The world of corporate governance sometimes resembles Alice in Wonderland, where what might look real is not. As we peer through the looking glass, we see actors taking potshots at a range of governance protocols—with accusations that at first seem appealing, but a closer look finds that many of these parties appear to be serving their own self-interests.
A few months ago, the director and a researcher at Stanford University’s Corporate Governance Research Initiative, issued a paper with the above title, confronting some of the more common “myths” surrounding corporate governance. Let’s take a look.
Myth: The CEO should not serve as chairman
Researchers: Over the last 10 years, S&P 500 companies received more than 300 shareholder proxy proposals mandating separation of the two roles, during which a combined chairman/CEO dropped from 71 percent to 35 percent. But the evidence doesn’t support the notion that separation is better. One study found no statistical relationship between the chairman’s independence status and operating performance, and another found no evidence that a change—either separation or combination—impacts future operating performance. A third found separation due to investor activism actually is detrimental to performance, where companies forced to make the change exhibited negative returns around the announcement date, and still poorer operating performance thereafter.
Analysis: There’s no doubt mandated separation of chairman and CEO makes little sense. I’ve long maintained that a board of directors is best positioned to make this determination based on the company’s circumstances and individuals involved.
While there are theoretical arguments for required separation, they’re muted by evolution in the boardroom, including that a preponderance of directors now is independent, and key committees—nominating, audit, compensation—are comprised entirely of independent directors. A lead director is a counterbalance to a chairman/CEO, and the independent directors regularly meet privately without management personnel present. And disclosures are required of the company’s leadership structure, including related rationale.
There are circumstances where separation might make sense, such as in the case of a newly promoted CEO, where a track record in the new role is useful before bestowing the chairman mantle as well. But boards should continue to be allowed to make this decision. For a fuller discussion of this subject, readers might want to refer to Governance, Risk Management, and Compliance, John Wiley & Sons, Chapter 17.
Myth: CEOs make the best directors
Researchers: CEOs often are considered to be the best directors, as their managerial knowledge allows them to contribute broadly to strategy, risk management, succession planning, performance measurement, and shareholder and stakeholder relations. Empirical evidence, however, is less positive. One study found no evidence that appointment of an outside CEO to a board positively contributes to operating performance, decision making, or monitoring, and another found active CEO-directors are associated with higher CEO compensation levels A third found that most corporate directors believe that active CEOs are too busy with their own companies to be effective board members, saying the CEOs often are unable to serve on time-consuming committees or to participate in meetings on short notice, and are too bossy, poor collaborators, and not good listeners.
While there are theoretical arguments for required separation, they’re muted by evolution in the boardroom, including that a preponderance of directors now is independent, and key committees—nominating, audit, compensation—are comprised entirely of independent directors.
Analysis: I’m not sure this is truly a myth. I’ve no doubt, based on significant experience with directors of large companies, that current or recently retired CEOs are well positioned to provide outstanding guidance in the boardroom. They bring a knowledge base and perspective that’s extraordinarily important in providing valued advice to management and monitoring its performance.
For active CEOs, however, the issue is becoming moot, as more corporate boards are insisting that their companies’ CEOs devote the vast majority if not all of their time to running the business, leaving little if any time and energy for other company boards. Some boards now limit such service to perhaps one other company board, so fewer active CEOs are available for board service.
Virtually every CEO with whom I’ve worked wants to see at least one other executive with CEO experience on their company’s board. And I don’t believe the major reason is to have directors who are sympathetic to higher pay packages. Rather, they want individuals who have walked in their shoes and know first-hand how to deal with the challenging issues they face. Other CEOs are best positioned to provide valued mentoring as well as experienced-based advice and counsel in dealing with the difficult challenges of running a business.
Certainly it makes little sense for a board to be composed of all or even mostly other company CEOs. But the reality is that boards generally are better off having at least one former CEO, or even an active one with sufficient time, to bring a desired experience base to the boardroom. Such individual(s) combined with directors with other relevant skill sets, with the right chemistry, together are best positioned to effectively carry out a board’s oversight responsibilities.
Myth: Interlocked directorships reduce governance quality
Researchers: An interlocked directorship—where an executive of Firm A sits on the board of Firm B while an executive of Firm B sits on the board of Firm A—is criticized as creating psychological reciprocity that compromises independence and weakens oversight. While some evidence suggests interlocking can create this effect, research also suggests interlocking can be positive, by creating a director network that can lead to increased information flow, where best practices in strategy, operations, and oversight are more efficiently transferred across companies. Networks also can serve as an important conduit for business relations, client and supplier referrals, talent sourcing, capital, and political connections. One study found that companies sharing network connections at the senior executive and director level have greater similarity in their investment policies and higher profitability. Another study found board connections between firms leads to higher value creation in mergers and acquisitions, and another found companies with a well-connected board have greater future operating performance and stock price returns than other companies.
Analysis: The term “interlocking directorship” brings memories of long ago, smacking of self-dealing and evil back-room activities designed to reap obscene profits or siphon corporate funds for executives’/directors’ gain. As such, the term is a loaded one, and seemingly difficult to justify. But leaving terminology aside, the idea of well-connected executives—active or retired—serving on corporate boards can serve a positive purpose. As noted by the researchers, networking does indeed lead to better communication of leading practices in strategy and operations, as well as promoting important business relationships and talent and capital sourcing.
As such, well-connected directors are a positive for many corporate boards.
More myths and what’s driving them
The researchers address other “myths,” which will be analyzed in this space in next month’s Compliance Week issue. And we’ll also look at the drivers for these accusations and their sometimes self-serving nature. (Interested readers may refer to the full paper, Seven Myths of Board of Directors, published in the “Stanford Closer Look Series,” Sept. 30, 2015.)