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Keeping an eye on America's future.

The National Association of Corporate Directors selected Edmund T. Pratt Jr. as its 1992 Director of the Year. The award is for significant contributions to good corporate governance in both the corporate and nonprofit sectors and is presented annually by the NACD in conjunction with the National Union Fire Insurance Co. of Pittsburgh. Pratt retired in March 1992 as Chairman of Pfizer Inc., the New York-based pharmaceuticals company. He joined the company in 1964 as controller, became president in 1971, and chairman and CEO in 1972. He remains a director as well as Chairman Emeritus of Pfizer and currently serves on the boards of General Motors Corp., Chase Manhattan Corp. and Chase Manhattan Bank, Celgene Corp., and International Paper Co. Excerpted below are his remarks at the NACD awards dinner in October 1992 at the Waldorf-Astoria.

In recent years, we have witnessed a sea change in corporate governance. Institutional investors have replaced individual shareholders as the majority owners of large public companies. As a result, the role of corporate directors is being examined anew.

Not surprisingly, the new owners of Corporate America are seeking an influence commensurate with their ever-larger blocks of stock. That is entirely legitimate. Who can doubt that shareholders have a right to make their views known and, ultimately, to change things if necessary?

Yet, from the right to change things, to knowing when and under what circumstances to exercise that right, is a giant step. Given a properly functioning board, it is a step no shareholder - institutional or otherwise - should ever have to take.

That's because the board of directors has a fiduciary responsibility to oversee the management of the corporation. Those of us who are corporate directors are members of a body that is traditionally supportive and collegial but also legally independent of, and with authority over, management.

Directors have a duty to oversee the long-term plans of management, to advise on strategic direction. On the vast majority of matters, they support management. So they should. The board should oppose management only on clear and convincing evidence of error or incompetence.

For a board is not an alternative executive branch" of corporate government. Neither is it - as some nowadays seem to think - a legislative body, nor an assembly of various corporate, employee, and shareholder factions. Indeed, a board of directors is neither a congressional committee, nor the president's cabinet, nor the Joint Chiefs of Staff.

Well, then, what are a board's obligations? What is the director's role?

The more energetic advocates of so-called "shareholder rights" reforms argue that the director's obligations are indistinguishable from the short-term maximization of shareholder profits. I think that is mistaken.

That the director's responsibilities are inseparable from the interests of shareholders, however, I thoroughly agree.

The difference is that both convention and law allow boards of directors to recognize that the long-term maximization of shareholder value is the proper target, and that this involves recognition of other constituencies within the context of their primary responsibility to the shareholders.

Let me give you an example from experience. At Pfizer in the 1980s my colleagues and I realized that our industry was changing and that, more than ever, the name of the game was innovation. With shortened patent lives and an accelerating pace of new drug technology, we knew that only those companies with the technological resources to build strong new product pipelines in the 1990s would survive.

We developed a plan and stuck with it, even though it entailed some short-term sacrifices. We poured money into R&D. That cost us in terms of short-term profits. The price of our shares declined. As a result, we had to put in place some measures to protect the company - and, I believe, its stockholders - from abusive takeover bids that could have resulted. Wall Street was not altogether happy. And not all of our shareholders were happy. But those who stuck with us sure are happy today.

In 1985, Pfizer ranked 101st in sales in the Fortune 500 and 34th in profit. Last year, we ranked 69th in sales and 25th in profit. We were 18th nationally in market capitalization. I call that building shareholder value.

Should we have deviated from our plan in order to boost our short-term stock price, and risked long-term corporate decline? Should we have invited abusive takeover bids that might have meant a short-term premium but would not have represented a fraction of the company's growing - and now proven - future value? Of course not.

Pressure for Profits

This ability to look to the future will be critical to America's competitive edge in the 1990s. A recent study by the Harvard Business School showed that only 21 cents of the American investment dollar go to long-term projects. That's compared to about 50 cents for Japan and Germany. The payoff over decades for Japanese and German shareholders, workers, companies - and national economies - has far outpaced our own. The study pinned much of the blame for America's shortsightedness on investor pressure for near-term profits.

Without independent boards to shield companies from short-term pressures, America will have a tough time staying competitive in the global marketplace. Rest assured, Japan and Germany will get past their current troubles and come out leaner, meaner, and looking ahead to the 21st Century. We'd better be ready.

And that is where we directors come in. Meeting our responsibilities will require us to become ever-more active and effective.

Those clamoring for change in corporate governance practices are absolutely right to think that the rubber stamp has no place in the board room of the 1990s. Effective directors have to monitor closely the performance of the companies we serve, evaluate their long-term plans and strategies, and stand prepared to offer advice and counsel to ensure the company's future. And if we see things are off track, and that management is not responding, we have to act decisively to protect the company's interests.

We can accomplish this only if our boardrooms are open to genuine dialogue and differing perspectives. In 1971, when Pfizer was 122 years old, we began to construct its first outside board, by bringing on Felix Rohatyn. Outsiders are now a two-to-one majority on the Pfizer board.

Collegiality among directors is important, but not at the price of passivity. Felix once said he never sat on a board with such mutual trust and respect as Pfizer's. I hope he's right. But the trust he's talking about wasn't built on blind faith. It was hard-earned, built on the premise that everyone's views are heard and everyone speaks his mind. Sometimes it gets rough, but the end result is mutual respect, and a stronger, more competitive company.

Dialogue is also the key to the relationship between boards and institutional investors. These are, after all, the major shareholders in many companies.

Institutional investors have every right to look carefully at corporate performance. And we directors have every obligation to listen to their views. They expect a meaningful exchange of information about the companies in which they invest and about their prospects and strategies. To this they certainly are entitled.

Misguided |Reforms'

By the same token, many current proposals to remedy what is supposedly wrong with how corporations govern themselves should give us pause. The dramatic changes in ownership we have witnessed in recent decades has been accompanied by a host of suggestions for reform of corporate governance. To put it mildly, they vary in quality. No doubt all are well-meant, and some might even be helpful to individual companies. Alas, many are misguided and a few are downright silly.

Some people would insist on mandatory outside board chairmen. In some unusual cases, an outside chairman might be useful to a corporation. In general, however, it's a recipe for unnecessary and unproductive tension and, more important, for confusion and delay in responding to the increasing challenges faced by American companies.

And there are other peculiar proposals around, such as limiting directors to serving on a single board. What a surefire way that would be to limit the availability of the few truly world-class experts that exist in medicine and science, finance, international affairs, and other specialties.

I have heard it said that retired CEOs should be excluded from serving on the boards of companies they once led. But I ask you: Who knows the company better? No one. And, I might add, there are also very few people with a greater stake in its continuing success. There may be times when a retiring CEO is not an appropriate candidate for the board, but this should be determined by the board and the voting shareholders, not by fiat.

It seems to me that many reform proposals share a common misperception. Their proponents seem to believe that corporate governance should mirror political governance, that corporations somehow should be "democratized."

They argue that boards should be more "representative" of various constituencies, for example, or headed by an outside chairman who can "check and balance" the CEO. But this is to misapply the democratic principle.

Democracy has many virtues, but no one - not even the ultimate optimist - would include among them the efficiency and long-term profitability investors seek from the corporations in which they invest.

Corporate democracy does not require that shareholders directly participate in every decision, any more than democratic governments must place every piece of legislation before the voters. We don't expect government officials to take every thorny issue to a referendum. We expect them to use their judgment. We expect corporate directors to do the same. In each case, elections allow voters to dismiss those whose performances they judge substandard.

I can say from experience that the best way to avoid conflict with investors is to bring them into the process. Don't leave them on the outside trying to look in. As corporate directors, we serve at the pleasure of our shareholders. We have a responsibility to work with them and to listen to them.

But, ultimately, we as directors - and not the shareholders - should remain directly responsible for deciding what is in the best interests of the corporation as a whole.

That said, it all comes down to a simple message for directors, shareholders, and managers alike: * Responsibility. * Dialogue. * And keeping an eye on America's future - in which we all have a common stake.

I am confident that, working together, we can find ways to turn the growth of institutional ownership into an opportunity to renew and strengthen American business and to prepare our nation for the rigors of global competition that lie ahead.
COPYRIGHT 1993 Directors and Boards
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Author:Pratt, Edmund T., Jr.
Publication:Directors & Boards
Date:Jan 1, 1993
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