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Directors who deserve respect.

The evolution of institutional investors has fundamentally affected the dynamics of corporate governance in the United States. For a long time, corporate governance seemed to be thoroughly settled, to have no dynamic component. The theory was well known. The shareholders elect the board and the board appoints senior management. Accountability, in theory, runs in the opposite direction: Management is accountable to the board and the board is answerable to the shareholders.

But, we have all known for a long time that for public companies, that theory doesn't conform to the facts. For public companies, control of the proxy machinery, coupled with wide distribution of share ownership, meant that, in fact, management appointed the board, and shareholders more or less automatically blessed that selection.

Loyalty, in legal theory, runs from the director to the corporation and derivatively to the corporation's shareholders. In practice, however, except in extreme situations, the very human impulse of many outside directors has been to feel loyalty to the company's CEO, the leader in whose hands the future of the enterprise is seen as resting.

This disjunction between theory and reality was for a very long time not problematic. But things are changing. The waters of corporate governance have been roiled by the emergence of two great forces: the evolution of a global market and the growth of institutional investors.

These forces are dynamic. For good or ill, they will continue to exert transformative pressure on corporate governance structures. They will be -- indeed, are now -- pushing in the direction of greater efficiency and greater accountability. These forces will inevitably give rise to proposals for change, and the less successful we are seen as being in international economic competition, the more frequent and insistent those proposals will become.

Proposals for change may be modest or they may ultimately be radical. These proposals will, of course, be occasions for political and economic struggles. I want to suggest that before those fights occur, it would be prudent and responsible for the leadership of Corporate America to recognize the tectonic shift that has been, and is, occurring in our economy and to accommodate those changes in a responsible way, with due regard for the corporation's long-term wealth-creating mission in mind.

I suggest that the board of directors provides the correct place for appropriate corporate governance adaptation to the new realities to occur. It is the correct place for informed, sympathetic, but effective corporate monitoring. The most elementary and important adaptation that is necessary, it seems to me, is a redefinition, in the minds of those men and women who serve on corporate boards, of the legal and social requirements of the role of corporate director.

The conventional perception is that boards should select senior management, create incentive compensation schemes, and then step back and watch the organization prosper. In addition, board members should be available to act as advisers to the CEO when called upon and they should be prepared to act during a crisis -- an emergency succession problem, threatened insolvency, or a management buyout proposal, for example.

This view of the responsibilities of membership on the board of directors of a public company is, in my opinion, badly deficient. It ignores a most basic responsibility: the duty to monitor the performance of senior management in an informed way.

Outside directors should function as active monitors of corporate management, not just in crisis but continually; they should have an active role in the formulation of the long-term strategic, financial, and organizational goals of the corporation and should approve plans to achieve those goals; they should as well engage in the periodic review of short- and long-term performance according to plan and be prepared to press for correction when, in their judgment, there is need.

Active Monitoring

For outside directors to assume a more active role in corporate monitoring may require implementing changes of many kinds, but most basically of all it requires that outside directors understand that their duty requires more of them than simply acting as advisers and requires more than acting once a crisis has arisen. It requires that directors understand and assume the burden of active long-term monitoring.

Effective long-term monitoring requires more of outside directors than an appreciation of the scope of their responsibility. It requires a sympathetic and productive relationship between the outside board members and the CEO, and the acknowledgement by the CEO of the legitimacy of the monitoring role and its requisites.

More than this, effective sympathetic monitoring requires a commitment of time and resources, especially information, and sometimes independent advice. A few hours a quarter may satisfy the role of passive adviser in good times; it is not sufficient to meet the obligation to act as a monitor. The demands of the position, if properly understood, are inconsistent, in my opinion, with service on an impressively long list of boards.

Host of Innovations

There is a host of innovations or mechanisms that might be explored to develop a board that functions like a sympathetic, long-term owner, rather than as either a passive adviser or merely as a financial investor:

* A non-CEO board chairman (along the English model) may prove to be attractive to some companies, but not for others.

* A periodic meeting of the outside directors outside of the presence of the CEO might be helpful.

* Direct access to corporate information and personnel might be possible.

* Periodic, structured meetings between outside directors and large, long-term shareholders might prove productive.

* Board size might be reduced so that meetings implicitly invite participation and acceptance of responsibility.

I don't mention these possibilities as any endorsement of them but as examples of the sort of moderate adaptation that is possible.

In all, corporate governance -- including the way in which the board regularly functions and the processes through which it interacts with the corporation's senior management and with the corporation's long-term stockholders -- should be thought of as one source of possible competitive advantage, as one way to make the organization function more effectively. The corporation's own techniques and mechanisms of governance should themselves be the subject of explicit board discussion and review from time to time.

In declaiming upon the duties of outside directors to monitor the long-term performance of corporate management, I do not seek to promote adversarial boards. I understand that boards generally should be cooperative, collegial organs.

And I recognize that in the large multi-division firm even the most responsible of outside directors will only be able to address issues of the broadest general importance to the company. The nature of such an organization inescapably confers certain authority on senior management. The CEO's greater specific knowledge of the firm and its markets and his or her greater opportunity to consider subjects relating to the company's business will qualify his or her opinion or recommendation for substantial deference even from a director who conscientiously monitors long-term performance.

Too High a Price

What I cannot accept, however, is that it is proper or, over the range of companies, it is efficient to purchase collegiality on the board at the price of passivity. That price is too high.

But while responsible outside directors cannot be passive, their monitoring need not impair constructive collegiality on the board. Finding a way to make a contribution through informed, sympathetic monitoring of long-term performance, while minimizing friction, is part of the challenge of board service. The task requires management and human relations talent. But most organizational contributions do. There is as much art as science, I suppose, in constructive corporate monitoring.

When I consider the role of the corporate director in the context of global economic competition, I begin to see the role of the outside director as a private office imbued with a public responsibility. In most contexts, the director's responsibility runs in the first instance to the corporation as a wealth-producing organization. Promotion of the long-term, wealth-producing capacity of the enterprise inures ultimately to the benefit of the shareholders as the residual risk bearers of the firm, but it also benefits creditors, employees as a class, and the community generally.

Because I do see a director's role as imbued with some elements of a public or civic responsibility, I see the men and women who accept this responsibility, and who do it conscientiously and well, as performing a service to the whole community, to the nation. They deserve our respect. But men and women who as directors are passive, who view their role as mere advisers, who are pliable and pleasant, who do not insist upon a real monitor's role, do small service to anyone and deserve little respect.

I believe that for the most part, the men and the women who sit on the boards of our public companies want to do the right thing in that job. They want to deserve the respect of the communities from which they are drawn. If, in many cases, they don't monitor senior management very actively now, I suppose it is in substantial part because they don't understand that right conduct in this office does require more than serving as a corporate adviser. In many instances, they accept as correct a conception of their duty that is narrower than it should be.

A True Belief

Our recent experience seems to confirm my belief that if and when the men and women who sit on corporate boards come to truly believe that their duty -- not simply their legal duty but to a broader and more deeply felt civic duty -- demands that they act as active monitors of management's long-term performance, they will then begin to find ways to satisfy that obligation.

So, I make these observations in part to exhort those men and women who serve on the boards of our public corporations to understand and fully accept the burdens of their office, for all of our sakes. In doing so there is honor. But, in playing the comfortable role of genial adviser there is little honor; there may, ultimately, be dishonor.

The notion of honor and of an unenforceable but nonetheless real public duty may strike the reader as quaint, as a ghost of an earlier age. But I hold to another hope: that we have not yet forgotten the claims that duty can legitimately make upon us, for the benefit of strangers.

In this age of global competition, all of us will be affected directly and indirectly by how well our economy -- our people -- can perform in relation to other populations. Our rules of corporate governance will not alone constitute the decisive difference that determines the future state of our economy or the welfare of our people. We must succeed in many areas that are probably more critical than the form of our organization. But the rules of our organization are nevertheless vital, and the role of outside directors within those rules can -- if properly understood -- contribute to the long-term vitality of our economy and to the welfare of our people.

It is this potential, to contribute to the welfare of others, that offers the deepest rewards and is the real source of the burden placed upon those good enough to accept and to satisfy the obligations of this office.

William T. Allen is Chancellor of the Delaware Court of the Chancery. Established in 1792, the Delaware Court of Chancery is a non-jury trial court that in effect is the nation's only specialized court of corporation law. Mr. Allen assumed the duties of chief judge of the Court of Chancery in June 1985. During his tenure he has written more than 300 judicial opinions on a broad range of legal questions. Because of the special jurisdiction of the Court of Chancery, the fiduciary obligations of directors have been a frequent topic of these opinions.
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Title Annotation:Governance and the Board; corporate directors
Author:Allen, William T.
Publication:Directors & Boards
Article Type:Column
Date:Sep 22, 1992
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