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Directors: step up to your responsibilities.

Governance and the Board

I was invited to become FMC Corp.'s chief executive officer in a very civilized manner. The chairman of the board's search committee invited me to dinner in San Francisco, and over drinks he broke the news. I was the board's choice for the top job.

My response rather startled the director. Instead of the usual, "I am honored by the board's confidence in me, etc." I replied flatly, "How do you know that I'm the man you want?"

No board member had asked me what I stood for, or what I would do as CEO. As it happened, I had a number of plans, most of which represented a significant break with the status quo. (For example, I intended to move corporate headquarters out of San Jose, home to FMC for almost a century.) The directors needed to know about these plans. They needed to accept them. They needed to give me authority to move forward decisively, without being routinely second-guessed. And they needed to hold me accountable for achieving what would now be mutually agreed-upon goals.

In recent years, and coincident with the emergence of an environment where corporate control is increasingly challenged, corporate boards have come under attack for inadequately monitoring management performance and protecting shareholder value. I think much of the criticism levelled against corporate managers and directors is deserved. But I am highly skeptical of proposals to "reform" corporate governance by mandating a legislative or regulatory overhaul of board procedures.

Some of the proposals that are being discussed include: * Requiring formal institutional investor representation on the board; * Giving major stockholders the power to sponsor their own proxies independent of board approval; * Creating two tiers of power and authority within boards, by giving outside directors specific additional powers; * Appointing a committee of shareholder representatives to review management performance; * Requiring major stockholders to participate in determining top management compensation; * Enabling courts to second-guess whether boards acted properly in turning down "strike suits" (in effect overturning the business judgment rule); * Requiring companies to separate the positions of chairman of the board and CEO; and * Imposing a special "fat cat" tax on executives compensated above a pre-determined level.

While the direct damage that these proposed "reforms" would inflict varies, they all have one important, and dangerous, element in common. They would all deprive -- and therefore relieve -- the board and the CEO of some of the responsibility they now have (at least in theory) to take decisive action to protect and enhance shareholder value.

In my view, these uninformed -- and in many cases unworkable -- "solutions" would be a move in precisely the wrong direction. As recent initiatives by the boards of General Motors and several other major corporations have demonstrated, directors already have very significant, if often latent, powers. The question that should be exercising would-be reformers of corporate governance is not "How can board powers be enhanced or circumscribed to promote stronger governance?" but rather "How can directors and top management be persuaded to wield the authority they already have more responsibly, more effectively, and more decisively?"

Fundamental Reality

Efforts to strengthen corporate governance must start by recognizing a fundamental, albeit circular, reality: Namely, a board will be as effective as top management, and specifically the CEO, wants it to be -- and top management will be as effective as a board insists that it be.

More specifically: * If a CEO wants strong board members, he will get them. * If a CEO wants the board involved, it will be. * If the CEO feels the board role includes tough-minded evaluation of his own performance, the board will oblige. * And if the board chooses, evaluates, and rewards a CEO on the basis of shareholders value, the directors will get a CEO who puts shareholder value first.

In other words, the fundamental challenges of corporate governance remain what they were more than 20 years ago, when I was invited to become chief executive of FMC Corp. These challenges are, first, to select an effective board and, second, to ensure that a board aggressively and effectively measures, monitors, shapes, and rewards top management performance against agreed-upon objectives.

In recent years there has been a positive trend toward smaller, less cumbersome boards with fewer "inside" members. Unfortunately, there has also been growing pressure to select outside directors for reasons that don't have much to do with effective corporate governance.

Selection Criteria

In my view there are four basic criteria for selecting outside directors.

First, they must accept that their primary responsibility is to increase shareholder value.

The board of directors is not elected to protect the interests of a variety of corporate constituencies, or stake holders. It is elected to represent the interests of shareholders.

Of course, directors can't ignore other stake holders. Any company that fails to deal honorably with its employees, customers, suppliers, and the communities in which it operates is going to pay the price in lower productivity, declining markets, greater regulation, and political interference. Any company that fails to protect the interests of its debt holders will have a hard time raising capital to pursue promising opportunities. Directors must understand that their sensitivity to the interests of other corporate stake holders will have a major impact on shareholder value. But they must also view the interests of these stake holders through the prism of shareholder value.

The rise in institutional ownership has generally reinforced the focus on shareholder value, as the concentrated power of large institutional investors has enabled them to force insensitive directors to address inadequate performance. Unfortunately, some institutional investors, in particular state government or labor union pension funds, have succumbed to political pressure and put other objectives before shareholder value. At FMC, for example, institutional investors have threatened to sell our stock if we did not oppose state tax limitation efforts or take other politically motivated actions, such as selling our holding in South Africa.

An important responsibility of today's CEOs is to understand the motivation of large pension fund managers, openly supporting their position when warranted but vigorously resisting those proposals that would have a negative impact on corporate performance.

Personal Fortitude

Second, outside directors must have independent minds and the personal fortitude to express dissenting views.

The biggest barrier to effective outside directorship has been the "old boy" network that dominates some boards, making it personally unpleasant for directors to question the performance of their peers -- and, often, their friend. A wave of takeovers and a few major liability judgments against directors have shaken this "get along and go along" attitude (sometimes, unfortunately, replacing it with a "play it safe and hand over the keys to the vault" attitude). Still, I think a reluctance to confront tough issues is the greatest failing of many corporate directors.

Third, directors should have high-level experience in their fields of endeavor.

This is important not only to ensure that directors can make substantive contributions, but also because experience and success command respect and promote independence and willingness to take forthright positions on difficult issues.

Finally, directors should offer corporate management a window on the world outside of the company.

The corporate governance debate has centered on the contention that management protects its prerogatives more vigorously than shareholder value. Without dismissing this genuine concern, I'd like to suggest an even greater danger that has received much less attention: management insularity.

In a dynamic, well-run company top managers are likely to have "grown up" in the business. They have an ingrained self-satisfaction with the company's products and its proprietary technologies -- and a fundamental suspicion of things "not invented here." In many American companies they are also focused too narrowly on domestic markets, and they have inadequately grasped the impact that political decisions made in foreign capitols, in Washington, and by state legislatures could have on the long-term viability of their businesses.

Expand Horizons

Outside directors should feel an obligation to help expand management's horizons. Directors whose careers have included distinguished public service can help identify domestic and international public policy trends that represent opportunities or threats to the company. Directors with technological expertise can help evaluate the company's existing technology base and the impact of emerging technologies. CEOs need to be much more aggressive in eliciting these outside perspectives and utilizing directors' expertise to enhance corporate value.

My emphasis on the CEO's responsibility is quite deliberate. While I've focused on the qualities of effective directors, in fact it is the CEO who is the real key to strong board governance.

It is the CEO, in most companies, who has -- and in my opinion should have -- the greatest impact on selection of directors. It is the CEO who sets the tone for board deliberations: by continually focusing (or failing to focus) on shareholder value; by initiating (or evading) frank discussion of problems; and by soliciting (or ignoring) external viewpoints that may challenge the company's comfortable modus operandi.

Therefore, choosing a CEO who understands these responsibilities and subsequently monitoring and rewarding his or her performance are the most important responsibilities of a board of directors.

Understand the Goals

When selecting a CEO, the board must press candidates to understand their goals and the relationship these goals bear to shareholder value. The board must also ensure that progress against these pre-established goals is rigorously measured and openly discussed, and it should be understood that performance will have a substantial impact on CEO compensation.

It is during the selection process that the board must first establish what they expect of a CEO and how they expect the CEO to involved and utilize the board. At the same time, the board should make it clear that the directors are prepared to replace the CEO if his or her performance repeatedly falls short of clearly delineated expectations.

This is a straightforward, and probably uncontroversial, description of the board's most fundamental responsibilities. It is not, however, a description of how most boards perform, or how most CEOs insist that their boards perform.

One issue generating widespread, increasingly vocal criticism is the compensation of corporation manager. While this criticism is often justified, it should be understood that the more serious critics of corporate compensation aren't nearly as disturbed about the size of compensation packages as they are about the highly uncertain relationship between pay and performance.

These critics have an excellent point. Unfortunately, the proposed legislative or regulatory solutions to the executive pay problem would not in my judgment either solve this problem or reinforce the board's existing responsibility to exercise good judgment and appropriate control over corporate compensation plans and practices.

Directors already have the authority -- which in my view they should exercise more rigorously -- to monitor top management compensation systems and to oversee compensation plans to ensure that CEOs are not disproportionately rewarded for performance that is only very indirectly based upon management contribution.

Appropriate Rewards

At the same time, when it comes to awarding options, performance share, or restrictive stock programs, directors have the responsibility to ensure that the value of awards at the time they are made is not unrealistically high and that shareholders are not subject to excess dilution as the result of such awards. If, however, these awards are appropriately granted, the compensation to executives based on stock appreciation -- which many times will be quite significant --should be recognized for what it is: a reflection of the increase in value. that benefits all shareholders.

I suspect that the preceding discussion has done little to placate the critics of corporate governance. Indeed, it may have reinforced their perception that CEOs (and former CEOs) uncritically defend the status quo and resist changes that challenge their prerogatives.

And that perception would be partly right. While I believe that directors and CEOs should be encouraged to exercise their considerable powers more forcefully, I am very skeptical of proposals to cede or even share these powers with institutional investors, or the Securities and Exchange Commission, or some other group of corporate "watchdogs." In my view, based on more than 20 years of experience as an inside and outside director and as CEO, such outside intervention invariably renders corporate decisionmaking slower, more cumbersome, and more political. Shareholder value can only suffer as a result.

Pace of Reform

Moreover, there is a real danger that these "reform" efforts will slow or halt the pace of genuine reform that is now starting to take place in American corporations. Boards are becoming less complacent and more active. CEOs are becoming more sensitive to shareholder's interests and concerns. Managers are focusing on shareholder value, and those who aren't are losing their jobs to successors who will. Companies are increasingly delivering value, and those that aren't are being subjected to the discipline of the market -- an institution both more efficient, and more relentless, than any overseer Congress or a shareholder watchdog could appoint.

Corporate governance could, and should, be strengthened. But before we erect a new regulatory superstructure, before institutional investors try to start running companies as well as investment funds, before we enact punitive tax penalties on "excessive" executive compensation, let's encourage -- and allow the market to continue to encourage -- corporate boards to use he significant power they already have more aggressively and more effectively.

In the end, a strong, mutually challenging, and mutually supportive relationship between a board and a CEO united in their pursuit of shareholder value cannot be imposed by legislative or regulatory or even institutional investor fiat. It can only be created by a CEO who selects and appropriately uses a strong board, and a board that selects and appropriately advises, challenges, evaluates, and rewards a strong CEO.

Board of Directors FMC Corp.

Robert N. Burt Chairman, President, and CEO FMC Corp.

William W. Boeschenstein Retired Chairman and CEO Owens-Corning Fiberglas Corp.

William B. Boyd Retired Chairman, President, and CEO American Standard Inc.

Larry D. Brady Executive Vice President FMC Corp.

B.A. Bridgewater Jr. Chairman, President, and CEO Brown Group Inc.

Paul L. Davies Jr. President Lakeside Corp.

Jean A. Francois-Poncet Member of the French Senate

Robert H. Malott Chairman of the Executive Committee; Retired Chairman and CEO FMC Corp.

Edward C. Meyer International Consultant and Former Chief of Staff United States Army

Wiliam J. Perry Chairman and CEO Technology Strategies and Alliances

William F. Reilly Chairman and CEO K-III holdings

Peter L. Scott Retired Chairman Black & Decker Corp.

James R. Thompson Former Governor of Illinois; Chairman of the Executive Committee Winston & Strawn
COPYRIGHT 1992 Directors and Boards
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Governance and the Board
Author:Malott, Robert H.
Publication:Directors & Boards
Article Type:Column
Date:Jun 22, 1992
Words:2398
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