Serving the Shareholders

With billions of dollars in losses racked up on Wall Street casting new light on how boards of directors operate, the time may be right to re-examine the nation’s corporate governance laws
Illustration by Bernard Maisner

On Sept. 15, 2008, when the 158-year-old investment bank Lehman Brothers filed the largest bankruptcy in U.S. history (with assets of $691 billion), its 11-member board of directors included nine retirees, five men over the age of 74, and, apart from Lehman’s chairman and CEO, only two people with any direct experience in the financial services industry.

By most accounts, Lehman’s collapse set in motion the improbable crumbling of a handful of other venerable institutions and the global economic avalanche that followed. The resulting financial turbulence greatly affected Michigan and Detroit, as traditional lending sources dried up and consumers began monitoring nearly every outward expense in juxtaposition to their falling 401(k) balances and other market investments.

While few Michigan-based corporations have been immune to the global financial meltdown — whether it’s the Big Three automakers, Masco Corp., Penske Automotive Group, Pulte Homes, or Borders Group — the state’s 29 public companies that are part of the Fortune 1000 list of the largest American companies have been generally well-managed. Still, as General Motors and Chrysler (and initially Ford Motor Co.) were grilled by members of Congress last fall for flying to Washington in corporate jets to ask for loans to shore up their balance sheets, it became clear that corporations and their boards are now operating in an arena of increased scrutiny (even private companies are under greater review, as is the case with Chrysler).

The ensuing examination about why certain corporate actions or policies were pursued on Wall Street and why various complex financial instruments were permitted has tended to focus on the senior management of now-failed or troubled institutions. But those entrusted to oversee senior management’s strategies and police the interests of shareholders, whether in Michigan or elsewhere, have largely escaped closer examination.

“There are so many contributing factors leading to the situation we’re in today,” says Stephen Wagner, a managing partner at Deloitte, which operates a large public accounting office at Detroit’s Renaissance Center. “But for corporate boards to assert that they’ve had no culpability in this process is impossible.”

Indeed, the widespread trouble afflicting so many U.S. companies has raised some burning questions about whether the current corporate governance structure is working, and whether the overseers of shareholders’ capital — the boards of directors — are functioning effectively.

Since the advent of the modern U.S. corporate structure, shareholders have relied on the board and executive management to carry out company business, but have also relied on governmental agencies and other gatekeepers.  At an elementary level, board members are elected by shareholders as guardians of shareholder investments.  But shareholders rely on external corporate gatekeepers as well, such as auditors, government regulators, accountants, and lawyers, who offer opinions or make decisions that (at least for publicly traded companies) can be reviewed and evaluated by a shareholder, or potential investor.

Though it would be difficult to pin the sinking of Lehman Brothers, Bear Stearns, Fannie Mae, Freddie Mac, Merrill Lynch, and AIG on a single cause, most observers agree that senior management failed to assess, and boards failed to understand, the enterprise risks in the debt and investment decisions that were being pursued. The combined lack of information proved devastating.

What’s more, the resulting credit market collapse that vaporized nearly $11.2 trillion in U.S. household net worth last year — representing an 18 percent drop from 2007, the largest annual decline since the federal government began taking quarterly records in 1952 — and the trillion dollars and counting in bailout funds provided by taxpayers has many people looking for someone, or something, to blame.

Harvard Business School professor Jay W. Lorsch believes some of the blame should be directed toward the performance of corporate boards. Lorsch, co-author of the recent book Back to the Drawing Board: Designing Boards for a Complex World, believes boards are being pressed to perform unrealistic duties, given their traditional structure and time constraints of members. “It’s clear, in many cases, that boards have to do a better job of understanding what’s going on in their companies,” Lorsch says. “And we need to begin thinking about how else boards can gather necessary information.”

Commonly, boards obtain information and knowledge about company matters from management and auditors; however, if those
sources of information are inadequate, it will inevitably have consequences for boards. “If management didn’t know exactly what was going on, then how was the board expected to know?” adds Lorsch, who has advised and served on several corporate boards in diverse industries.

The notion that boards need greater access to company data is largely supported by the findings of an April 2007 corporate governance survey of 825 public company directors and more than 1,800 managers and executives. About seven of 10 directors indicated they were satisfied with their access to the financial information of the companies they serve, according to the McKinsey & Co. study. But satisfaction levels drop noticeably when access to strategic and operational information was considered. Only 50 percent of directors say they were satisfied with their access to information in these two respective areas. Not surprisingly, inside directors — executives serving on their own companies’ boards — expressed higher levels of satisfaction than independent directors (defined, in general, as someone who has not been an officer or employee or had any material relationship with a company for a three-year period prior to nomination to a board). The results of this study, conducted before the credit crisis, would likely have yielded different results if performed in the fall of 2008.

One problem (or, perhaps, advantage) faced by corporate boards is that they’re largely an afterthought to the media and the public. Usually, the media highlights a board’s activities only when addressing a possible scandal emanating from the boardroom — which isn’t too common. Yet boards — like Lehman Brothers’ — are often viewed as a group of mostly retired executives, bankers, lawyers, academics, and politicians who are well-compensated for their limited work and who gather periodically around a conference-room table to view PowerPoint slides and provide their stamp of approval for initiatives advanced by the CEO. But this is not entirely true.

Aside from hiring (and firing) the CEO, the function of boards of directors includes monitoring management and its strategy, while acting as an advocate for shareholders. Recently, more corporate directors have begun to acknowledge that they must oversee business risk as part of their overall strategy-setting role. A 2002 survey by McKinsey & Co., involving 200 directors representing 500 boards, revealed significant concerns about companies’ abilities to manage and assess enterprise risk. Of the participants surveyed, 36 percent said they had only a partial understanding of the major risks facing their respective organizations. In contrast, the 2006 survey revealed that nearly 90 percent of directors understood the major company risks. While it was a marked improvement, some would suggest that is still surprising.

For some time, the impact of boards has been questioned, as directors were often viewed as too beholden to CEOs, rarely asking tough questions or challenging the directives advanced by senior management. In a November 2008 interview with The Wall Street Journal, billionaire investor and longtime shareholder activist Carl Icahn cited a lack of accountability as a fundamental problem leading to the financial crisis. “You had very few real, functioning boards to control what happened on Wall Street,” said Icahn, who recently launched United Shareholders of America, a campaign to make companies and CEOs more accountable. According to Icahn, the crux of the problem is that CEOs often “put their friends and cronies on the board, and these guys aren’t going to throw him out.”

But, according to Wagner, that notion may be a thing of the past. “Composition of boards 20 years ago [was] much different than it is today,” he says. “In the past, CEOs tended to select people for their boards who they knew, trusted, and felt comfortable with, and those they were confident would support them.”


Although the cases are few and isolated, there are some recent high-profile examples of boards misbehaving. Consider the conduct of the board at Tyco International in 2000, which led to public and investor outrage. Tyco paid a former director $10 million, and gave $10 million more to his foundation, for his role in Tyco’s acquisition of commercial- and consumer-finance lender CIT Group Inc., which Tyco ultimately spun off as a separately traded company.

Later that year, Tyco CEO L. Dennis Kozlowski and the entire Tyco board were removed because of corrupt practices, eventually leading to various criminal convictions and a 20-year prison sentence for Kozlowski. Some members of the media contend that Tyco’s directors might’ve had difficulty maintaining their independence from management.

More recently, in 2006, the chairman of Hewlett-Packard, along with roughly a half dozen other top officials of the firm, resigned or were fired amid a scandal over illegal corporate spying. The spying campaign, launched by then HP board chair Patricia Dunn in response to leaks to the press of internal corporate discussions, included surreptitiously obtaining the telephone records of HP board members and employees, surveillance of board members and journalists, and the e-mailing of spyware to journalists in an effort to learn the identity of their sources within the company.

In addition, the adoption of the Sarbanes-Oxley Act in 2002 was an attempt to ease investor anxiety caused by the financial scandals perpetrated by companies such as Enron, Tyco, Adelphia, and WorldCom. Following its passage, the Securities and Exchange Commission, the New York Stock Exchange, and NASDAQ required that listed U.S. companies have a majority of independent directors.

So, while the current economic malaise may be fueling considerable negative sentiment toward corporations, there are what many believe to be increasingly positive trends emerging in board structure. A recent study of board characteristics by the RiskMetrics Group, a leading provider of risk management and corporate governance services, reveals that board independence continues to rise. In 2008, 78 percent — a four-point increase from the prior year — of all directors at Standard & Poor’s 1,500 companies were independent.

However, in the process of striving to achieve greater corporate accountability and populate boards with outsiders, an unintended shortfall may have occurred. Too many boards — such as Lehman Brothers’ — seat members lacking in acute industry knowledge. And without it, probing, incisive questions from board members to management often become less frequent.

Moreover, researchers have struggled to find concrete evidence that independent boards actually enhance a corporation’s performance. “Maybe the way we’re defining independence and thinking of achieving it is the wrong way of going about it,” Lorsch says.

In large part, a board’s success depends on the competency and commitment of its individual members, together with their understanding of fiduciary duties and their ability to work together as a group. When integrated, such factors will inevitably affect the board’s overall culture. A strong board, according to Wagner, contains a variety of skill sets, experiences, and viewpoints in an open environment. It combines members who can provide insight regarding strategy and risk, with specialized industry knowledge that’s relevant to the particular business environment in which the company functions.

“A good board needs to be a composite of people who know the industry and people who have complementary views,” says former Chrysler President Thomas Stallkamp, now a director for Auburn Hills auto supplier BorgWarner and for Deerfield, Ill.-based health-care company Baxter International.

“An effective board functions as a unit that challenges and questions management,” he adds, contending the questioning of management actions is far more common now than in the past.

In general, problems with boards arise in three areas: processes (the way boards are run), people, (the personal and professional backgrounds and qualifications of board members), and culture (the relationship between boards and management). The composition of a board is often the key determinant of its potential value and cohesiveness. “If you build the right board, with the proper complement of expertise, you’re going to get the appropriate balance and perspective in helping a business prosper,” says Leslie Murphy, a former partner at Plante & Moran in Southfield who’s now a board member of Kelly Services Inc., a large employee-staffing firm in Troy.

On the other hand, a board lacking a culture of shared values and focus can have dreadful consequences, as evidenced in the boardroom of HP just a few years ago. “If a culture of trust is created, and every member’s point of view is respected, it gives the rest of the board pause to consider that viewpoint in determining the business objective,” Wagner says. “But a negative force on the board or some kind of negative stigma associated with speaking your mind can lead to a very dangerous situation — and that’s not healthy.”

According to Lorsch, the composition of boards, in general, needs to be given closer consideration. “You get people who are too old and are on a board because of who they know, and that’s not a good idea,” he says. “Boards should be made up of a diverse group. There should be a better balance — a greater mix of ages, sex, and ethnic background.”

If achieving diversity among directors, as measured by the number of women and minority board members, is the objective, then considerable progress is needed. According to a RiskMetrics Group report on Standard & Poor’s 1,500 companies, women hold 12 percent of all directorships, a figure unchanged from 2005, while minorities hold 10 percent, which has been constant since 2004. And according to research released in December 2008 by executive search firm Korn/Ferry International in its 34th Annual Board of Directors Study, 15 percent of the Fortune 1000 companies still have an all-male board.

As part of the data compiled in Korn/Ferry International’s study, directors of Fortune 1000 companies reportedly spend twice the time on board matters now as compared to 20 years ago. On average, directors spent 16 hours a month in 2007 working on board matters for each board on which they held a directorship. This figure included the time spent reviewing and preparing materials, attending meetings, and traveling.

That’s inadequate, says Wagner, as the time devoted by boards, in general, don’t realistically allow members to comprehend the complexities of their companies’ business. “We need to rethink the commitment associated with board service,” he says. “The time commitment needs to be increased by some meaningful percentage, perhaps as much as 50 percent in some cases.”

So while there appears to be a growing chorus blaming boards of directors for the distressed state of corporate America, there are some corporate-governance experts who suggest otherwise. “Boards are not designed, historically, to manage the day-to-day affairs of companies or to provide some kind of second-tier of management,” says Lewis Black, an attorney and co-author of Delaware Corporation Law and Practice, a leading treatise on Delaware corporation law. (Black also served on the legal-advisory committee to the New York Stock Exchange.) “Boards should have an idea of the business plan and set the company policy,” he adds. “But boards shouldn’t second-guess the executives they’ve hired to run the corporation. If the business isn’t doing well, they should hire new managers — but they shouldn’t interfere in business operations because they simply don’t have the day-to-day experience and knowledge that managers possess.”

Those pointing their finger at boards, as many shareholder activists have, may want boards to act as both forensic accountants and sheriffs as they continually sift through company operations. But that simply isn’t realistic, nor is it the function of boards under state corporate laws. The task of boards — which, in most cases, hold meetings quarterly, monthly, or as dictated by the particular circumstances affecting the company — is not to uncover systemic flaws or promptly remedy poorly executed business plans, especially in giant and complex financial institutions.

Overall, calls for greater scrutiny and enhanced personal liability for board directors seem to be gaining traction. So, too, are the signs for increased stockholder protections. The proposed recent amendments to the 2009 Delaware General Corporation Law reflect an elevated focus on corporate governance and board matters. If approved, the proposed amendments would permit bylaw provisions that require a corporation to allow stockholders greater access to its proxy solicitations in order to nominate directors, and require corporations to reimburse stockholders for proxy-solicitation expenses in connection with director nominations. Moreover, the changes would allow, in limited circumstances, the judicial removal of a corporation’s directors — but not without first determining that the director didn’t act in good faith and that judicial removal is necessary to avoid irreparable harm to the corporation.

Implementing such changes and enhancing personal liability for directors, Black contends, is a step in the wrong direction. “I see qualified people leaving or unwilling to serve on boards because they just don’t want the liability or to be subject to shareholder lawsuits.” Black, who doesn’t view corporation laws as being overly protective of directors, thinks finding a way to attract more business-knowledgeable people to serve on boards of directors would enhance the overall governance process. But he doesn’t think it will come about through increased regulation.

According to Stallkamp, the road to improved board practices begins with an independent director serving as the focal point for other directors. Second, he says, companies should make sure communication lines are open, allowing shareholders to contact the board directly, rather than management filtering any exchanges. Stallkamp also stresses the need for boards to maintain an active continuing-education process, along with participation in corporate governance matters — both of which are followed at BorgWarner and Baxter International.


Knowledge and access to company information remain essential considerations for directors, Wagner says. “Board members should never be surprised walking into a boardroom,” he says. “They should be part of a process of regular communication (with management) that enables them to deliberate [on] and influence outcomes.”

Regardless of where boards should fall on the list of parties potentially responsible for the economic crisis, the magnitude of the meltdown and disintegration of so many institutions will affect how directors of all organizations think, evaluate, and make decisions.

Whether viewed as an overdue wake-up call or an unfair impugning of directors’ integrity, regulators, legislators, and plaintiffs’ lawyers will fuel the debate over director liability and refocus their attention on the duty of care and its required oversight responsibility. And assessing whether enhanced regulations — in any form — are needed will be deliberated for some time.

To be sure, there’s no easy solution or quick fix to assuring better corporate oversight in the future. In the end, sound corporate governance requires a team effort between honest, informative management and a fully engaged and sophisticated board of directors willing to offer their expertise to diligently challenge, counsel, and guide the corporation. The recent failures and missteps of several of this country’s proudest institutions suggest there were too many boardrooms severely lacking these vital traits.

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Sounding Boards

Boards of Directors – The Essentials

Primary Function
The role of the board is to hire (and fire) the CEO and monitor the management of a corporation, acting as an advocate for stockholders. Moreover, the board oversees and approves the company strategy set by management. In essence, the board of directors tries to make sure that shareholders’ interests are well-served.

Nomination and Election
Directors are generally nominated by the board, but shareholders can also suggest nominees in some circumstances. Many boards establish a nominating committee, comprised of board members, to conduct searches for appropriate candidates and transition the new board members into their roles as directors. Directors are elected by shareholders. Some companies have staggered boards, where groups of directors are eligible for re-election in alternating years. Other companies place the entire board for re-election at once.

Board Composition
There are no state or federal law requirements to have a specific board composition; however, the NYSE and NASDAQ require their exchange-listed companies to have a majority of independent directors.

Board Categories

Chairman: Technically the leader of the corporation, the chairman of the board is responsible for running the board smoothly and effectively. His or her duties include formulating the company’s business strategy, and representing management and the board to the general public and shareholders. A chairman is elected from the board of directors.

Inside Directors: An inside director is either a shareholder or high-level manager or other employee who works for the company on a daily basis. They’re responsible for approving high-level budgets prepared by upper management, implementing and monitoring business strategy, and approving core corporate initiatives and projects.

Independent or Outside Directors: While having the same general responsibilities as the inside directors, outside directors are different in that they’re not directly part of the management team or employed by the company. The purpose of having outside directors is to provide unbiased and impartial perspectives on issues brought to the board.

A board’s activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the company’s bylaws.

Board size is usually determined by the company’s articles of incorporation or bylaws. The articles of incorporation will typically establish the minimum and maximum number that can compose the board, with the bylaws providing the exact number, the manner in which they should be chosen, and how often they should meet.

Age Limits
The NYSE and NASDAQ do not impose age limits on directors. However, a company’s bylaws or corporate governance guidelines can impose a mandatory retirement age.

Term Limits
The length of term served by directors varies by company and is typically established by the company’s bylaws. Term limits for elected directors are relatively uncommon.

Executive Sessions
Both the NYSE and NASDAQ require that independent directors have regularly scheduled meetings outside the presence of management and inside directors. There’s no minimum requirement, but most companies include an executive session as part of every board meeting.

Common Duties
• Governing the company by establishing broad policies and objectives
• Selecting, appointing, supporting, and reviewing the performance of the CEO
• Ensuring the availability of adequate financial resources
• Approving annual budgets
• Accounting to the stakeholders for the company’s performance
• Setting executive compensation
• Establishing dividend policies

SOURCE: Shearman & Sterling LLP


Cream of the Crop

Michigan’s Top Financial Planners

20 Largest Public Company Bankruptcy Filings 1980 – Present

Lehman Brothers Holdings Inc. 09/15/08 – Investment Bank – $691,063
Washington Mutual, Inc. 09/26/08 – Savings & Loan Holding Co. – 327,913
WorldCom, Inc. 07/21/02 – Telecommunications – 103,914
Enron Corp. 12/02/01 – Energy Trading, Natural Gas – 65,503
Conseco, Inc. 12/17/02 – Financial Services Holding Co. – 61,392
Pacific Gas and Electric Company 04/06/01 – Electricity & Natural Gas – 36,152
Texaco, Inc. 04/12/87 – Petroleum & Petrochemicals – 34,940
Financial Corp. of America 09/09/88 – Financial Services & Savings and Loans – 33,864
Refco Inc. 10/17/05 – Brokerage Services – 33,333
IndyMac Bancorp, Inc. 07/31/08 – Bank Holding Company – 32,734
Global Crossing, Ltd. 01/28/02 – Global Telecommunications Carrier – 30,185
Bank of New England Corp. 01/07/91 – Interstate Bank Holding Company – 29,773
Lyondell Chemical Company 01/06/09 – Global Manufacturer of Chemicals – 27,392
Calpine Corporation 12/20/05 – Integrated Power Company – 27,216
New Century Financial Corporation 04/02/07 – Real Estate Investment Trust – 26,147
UAL Corporation 12/09/02 – Passenger Air Carrier – 25,197
Delta Air Lines, Inc. 09/14/05 – Passenger Airline – 21,801
Adelphia Communications Corp. 06/25/02 – Telecommunications – 21,499
MCorp 03/31/89 – Banking & Financial Services –20,228
Mirant Corporation 07/14/03 – Electric Services – 19,415

* Listed in descending order by Pre-Petition Assets (Assets in $mil)

New Generation Research, Inc. Boston, MA