts about Soft Behaviors

As a result of the reforms Mr. Leslie has put in place, Avaya’s audit committee is thoroughly schooled in the company’s financial performance. In fact, the discussion of the audit results is led by members of the committee, rather than management, which has brought a whole new flavor to the discussion.

Counterbalance the CEO
Few issues are more hot — or more contentious — right now than the relationship between the CEO and the board of directors. “Independent” boards — that is, boards with few inside directors — have become the trend du jour. But as the Enron and Tyco sagas illustrate, even companies that comply with the recommended ratios of outsiders to insiders can stumble badly. “The fulcrum of governance is the chief executive officer,” Federal Reserve Board Chairman Alan Greenspan, a veteran of more than a dozen boards, told the U.S. Congress in July 2002.

Balancing the power of the CEO with that of the board is critical to effective governance, but it takes more than optimum insider–outsider ratios to establish equilibrium. At some companies in which the CEO also serves as chairman, boards are appointing another member to serve as lead director. But this, too, seems little more than a palliative: If directors believe there ought to be a separation of power between management and the board, they ought to insist on the appointment of a nonexecutive chairman.

Our experience persuades us that companies benefit when the roles of CEO and chairman are split. The 1992 publication of the Cadbury Commission report on corporate governance in the U.K. ushered in a sweeping change in governance practices in Britain. Today, only a few major U.K. companies have a single chairman/CEO; the increased transparency resulting from better-balanced governing mechanisms prepared British companies for the era of increased shareholder activism, as Financial Times columnist John Plender remarked recently.

But there are other, less obvious reasons to recommend this separation of powers. One of the most prevalent private complaints of chief executives is that they have no one with whom they can talk deeply and seriously about the difficulties, some of them intensely personal, of running a complex enterprise. The avidity with which hundreds of CEOs flock to the annual meeting of the World Economic Forum in Davos, Switzerland, attests to their thirst for contact. A nonexecutive chairman can become the confidant and coach that so many chief executives crave, especially if (as is often the case in the U.K. and Australia, which also adopted Cadbury-like governance mechanisms in the past decade) the chairman is a retired CEO of another company who is clearly not in competition with the company’s chief.

Evidence indicates that U.S. companies will be slow to adopt this approach; in January, for example, AOL Time Warner Inc. appointed CEO Richard Parsons to the additional role of chairman. So, short of role splitting, there are other measures companies can and should take to ensure an appropriate power balance between CEOs and directors. Former Securities and Exchange Commission chairman Roderick Hills recommends that the board nominating committee, not the CEO, recruit and hire directors. That change has become increasingly accepted; Korn/Ferry managing director Charles King says that nominating committees today initiate about 70 percent of the director searches he conducts, versus about 10 percent eight years ago. To reinforce its independence, a CEO/chairman should not be a member of the nominating committee. But because CEO–board chemistry is vitally important to corporate governance and operations, the chief should be able to vet and veto nominees with whom she or he is not comfortable.

Mr. Hills also says that audit committees, in particular, must have the ability to structure their operations to create their own power base. Audit committee directors should determine for themselves what they want to see — not simply accept what management hands them. He also urges that independent directors choose the company’s external auditors, negotiate the auditing fee, and establish the reporting line from auditor to board. As Mr. Hills, who currently chairs the audit committees at Chiquita Brands International Inc. and ICN Pharmaceuticals Inc., puts it, “You need to confer independence on the outside auditors.”

 
 
 
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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.
 
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