Corporate Governance Structure Value-Added New Strategy

Author: Jay A.
Translator:
Publisher:
Publish Date: 2003-01-01
Features: On the contrary, the board of directors of Disney Company is often criticized because several of its "outsider" directors have business relationships with the company or the CEO. For example, one director is the personal lawyer of President and CEO Michael Eisner, while other directors are involved with the CEO and his wife in a charitable organization. These and other entanglements raise the following question: Can board members remain objective and always consider the best interests of shareholders when their actions affect their personal or other relationships with the CEO? Another example of a board lacking independent directors is Rite Aid. In the late 1990s, salespeople and company insiders dominated the board, in addition to the company's founder and two senior executives of Rite Aid. The board members also included Nancy Leiberman, the company's legal counsel Scott Apel, partners at Slater, Meigs, and Fromm; Leonard Stone was the CEO of Hasbro, a supplier of Rite Aid pet products. Due to the overly aggressive expansion plan implemented by CEO Martin Kras, the board's response to issues was slow. In the fiscal year of 1999, the company's debt increased from 1.8 million to 2.6 million; the company's stock plummeted; while in the previous three fiscal years, the company's revenue doubled, but the pre-tax income decreased by approximately 500 million. During the 12 months following the issue, the board's audit committee only held two meetings. Finally, the CEO was ousted. The ratio of insiders to outsiders is just one of the tensions between the board's other practices and independent objectives related to effective governance. For example, paying directors in stock or stock options gives them direct financial interests in the company. Similarly, hiring directors can expand the company's capabilities—for example, by forming strategic partnerships with other organizations. However, both approaches promote interdependence rather than independence.
In summary, when the board is composed of independent directors, its power is maximized. This power is enhanced when these directors possess world-class knowledge about the key issues facing the board. It is further strengthened when the directors have personal credibility and the ability to inspire and engage with the CEO and other board members.
Time and Opportunity Board members are extremely busy individuals, making the time they can allocate a critical factor in the board's effectiveness. Many of the issues the board faces are complex and time-consuming, as they require knowledge of markets, business, finance, and law. In times of crisis, such as hostile takeovers, time constraints become a serious problem. Clearly, the amount of time board members can dedicate is a key consideration in their selection.
If board members do not have enough time to attend crucial board meetings and prepare adequately, this can lead to the board's greatest failure. This potential issue can be partially addressed by selecting directors who have limited outside commitments. During most of his tenure as CEO of General Electric, Jack Welch refused to take on any board roles outside his company, arguing that as a CEO, the time required was already greater than a full-time job, leaving no extra time for a board. He only joined a board near the time of his retirement. It is difficult to argue with Welch's perspective, although it is somewhat extreme when considering that CEOs can often learn from serving on external boards. However, it is undeniable that CEOs should not hold more than three external board positions, and ideally, most should have only one or two. In fact, this conclusion aligns with the views of many CEOs. A 1999 survey report by the National Association of Corporate Directors found that most CEOs do not hold external board positions, and virtually no one serves on more than three boards.
The situation regarding the number of board commitments described above does not apply to individuals who primarily focus on board work. Either because they are retirees or because they are full-time board members. Additionally, some venture capitalists with significant ownership stakes in companies may hold seats on the board of each company. However, for most board members, dedicating their entire time to board work and making effective contributions to five or six major company boards is rare.
Therefore, our advice on seeking board members is clear: look for individuals who are not currently serving on several boards. Ideally, they should hold positions on only one or two boards. In summary, the board may want to seek individuals with ample free time, preferably retirees or full-time board members. Having several board members with flexible schedules is particularly important in major crises, such as legal investigations, tender offers, or situations requiring significant board time. Board members with another full-time job may struggle to step away from their daily responsibilities to address major crises. On the other hand, individuals with flexible schedules are often able to dedicate their time freely.
A Diverse Board It is a good idea to have a mix of people on the board. Some may have primary full-time external jobs, while others have flexible schedules.
Selecting the Right Members Establishing the right member structure for the board is clearly a complex process. The selection process must include a wide range of factors, including the knowledge and collaboration required for board membership and operational efficiency. Unfortunately, there is no universal formula for creating the best combination of board members. However, the boards we have studied that have formed the best combinations do follow certain common procedures. A brief overview of these key procedures and practices is as follows:
The Role of the Nominating Committee The process of selecting board members is crucial and is typically handled by a committee composed entirely or mostly of independent directors. Many boards have a nominating committee, which focuses solely on issues related to member composition. Others have a governance committee, which has a broader agenda but dedicates significant time to identifying and recruiting board members. A 1999 director survey by Korn Ferry & Company found that CEOs and committees with a high proportion of outside directors have roughly the same influence in determining who is nominated for board membership. This result aligns with a 1999 survey by the National Association of Corporate Directors, which found that in only 7% of cases was a new director nominated solely by the CEO—a percentage that had declined from 27% in 1995. Of course, finally, shareholders approve the membership—although shareholders rarely oppose the board's recommendations. In the absence of an independent nominating committee, the CEO inevitably dominates the process. In such cases, there is a significant risk that the board may lack the necessary authority to perform this function.
Moreover, the board must strike the right balance when intervening. It is essential for CEOs to provide their input when selecting new directors, as they will have close collaboration. CEOs are also likely to be the most informed about the strategic knowledge requirements. However, if directors feel overly indebted to the CEO due to their position on the board during the initial selection, it may hinder their ability to oversee the CEO effectively. It is risky for CEOs to try to place individuals on the board who are unwilling to challenge the existing management structure. Therefore, it is crucial to have a strong, independent director lead the nominating committee, with the majority of its members being outsiders.
The Search Process Itself