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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 performance 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 tougb 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 sery. ing 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 discus. sions 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 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.
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 be very best leadership and evaluation processes be developed and refined.
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.
And of utmost importance, the Board member himself must insist that he be permitted to play his proper role. The Board member is increasingly accountable for his performance, 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.
QUESTIONS AND ANSWERS-AFTERNOON Q. Mr. Barr, what key types of information should be provided directors so they can adequately perform their jobs?
A. BARR. That, of course, goes right to the heart of why you have directors. Three companies I'm associated with have a letter from the President or a letter from the Chief Financial Officer which goes through the performance of the company, compares it with the prior year, and against the plan that's been established. Then the letter explains the variances between the prior year and planning. The letter also makes predictions for the balance of the year. This answers the basic questions: where the company is with relation to last year and with relation to planning, what is happening, what is being done about it, and what management sees coming up. In most large corporations, big capital budgets and capital expenditures are approved. Here one needs a close grasp of what the company is planning to do and should get into the question of capital budget, although in many instances big businesses get so technical that it's difficult to make a good input there. Of course, it is important to look closely at acquisitions.
Q. Mr. French, should the Chief Financial Officer be a member of the Board, or should be serve in an ex officio capacity ?
A. FRENCA. I see no reason for the Chief Financial Officer to be a member of the Board. Because he is part of the Chief Executive staff, he should participate in Board meetings whenever it's appropriate. But it's awfully hard for him to participate objectively in deliberations and decisions on matters which he is recommending to the Board.
Q. In your view, Mr. French, what it the director's responsibility to the employees of the company (as opposed to the shareholders)?
A. FRENCH. A company has a number of constituents—its shareholders, its employees, its customers, and so forth. Boards have an obligation to make sure that companies are run as good corporate citizens. No successful company is run long without good employee relations, a good employee benefit program, a good compensation package.
Q. Mr. Lewis, what do you feel is the minimum time commitment an outside director should be prepared to devote to the Board to fulfill his total responsibilities-apart from the regular meetings?
A. LEWIS. It depends upon the size and complexity of the company. There's no way to determine whether one should spend six hours, ten hours, or a day, but it is important to satisfy yourself that you have a keen knowledge and understanding of the business and performance of the executives. If you don't have that much time, you ought to get off the Board.
Q. Mr. Barr, what is the difference in function between a "professional director" and an independent consultant employed in problem areas?
A. BARR. There's a vast difference. A consultant reports to the management, whereas a "professional director" is more responsible to shareholders, represents broader constituents, and works in areas that are functions of outside directors.
Q. Realizing that an important function of the Board is to evaluate the performance of the CEO, Mr. Barr, what are your thoughts about the CEO giving a regular performance review of the directors ?
A. BARR. I think it's a good idea.
FRENCH. It's not done very often, but I think it's an excellent idea. Pillsbury has a committee where the Chief Executive gives an ongoing evaluation of the
Board's role as we do of his. As a matter of fact, that committee also evaluates what several of us are doing on other committees of the Board.
Q. Mr. Barr, how does one prevent direct lines of communication between second level executives and Board committees from becoming a forum for secondguessing management decisions ?
A. BARR. Let's take the audit area. Management lay down policies, accounting standards and procedures; and it's the duty of the audit committee to make sure that those policies are observed and obeyed throughout the company. While the audit committee gets down very low in the management of the company, it is effectively assuring that the management policy is implemented. The one place where Board committees might second-guess management is where people down the line think there's something seriously wrong ... that there is management fraud some place. In that instance, staff needs an avenue open for it to report what it knows and wants to correct without being disciplined.
Q. Mr. Lewis, you have a truly unique Board and your relationship must be quite different than those of other Chief Executive Officers. Would you comment on your relationship with your Board?
A. LEWIS. The U.S. Railway Association is a special planning agency set up to deal in a very complex subject that affects the economy, shippers and consumers, and local communities. Without a Board that was representative of these groups, it could not do an effective job. It has been a good Board, a working Board. Its members have taken their duties and responsibilities very seriously, and they know they are dealing with a complex situation. We have been lucky to be able to keep out conflicts among the members.
BARR. I serve on a public corporation called Student Loan Market. It's an organization formed by the Government, chartered by Congress, to create a secondary market for guaranteed student loans. This is my first experience with a Board on which constituents are represented like they are on Mr. Lewis' Board. It's one of the best Boards I've ever been on, even though the pay is low and it violates all the rules.
LEWIS. One difference betwen our Board and the average Board is that we also get paid a nominal figure, three hundred dollars a meeting, but our Board meetings have been starting at 8:30 in the morning and going until 6:00, and they've been two and three days long.
Q. Mr. French, where serious moral, legal or business judgment conflicts arise in CEO-Board relationships, the simple solution is for the individual director to resign. This solution, however, is an abdication of the responsibility of the Board member to the stockholder. What other practical solution is there?
A. FRENCH. The only real solution is for the directors to discuss the problem among themselves. Usually there's a committee which could do this.
Q. How much should professional directors be paid?
HARMAN. Myles Mace isn't here, but he said most directors are paid too much for what they do, and not enough for the responsibilities they carry.
Barr. I think it's wrong to compensate these men on a per diem basis; then you put them in the consultant category. I think they should be paid on an availability basis rather than a per diem basis.
LEWIS. It has to be some relationship to time. On an annual basis, you should be talking about compensation that would cause people who are quite senior and in business to be willing to go into the job. This would be talking about compensation that would run, if you were fully employed, well in excess of two-hundred thousand dollars.
HARMAN. It seems to me that a director who makes a contribution and who is experienced and as intelligent as the Chief Executive Officer ought to at least be paid the equivalent of the Chief Executive Officer on the day-to-day basis. So if the income of the Chief Executive Officer is roughly two hundred thousand dollars a year base, then why shouldn't the director be paid on the basis of two hundred days a year, a thousand dollars for the day.
BARR. I think that's high; I don't think I'm worth that much.
FRENCH. Well, it's not a subject on which one can generalize. Of course, it depends on the size of the company. But one of the most significant ways to signify to people the importance attached to their being a director is the amount offered. I'd be inclined to agree with Mr. Harman as to the amount.
Q. This question is addressed to the panel. Outside of on-the job experience, how can today's director prepare to do a more effective job in the future?
A. FRENCH. There is not any way to prepare to be a director per se. But in structuring the makeup of its Board, a corporation should think seriously about the kinds of experience and talents it needs in the directors. Then, when those directors get to know the company, they can apply their frames of reference. The value of their input comes from knowledge of the company and their experience rather than anything they have done specifically to learn how to be a director.
LEWIS. You must have a degree of experience in business that qualifies you to make business judgments. I think it's desirable to have a good, critical, analytical mind and to have had the kind of experience in business that enables that mind to work out problems. The selection process should find people who are qualified to be directors. The most important thing directors do is to have the guts, but the sensitivity too, to handle themselves correctly so they won't be rubber stamps.
At the same time they shouldn't be oddballs and create more disturbance than they provide help in solving problems. It's important for Board members to get their minds above the operating level and at the Board level of policy. There are many things they can do; foremost, they can read about what corporate policy should be at the highest level. They can and should spend considerable time on strategy.
[Whereupon, a 2:02 p.m. the committee adjourned, to reconvene at the call of the Chair.]