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'The governance system is sound.' (Chairman's Agenda: Balancing Shareholder Interests)

|The Governance System Is Sound'

A most visible and vocal spokesman among U.S. chief executives on corporate governance issues is H.B. Atwater Jr., Chairman and Chief Executive Officer of General Mills Inc. He has addressed in many forums over the past several years issues of management/shareholder relations arising from the increasing institutionalization of corporate ownership. He affirms with gusto the strengths of the present governance processes, but is also ready to recognize certain weaknesses within the system that can be improved. The observations in this article are drawn from his comments at a corporate governance workshop held at the Wharton School of Business, under the auspices of the school's SEI Center for Advanced Studies in Management.

On Innovation and Risk Taking: "American competitiveness and corporate performance are essentially the same thing. Competition is the central element of performance. To put it very simply, success is driven by being better - meaningfully better - than your competitors. Increasingly, timing is vitally important. For instance, in the food business, the company that first gets to the market with a new idea tends to get an index of sales of 100. The second player will tend to get 50, and the third player, if it even can get on the shelf, might be lucky to get an index of 25.

"It is not good enough to be third with an idea. You essentially have to be first with the idea and with the proper execution of it. To move rapidly and to innovate ahead of your competitors frequently means you have to act on incomplete information. You also have to recognize that you will have failures. If, in fact, every risk you took were 100% ensured of success, there would be no profit factor and no opportunity."

On the Corporate Governance |Tension': "The continual process of innovation and risk taking presents what I call the corporate governance |tension.' It is a tension between innovation and control. It exists at all levels of governance. If you look at the world economic scene, the contest between the centrally planned, control-oriented economies and the freer or more innovative economies has been won by the forces for innovation. In management, the command-and-control pyramidal hierarchy doesn't work anymore. Enablement, innovation, and risk taking throughout a corporation are absolutely central to success. Certain divisions tend to get a |let's not make any mistakes' attitude, while others are more risk-oriented. Almost without exception, the more innovative ones do well. To put it another way, if you absolutely intend to make no mistakes, that may be the biggest mistake you can make."

On What Is Good Corporate Governance: "I would argue that good long-term performance is, in fact, the measurement of good corporate governance. If a company has been performing well over the long term, I think it can be said that it has been governed appropriately. Unfortunately, issues of governance and performance are not meshed in an appropriate way at the moment. Some public pension funds attempt to measure governance as a separate issue from long-term economic performance. Their focus is on such elements as staggered boards, poison pills, cumulative voting, and confidential voting as measures of governance. In fact, some studies have indicated an inverse correlation between these so-called governance issues and performance. If you think about it, sound, long-term economic performance is, in fact, the best measurement of governance."

On Management Selection: "The first and most important function of the board is management selection. Boards have to select a CEO and regularly evaluate the CEO and his or her succession plan. And CEOs have to be replaced if they aren't performing. The conventional wisdom of the board as a passive lap dog of management is way off base. Boards are, in fact, routinely replacing non-performing CEOs. In doing some informal polling of my friends who sit on boards, I have found few who haven't been involved on a board that relieved a CEO."

On Management Compensation: "Boards must compensate the CEO and management with plans that link compensation to shareholder objectives. In this regard, I believe that the stock component is vital. At General Mills, we offer our officers the option of declining merit salary increases in return for additional stock options. More than 95% of them take us up on it.

Ownership is absolutely critical. Most General Mills executives have 75% or more of their net worth invested in the company. You can believe that they have a strong common interest with shareholders in seeing our stock appreciate in value. In my judgment, although the movement in this direction has been dramatic over the last 10 years, all American companies still have a fair way to go."

On Board Selection: "Many of the boards have a model as to the mix of directors they want, depending on what businesses they are in. For instance, if you're in the pharmaceuticals business, you want a director or directors with some medical background. You want a balance on the board. You also want a cohesive board. A so-called representative board, where you have individuals whose function is to represent certain groups, absolutely militates against risk taking and innovation. Clearly, to move fast and be innovative you have to have a cohesive board. Political governing bodies, which are representative, are not generally viewed as being either innovative or fast-moving."

On Board Oversight: "There is a belief that it is impossible for boards to properly monitor what is going on within the company because they don't have full information. The fact of the matter is, from security analyst reports, news reports, and, frankly, just asking the appropriate questions at board meetings, the information is available. A chairman gives directors misinformation at his absolute peril. Boards will put up with risk and they will put up with the failure of a properly taken risk, but I don't know of any board that will put up with not getting full and accurate information."

On Evaluating Board Processes and Performance: "This is not done formally or completely in many companies. I believe that much more attention has to be paid to this. I am advocating this to my compatriots, and, frankly, there is some resistance. At General Mills, once a year I meet with the board to review everything that has to do with our board meetings - how frequently the board meets, what subjects we discuss, what materials we get ahead of time, the length of time for discussion, the ability to raise new issues, and other matters. That works very well for us and in other boards where I see that done.

"However, when it comes to evaluating the individual director's performance, I would say that more could be done in this regard. This is not something that management should do. After all, management works for the board. On the other hand, the chairman of the nominating committee, or whoever would be the appropriate person or group to lead this review, is usually not enthusiastic about evaluating his or her peers. It is a problem."

On Communication Between Shareholders and Corporations: "Again, the conventional wisdom is that corporations don't talk to shareholders and that they don't want to talk to shareholders. That is just not true. Most corporate managements frequently talk to investors in all kinds of ways and in any number of different forums. Frankly, I enjoy doing it, and it is very much in the self-interest of the company to do this, for a number of reasons. First, uncertainty is the enemy of high stock prices. If investors don't understand and aren't comfortable with what you're doing, not only are you not going to find buying pressure on your stock, you might find selling pressure. Secondly, I find that if you explain your long-term strategy properly, especially if it involves investments for the future that suppress current earnings, and give your investors a series of check points so that they can understand the direction you are going, you will get strong support for your longer-term investments. I do not find investors taking affront because you are having some development expenses today that are going to result in something good in the future. When they do take affront is when you don't have the results you said you would have. Then you have problems.

"There is an additional reason why managements like to talk to shareholders. Investors and analysts who follow our industry obviously follow the other companies in the industry. While I follow the competition closely myself, I do from time to time learn things about competitors, or insights into the competition, through these contacts that I wouldn't otherwise find out. That's very useful. And in our company we try to make sure analysts see not only me but a number of other managers. That lets the investment community know that this isn't a one-person show and that there are other strong executives here."

On the Issue of |Access': "There is a public-private dichotomy on the subject. The private pension funds do not have problems with access nor do they feel that they can't see the management. They see management regularly, as much as they want to. On the other hand, the public pension funds say they can't talk to managements, that they don't know how to do this. Why is there this strange dichotomy? There are a couple of reasons. The public funds, in many cases, are creatures of state government. They have small staffs. They are in index funds. To follow each company in the index fund would seem redundant to them. Partially as a result, they tend to focus on what one of them called |the chlorine in the water,' that is, making sure companies don't have staggered boards or poison pills and that they do have cumulative voting and confidential voting. They somehow have equated these with performance. I have never been asked about poison pills by a private pension fund, but I am asked all the time by public pension funds. Corporations want to talk about their performance and not these kinds of things. The fact is, the personnel aren't there on the public side to talk to managements about performance the way they are on the private side. Somehow this gap has to be bridged."

On Accountability Forces: "Quite clearly, there are corporations that perform better than others. There are corporations that get into trouble. What does a shareholder do when there is trouble? Or, to approach it from another viewpoint, what are the accountability forces on a board of directors, because boards are clearly accountable to shareholders for long-term economic success. There are many.

"The first is product markets. If the company is not doing its job right, it will begin to lose market share. Another accountability pressure on boards is the financial markets, which reflect their opinion of the company's stock or other financial instruments rather quickly. If, for example, it looks like a company's technology is being overtaken, before it ever shows up on the bottom line you begin seeing negative security analyst reports and a sell-off in the stock.

"Then, of course, there are statutes and regulations and case law with regard to director liability. There are any number of suits against boards of directors that have resulted in fairly substantial liability against directors who have not done their job right. This is certainly something that sensible directors think about in pursuing their duties. And the final accountability pressure on boards is shareholder action."

On Shareholder Recourse: "Clearly, one recourse is to sell the stock. Selling is sometimes treated as a bad thing. Selling is a totally appropriate response under many circumstances. If the stock has hit a target, if you're worried that a stock is going to decline, one has an obligation to sell. Managements that are sensible understand quite well that their stock is going to be bought and sold over a period of years. Beyond selling, there are several steps of recourse that are important and that are not being followed to the degree that they could be within the current corporate governance structure.

"The first is to communicate with managements. Believe me, CEOs do listen, particularly if investors are unhappy with what you're doing. They will put it into their strategic consideration. They well understand that if they persist in a course that shareholders aren't comfortable with, that it is going to have an adverse effect on the company's stock. But as I noted, in the case of the public pension fund, there is precious little communication with management about performance. If the communication with management is inadequate, there should be communication with directors. We are just beginning to see this happen with the public pension funds. Personally, I think this is a good trend, and I suspect we will be seeing more of it. If those two steps do not work, there are shareholder resolutions. The final recourse is elections of alternative slates of directors.

"While some public pension funds have dismissed the latter as a feasible option, increasingly such elections are taking place and are succeeding. It may sound strange to be a corporate manager advocating that unhappy shareholders follow this recourse, but I believe if it is done where performance and communication are inadequate, it will have a salutary effect."

On the Future: "The corporate governance system in the United States is sound. Our competitiveness is improving. Our manufacturing sector is getting substantially stronger all the time. Boards are independent. They are replacing CEOs. They are increasingly tying compensation to performance. Boards are evolving in an appropriate way given the circumstances. Most corporations are well governed. We tend to focus on those that are not, and, quite clearly, there are some that are not, as there always will be. Where problems exist, there is appropriate and effective recourse."
COPYRIGHT 1991 Directors and Boards
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Author:Atwater, H. Bruce, Jr.
Publication:Directors & Boards
Date:Mar 22, 1991
Words:2304
Previous Article:Fighting the good fight.
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