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"GENERAL ROLE OF THE BOARD The Board should be the primary force pressing the management to the realization of its opportunities and fulfillment of its obligations. This requires meaningful involvement in company affairs both in Board meetings and outside.
The principal concerns of the Board are the broad policies of the Corporation, its general direction, pace and priorities. Its members should be fully informed in advance of all major proposals, and should have an opportunity to make a meaningful and deliberate contribution to the decision-making process. The Board should not become involved in the details of day-to-day business operations.
The Board should appraise performance on an ongoing basis, and take appropriate action to stimulate or advise to change top management. It should also review and provide guidance on basic operational aspects of the Corporation, including its sales and profits, the adequacy of its personnel and personnel policies, and its financial, accounting and audit standards and resources consistent with first-class corporate citizenship.
Outside directors will be expected to become familiar with the condition and operations of the Corporation through Board and committee meetings and by personal observation and inquiry."
The relationship spelled out in that statement really works; in fact, it has worked magnificently because just developing the formal state created an understanding of how each of us felt. Principally it works, however, because the Chief Executive is secure enough in his own authority and ability so that he is not threatened by a strong Board. He is open to ideas other than his own and receptive to guidance from his directors.
The kind of strength this CEO has does not result from domination. In such a relationship the CEO should promote open discussion and even introduce topics which he might consider potentially uncomfortable should he feel that they require the Board's consideration. The CEO must be able to stimulate participative involvement by his directors without losing control to them. He and his directors must never forget that the final decisions are up to the CEO.
I am not describing an idealistic situation. It is how things are working today in many companies, large and small. Running a company today is so demanding that the CEO should be seeking all the help he can get from his directors. This approach also is stimulating to his Board and, in turn, creates an environment that helps attract high quality candidates to serve on the Board.
"THE ROLE OF THE PROFESSIONAL DIRECTOR"
(Joseph W. Barr, Former Secretary of the Treasury) At a business seminar at Loyola College in Baltimore, I concluded that the sheer constraints of time make it difficult for the average outside director of a publicly held corporation to live up to the expectations of the governmentespecially the Securities and Exchange Commission—plus investors and lenders.
I then suggested that these time constraints could be overcome and a middle ground carved out by utilizing the services of a “professional director" who spends all his time as a director of various publicly held corporations.
To test the concept, I sent copies of my speech out to roughly 200 men in indus try, finance and government. The replies raised serious and thoughtful questions, objections, or areas of concern.
They reflected a deep and pervasive concern over the way our great public corporations will be managed, and a certain anxiety and perplexity as to how public companies can live up to ever higher expectations from the government, investors, and the public. They nearly all reflect an uneasy feeling that the old ground rules are shifting and that no one quite knows how the new game will be played. If corporate affairs are being pushed toward total exposure, it is only proper that I reexamine publicly my statement on the role of the professional director in light of the comments I received.
First of all, there were objections to the term “professional director.” I believe they were justified. The term carries a certain implication that perhaps manage ment cannot cope with the business and needs a "professional director.” More important, clinging to the term “professional” leads into the trap that the SEC narrowly avoided last year. You will remember that in 1974 the SEC publicly stated that it had under consideration a set of guidelines for the conduct and selection of directors of public corporations ... very definitely a move in the
direction of professionalism. They abandoned this effort in December 1974 after determining that they could not develop a working consensus on their guidelines.
Also, it would be troublesome defining the standards of ethics, the technical training, and the practical experience and background that are implicit in the term “professional.” To eliminate these difficulties, I will abandon the term "professional director" and replace it with “extra time director."
The second area of concern was that the public recognize that the contributions made to Board deliberations by the CEOs of other large publicly held corporations were invaluable despite their time constraints. However, it should be noted that there is a deep skepticism in the Congress and in the regulatory agencies as to the effectiveness of these relations between companies ... even when no conflict of interest is involved. There is a rather pervasive disbelief that the CEO of one industrial giant facing problems around the world can help direct the affairs of another multinational behemoth.
The third area of concern to emerge that a professional director could not keep his hands off day-to-day operations which are properly the concern of management-also is valid, An "extra time director" must be constantly vigilant in staying away from operating or personnel decisions. This is a legitimate problem area that should be faced squarely and understood clearly by management and the "extra time director."
The fourth area raised was the worry that a professional director would want his own staff. This is an explosive area with a great potential for creating confusion and discord within the company.
The fifth source of concern related the independence of the professional director to his additional compensation. Here again, some difficulty exists, but somehow it seems to fade a bit if the term "extra time director" is used. The compensation is for "extra time," not to subvert a professional.
Finally, there seemed to be an undercurrent of opinion that it would be best to have no outside directors. This is perfectly understandable. In many companies it is difficult for management to realize that the awesome public prestige that usually surrounds the founder of a great industrial empire just does not pass on down to his successors. As a result, the way in which investment decisions are made change radically. There is no doubt that in earlier years men like Walter Chrysler, Alfred Sloan, William McKnight, and Eli Lilly attracted investors who were going along for a ride on the personal ability of the man. In essence, these men and many others were heading great public corporations, but their own personal prestige was so great that the companies had certain attributes of a private operation. As these men left the scene and were replaced by managements not nearly so well known by the public, the private character of the companies disappeared, and they emerged as truly public corporations with outside directors who were expected to direct. Thus, it is only natural that many managements today look back with a certain nostalgia to the days of the founder and the inside Board.
of the six areas of concern, one, the objection to the term “professional" is I believe unanswerable. I have cheerfully dropped that adjective and substituted the expression “extra time director” which is more accurate. Of the other five, two were valid warnings of possible troubles. The issues of compensation and interference with day-to-day management should be addressed clearly and precisely. The last three issues I would class as understandable.
Having said this, it still appears that the presence of at least one “extra time director" on the Boards of publicly held corporations can be of significant benefit to shareholders, to management, and to the other directors. There is just no way to improve on the priceless assets of time and the absence of operating responsibility possessed by the "extra time director."
In addition to the six areas of concern, there was no additional area of almost unanimous approval. Nearly every respondent agreed that the audit committee furnished the best recognized and most widely accepted vehicle for the work of the "extra time director."
Over the past few years the audit committee has come into its own. The use fulness of a committee of outside directorg working with the inside controllers and auditors and the independent auditors to produce responsible and meaningful financial statements is now almost universally accepted. Many Government agencies like the concept because they feel that an audit committee of outside directors in a publicly owned company will be more interested in representing shareholders than management ... at least if the audit committee pays any
attention to the Securities laws. Management seems to have learned to live with and to use the services of an audit committee. Accounting firms now have a forum of outside directors to talk to in cases where fraud, illegal conduct, or sheer basic differences of opinion arise with management. And last, investors, lenders, and analysts seem to cheer on the audit committee as another check on the reliability of a company's figures. So the audit committee is widely acclaimed.
But with all this acclaim, there seems to be an increasing unease on some audit committees. They are fairly well convinced that in the event of troubles the Government plus investors, lenders, analysts, and reporters will be charging straight at the audit committees. As a result, service on audit committees involves some fairly awesome responsibilities. The chairman of the committee, especially, seems to be on the point of exposure.
"Extra time" becomes probably the best and only defense to directors serving on audit committees, especially the chairmen. Spending two to four hours a year in cut and dried sessions with a perfunctory look at the figures and the situations raised by the management letter does not seem to be either a defense or the proper discharge of the responsibilities to shareholders associated with service on an audit committee.
The audit committee should address at least the following areas. First and most important is knowing the people with responsibility for the numbers ... the staffs of the controller, treasurer, auditor, and the tax counsel. Numbers can be a very dull business, but they come to life with these staff people and take on a meaning which seldom is developed from just examining the documents. In addition the opportunity to know the outside directors who are members of the audit committee gives staffers a place to go if they think that fraud or illegal acts are being practiced by management.
Secondly, the committee should be familiar with any current or potential problems in the company that may involve material shifts in the numbers. These may involve problems in inventory, tax liabilities, litigation, transaction or translation gains or losses, or unexpected swings in the fortunes of subsidiaries. Audit committee responsibility in these areas is not a vehicle for solving or correcting problems, but a monitoring operation to make certain that the financial statements disclose fairly the company's position.
And last, audit committees have only recently been charged with oversight in the areas of domestic political contributions and illegal or perhaps just unusual overseas transactions.
The "watchdog" aspect of the audit committee should not be overemphasized but unfortunately it is there. With it is the time requirement ... especially for the chairman. So the "extra time director" can be a valuable addition to any audit committee. He cannot relieve other directors of their own liability, but by his extra efforts he can make the functioning of the audit committee more meaningful. If the audit committee is performing effectively, then the entire Board can move closer to public expectations.
THE CHANGING ROLE OF DIRECTORS IN THE 1970's
(Arthur D. Lewis, Chairman, U.S. Railway Association) The basic legal concept of what Boards are supposed to do has not changed over time. Boards have always had a fiduciary responsibility to represent the best interests of the stockholders, preserve the basic integrity of the assets, and maintain the financial position of the company. Similarly, they have always had responsibility, however neglected, to see that the corporation meets its responsibilities to the public. The Board has had the specific duty of selecting the Chief Executive and his successor and acting as an advisor to him. It has worked with him to set corporate objectives and strategies and act as a review board in determining his performance and the performance of his staff.
It has of course delegated to management the responsibility and authority to run the company. But it cannot delegate to management that ultimate responsibility and accountability to the stockholder and the public.
Thus, the fundamental underlying role of the Board is not changing. What is changing is the degree to which Boards are being held accountable for their actions. Because accountability has become a demanding fact today, there is an obvious need to reemphasize the need for adequate Board performance.
Almost invariably, writers on the subject are critical of Board performance. Rightly or wrongly, the corporation has been, in the view of the critics, largely indifferent to the rights of its stockholders, of women, of minority groups and of consumers, as well as to the preservation of a healthy physical environment. The corporation became the symbol of a comfortable and self-serving establishment-of an irresponsible authority. In recent years, stockholder suits have be come commonplace as some corporate officers and directors have made personal gain from inside information. There has been misrepresentation--and cases of outright fraud on the part of some major companies.
Another unsettling development has been spectacular business misjudgment and failures in recent years. The misjudgment largely concerned conglomerates, which were supposed to work management wonders, control profits, and improve corporate results. The opposite often turned out to be the case.
These multiple ills have been sufficient to bring increasing Government regula. tion—from the Securities and Exchange Commission, the Federal Trade Commission and agencies enforcing health, safety and equal opportunity provisions, to name a few.
One of the fundamental problems stemming from recent corporate misbehavior and the failure of performance among large organizations has been the undermining of public confidence in business.
The question today is what the Boards of Directors were doing in the period leading up to the unfortunate events and developments. What the Boards were doing, in the view of many, was failing in their responsibilities.
Peter Drucker is quite concerned that more than just additional regulation will be involved if Boards do not close the performance gap. Society, Drucker says, will find ways of exerting its will in the determination of a Board's makeup. He states that “the alternative to top management's developing an effective Board for its own needs and those of the enterprise is the imposition by society of the wrong kind of Board, especially on the large corporation. Such an imposed Board will attempt to control top management and to dictate direction and decision. It will indeed become the boss' ... the first signs of this are clearly around us indeed, it may already be too late to reverse the trend." Drucker goes on to say that "the decay of the traditional Board has created a vacuum. It will not remain unfilled."
There is no question but that in the last couple of years there has been some improvement in Board performance as a reaction to all the criticisms that have arisen. More chief executives are moving to assure their Boards greater involvement in critical decisions affecting the company. There is an increasing trend to improve Board effectiveness by establishing key committees. Concurrently, more Board members are insisting that the Chief Executive act in such a manner as to permit them to carry out their role effectively.
One of the things corporate management can do to stimulate an improvement in Board performance is to take the leadership in the establishment of a professional society to which an active Board member can belong. It is ironic that of all the elements of management, its most critical one, the Board, is the only one in which today there is no institutionalized method for the improvement of performance.
The principal benefit of such an organization would consist of the broad pressure it would exert to improve the professionalism of the director. However, it also could exert pressure not just for improved directors, but also against the Chief Executive, who must realize that, if he is to function at the highest level of his ability, he must find a way to use his Board more effectively. The creation of a professional society of this kind would in itself focus energies and ereate an awareness that performanee of Board members must be and will be enhanced.
Corporations also urgently need to encourage the development and use of the so-called "professional" director. The Chief Executive needs Board members who have the time required to become thoroughly knowledgeable about the problems facing the company and the performance of its officers and are able to spend the time to act as an able advisor to the Chief Executive himself. He needs someone at the Board level with whom he can converse in some detail. The professional director can make a real contribution in having a view only from the level of the Board and not the operating management. Management, in many instances, tends to be ingrown and principally involved with company and industry matters affecting corporate performance. On the other hand, the professional director should be sensitive to those complex external forces which affect corporate performance. The professional director would also have the expertise and time available to chair the tough committees effectively-the audit committee, for example.
The role the professional director can play is not broadly understood, but he can make an important impact on total Board performance, and the concept of his role should be developed.
Another fundamental question is whether or not the Chief Executive also should serve as Chairman of the Board, or whether it would be better to have an outsider serve as Chairman. Although there has been a trend since World War II to combine the two positions, the desirability of the trend must be examined. When the Chief Executive Officer is the Chairman, the Board's ability to ability to organize itself for its important oversight and review functions is impaired. The executive role of management and the oversight role of the Board are blended, and the latter role is compromised. There needs to be a greater separation than exists today between the Chief Executive and the Board for a proper evaluation of the Chief Executive's performance. A Board Chairman who is not a member of management can organize the activities of the Board and thus permit it to achieve some independence in judgment and policy-something which is essential if the Board is to develop its role properly.
The presence of insiders on the Board of Directors compromises the role of the Board. In no way can they fulfill the proper role of Board members. Their potential for contributing to corporate decision making has already been fulfilled before the decision is brought before the Board. No member of management should be on the Board except the Chief Executive. At most, such membership should be held to less than 20 percent of the total Board membership. Outside members of a Board should not have to vote as a solid block merely to express their views.
One of the important trends currently taking place in improving the effectiveness of the Board is in the development of committees of the Board. Committee action enables members to get closer to the problems of the corporation. The oversight role is expanded by the attention a subcommittee can give to a problem which is much greater than the attention that can be given it by the Board as a whole. By dividing up the responsibilities among the various members of the Board, the Board can discharge them without an inordinate amount of time for each member. Some degree of specialization can develop, with each director serving on subcommittees to which his own personal expertise relates.
The size of the Board should be given additional consideration. The Chief Executive must devote a substantial amount of time to Board matters and discussions with individual members if he is going to utilize the Board effectively. It is necessary for him to work a Board intensively if it is going to develop the expertise and degree of communication which is essential for good Board performance. However, each member of the Board increases substantially the workload on the Chief Executive Officer, and the difficulty of communications increases sharply with the additional members. Thus. it would appear that even in the larger companies, 10 outside members represents an optimum size. Less than that limits too much the skills that the Board can bring to the company. More than 10 increases the workload on the Chief Executive to a greater degree than the effective contribution that can be made by the additional Board member.
Finally, the internal working mechanisms of the Board must be in good order. The first step in doing that is to formulate a job description for the Board of Directors with a clear delineation of the working relationships between the management and the Board. Second, there must be an information system developed which clearly informs the Board as to the company's operating results and financial position and is presented in a form which can be readily digested. Third, this information must be distributed to the Board well in advance of its meeting, so that members have a chance to study it properly. Fourth, there must be sufficient time at the Board's meetings to explore thoroughly all subjects of concern. Presentations must be organized in such a way as to stimulate suggestions and comments from the Board members. The Chief Executive must be responsive to questioning and not defensive in his answers. He must actively seek the Board's counsel. Fifth, the Board must also be given adequate advance opportunity to study major policy decisions; and there should be repeated discussions, if neces. sary, to assure that the matters are completely understood long before a vote is required. There should be no surprises regarding major corporate policy matters and decisions.
It is the Chief Executive who determines whether the Board fulfills its role properly. He is the key. Unfortunately, it is the rare Chief Executive who delib