Problems with Boards

One of the main functions of a board is to evaluate top management, especially the CEO. For many firms, however, the board's chairman is also the firm's CEO! For example, Philip M. Condit is both the board chairman and CEO of Boeing and C. Michael Armstrong is the chairman and CEO of AT&T. Furthermore, these examples do not represent the exception. Among the 30 firms that belong to the Dow Jones Industrial Average, which consists of our country's major corporations, only eight firms have a separate CEO and board chair . For the Fortune -listed firms, only 10 percent have a non-executive chairman. ^[14] Therefore, the person who manages the firm is the same person who runs the board meetings and its agenda; thus, he or she is the person who controls the information that is given to the board. This being the case, is it really likely that the board is capable of seriously evaluating or challenging the CEO? It can happen, but usually not without significant shareholder pressure. For example, the telecommunications firm Qwest, facing an SEC investigation over accounting procedures, recently fired chairman and CEO Joseph Nacchio. However, it took a bit of scandal and a large number of business problems to bring it about.

Even if a CEO were not the board chair, it doesn't necessarily mean that he or she is under a more careful watch. While it is true that most boards have more outsiders than insiders (according to the Korn/Ferry study, the average board has three times as many outside directors as insider directors ”insiders being defined as company employees ), many of these so-called outside board members have some sort of business or personal tie to the CEO, which is how they became members of the board in the first place. For example, Disney's CEO is Michael Eisner, but Disney, which has been criticized by BusinessWeek as having one of the worst boards in corporate America, has a board comprised of numerous current Disney managers such as the chief corporate officer and heads of various Disney operations. But Disney claims that 13 of the 16 board members are independent directors. These "outsiders," however, include Reveta Bowers, headmaster of the school that Eisner's children attended; George Mitchell, a paid consultant to Disney and an attorney whose law firm represents Disney; Stanley Gold, president of Shamrock Holdings, which manages investments for the Disney family; Leo O'Donovan, president of Georgetown University, where one of the Eisner children attended school and the recipient of donations from Eisner; Irwin Russell, Eisner's personal attorney; and Robert Stern, architect for several of Disney's projects. ^[15]

In response to the business scandals and plummeting investor confidence in corporate America, the NYSE adopted new guidelines on board structure for its listed firms. We discuss these new policies in Chapter 12. However, one of the new rules disqualifies board directors from being considered independent if they have relatives working at the company. It turns out that board members Stanley Gold, Raymond Watson, and Reveta Bowers have children working at Disney. ^[16] They must now be categorized as management-aligned directors.

Will Disney's board challenge Eisner? Not only do some of these directors work for Eisner, but there are also others who benefit from not angering him. In other words, this board has too many insiders, and those insiders have business or other vested interests with the CEO. Among the firms that have been reeling from scandal, Tyco, Global Crossings, and Adelphia have boards that are filled with former or current executives. Furthermore, one of Tyco's outside directors was paid $10 million for helping to arrange the acquisition of CIT Group. Adelphia CEO John Rigas, along with his three sons, held four out of the nine board seats. Should shareholders believe that John Rigas was ever going to hear, "Dad, you're fired?" Eisner also contends that if he started to do irresponsible things and the firm started to fail, the board would get rid of him. ^[17] However, after a controversial $75 million payout to former Disney President Michael Ovitz and a lucrative contract penned for Eisner a few years ago (he has made more than $700 million as CEO in the last five years ), Disney's market value fell to less than half of what it was during the nice run-up of the 1990s. Should anyone be surprised that Eisner is still at the helm? This isn't to say that Eisner should be fired, but no one should be surprised that he hasn't been.

Another problem with some boards is that the directors do not have a significant vested interest in the firm. For example, most of Disney's outside directors own little or no stock. ^[18] In 1997, BusinessWeek reported that Occidental Petroleum's board had approved a $95 million payout to its CEO, but two of its board members, George O. Nolley and Aziz D. Syriani, only owned 2,280 and 1,450 shares of the firm's stocks, respectively ”despite the fact that they had sat on the board for 14 years. ^[19] The article also reported that AMD director Charles M. Blalack and Microsoft director Richard Hackborn owned no shares in the company for which they served as director. Can these board members sympathize with their shareholders? Probably not.

However, things have been changing. For example, some firms, like Ashland Inc., are setting stock ownership targets for their directors. ^[20] To Eisner's credit, he has asked his directors to own more stock. ^[21] For General Electric, the outside directors are clearly aligned with shareholders, as they each own (at the beginning of 2000) an average of $6.6 million of GE stock. ^[22] According to the 2001 Korn/Ferry study, 53 percent of the directors were required to own some of the company's stock.

In general, should investors really worry about the lack of independence and lack of stock ownership of some directors? Eisner has argued that we should not. But according to academic studies, we should. It is pretty well documented in these academic papers that CEOs primarily get fired if the stock price has been declining dramatically or if earnings have been significantly down. According to these same studies, however, it is often the case that those boards that fired a CEO were boards that were comprised of directors who did not have a strong tie to the CEO and held a large portion of the firm's stock. ^[23] In other words, boards that were more objective and had more personal wealth at stake were more willing to make the dramatic decision to fire the CEO. This may help explain why the CEOs of Coca-Cola, Ford, and Mattel have been fired recently, while Eisner labors on as CEO of Disney. Interestingly enough, when CEOs do get fired, some of those directors who were somehow aligned with the CEO were also let go ”perhaps as a way of getting rid of the whole lot. ^[24] Therefore, directors can serve a meaningful, rather than symbolic, monitoring role for the corporation, but there may have to be enough of them who are independent of the CEO. That is, it seems that directors are fully capable of getting rid of poorly performing CEOs on the behalf of shareholders, but they must be willing and motivated. The next question is, what about their other responsibilities as directors?

Even if a director is someone who really cares about the firm, is independent, and is a significant stockholder, is he or she capable of providing the time and expertise required to fully understand and approve the major operating and financial decisions of the firm? Some directors, especially those who are potentially good at it, may be overextended. For example, many directors serve on multiple boards. According to a 1997 BusinessWeek article, Ann D. McLaughlin, Raymond S. Troubh, Frank C. Carlucci, Allen F. Jacobson, John L. Clendenin, Willie B. Davis, and Vernon E. Jordon all held directorships in ten or more firms. ^[25] Coca-Cola has five directors (out of 13) who serve on at least five boards. Most directors also hold their own highly demanding full-time jobs. According to the same BusinessWeek article, Gareth C. Chang served on the board of Mallinckrodt Group, but he had to miss 49 percent of the board meetings because he was busy as the senior vice president of Hughes Electronics. Similarly, the vice chairman of Chase Manhattan, William B. Harrison, missed 29 percent of the board and committee meetings at Dilliards, where he serves as a director. Finally, Vernon Jordon is a senior partner of a law firm, but recall that he also sits on ten boards. Therefore, it should not be surprising that he missed 40 percent of Dow Chemical's board meetings in 1996.

In addition, some directors simply do not have the expertise to be a board member. This means that independence, in and of itself, is not a sufficient quality for being an effective director. Some boards like to have a few figureheads, such as a celebrity or a former army general. O.J. Simpson, for example, was once on the audit committee of Infinity Broadcasting. It is certainly possible that celebrities or figureheads may be able to offer some expertise, but there are probably others who could offer much more. For example, it would be useful for Coca-Cola to have an outside director with experience in consumer marketing, but according to a 1996 BusinessWeek article, it doesn't. ^[26] Further, according to one academic study, having bank executives on boards, even those whose own bank is not linked to the firm, turns out to be very useful because they are able to provide their expertise on the credit markets. ^[27]

Finally, some boards are simply too big. With large boards, it is unlikely that anything can really get done, and it is unlikely that every director will be actively involved. When there are many directors, it is too convenient for any one of them to believe that the others are doing the monitoring job. Therefore, they do not have to work so hard. In a small board, each director knows that he or she must do more work because there are few others to do it. Kenneth Roman, who chaired Compaq's governance committee, believed that 11 directors allowed for an informal and interactive grappling of the issues. Disney's board has 16 members, and Enron had 15 members. Are such boards too big? Is size part of the problem? Academic researchers believe so. According to some studies, firms with fewer directors have higher market values, indicating the effectiveness of smaller boards. ^[28] Interestingly, Tyco International, the troubled firm detailed in previous chapters, proposed in 2002 to increase its board size from 11 to 15. ^[29] The company eventually cancelled the shareholder vote on the matter under heavy criticism that it would move its board in the wrong direction and further decrease investor confidence in the firm.

There are many potential problems that plague boards today. Many directors may not be truly independent, they may be too busy, or they may not have the expertise to carry out their obligations. These problems seem to explain why some of the current scandals occurred.