It’s so hard to fire a CEO for cause that many boards don’t try, even when ethical problems are involved.
—The Wall Street Journal, October 30, 2006
Scary, isn’t it? In the often courage-challenged culture of the North American boardroom (British boards are having more success in curbing runaway CEO pay, according to a recent Financial Times report)) the full extent of directors’ inability to assert common sense and protect the interests of stakeholders becomes increasingly apparent. A central problem persists. As long as boards are composed mainly of current and former CEOs who have a vested interest in perpetuating the status quo and all the trappings that go with it, as long as board membership continues to be drawn from the same overused pool of like minded people with similar backgrounds, as long as directors continue to think that all the problems of the company can be solved by doling out more and more millions to the CEO like some giddy aunt stuffs fruits and nuts in the annual Christmas cake, the disconnect among pay, performance and the board’s ability to govern will continue.
There is only one missing factor that is required to bring about the change the whole world outside the boardroom, including every directors’ mother, knows must take place. It’s called leadership. North American boardrooms need to find their modern-day Churchill. Now, there was a man who knew a thing or two about turning a dysfunctional ship around. Real leaders like this have taken on world scale tyrants and dictators with amazing success. There is no reason why they cannot set things right with a few petulant, garden-variety CEOs. No reason, except that there is no one even close to the boardroom equivalent of the man who saved civilization.
Why this is so is a question shareholders and thoughtful stakeholders might wish to ponder.
Governance reforms at this global company come with a huge price tag and are rather slow at that.
Some interesting corporate governance reforms have been announced at Marsh & McLennan Companies, the huge financial services and consulting conglomerate with $12 billion in reported annual sales. Many of the reforms, like mandating the appointment of an independent director as board chair, provision for continuing education of directors and annual board and director evaluation, are ideas The Centre for Corporate & Public Governance, along with other governance experts, has been urging for nearly two decades. Few break any new ground, but even adopting reforms that have been on the shelf for a decade or more is progress in what is essentially a glacial environment.
The company claims the changes came about through an ongoing process of review. Hello? These reforms were the result of events leading to a deal struck with U.S. regulators and New York State Attorney General Eliot Spitzer in January 2005 to settle charges of price fixing, bid rigging and payoffs in the insurance industry which saw the company pay out more than $850 million in restitution. A separate settlement with MMC’s Putnam unit resulted in that company paying out more than $100 million in April 2004 in connection with a market trading scandal that worked to the exclusive benefit of some of Putnam’s biggest clients.
It was a wave of scandals and criminal probes that came as a shock to Marsh’s board at the time and brought my one-time next door neighbor and former MMC chair and CEO, A.C.J (Ian) Smith, out of retirement to head the Putnam board during its period of turmoil and rebuilding.
But it shouldn’t take more than 18 months to do the obvious and what common sense has demanded for years. The current reforms were so long in coming that they raise concerns that MMC’s board is still less than the model of the energetic vigilant watchdog its stakeholders require. The uber-lame statement regarding directors being urged not to hold more than four additional board positions (but allowing for exceptions with the current group and any director in the future who requests it) is a travesty. What kind of responsible director could possibly take on governing duties at Marsh & McLennan and still do justice to several other board positions, or vice versa? This is the kind of state of denial that boards regularly stumble into and is arguably one of the reasons why MMC’s board failed to detect or prevent the previous scandals. As long as boards are composed of people who are not entirely connected with the pace of changing values in the wider society and who take their cues from who is in and who is out of the cozy club, these tragedies will continue.
Marsh & McLennan’s boardroom reforms are a step forward. But they are an expensive one. The price tag to investors should not have been the billion dollars paid out in restitution and penalties and hundreds of millions more in lost business and reputational treasure.
The Globe and Mail’s annual review of corporate governance in Canada shows the newspaper shares many traits with the incurious, self-satisfied boardroom.
More about the tough life of sacrifice and service in the boardroom is found in The Globe and Mail’s yearly review of the state of corporate governance in Canada –a report whose annual rankings of its version of the best and worst boards produces cheers from the top, boos from the bottom, and a big yawn from all those in the centre. The piece begins by reporting how David O’Brien, a director of many prominent companies, had to interrupt his safari in Kenya in order to participate by satellite telephone in a board meeting. No doubt Mr. O’ Brien would have been celebrated for his heroic efforts on his return to the Toronto Club. And you thought the life of a single mother balancing a job, household expenses and two young children was tough. Where do they find such people?
As it has for the past several years, The Globe and Mail trots out an annual procession of the same actors to give voice to the same thoughts: Corporate governance is more important than ever and real changes are underway. There is always the caveat from some director that we need to take care not to go too far. Oh yes, and what a shame there are not more women at the director’s table, but progress is being made. You will not find anywhere in the story the words of the average stakeholder or small investor who might actually speak in an authentic voice and be less inclined to talk in the predictable platitudes that the newspaper serves up from these main boardroom players. And you will not find this cast of directors shedding any light on why it took the worst series of boardroom scandals since the Great Depression before they realized the obvious, why they pay themselves so much more now than in pre-Enron days when directors were insisting that they were working as hard as possible, or why board members on whose watch companies fall into scandal and disrepute are continually being appointed and re-appointed to more boards.
The creation of a self-regulatory organization (SRO) for directors which would hold them to a rigorous standard of professional conduct and have the power, in effect, to disbar violators from serving on a board –an idea which The Centre for Corporate & Public Governance conceived and promoted in submissions to legislative committees in Canada and the United States some years ago– is not even on the directors’ (or the Globe’s) governance navigation system. What these directors are doing today to empower shareholders more fully remains an unexplored topic as does any meaningful discussion of excessive CEO pay, mainly I suspect because so many directors have been beneficiaries of the existing wave of insanity; our safari-going Mr. O’Brien, for instance, was one of the top paid CEOs in Canada a few years ago when key operating divisions of Canadian Pacific were spun off under his leadership.
It is perplexing in the 21st century, when so many citizens, consumers, employees and investors have a genuine stake in the quality of corporate governance and the decisions boards make, that the term “stakeholder” does not even appear in the story. The concept of stakeholder capitalism, a term I coined in the 1980s, has been established well enough to at least warrant some discussion, as it really does go to the heart of a board’s wider mission and responsibilities today.
Many of Canada’s top directors, like those quoted in the piece, have sat in the boardroom year after year—some for decades. Many were fully capable of standing up and bringing about change before disasters like Enron, WorldCom, Hollinger and Nortel struck, when it was first required and when shareholders and other corporate stakeholders really needed it. Most did not. They could have taken an early prominent role when the disclosure requirements of the Toronto Stock Exchange (TSX) corporate governance guidelines were repeatedly ignored by hundreds of listed companies. None did. The subject of excessive CEO pay, an issue upon which so much of capitalism’s credibility is being tarnished and a gathering cloud of ill will is forming, needs champions of change and restraint in the boardroom. They have not yet arrived. It is difficult to have confidence that these same directors are the ones who can now look into the future and say which seeds will grow and which will not, to borrow from Shakespeare.
In its annual pilgrimage to Canada’s boardrooms, The Globe and Mail appears to be taking its cue from that very institution where the tough questions so often go unasked and unanswered. It seems that with each new owner, the Globe’s once iconic reputation becomes more watered down and more accepting of the status quo. And like the boardroom, the Globe seems to be more comfortable dealing with the same individuals year after year (some of whom I have known and liked on a personal basis over several decades, but that really is beside the point) rather than seeking out a more distinct source of unconventional boardroom wisdom. There is no law as far as I am aware that requires directors to speak as a chorus in constant unison; a few solos can still get the job done and at the same time strike a more human and evocative note. And I can report from personal experience in venture capital circles and elsewhere where ideas really matter, that to the innovative and ethically driven minds that are changing the landscape of business (and society) in remarkably constructive ways and whom I am privileged to interact with on a daily basis, the repetitive self-congratulating voices of the old boardroom guard are about as irrelevant, unnoticed and uncool as a basement mimeograph machine.
Lack of curiosity for the unexpressed forces of impending change and exclusive embrace of the group mindset are attributes of neither sound journalism nor the well-governed corporation and, indeed, have left both institutions reeling from the consequences of their absence.
Disclosure note: I was an early proponent of an annual assessment on the state of corporate governance in Canada, having written on the subject in the op-ed pages of The Financial Post, The Globe and Mail and elsewhere since the 1970s and having been quoted extensively on related news items by reporters in those publications. In 2002, when The Globe and Mail was considering the idea, I was asked early in that process for my advice (given pro bono) as to the kind of issues and themes it should address, and was interviewed at length in the inaugural edition.
The law has spoken forcefully about Skilling’s freedomless future; about Enron’s feckless board, the ethical verdict is still awaited.
Having received a prison sentence of nearly 25 years, the law has finally taken its course for Jeffrey Skilling. However much I have detested the arrogance and deception which he was found to have inflicted upon shareholders, employees and all those who placed their confidence in a company that was once trumpeted among America’s best, it is a joyless spectacle. The closing chapter in this tragic play will, absent a successful appeal, likely see him spend the rest of his life incarcerated.
As Skilling prepares to surrender his freedom, my thoughts turn to those from whom the criminal law appears incapable of extracting any meaningful sentence: the directors who hired and were supposed to monitor Skilling and the rest of Enron’s top management –the same directors who insisted they were unaware of wrong-doing and were diligent in their duties. About those directors, Enron’s own internal investigation concluded:
With respect to the issues that are the subject of this investigation, the Board of Directors failed, in our judgment, in its oversight duties. This had serious consequences for Enron, its employees, and its shareholders.
…
The Board, and in particular the Audit and Compliance Committee, has the duty of ultimate oversight over the Company’s financial reporting. While the primary responsibility for the financial reporting abuses discussed in the Report lies with Management, the participating members of this Committee believe those abuses could and should have been prevented or detected at an earlier time had the Board been more aggressive and vigilant.
But the most telling indictment of failure on the part of Enron’s board came in the form of a report by the U.S. Senate Permanent Subcommittee on Investigations, which, after months of hearings and investigation, concluded:
…much of what was wrong at Enron was not concealed from its Board of Directors. High risk accounting practices, extensive undisclosed off-the-books transactions, inappropriate conflict of interest transactions, and excessive compensation plans were known to and authorized by the Board. The Subcommittee investigation did not substantiate the claims that the Enron Board members challenged management and asked tough questions. Instead, the investigation found a Board that routinely relied on Enron management and Andersen representations with little or no effort to verify the information provided, that readily approved new business ventures and complex transactions, and that exercised weak oversight of company operations. The investigation also identified a number of financial ties between Board members and Enron which, collectively, raise questions about Board member independence and willingness to challenge management.
The failure of any Enron Board member to accept any degree of personal responsibility for Enron’s collapse is a telling indicator of the Board’s failure to recognize its fiduciary obligations to set the company’s overall strategic direction, oversee management, and ensure responsible financial reporting.
Yet the freedom of those directors today, unlike that of the CEO they were charged with supervising, is not in peril. Many have gone on to serve on other boards. They are considered members in good standing of the cozy club. The criminal justice system apparently has no claims upon those who protested before an incredulous Congress that they saw and heard no evil and did not know what was really going on. It is a scene that has been played out many times before in the great boardroom scandals of the past century among directors who failed to ask the right questions and who, though appointed by shareholders to be the vigilant guardians of their interests, were little more than shut-eyed sentries under the spell of management.
I have often wondered how otherwise self-respecting and sophisticated members of the business community could allow themselves to be placed in a position were they regularly wind up claiming to be innocent dupes. Time and again when that happens we find there has been a failure to ask the right questions and to devote sufficient attention to understanding the company they were supposed to be governing. Yet there appears no shortage of such individuals and they are readily recycled in boardroom after boardroom.
For the final atonement of Enron’s directors, we must await the verdict not of the law, but of ethics. The true cost for these actors may not come in time imprisoned but in the moral opprobrium of history. In the end, these sometimes more elusive forces may prove to be a much tougher judge of those who could have prevented the Enron catastrophe but instead sat in comforted slumber as management cast its web of intrigue and deception ever tighter around them.
But is it the desire for more money, and not the quest for better governance, that is really driving the hike in directors’ compensation?
Our friends at the Conference Board announce that directors’ pay for the past year was up considerably from the previous twelve months -–in some cases jumping by more than 20 percent. What a surprise. The trend for directors to pay themselves more has been growing since the epidemic of business scandals in 2002, when there was a marked grab for more cash even in the face of tumbling share value, indicted CEOs and bankrupt companies. Since then, the increase generally has been 20 to 30 percent a year for some sectors.
To me, making a play for bigger bucks at a time when investors had suffered considerably and public confidence in the leadership of big business had become so worn smacked of a colossal lack of judgment. It was the same lack of judgment that got business into the mess in the first place –which essentially had stemmed from the failure of directors to direct.
The argument directors and their handlers make is that it takes much more time to be a good director since Sarbanes-Oxley was passed in 2002. But if you had asked this same self-aggrandizing chorus about the need for boardroom changes prior to Sarbanes-Oxley and what they were doing to bring them about, as I often did in personal conversations and in my op-ed pieces, the response was always the same predictable cliché: they were working as hard as they possibly could to be the best directors they could be. These directors gave the impression of being the boardroom equivalent of coal miners who descend into the earth for monthly meetings and return covered with the sweaty soot of tough committee work.
Having been in those rooms and known many directors personally over a couple of decades, my observations led to a different conclusion. While some take their duties seriously and prepare for their meetings, too many others are like former Ontario Premier David Peterson, who admitted under oath during a regulatory hearing into the demise of YBM Magnex (one of many companies whose board Mr. Peterson sat on at the time) that he did not make notes at board meetings nor did he take any material away with him after the meetings. It was apparently a drift-in, drift-out situation. It’s the kind of easy-going, don’t-rock-the-boat, director style that the cozy club seems to appreciate and which makes Mr. Peterson still much in demand by CEOs as a director, even though YBM Magnex went under in disgrace and the U.S. Justice Department was alleging that company management engaged in money laundering.
Does huge pay make for a good board? Nortel had the highest priced board in Canada for a number of years. The company today remains on life support, its share value a pale image of its heydays; the taint of scandal and accounting irregularities difficult to shake. But if boards are to be paid more and more, there should at least be a fuller accounting to shareholders of exactly what directors have done to earn their money. Assuming for the moment that shareholders actually hire the board, as the law counsels they must, then owners should have information upon which to assess director performance, and should require that an annual assessment of board performance be conducted and provided to investors prior to annual meetings. And certainly there should be a limit on the number of outside boards on which any director is permitted to sit to ensure that investors are getting the full attention of their directors.
Don’t hold your breath waiting for these changes. At best, it seems, many boards have a tenuous connection with reality in terms of knowing what is in the best interests of shareholders or what the company and its management are actually doing. Directors may make many claims that they have finally gotten the message about what good governance is all about, but as I recently posted in Finlay On Governance, they have been making the same claims before and after every wave of scandal for the past 100 years.
Given the checkered history of the boardroom, it seems reasonable to conclude that it is the desire for more money, and not the quest for better governance, that in the vast majority of cases is driving the increase in directors’ pay. The same mindset that has seen boards hand out record amounts to CEOs in recent years, and often without any discernible relation to stock performance or other realities of business life, is what is causing directors’ pay to soar. It’s just too good a deal to allow a little thing like proper accountability to shareholders to get in the way.
Ousted NYSE head Richard Grasso ordered to repay millions in improper pay; directors chastised by judge for being asleep in the boardroom
Indeed, many members of the (NYSE) board testified that they did not know about the SERP and if they did, they did not know what the balance was.
This court also finds this affirmative defense of neglect to be shocking. That a fiduciary of any institution, profit or not-for-profit, could honestly admit that he was unaware of a liability of over $100 million, or even over $36 million, is a clear violation of the duty of care. The fact that it was a liability to an insider (chairman and CEO) is even more shocking and a clear violation of the duty of loyalty.
–New York State Supreme Court Justice Charles Ramos in a decision ordering former NYSE CEO Richard Grasso to return millions of dollars in contested compensation.
Finally, the “slumber defense”, so often employed by directors who claim they really didn’t know what was happening, is beginning to offend the courts as much as it ought to offend shareholders.
Ironically, I covered this very point in a letter to the NYSE board a year before the Grasso scandal erupted.
The spectacle of Enron’s board pleading ignorance to the advancing dangers that brought down the company is a scene that has been played out repeatedly in the great corporate disasters of the past century.
I then went on to deal with the subject that would eventually lead to Grasso’s undoing, and the board’s embarrassment –oversized pay awarded in a climate of boardroom permissiveness and complacency.
Excessive CEO pay has been an indicator of the manifest deficit in ethics and values that has overshadowed too much of the business world. In the 1970s, the average CEO made about 43 times what the average worker made. In 2001, that gap had widened to 500 times. This phenomenon, representing the largest transfer of wealth from owners to a small class of hired professionals in history, interestingly coincides with the greatest decline in respect for business and its leaders, the largest loss of shareholder wealth and the longest parade of disgraced CEOs since the Great Depression. It symbolizes more than a dysfunctional system of compensation. It stands as an emblem of the failure of directors to live up to their ethical and legal responsibilities and tarnishes the moral authority of capitalism.
The judge has given directors and CEOs across America and elsewhere plenty to think about.
