Socrates taught that “the unexamined life is not worth living.” Although a penniless philosopher who lived centuries ago, his advice has useful application in the 21st century corporate boardroom. Why is the unexamined boardroom life not worth living? For the same reasons Socrates advanced at his trial—it’s our responsibility to be independent, critical thinkers, and it’s our duty to raise and discuss challenging issues. This activity, in Socrates’ words, “is really the very best thing that a [person] can do, and life without this sort of examination is not worth living.”
For Socrates, the search for truth and wisdom was essential for nurturing the growth of the soul. It was also necessary to the health and welfare of the state. So it is for corporations and those who serve on their boards; good corporate governance—meaning independence, critical thinking and reflection—is essential to the health and welfare of a corporation. If we have learned anything over the past several years, it’s that the concept of what constitutes appropriate boardroom behavior is a constantly evolving, yet increasingly more rigorous, standard.
This is the fourth in an occasional series of articles aimed at helping directors direct. It examines the changing life in corporate boardrooms today in view of the emerging trend toward independent chairmen or lead directors. In the wake of the corporate scandals we’ve witnessed over the last four years, the trend toward independent leadership in the boardroom is not surprising; in many ways, it was already in place, and the wave of corporate scandals simply accelerated the changes. As the number of independent directors increases on boards, ineluctably so will the responsibilities placed upon independent directors.
In examining boardroom life, it’s critical to avoid the natural tendency of so many to elevate form over substance. Mandating the separation of the CEO and chairman functions, for example, is not a magic bullet. Those functions were split at Enron and WorldCom, and it did neither company any good. Similarly, while there is much to learn from other companies’ successful—or failed—approach to similar issues, there are no shortcuts, blueprints, or one-size-fits-all structures that guarantee an effective board. Effective corporate governance exists if, and only if, corporate constituencies can trust what companies say about their financial performance. The issue is how boards can best position themselves to achieve that result.
Over the course of our history, most American corporations have combined CEO and chairman functions, and they’ve done so very effectively. More recently, separating the functions has become fashionable. It’s been embraced, for example, by companies that have fallen, or are nicked, attempting to demonstrate that they’ve changed. It’s also a very common tool in corporate succession strategy. The CEO reports directly to the board, so there’s an inherent conflict in having the CEO reporting directly to the body he or she oversees. On the other hand, there are synergies in having the head of management serve as the head director, which can help maximize shareholder value, the overall goal of any corporation.
Although the Securities and Exchange Commission doesn’t yet set normative standards of corporate behavior, its influence over corporate governance has been growing. That’s largely the result of recent corporate implosions, the adoption of The Sarbanes-Oxley Act of 2002—which gave the SEC more say over what traditionally had been state corporation law issues—and the fallout from mutual fund shenanigans. Thus, the SEC “persuaded” the NYSE to separate the chairman and CEO functions when that entity reorganized in the post-Grasso era. Whether the NYSE would have adopted that approach if left solely to its own devices is unknown, and unknowable. Similarly, the SEC has (by a deeply divided vote) dictated independent chairmen for mutual funds registered with it. These are clear signs that a majority of the current Commissioners of the agency favors an approach that splits the two functions.
The most influential factor accounting for the recent trend toward split chairman and CEO functions, or lead director positions in board structural changes, though, is the NYSE’s amended listing requirements (adopted pursuant to the SEC’s directive back in 2002), calling for regular meetings among non-management directors lead by a designated director. As a result, 84 percent of S&P 500 boards now have a lead or presiding director.
At the same time as these structural changes have been evolving, the liability framework for outside directors has also been changing. As noted in my recent Compliance Week column on directors’ liability, pressures are being brought to bear on outside directors—some parties are going so far as to try to hold directors personally liable for corporate misconduct they allegedly could have, or should have, prevented, but didn’t. The changing dynamics in boardrooms and the changing nature of personal liability point up the necessity for independent directors to interact effectively with fellow directors and management. What follows are some practical suggestions for how independent directors can enhance corporate performance, without usurping the roles necessarily entrusted to management.
Boards should designate a lead outside director (unless the company already has split the chairman’s and CEO’s functions).
As noted, the serious issue isn’t whether the chairman and the CEO functions are split, but whether the outside directors are properly organized to perform their important oversight and collaborative functions. The best way to do this is by having the outside directors designate one of their number as the lead outside director. Individuals who consent to serve in this capacity will want to avoid holding that position on multiple boards.
Lead directors/independent chairmen should have an established, clear set of responsibilities.
Because the prerogatives of management are critical to a company’s successful operation, and because the benefits of having a lead director or independent chairman only flow from the proper structure and implementation of that position, it is critical that the lead director/independent chairman have a carefully-delineated statement of responsibilities, obligations and authority. Of course, once an articulation of such responsibilities is crafted, it’s of the essence that they be fulfilled. It’s far better to have no delineation of responsibilities than to have responsibilities delineated that are then left unfulfilled.
Coordination is necessary.
Whether a company has separated the CEO and chairman functions, or has a chairman/CEO and a lead director, coordination is necessary to prepare the board agenda and address issues confronting the board; as the saying goes, two heads are better than one. This is certainly an improvement over situations in times past when directors were hamstrung by a CEO’s agenda. Management will be in the best position to know what critical issues need to be brought before the board, and when those issues are ripe for consideration. By the same token, and consistent with the board’s oversight function, each meeting should also include periodic reviews and reports that assure the board that management is complying with board directives, policies and procedures.
The existence of a lead outside director cannot be permitted to diminish the importance and functioning of the other independent directors.
Every director is important and has a role to play. And at various times and in different situations, every director needs to step up and be a leader. It being spring, the natural analogy is to baseball: At various times, every player has to step up and exercise leadership. Of particular importance is the need to delegate certain critical responsibilities to individual outside directors—for example, compliance, compensation, disclosure, risk assessment, governance, and audit-related responsibilities. No single outside director can handle the multiplicity of important oversight roles the board collectively is required to perform. The lead outside director is responsible for coordinating all these activities, and ensuring that the work of individual directors and committees are ultimately the basis for judgments by the entire board.
Independent directors must avoid the dreaded extremes of a dysfunctional board: undue pliancy or adversarial boardroom conduct.
It’s now clear, if it wasn’t previously, that directors can’t allow themselves to be governed solely by management’s dictates; directors have obligations to do more than simply vote on issues management tenders for the board’s consideration. Directors need to understand the issues tendered to them, understand the alternatives that are not being tendered to them, and they must initiate oversight reviews on their schedule, not the schedule given to them by management. By the same token, the fact that directors have an oversight responsibility—and a responsibility to question and understand management decisions—does not justify the development of an adversarial relationship in the boardroom. Collegiality doesn’t require acquiescence, but it also doesn’t require internecine warfare.
Outside directors must be diligent, thorough and committed.
To a large extent, the lead outside director or independent chairman needs to be aware of the various oversight responsibilities being performed by his or her colleagues, and ensure that nothing is falling between the cracks. This requires that outside directors must be properly informed, both by management and by outside experts. It’s critical that outside directors actually prepare in advance of meetings, and be prepared to have meaningful deliberations on critical issues. Concomitant with these obligations is the obligation to attend all, or virtually all, meetings, on time and in full.
Trust, but verify.
Of necessity, the board must rely on representations made to it by management, and by management’s experts. But that doesn’t mean that everything should be taken on face value. How do the directors know that things are exactly as they’ve been represented? Are there questions they should be asking that haven’t been asked? Are the outside directors making good use of the external resources available to them, in the form of their own experts and advisors? These are the types of questions that will be asked if bad things happen to a good company. It’s better for the outside directors, and especially the lead outside director, to be asking these questions before bad things occur, not after.
Be a wise counselor.
As the American Bar Association’s Corporate Director’s Guidebook states, “Effective directors act as senior counselors to management without assuming management functions.” Being a wise counselor means more than simply accepting what one is told at face value. There is a critical need for outside directors to understand the factors that caused management to choose a certain course, the alternatives that were considered and rejected, and the reasons for the decisions that were made. This means that the outside directors need to do more than listen and agree; they must understand.
Utilize on-site visits and direct interaction with management.
On-site visits are an effective way to interact with management and learn more about their principles and the tone they actually set at the company. A recent article in CFO Magazine described such an encounter when a new director joined Denny’s Corporation and the CFO took him restaurant hopping. The CFO provided “a window into the company” and the director gained “huge respect” for the CFO and his approach to his job. Developing these sorts of direct relationships are useful and improve communication between directors and management, which leads to better governance.
The lead director/independent chairman needs to ensure that the outside directors and management have looked for problems before they arise, and are prepared to deal with the company’s next crisis.
It is axiomatic that bad things do happen to good companies. There isn’t the slightest doubt that even the best-run companies will confront their share of corporate crises. Finding problems before they’ve arisen is the surest way to preserve the well-being of a company, and for management to preserve its management positions. But, if problems do arise, the company must be capable of responding immediately and effectively before the problems turn into a full-fledged crisis.
Focused proactivity on the part of outside directors will make them more effective and, concomitantly, reduce their exposure to personal liability.
Over the past several months, we’ve seen a number of factors that have led to the imposition, or attempted imposition, of personal liability on outside directors. It is fitting that the one characteristic that will make directors perform better—focused proactivity—will also serve to reduce the likelihood of their own personal liability. The lead director/independent chairman will need to be focused on the steps that should be taken to satisfy this obligation, without usurping legitimate management functions.
As noted earlier, the changing landscape for the obligations and responsibilities of outside directors requires that they organize themselves, and look to one of their number to take the lead in ensuring that the multiplicity of obligations they owe to their company are, in fact fulfilled. These are salutary developments that will ensure that companies are better run, and in turn, perform better, with fewer assertions of personal liability against the outside directors.
The column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.
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