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offs. He wrote it before the resulting board and management shakeups we are now witnessing—as examples, the firings at Gulf and the decision by Phillips Petroleum just last week to raise outsider membership to a majority of the board and increase the number of board committees. Drucker wrote of boards' inability to function before these events took place, but not before the great social upheavals of the late 'sixties. It is largely because of those upheavals that the current strong pressure for change in corporate accountability came about.

Those upheavals helped shatter the image of the large business corporation as a responsible public citizen. Rightly or wrongly, the corporation was, 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 preservation of a healthy physical environment. The corporation became the symbol of a comfortable and self-service Establishment-of an irresponsible Authority. In recent years, stockholder suits have become commonplace as some corporate officers and directors have made personal gain from insider 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, but the opposite often turned out to be the case; many other. wise sound American companies wound up with seriously impaired balance sheets and operating statements. The failures were those stunning ones we have witnessed in the early '70's, such as the Northeastern railroads, major banks, and, recently, the W. T. Grant Corporation,

These multiple ills have been sufficient to bring significantly increased government regulation-from the Securities and Exchange Commission, the Federal Trade Commission, and agencies enforcing health, safety and equal opportunity provisions, to name a few. It has brought significant court actions by stockholders holding directors responsible for the broadest reach of corporate performance.

Rod Hills has stated that one of the fundamental problems stemming from recent corporate misbehavior and the failure of performance among large organi. zations has been the undermining of public confidence in business. I concur in this belief and consider the implications for the continued independent conduct of business to be serious indeed.

The question for us today is, what were the boards of directors doing in the period leading up to the unfortunate events and developments I mentioned a moment ago? What the boards were doing, in Peter Drucker's estimate, was failing in their responsibilities.

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-again in Management—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.”

Everett Smith, a senior partner of McKinsey & Company, puts it another way: "In the long term, the corporate system as we know it depends for its existence on public confidence. If our corporations are not well run in the total sense of having good harmonization of all the interests involved, the public will not continue to believe that they are functioning in the general public interest. And if that day comes, the politicians will be only too ready to find a different way of handling things."

I urge that we not take the thoughts of Messrs. Smith and Drucker lightly. Their fears are well founded. The potential threat that society will force a basic change in composition of the boards of larger companies is closely akin to the pressure for the breakup of the big integrated oil companies. Public distrust is the underlying cause in each case.

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. I suspect that more individual members are doing their homework a little more assiduously. As Myles Mace says, the audit committees are actually beginning to function today, requiring hours of study and deliberation rather than the 15-20 minutes such meetings formerly took. But the improvement is modest at best.

I am frankly reminded more of a wave breaking on the shore of a lakerather like that which might be caused by a passing speed boat-than of a significant rise in the level of the water in the lake. We are responding, sort of on an ad hoc basis, to rather traumatic events. I don't think we are going to improve significantly the role played by the board until we institutionalize that role to a much greater degree than is the case today.

I feel that we must find ways for accelerating the improvement in board performance. One of the things corporate management can do to stimulate that improvement 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. We hare abundant training programs for all other elements of management but none, really, for the directors. Literature having to do with its role and conduct is sparse. We have developed the concept of the professional manager, but not a concept for the development of the professionalism of the director.

I used to be a member of the Young Presidents Organization, which was brought into being to help the young executive perform his role as president. Over a long period, it has done a good job of improving his effectiveness and professionalism. Why can't we have something which would have a similar goal of upgrading the concept and practices of the board as an institution, as well as the competency of the individual board members? Its primary purpose would be to help develop the individual skills of the director, institutionalize to a greater degree the role of the board and create a climate for interchange of experience and ideas which can be helpful in improving board performance. Keith Louden has broken ground with his concept of the development of the Corporate Directors' Institute. In Louden's view, the institute would be a clearing house for legal information. It would issue a regular newsletter, hold seminars, sponsor special research studies and issue pertinent books and other publications on the role of the director and the functioning of the board.

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 create an awareness that the performance of board members must be and will be enhanced.

The start-up costs of such an organization would not be large and could well he defrayed by five or 10 large corporations making whaterer contribution is needed. Perhaps some organizations such as the National Industrial Conference Board could sponsor it. After its start-up, there is no reason it could not be selfsustaining.

Also, I agree with Keith Louden and Joe Barr that corporations 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 he sensitive to those complex external forces which affect corporate performance. The professional director would also have the expertise and time available to effectively chair the tough committees—the audit committees, 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.

I would also like to raise a fundamental question as to whether the chief executive also should serve as chairman of the board, or whether it would be better to have an outsider serve as chairman, There has been a trend since World War II to combine the two positions, and I question the desirability of the trend. When the chief executive officer is the chairman, the board's 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 title of chairman of the board has been preempted by the chief executive officer, and it is a prestigious title. It also permits the creation of the title of president and chief operating officer, which is, perhaps, a desirable title in the larger company. So we won't turn back the clock on this upgrading of titles, but perhaps we can choose an alternative and have the chief executive officer carry the title of chairman of the corporation-thus permitting another, non-management person to fulfill the role of chairman of the board.

I think, too, that 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 the board members. Their potential for contributing to corporate decision-making has already been fulfilled before the decision is brought before the board. Thus, I personally do not believe any 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 subcommitttees to which his own personal expertise relates.

In discussing ways and means of making the board more effective, the size of the board should be given 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 additional members. Thus, I believe 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. Again, the size of the board is somewhat conditioned by whether the chief executive is also the board chairman.

And, lastly, 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 also must be given adequate advance opportunity to study major policy decisions, and there should be repeated discussions, if necessary, 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.

I cannot conclude this speech without reemphasizing the well known fact that 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 deliberately invites strong-minded men to serve on his board—who deliberately stimulates them to challenge him, to disagree with him, to make demands upon him. Yet only in this kind of atmosphere and with this type of relationship can the very best leadership and evaluation processes be developed and refined.

Too often the chief executive contemplating a stronger board thinks only in terms of consequences that might restrict him. But as I have indicated, the chief executive presiding over a weak board surrenders valuable assistance. He is working without an essential tool.

A strong board amplifies in many ways the ability of the chief executive to deal with the fundamental business problems which affect company results. The board's focus on corporate strategy, its interaction with the chief executive in performing its review role, the discipline that it encourages in corporate planning and decision making all work to strengthen the performance of the chief executive.

Again, I should not like to conclude this speech without specific emphasis on the need for the board member himself to insist that he be permitted to play his proper role. The board member is increasingly accountable for his perform. ance, and he should not be willing to serve on the board of a company whose chief executive does not encourage his full participation in proper board duties.

In any case, these discussions on just how boards shall respond to the call for greater accountability are vitally important. I know that we are all anxious to see them continue, realizing as we do that the ultimate success of our business enterprise system rests largely on the degree to which public confidence is maintained in our larger corporate organizations.

STATEMENT OF LEWIS D. GILBERT

As a shareholder and spokesman, as a public duty, without compensation, for so many other small stockholders at annual meetings, at their request, I wish to take sharp issue with the statement of the Chairman of the Securities and Exchange Commission. Mr. Roderick Hills stated before your committee that we do not need some form of Federal Incorporation of publicly owned corporations.

The reason is a simple one. The present laws set up by Congress, governing the Securities and Exchange Commission consist of mere full disclosure provisions where shareholder rights are basically concerned.

The reasons have been brought out so forcefully by the recent monumental study, “The Case for the Federal Chartering" by Ralph Nader, Mark Green and Joel Seligman. The various state laws do not give adequate protection to the public shareholders, since as it pointed out, especially in Delaware, they are management, not shareholder oriented.

As a result of ESOPS and modified ESOPS we are going to have more public shareholders in the years ahead than ever before. The need for fair representation of all segments of ownership, including consumer and employee representation can be achieved with the right of cumulative voting being made mandatory by Federal legislation, exactly as was done with Comsat when the Communications Satellite Act was enacted.

It may be asked therefor why we do not have more elections of independent directors where we already have the right? The answer is again a simple one, the high cost of proxy solicitation. Therefore the proxy rules of the SEC must be improved to this effect. Here however, we do not need Congressional action, the SEO already has been entrusted with that obligation, what is missing is their setting up the mechanism for fair, just and equitable use of the proxy mechanism where independent nominations for directors are concerned.

What Congress should be asking the Commission is why this has not yet been formulated, as both the writer and Professor Donald Schwartz of Georgetown Law School and himself a former member of the SEC staff have long advocated.

The SEC should be setting up the proxy rules in such a way that when shareholders with ownership of a minimum percentage shares request the company to carry the nomination in an official proxy statement, which it may be pointed out is paid for out of the Corporation treasury and not by management, they will be able to do so.

Owners would then have the right to say why the nomination is to be made in 200 words and if cumulative voting is made mandatory and enough corporate voters wish it, it will not be an exercise in futility.

I have purposely left blank what the minimum number should be as this should be established by the SEC after public hearings on the subject. And here I would also like to incorporate into the record the comments recently made by the Wisconsin State Commissioner of Corporations, Jeffrey B. Bartell with whose viewpoint I am in complete accord.

[From the Milwaukee, Wis. Journal, May 28, 1976]

BARTELL SPEAKS OUT ON PROTECTING STOCKHOLDERS' RIGHTS

(By Mark Ashley) Arrogant managements are trampling the rights of far too many stockholders, according to Jeffrey B. Bartell, state commissioner of securities.

Bartell told the Milwaukee Chapter of the National Investor Relations Institute Thursday at a luncheon meeting in the John Ernst Cafe that corporate executives too often treat shareholders like second class citizens.

If the trend continues, he warned, drastic changes can be expected.

For one thing, disillusioned stockholders will pull out, leaving a void in the capital formation of nuinerous companies, he predicted.

CRACKDOWNS LIKELY

For another, he said, regulatory agencies such as the office he supervises will step in with corrective measures.

If corporations fail to meet their obligations to investors, he continued, business and industry, so integral to the growth of the nation in its first 200 years, will take a position of diminishing importance during the next 100.

Bartell cited the corporate takeover threat as an example of how managements, in their desperate efforts to hold on to their jobs, have shunted shareholders aside like so many meddlesome children.

He singled out Fort Howard Paper Co. of Green Bay for its recent action aimed at preventing a takeover.

MANAGEMENT ENTRENCHED

Fort Howard Paper changed its bylaws in such a way that an aggressor would be unable to gain effective control without the support of 80 percent of the outstanding stock, he noted.

Granted that the action was approved by the shareholders themselves, he said, the firm nevertheless has prevented shareholders from making a choice on who should run the company.

“What has happened is that the corporation has locked in the incumbent management and thrown away the key,” he said.

“It has, in effect, told its shareholders they cannot be trusted to make appropriate decisions concerning the most basic of corporate affairs—who will manage."

WOULD REJECT OFFERINGS

Bartell said that in view of the Green Bay company's restrictive action, he doubted that his office would permit the registration of new Fort Howard stock for sale in Wisconsin.

It would be unfair to a buyer, he said, since voting rights in the company's affairs have been so heavily restricted.

Bartell also urged greater candor on the part of corporate executives. He said stockholders deserve information about company operations if they are to make responsible decisions.

When a firm takes steps to reduce corporate democracy and disclosures, entrench the management (whether it's good or bad) and increase the changes for action not in the stockholders' best interests, he said, “I think we should all become concerned."

He added that if trends in those directions continue to spread, “the corporation of the future might well turn out to be something to disdain and distrust."

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