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Independent directors are a good thing: a financial advisory firm CEO argues that smart companies are treating Sarbanes-Oxley requirements as an investment in good governance--and that independent directors, rather than curbing risk and initiative, are at the core of a new dialogue with investors.

Critics of the Sarbanes-Oxley Act of 2002 have raised concerns far beyond the usual assessment of increased compliance costs or the increased challenge of attracting new board members for America's public corporations. Indeed, some critics suggest that an unintended effect of the law is an erosion of corporate vitality.

Former Reagan Administration official Peter J. Wallison, for instance, suggested last year in a Wall Street Journal article that we are all in a bit of an economic mess because of Sarbanes-Oxley. He argues that "the CEOs and other professional managers who run these enterprises day to day" hold the answer to corporate growth and American economic prosperity through unfettered entrepreneurial effort--"to take the risks and make the investments that had previously brought the economy roaring back from periods of stagnation or recession."

Legislatively mandating any power or responsibility to independent directors, the "part-timers," is a roadmap to corporate inertia and a preference for the "safe and sure," says Wallison. "The problem is, if the main economic actors in our economy--the corporations traded on the New York Stock Exchange and Nasdaq--are now to be controlled by committees of the risk-averse and timid, we may all face a future of limited economic growth."

I suggest that critics such as Wallison continue to view Sarbanes-Oxley from a traditional, management-centric perspective, one that ignores the basic reality that management, boards of directors and shareholders of public American corporations are now interacting in a new and more open forum. I also believe that the management and boards of the most successful American corporations will use their "investment" in the law as a new and valuable asset to attract capital, to increase share values and to grow.

Over $1 billion was spent in 2003 by public U.S. corporations on Sarbanes-Oxley compliance, chiefly by hiring outside consultants and spending on systems for corporate governance. At a minimum, this investment has created a much higher awareness of governance issues among corporations, investors, the SEC, rating agencies and state and federal regulators. This investment is also reflected in the hiring of new independent board members, the frequent division of CEO and chairman of the board responsibilities and the creation of senior management positions in compliance.

Now that audit committees have been restructured, lead independents identified, meeting schedules expanded and board budgets increased, most American companies have a stronger independent board platform. As Wallison suggests, "Given this background, it would not be surprising if independent directors--as a majority now specially constituted by law and regulation--interpreted their mandate as authority to take a more active voice in the assessment of company risk than had been true in the past." No question about it!

Gone are the days when the independents could provide private, episodic advice and support to executive management. Often, independent directors defined their role as interested outside observers to the CEO's initiatives. Now, for example, General Electric Co, wants its independent board to be "our most constructive critics and wisest counselors."

The next logical step towards developing Wallison's "active voice" is for independents to develop their own agenda. Issues such as stock options, management compensation, proxy procedures and financial disclosure are critical items on any board agenda. In addition, an economic assessment of strategic alternatives (independence, acquisitions, company sale) now constitutes an additional agenda that regularly should be addressed by the independents as fiduciaries for current investors.


Moreover, a professionally developed and unbiased view of overall company risk and strengths--as measured by earnings, capitalization, share valuation and liquidity, strategic plan and competitive position--ought to be an integral part of every board member's agenda. Independent boards need to develop and express their own views and conclusions, whether entirely consistent with management or not, about these critical shareholder value issues.

The question can be asked: Does this governance expense and independent board agenda-building lead anywhere other than to confusion and to the incapacitation of executive management? Actually, I think that many corporate executives are developing a new perspective--that their Sarbanes-Oxley investment has created a valuable asset for their corporation, versus simply increasing the cost of doing business. At a minimum, the investment made in an independent board has created an asset more valuable to shareholders than ever before, both in decision-making and shareholder communication.

The independent board members' agenda ought to reflect the general risk-and-return objectives of the majority of the shareholders. Historically, many independents relied on management's priorities, and maintained a watch over stock price to approximate a shareholder's priorities. Now, however, independents are experiencing a fundamental priority shift, mandated by regulation and the courts; this is inexorably enhancing the preeminence of shareholder priorities over those of management.

Business leadership today demands successful participation in a more open forum focused on creating shareholder value. The value of that forum is that board decisions reflect an arms-length, informed dialogue. Too often in the past, CEOs have short-circuited a successful dialogue with shareholders by insisting on communicating with them in traditional ways.

The challenge many corporate executives face is developing confidence in their investor audience. CEOs, accustomed to delivering finely crafted earnings announcements, find lower institutional investor interest because of, in part, a sudden flurry of distrust in corporate managements. If a company is fortunate to have research coverage, it's likely drawing less attention; many investors believe that more than a few CEOs and equity research analysts have been guilty in recent years of selective disclosure.

Few observers believe these trends will change soon. Wall Street firms will continue to grapple with profound structural changes in the way they intermediate information between investment banking and institutional clients. As a result, a large number of public companies will be increasingly forced to interact directly with shareholders. Many observers believe that executives need a new perspective, and a new voice, fresh and independent, to enhance this direct shareholder dialogue.

The nature of this dialogue will change fundamentally as a result of the recent investment in corporate governance. With the legislation, awareness, litigation and regulation sweeping U.S. capital markets, chief executives have a mandate to communicate differently with shareholders.

A typical historical perspective on this corporate dialogue had a "we--them" mindset. "We" included executive management and the board; management laid out the business plan and historical results, and boards provided little more than anecdotal input. In this model, publicly disclosing board dialogue about strategic issues was viewed as treading a dangerously slippery slope.

In fact, many CEOs characterized everyone outside the boardroom--including shareholders, the press and competitors--as "them" when it came to discussing important information. But an alternative, and admittedly provocative, perspective is one in which management, the independent board and shareholders communicate in a very new way.

Investors should have regular access to the views of the independent board, and if independent directors gain information from their efforts and agenda, investors should want to hear their views. For example, the company could have the lead independent director or head of the audit committee participate in quarterly earnings conference calls to investors.

This step may seem drastic--probably no public American corporation regularly includes its directors on earnings calls. But, if the corporate goal is to provide all pertinent information to investors, this begins to make sense.

When Regulation Fair Disclosure was adopted by the SEC in 2000, it contained two basic notions. First, companies should not have private conversations with outsiders involving material information, without sharing such information with all investors. Second, companies were encouraged to use all media, especially the Internet, to disseminate such information widely and instantaneously. After the hue and cry about feasibility and cost died down, U.S. public companies adopted Regulation FD.

Regulation FD inadvertently raised the bar about the scope of information disclosed, to include business and competitive data typically not found in SEC disclosure documents. When companies speak about important matters, Regulation FD now demands that such information is shared globally--and consequently, the views of the independent directors are and should be important disclosure for all public corporations.

Why take this risk? Why enhance the role of independent directors, other than to comply with Sarbanes-Oxley and SEC requirements? Isn't "compliance" enough in 2004 and beyond? And are the independents of many public corporations prepared for these tasks?

All are crucial questions. Clearly, corporations can develop fresh voices to enhance their credibility in their expanded dialogue with investors. Every public company's CEO is obligated to provide accurate information, to facilitate investment in the company's equity and debt securities. The independents' voice can help accomplish this goal.

Are independent boards up to this task? In some cases--and investors know them when they see them--independent board members' commitment and qualifications are simply inadequate. These directors ought to be removed, and a new profile created. An independent director position is a tough, time-consuming job, not a reward. Not all independent directors will be eager to develop and manage their own agenda, and fewer will be eager to communicate to investors.

This transformation seems a formidable task, but so does the job of revitalizing the capital markets and the economy. These initiatives are aggressive decisions intended to maximize return on investments in corporate governance and to enhance dialogue with investors. Ultimately, as equity markets continue to recover and capital flows more freely, companies that have used these corporate governance investments wisely will be the beneficiaries, realizing measurably increased shareholder value.

Such value--based on earnings, growth and innovation--is what corporate managements can contribute best towards the revitalization of the American economy. And strong, independent boards will play a vital role to encourage the creation of shareholder value in a new, powerful way.

Scott Wendelin is CEO of Prospect Financial Advisors in Los Angeles, a registered broker/dealer that provides companies with independent financial advice and capital access. He can be reached at or 310.479.6464.
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Title Annotation:Viewpoint
Author:Wendelin, Scott
Publication:Financial Executive
Geographic Code:1USA
Date:Mar 1, 2004
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