Evaluating the board: the next dimension.
Governance is about accountability and control. For more than two decades, the debate has centered largely on the CEO. A system short of outright firing for cause was needed as a way to correct course. But what about boards? Who watches the watchers? In a recent Korn/Ferry International study of 1,000 directors and chairmen of the Fortune 500 industrial and service companies, three-fourths report that the CEOs of their companies receive a formal annual evaluation, usually by a board committee. Only one-fourth say the board's performance is formally reviewed. A 1993 Heidrick Partners survey of Fortune 1,000 companies revealed that 91 percent of CEOs say directors should know how they measure up, but the same group also showed that CEOs were reluctant to discuss shortcomings with ineffective or marginally effective directors. Just 13 percent of those responding say they had director evaluation programs.
In a lively - at times, contentious - roundtable session, participants note that this is changing quickly, as performance criteria and execution continue to evolve. GM's governance guidelines, which have become a benchmark for others, require the board to make an annual self-assessment. Others claim that only disinterested parties can certify a board's performance. Governance watchers Marty Lipton and Ira Millstein think the lead director should direct the evaluation. CE roundtable participants reckon that self-assessment - either by the entire board or by a committee of the board - is the way to do it. In the following discussion, Texaco Chairman and Chief Excecutive Al DeCrane describes an evaluation process covering nine areas of board responsibility that involves both committee evaluations and one-on-one sessions with the CEO.
Weeding out ineffective directors isn't so easy - unless you're Scott Paper's Al Dunlap. Seven of Scott Paper's 13 directors were fired, oops, did not seek re-election. A Conference Board/Booz Allen survey last year had similar findings about evaluation. It reported that removal of directors remains rare - only 13 incidents were cited among the 546 companies surveyed.
Dunlap, never shy about expressing opinion, sparks a separate controversy over director compensation. Directors should be paid only in stock, he says, no exceptions, while board terms should be limited to one year. If directors don't measure up, they should get the boot, no excuses. Others disagree. On this point, participants mirror the responses to the Korn/Ferry study, in which only 11 percent say directors should be paid totally in stock with 89 percent opposed. However, 89 percent also say directors should be paid partially in stock. (Sixty-two percent of all outside directors are, in fact, compensated with some form of company stock, or combination of stock options and grants.)
Will evaluating the board make a better board? Yes, say participants. Will companies that practice good governance hygiene outperform companies that don't? Not necessarily, they say, although tying compensation to company performance should help. This relationship is worth benchmarking in the future.
THE EVOLUTION OF EVALUATION
J. Michael Cook (Deloitte & Touche LLP): Corporate governance is being written about and talked about everywhere today. The burning questions are: How do we pay CEOs and boards, and how do we evaluate them? There is great willingness to evaluate the performance of a board as a whole; but far less to evaluate the performance of individual directors. While liability considerations may be a factor, I believe companies feel it's tough enough to get good directors without evaluating them on an individual basis, especially if those assessments are made available to shareholders. This leads to questions of who should do the evaluation and how? What are the appropriate criteria? Sometimes the collective board's effectiveness is measured by the effectiveness of the CEO and that of the company. If the company is performing, does that mean the board is doing a good job, or simply that the board is in the right place at the right time? Either way, if boards are assessed, companies must decide what to do when individual directors - or the board as a whole - are found lacking.
Alfred C. DeCrane Jr. (Texaco): Three years ago, we began to evaluate annually our 13-member board based on its nine areas of responsibility. We arrived at these areas with help from counsel, and then our corporate secretary went back through the minutes of the last three years' board meetings to ensure we didn't forget any particular procedures or duties the board carries out.
Since many boards now act through committees, I also ask each committee to review itself against certain benchmarks. These benchmarks include the scope of its assignment, the time allowed, the information provided to members before meetings, and so on. I feel that helps the directors on that committee apply the same standards to board evaluation.
J.P. Donlon (CE): Al, do you spend time with individual directors?
DeCrane: Every year, I meet one-on-one with each board member. This allows freedom of expression, so any member can say, "I wish we had more of this," or "I wish 'X' didn't talk so much." We also have something that many other companies do not: a formal board committee of nonmanagement directors. It comprises everybody except me and the vice chairman. That committee has a chairman, so any director who has a complaint about me and doesn't want to eyeball me in that one-on-one meeting has a forum to go and hide behind the committee chairman. That committee meets at least twice a year, because it also deals with compensation for inside directors and key employees. The compensation committee does preliminary work on our compensation, but the committee of nonmanagement directors approves it.
Walter R. Young Jr. (Champion Enterprises): We've been doing board evaluation for four years. Originally, we simply measured against six functions. The board requested a more detailed evaluation, so we now have a three-page questionnaire. This year, we're evaluating separate committees and individuals. These annual assessments help us identify problems and set priorities.
Terry Savage (Director, McDonald's; Broadway Stores): How would a company structure a process for board self-evaluation if it had never done it?
Nell Minow (LENS): First, you have to create a committee to agree on the goals for each director and the board as a whole, and run that by the entire board. Then, a member of that committee should ask each director privately, "How do you think this director did? How do you think that director did?" and then report on that. It's equally important to evaluate the CEO separately if he's also the chairman.
DeCrane: If boards get in the habit of benchmarking - however they construct it - they can move much more rapidly. They will know where the weak points are, what their responsibilities are, and who on the board is not acting in good faith.
HERE TODAY, GONE TOMORROW
Cook: What happens when board evaluations reveal director underperformance?
Albert J. Dunlap (Scott Paper): Get rid of them. Boards can oust an ineffective CEO and management; what divine right does the director have to go on ad infinitum? I got rid of seven out of 13 directors last year.
Savage: Got rid of them? How?
Minow: Yeah, how did you do that?
Savage: Did you decide it? Yourself?
Minow: That's the problem.
Dunlap: No, no, no. One director was late or left early 23 times and missed seven meetings in two years. Other people resisted every situation brought forward. Others contributed immeasurably to the management debacle that caused revenues and the stock price to plummet. Only a strong CEO has the confidence to eliminate bad directors. If you have a whole bad board, run another slate and whack them all out. None of them deserves to be there.
Savage: But they're elected for a certain term. Were some of these directors let go before their terms expired?
Dunlap: Yes. The company was grossly underperforming. These seven directors were part and parcel of the problem. I spoke to them about what was wrong and why they shouldn't be directors; I enlisted the good directors to help me implement this process. Today, we have nine members on a reconstituted board.
Minow: In most situations, I would not be happy with the CEO saying, "I didn't like half my board, and I got rid of them."
Dunlap: It was not a unilateral, "I don't like you, you're gone." We needed directors with different types of skills. The good directors understood this. We had to make sure we had a majority who were going to vote for the dismissals. Was this news well-received by everyone? Of course not. We said, "There are two ways we can do this: Either we deal with it very nicely, or we make it a public issue. You wouldn't like that."
Russell Banks (Grow Group): I find it's difficult to evaluate by checking off boxes as to whether someone is a contributing board member. Other members are sensitive to the individual directors who are not performing to the benefit of the company. The delicate way to handle underperforming board members is to make sure they're not renominated at the end of their terms.
Dunlap: We couldn't wait that long. The company needed to be turned around immediately. Some of them refused to accept it. Why? Directors are a protected species: They do not want to turn crown the perks and goodies associated with being a director. The solution is a one-year term limit. Then, every year, the shareholder has the opportunity to nominate a board member or not. Maybe then you wouldn't have had the Graces, the Morrison Knudsens, or 40 other companies I could name.
John M. Nash (National Association of Corporate Directors): Historically, boards of directors pledged their loyalty to the CEO who gave them the board seat, instead of to the shareholders. That's starting to change now, because boards of directors are being held accountable by shareholders, particularly institutional shareholders.
Dunlap: Yes, it's a great secret: Shareholders own the company.
Banks: The way you handled underperforming directors clearly reflects your own circumstances. You said, "I have a lousy situation, and I'm going to clean house." But while we can all name 10 or 15 boards that have not lived up to their obligations, there are 10,000 public companies in this world, and a hell of a lot of them are conducting themselves well, and their directors are accountable to the shareholders and employees of the company.
James P. Heffernan (Herman's Sporting Goods): I have the dubious distinction of sitting on one of those boards whose performance has been woefully inadequate: Columbia Gas. After the debacle there, we formed a corporate-governance committee, but I ran into an ironic situation. We couldn't remove a director, because the bylaws said that shareholders elected them, so only shareholders could remove them. As part of our overall restructuring, we told the institutional shareholder community we'd like to change our bylaws so that any director could be removed by a majority of the board. We ran into a stone wall. The institutional shareholder community would not allow us to do that.
Minow: I'm sure you are aware of the abuses they feared from making that bylaw change. But all directors should be elected annually, and a credible nominating process is absolutely crucial. Without the cooperation of the nominating committee, board evaluation is nice to decorate the walls with, but it's meaningless.
Jon Lukomnik (New York City Comptroller's Office): I'll give you another example. A company was underperforming for seven years. Finally the board fired the CEO and hired a new one. Five directors who were there through the company's secular decline got more in fees than anyone else because, of course, after causing the crisis and firing the CEO, they had to meet a lot to hire a new CEO. Meanwhile, nothing changed under the new CEO. The shareholders wrote a letter to the company and sent it to every director. We received a lovely four-page reply from the head of the nominating committee, who was actually one of the five we identified, explaining that yes, the board had the skills to transform the company, but they were looking to add directors to get other skills. Now what do we do?
Heffernan: Execute innocent people to get the one guilty one. If the company has been underperforming for seven years, they're all guilty. They all ought to go.
Donlon: Should you share board evaluations with shareholders?
Lukomnik: Yes. CEO evaluations are public to the board, because he's accountable to the board. To whom are the directors accountable? Theoretically, shareholders elect them. But how can we elect them if we have no data on which to cast a "no" vote or a "yes" vote? If we shouldn't know whether they're doing a good job or not, why do we go through the charade? Why not just have the CEO appoint them?
Minow: I do not think evaluations should be made available to the shareholders or anybody outside the company. It would provide the basis for too many shareholder lawsuits.
William E. Mayer (CE/University of Maryland Business School): I, too, shudder to think of the lawsuits that would come out of making evaluations public. It would be totally counterproductive. As a matter of form, it might be terrific; as a matter of substance, you probably would end up using your nominating committee more effectively.
Young: To make either individual or collective board performance appraisals public takes them out of context. Board evaluations are meant to be constructive and get results. They are an interim step to setting priorities.
Heidi A. Nauleau (The Aarque Cos.): Public disclosure of individual director or board evaluations might make people even more skittish about joining your board.
Donlon: What's right with the current system?
Minow: I have found that 98 percent of the time, directors are good people, with the ability, desire, and expertise to do the right thing. They just don't do it promptly enough. It's the firemen's school: They sit there until the bell rings and then go put out the fire. But directors are there to prevent crisis. They are reluctant to act until crisis time - or even later - because they don't want to alienate the CEO who brought them on board. Directors need to be active rather than reactive.
Heffernan: The impact that a board of directors has on either the success or the failure of a corporation is overblown. It's all about management and markets, and the board has precious little to do with that, other than hiring a good CEO.
Donlon: So they should all go home after they hire the CEO?
Heffernan: No, but they have little impact after that. There's a current fascination among directors and shareholder activists that board members should be involved in setting the company's strategic plans. That's just absurd. How can a bunch of part-timers who come in 12 days a year make important strategic decisions?
Minow: I think boards make a difference. The difference between Compaq and IBM is that Compaq had Ben Rosen, who turned the company around really fast when it started to slip, and IBM had a lot of directors who had never looked at a computer before.
Fred N. Pratt Jr. (Boston Financial): I think in our case our board does make a difference. But it's important for each director to be pointed in the same direction, and board evaluations can go a long way toward that.
Donlon: Should every publicly traded company in the U.S. pay its directors only in stock?
Minow: Yes, because it's not these people's full-time jobs. It requires approximately two weeks a year.
Dunlap: Directors need an incentive to make an impact on the company. We pay our directors 100 percent in stock - no retainers, benefits, pensions, committee fees, or donations to charity. It's obscene for a director to have a token 100 shares and a $20,000 retainer fee when shareholders are losing money. If directors don't believe in the corporation, they shouldn't be on the board. Paying them 100 percent in stock puts them on the same basis as the shareholder and provides motivation.
Banks: Al, you can't make fiat statements about paying directors 100 percent in stock without qualification. Each director has the right to do what he thinks is right for himself and the stockholders. Many directors deserve a fee. One of the best directors we have only owns 100 shares of stock. When it came time for him to exercise his options, he put it into his pension plan. I got annoyed with him, but that's his prerogative. I find that he is a good, learned director, a life trustee of MIT. It comes down to individual morals and integrity.
Dunlap: If you're a director, it's assumed you have integrity and high morals. That goes without saying, and it's self-serving.
Banks: I don't agree with that at all.
Dunlap: [Eyes rolling.] Come on! If you don't have integrity, why doesn't someone kick you off? Give me a break!
Frank N. Liguori (Olsten Corp.): I applaud the concept of utilizing stock payment; we do that in our company, but we do a combination. Putting the directors in the same position as the stockholders is on target, but I don't think it has to be all or nothing. Sometimes directors are called upon to go way beyond what they originally signed up to do.
Alfred F. Fasola Jr. (Herman's Sporting Goods): That's true. For instance, what if you're in the middle of an acquisition, and you need a director's time for two days. Do you pay that person a per diem?
Dunlap: You pay their expenses to get to the meeting. Period. When you start paying directors ancillary fees, you've defeated the whole purpose. If you need them as a resource, they should be readily available with no ancillary fee whatsoever.
Minow: There are occasions, such as those involving a search committee or an acquisition, in which the director puts in a lot of extra time, and I support payment under those circumstances. However, from a shareholder point of view, I agree with Al that there's no better way to ensure board performance than aligning director pay with company results.
Jack Rosen (Continental Health Affiliates): But companies have boards to provide flexibility and different points of view. When you give directors equity, they often change the way they make decisions and how they assist the CEO in making his.
Donlon: Do you buy what Al says, that one should compensate them only with stock to change their behavior?
Rosen: No. Your goal is to bring in board members who are astute and mature, and let them judge their own behavior.
Barbara Franklin (Barbara Franklin Enterprises): Besides that, if you only pay 100 percent in equity, you restrict your board to people who are independently wealthy. You're leaving out academics, folks in nonprofit companies, and small-business people. That inflexibility doesn't make sense. I'd like to see a substantial portion of the fees paid in stock, but I don't think being overly rigid is in anybody's best interest.
Dunlap: Your argument about only having rich people on the board is an absolute, abject red herring. People serving on boards have other compensation, and if you have shares and believe in the company, guess what? That's going to be the best investment you could get. That's a red herring argument. It doesn't hold up.
Franklin: I'll have you know, Mr. Dunlap, I'm no red herring.
Liguori: Let's go further. Say I'm on your board and you've given me some stock. For whatever reasons - personal or otherwise - I want to sell the stock. Let's say I have three kids in college. I want to buy a home. How do you view me?
Dunlap: I view you unfavorably. They have this new thing. It's called a bank. You can go to the bank, and you can borrow on your stock. Your argument is just like every CEO who sells his stock, saying, "I have to pay for my ancient grandmother Who's going into a home."
Liguori: There's the problem: There are legitimate reasons for selling the stock.
Dunlap: I respectfully, vigorously disagree. Kenneth J. Gorman (Atlantic Mutual Insurance): Is there a correlation between paying in stock and the success of the company?
Minow: The one corporate governance element that does correlate with superior performance - in every study, ever - is director stock ownership. Not whether they're paid in stock, just how much they actually own. There's a wonderful, true story about a guy who's on a board where every director had more than $1 million in the company. And he said, you never saw the pocket calculators come out so fast.
Cook: Can you align shareholders' interests with directors' interests in ways other than with stock ownership? How about through cash compensation earnings indexed to company performance? For example, if earnings were up 200 percent in one year, directors would get paid 200 percent in cash of what they got paid the year before. If a director's fee is $80,000 a year, and the stock price goes down 10 percent, he gets $72,000.
Lukomnik: But every study shows it's the downside risk that motivates. If you own stock, your net personal value went down. The downside risk of real stock ownership motivates more than the upside potential of cash.
Donlon: Do evaluations make a difference? How do we know? What are the outcomes?
Nash: Evaluations dramatically change how boards perform. When the chairman of the nominating committee tells you how you're viewed by your peers, you start doing your homework. But few companies have a job description for directors or charters for committees. Does each director understand what his duties are when he serves on committees? Once those processes are monitored, it's easy to determine how a director is performing.
DeCrane: One of the board's responsibilities is to pick the CEO and motivate him.
Minow: And get out of his way when he's doing the right thing.
Nash: That's right. Build a bridge of trust between the CEO and the board. I don't want to be a policeman. I don't want to have to monitor. I want to help that CEO be effective, to make a good company.
Donlon: Based on today's discussion, what are the issues facing corporate governance? Will you change your behavior either as CEO or director?
Robert W. Lear (CE/Columbia Business School): There's no easy road to corporate governance. Everyone's trying to find a simple, easy approach to it, but there isn't one. It's a long, sluggish process that takes organization, a team of the right people, and years of practice.
Arnold B. Pollard (CE): Communication about corporate governance is now high, and that's a sign that we're in the home stretch as far as it being a real issue. We've come a long way toward tying company performance to management tenure: If the company's going downhill, directors know they will be scrutinized. It's quite different than it was 20 years ago.
Franklin: One of the things that's confounded me is that you can look at a board and, person for person, you have really good people there, but the board doesn't work. Why? Because the board isn't cohesive as a group, and it needs that to be effective. Al has a solution at Texaco.
DeCrane: Chapter 11 is a little severe. [Laughter.]
Franklin: That wasn't what I had in mind.
DeCrane: But it brings everybody together.
Franklin: True, a crisis often triggers unity. But you need to have that working relationship in place before you have a crisis.
Cook: I agree that good people don't necessarily make a good board. But you can't have a good board without good people. My concern is that we don't create unreasonable expectations and demands, because the people who are going to make good directors have many options for how they spend their time.
John P. Margaritis (Ogilvy Adams & Rinehart): I find too often that my clients want to attract a name, a star, to the board. I think instead what they should focus on is what talents and skills need to be added to the board.
Daniel J. Altobello (Caterair International): A board without objectives is like a ship wandering at sea without a rudder. It's imperative to set objectives and evaluate.
Nash: If you have a strong CEO and a weak board, you get nowhere. If you have a strong board and a weak CEO, you get nowhere. Only when both are strong and willing to do the job, do you get somewhere.
RELATED ARTICLE: A WHO'S WHO OF ROUNDTABLE PARTICIPANTS
Daniel J. Altobello is chairman, president, and CEO of Bethesda, MD-based Caterair International, a $402 million airline catering company.
Russell Banks was president and CEO of the Grow Group, a $500 million specialty coatings, paints, and household products company based in New York prior to the company's June 1995 acquisition by Imperial Chemical Industries. Banks is currently an ICI consultant.
J. Michael Cook is chairman and CEO of Deloitte & Touche LLP, a Wilton, CT-based, $2.2 billion accounting, auditing, tax, and management consulting firm.
Alfred C. DeCrane Jr. is chairman and CEO of White Plains, NY-based Texaco, a $33 billion International, integrated oil company.
Albert J. Dunlap is chairman and CEO of Philadelphia-based Scott Paper, a $4.5 billion consumer and commercial tissue products company.
Alfred F. Fasola Jr. is CEO of Carteret, NJ-based Herman's Sporting Goods, a privately held sporting goods retailer.
Barbara Hackman Franklin is president and CEO of Barbara Franklin Enterprises, a Washington, DC-based consulting and investment firm; she is also former U.S. Secretary of Commerce.
Kenneth J. Gorman is chairman and CEO of $650 million Atlantic Mutual Insurance, a New York-based property and casualty insurance company.
James P. Heffernan is chairman of Herman's Sporting Goods.
Robert W. Lear is former CEO of F.&M. Schaefer and current executive-in-residence at Columbia Graduate School of Business.
Frank N. Liguori is chairman and CEO of Melville, NY-based Olsten Corp., a $2.3 billion provider of home health care and temporary staffing services.
Jon Lukomnik is deputy comptroller of pensions for New York City, overseeing $50 billion in pension funds and $2 billion in short-term investments.
John P. Margaritis is president and CEO of New York-based Ogilvy Adams & Rinehart, a $39 million international public relations consulting firm.
William E. Mayer is dean of the College of Business and Management at the University of Maryland in College Park, MD, and chairman of CE.
Nell Minow is principal of Washington, DC-based LENS, a relationship investor and adviser.
John M. Nash is president of the National Association of Corporate Directors, a corporate-governance trade group.
Heidi A. Nauleau is president of The Aarque Cos., a $350 million management and investment group in Jamestown, NY, that provides management services for privately held businesses, principally in the steel-processing industry.
Fred N. Pratt Jr. is chairman and CEO of Boston Financial, a $31 million real-estate investment company with $5 billion in assets under management.
Jack Rosen is chairman of Englewood Cliffs, NJ-based Continental Health Affiliates, a $70 million health-care services company.
Terry Savage is a Chicago-based financial adviser and author of books on money management. She is a director on the boards of McDonald's and the Broadway Stores.
Walter R. Young Jr. is chairman, president, and CEO of Auburn Hills, MI-based Champion Enterprises, a $615.7 million manufacturer of pre-fabricated homes and buses.
RELATED ARTICLE: GUIDELINES FOR GOVERNANCE: THE NACD REPORT
Good corporate governance hinges on evaluating the performance of the collective board and individual directors, experts agree, but on what criteria should they be evaluated and how are these criteria measured? Board evaluation is sorely needed: Only 26 percent of boards are evaluated regularly, according to a recent Korn/Ferry survey of directors. More telling, perhaps, is that only 18 percent of respondents reported that a director had resigned or not sought re-election after the board found him or her ineffective.
In a report issued last year, a National Association of Corporate Directors Blue Ribbon Commission on Corporate Governance identified key guidelines for director selection, evaluation, compensation, and complete board evaluation. The commission included participants of this issue's "Evaluating the Board" roundtable, such as former U.S. Secretary of Commerce Barbara Hackman Franklin, Columbia Business School Executive-In-Residence Robert W. Lear, LENS Principal Nell Minow, and NACD President John M. Nash. Excerpts from the report, entitled "Performance Evaluation of Chief Executive Officers, Boards, and Directors," follow:
A board should be small enough to permit thorough discussion of issues, yet large enough to bring a variety of opinions to the table. Companies should strive to create a board of diverse backgrounds (including general management, manufacturing, engineering, law, human resources, research and development, etc.), recruiting on the basis of talent, expertise, and accomplishment. Diversity of race, gender, age, and nationality should be taken into account when selecting board members; however, board composition should reflect the shareholder constituency. Other factors for director selection:
* Integrity. Directors must demonstrate the highest ethical standards and maturity.
* Ownership. Each director should be a shareholder of the corporation.
* Experience. Director experience should have some practical application to the company's needs, and boards should not recruit celebrity candidates on the basis of fame alone. Board experience is desirable.
* Judgment/knowledge. Directors should be able to assess the company's strategy and evaluate management's performance. They should be aware of legal framework governing corporations and be alert to changing business conditions, technologies, markets, trends, and opportunities.
* Time commitment. Board and committee meetings only represent a portion of time needed to be devoted to the company. Preparation for board and assigned committee meetings and advisory time spent with management are also crucial.
* Conflicts of interest. Directors should have none.
The evaluation of the board's performance includes three segments: the performance of (1) the entire board, (2) board leadership (chairmen), and (3) individual directors. One director (or a small committee) should oversee the evaluation process, which might include scheduling meetings, organizing agendas, assigning tasks, and tracking recommendations.
The frequency of evaluations depends on need. One model is annual evaluations of CEO performance, company performance, and performance of the board, its committees, and its individual members. Under this model, each of these areas would be evaluated each year, with an in-depth study of each category once every third year. Board self-evaluation, alternatively, might be triggered by events: the appointment of a new CEO, failure to meet specific plan goals, etc.
SAMPLE EVALUATION: A MODEL
A sample board evaluation form includes these benchmarks for examining the effectiveness of the complete board. Board members are asked to rate statements from 1 to 5, from lowest to highest.
* Knows/understands company's philosophy, business plan, and strategic plan and reflects this understanding on key issues.
* Permits meaningful and open communication and timely resolution of issues at meetings.
* Evaluates individual directors' and overall board performance periodically.
* Reviews and adopts annual capital and operating budgets, which are regularly monitored throughout the year.
* Monitors cash flow, profitability, net revenue and expenses, productivity, and other financially driven indicators against performance projections.
* Monitors company performance with industry-comparative data.
* Stays abreast of trends affecting the company to guide company performance in the near and long term.
* Comprehends the difference between the board's policy-making role and the CEO's management role.
* Makes goals, expectations, and concerns clear to the CEO.
RELATED ARTICLE: MOTIVATING DIRECTORS: THE HOW AND HOW MUCH
Directors' salaries are on the rise, but for many sharp-eyed shareholder activists, how board members are paid seems to be more important than how much. That's largely because of an increasing spotlight on director performance. The best way to motivate, they say, is to put board members on a level playing field with shareholders: requiring them to take significant amounts of stock over cash and other benefits as compensation.
How have companies reacted?
Recently released research suggests that stock compensation for directors is gaining currency: The number of companies offering stock-based compensation and/or deferral alternatives rose substantially in 1994, according to a 1995 study of outside director compensation by management consultant Handy HRM. Fully 85 percent of the study's respondents in industrial companies and 77 percent in service companies maintained one or more stock-based compensation plans for directors. The study, based on a review of the proxy statements of the Fortune 100 industrial companies and 100 of the top 500 service firms, found that about one-quarter of all companies pay all or part of their annual board retainers in stock. That's vastly different from the norm 20 years ago, when virtually no company compensated directors with much other than cash.
But even the most progressive directors have their limits: Some 89 percent of the 1,000 respondents to a recent Korn/Ferry International survey said they did not think directors should be compensated totally in stock.
Corporate crisis may precipitate a move toward ownership. In the case of beleaguered commercial insurance brokerage Alexander & Alexander Services, crisis prompted introspection - and reorganization. "I would be very careful not to presume that there is one approach for every company when it comes to board compensation," says Frank Zarb, president, chairman, and CEO of New York-based Alexander & Alexander. Zarb's moves as newly installed CEO in April 1994 included adding eight new directors (for a total of 17) and compensating them 100 percent in stock. "We elected to redesign the company, and it was only one piece of the puzzle, one of many initiatives. The board was pretty enthusiastic over one point: We wanted to make stakeholders of all employees. So we started at the top." The eight new directors - including heavy-hitters such as former President Gerald R. Ford and former American Express Chairman and CEO James D. Robinson III - "brought different skills to the table."
Board compensation is hardly a one-size-fits-all proposition, as roundtable participants and others attest. A recently released report on director compensation, commissioned by the NACD, found some new patterns. Along with the often-cited Scott Paper and Alexander & Alexander Services, New York-based Travelers Corp. pays its directors in equity only. Other companies - Ashland, KY-based Ashland Inc. and Ft. Worth, TX-based Bombay Co. among them - have initiated stock ownership guidelines that define a target level of stock ownership to be achieved by directors over a specified amount of time. Still other companies - often small businesses - award stock options that vest over a specified amount of time.
Ashland Inc., for one, is pleased with its equity ownership program. Since January 1994, directors are required to own stock equal in value to at least five times that of their retainer within five years of joining the board (a total of $150,000 worth of stock). Reasons a spokesperson for the company: Chairman and CEO John R. Hall "wanted to be innovative. He and the other board members saw the value of ownership." The equity target got quick results: Within the first year after the company set targets, the median value of shareholdings of the outside directors increased from $140,000 to $370,000, with most of the increase due to share purchases. The total value held by all outside directors increased to $7.3 million, from $4.2 million the first year after the target equity program was established.
Just how much directors are paid, too, is increasing. The Conference Board's 1995 survey of corporate directors' compensation found that the median director compensation (including retainers, fees, and other benefits) was up across the board in 1994. Manufacturing companies had increased compensation by 5 percent, to $30,425; for financial companies, the median was up 14 percent, to $28,125; and among service companies, the median rose 12 percent, to $28,200. The survey, based on 783 companies, found that most often these increases were the result of higher retainers and all other fees, rather than the addition of stock options or increased fees alone.
- Frances Nuelle
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|Title Annotation:||CE Roundtable; includes related articles; corporate boards|
|Publication:||Chief Executive (U.S.)|
|Article Type:||Panel Discussion|
|Date:||Sep 1, 1995|
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