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The lead director.

In many boardrooms today, such a leader is already recognized by management and the outside directors.

In more than 70% of the major British public companies, the chairperson of the board is not the chief executive officer. In these British companies a non-executive outside director is the chairperson. The chairperson sets the agenda for the board, presides at the meetings of the board and of shareholders, and, frequently, individually or together with the CEO, speaks for the company. The CEO manages the company on a day-to-day basis. This arrangement has worked well in Britain. It is one of the key recommendations in the Cadbury Committee's draft report on proposals to improve corporate governance in Britain.

In the United States the opposite approach prevails. Less than 20% of our companies have a separate chairperson and CEO. The vast majority of American CEOs are opposed to separating the two roles. The principal arguments against such separation are that:

* It would dilute the power of the CEO to provide effective leadership of the company.

* It creates the potential for rivalry between the chairperson and the CEO, leading to compromise rather than crisp decisiveness.

* The chairperson may be overly protective of the CEO and shield the CEO from being held accountable by the board for poor performance.

* Having two public spokespersons leads to confusion and the opportunity for third parties to take advantage of the division.

While we have reservations about the validity of some of the arguments against the separation, we see no need to face these issues directly. Instead, we recommend that those companies that do not have a non-executive chairperson designate one of the outside directors as the lead director.

The lead director would not have a corporate title and would not have an office at the company headquarters. The lead director would not set the agenda nor preside at meetings of the board or of shareholders. Nor would the lead director act as a spokesperson for the company.

The lead director would be consulted by the chairperson/CEO on: (1) the selection of the board committee members and chairs, (2) the board's meeting agendas, (3) the format and adequacy of the information directors receive, and (4) the effectiveness of the board meeting process. The lead director would also coordinate an annual evaluation of the chairperson/CEO by the outside directors.

Finally, if the outside directors are confronted by a crisis because of the incapacity of, or failure of performance by, the chairperson/CEO, they would have a designated leader in place and would not lose time in organizing to deal with the problem.

While the immediate reaction of many chairperson/CEOs to this proposal is negative, we believe it is a critical factor in making boards more effective. In fact, we believe that in many boardrooms today such a leader is already recognized by management and the outside directors. This is a natural concomitant of responsibility for audits, compensation, and nominations being placed in the hands of committees composed only of outside directors. The chair of one of these committees usually emerges as a leader of the outside directors. In other cases it may be the director with the most seniority or the one who is most respected by the other directors. Our proposal recognizes and gives form to what in many cases has emerged on a de facto basis, but does not compromise the leadership prerogatives of the chairperson/CEO.

We recognize the possibility that a lead director might attempt to usurp some of the functions of the CEO or might become so friendly with the CEO as to be a shield against appropriate evaluation of the performance of the CEO and, when necessary, the CEO being held accountable for poor performance. On balance we think that this risk should be accepted. We think effective leadership of the outside directors is essential to enable the board to discharge its monitoring function properly. Providing such leadership far outweighs the damage perceived by some chairperson/CEOs.

Further, the risk of having a lead director is reduced by having: (1) a smaller board with all members participating fully, (2) a term limit for directors, (3) a mandatory retirement age, and (4) most important, careful selection of outside board members. Finally, the risk can be virtually eliminated by rotating the lead director role among the chairs of the audit, compensation, and nominating committees on an annual or biannual basis.

Martin Lipton and Jay W. Lorsch are thought leaders in the critiquing of corporate governance structure and processes. Lipton is a Partner with the New York law firm of Wachtell, Lipton, Rosen & Katz. Lorsch is Senior Associate Dean for Executive Education and Louis E. Kirstein Professor of Human Relations at the Graduate School of Business Administration at Harvard University. This article is adapted from, "A Modest Proposal for Improved Corporate Governance," published in The Business Lawyer.

Should the Chairman Be an Outsider?

Only seven companies among the S&P 500 have an independent director serving as board chairman, according to a recent study by the Investor Responsibility Research Center. Nonetheless, the separation of duties of board chairman and chief executive officer, with the chairman's role being performed by a nonmanagement executive, is moving quickly beyond idealistic concept to concrete proposal.

Separating the offices is being seen variously as a key reform of ineffectual corporate governance, an enhancement of governance for the '90s and beyond, or an unnecessary -- even misguided -- notion for improving management and corporate performance. The pros and cons are being debated vigorously. DIRECTORS & BOARDS asked the following three executives for their thoughts.

A Critical Realignment

Ralph V. Whitworth is President of the United Shareholders Association, a 65,000-member shareholder advocacy organization based in Washington, D.C. He has led negotiations with many major corporations that resulted in significant bylaw and corporate policy changes to advance shareholder rights.

The unprecedented upheaval now sweeping through the power structure of some of America's best-known corporations promises to spur a long-overdue realignment of accountability in Corporate America. But first, move boards must follow the lead of General Motors, Westinghouse, and American Express by naming an outside director as chairman.

At GM, the first of these giant companies to make the change, the board recognized that removing a moribund CEO does not guarantee positive change, especially if a company's governance structure and corporate culture reinforce a crisis-precipitating bureaucratic inertia.

Take IBM. As CEO and chairman, John Akers was backed up on the 17-member board by IBM president Jack Kuehler, senior vice president Frank Metz, and former chairman and CEO John Opel. Messrs. Akers, Kuehler, and Opel also sat on IBM's seven-member executive committee, which Mr. Opel chaired. Until recently, that committee was responsible for, among other things, nominating directors. (In Response to a United Shareholders Association-supported shareholder proposal, IBM has recently moved the nominating responsibilities to a committee made up exclusively of independent directors.) These insiders' ready access to corporate resources and information, and their control of the board's agenda and nominating function, ensured that they dominated the body to which they answered.

No one denies that this structure works efficiently when times are good. But it lacks the critical checks and balances that defeat conflicts of interest and foster debate in bad times, when shareholders need an independent representative most. No matter how diligent honest, and talented individual directors may be (and I strongly believe that this description fits all of IBM's directors), they can't escape the natural forces of collegiality, loyalty, and deference that builds within a board. Only well thought-out structural and procedural safeguards can mitigate inherent conflicts and ensure that accountability flows from management to shareholders via the board of directors.

With an outside director serving as chairman, and with key board committees composed exclusively of nonmanagement directors, it is clear that the executive answers to the board. At the same time, separating the power and duties of the chairman and CEO is not necessary in all situations. If nonmanagement directors clearly dominate overall membership and rigorous independence is maintained on key committees, including a working executive committee, inherent conflicts can be minimized and the board can fulfill its independent monitoring function.

But, as the boards of GM, Westinghouse, and American Express no doubt concluded, there is no better way to dramatically realign accountability in a management-dominated board than to appoint a nonmanagement chairman.

Lessons From the Private Company

Carl Ferenbach is a General Partner of Berkshire Partners, a Boston-based investment firm specializing in the acquisition and ownership of established middle-market companies. He formerly headed the mergers and acquisitions department of Merrill Lynch and started its leveraged buyout activities, and is a frequent lecturer and author on the subject of corporate restructurings and acquisitions.

The non-executive chairman of the board has been a common feature of the private, investor-owned corporate for years. As the equity markets have become receptive once again to new issues of common stock, particularly initial offerings, private companies transitioning into public hands have often retained this organizational feature. Simultaneously, this position has become a prime agenda item of those interested in corporate governance of public companies.

For an outsider to fill the position of non-executive chair effectively, he or she must be capable of establishing an agenda that enables the full board to meet its duties of care and diligence while establishing policy appropriate to all company constituents. Easily said, but not so easily done.

For instance, to be truly effective, the chair needs a sense of the company's relationships with key customers and knowledge of their satisfaction, an understanding of employee relations from both management's and the employee's perspective, and detailed understanding of corporate cash flows -- both the sources and the competition for uses. Only then can the strategic options facing management be organized and presented to the board for consideration of policy issues. While this approach is a departure from historical practice, directors should ask how often they are afforded the opportunity to hear the views of customers and employees through the ears of anyone other than management.

The non-executive chair of the private, investor-owned company obviously has some large advantages over his public counterpart. Monitoring management performance is the primary activity; and he represents control of the company. Without these structural advantages, can the non-executive chair function as effectively? And are there sufficient incentives to perform?

It is hard to answer yes on either count, but there are some lessons from the private that are applicable to the public:

* First, the outside chair should be someone with the time and commitment to define the issues and develop the agenda.

* Second, the board itself should have come into being through an objective process not controlled by management.

* Third, the board should have financial incentives consistent with those of the public shareholders, meaning that its members should risk some capital and perhaps have some options.

* Fourth, the outside chair should facilitate a thorough education of each new director in the needs of customers, the satisfaction of employees, and the sources and uses of corporate cash.

If these standards are met, then the public company and the private investor-owned company would have far more in common in the method of their governance. Given the increasingly extensive literature extolling the investment performance of private, investor-owned companies, this would seem a not unworthy goal.

The Board Has To Be in Control

Peter Morgan left IBM after a 30-year career to become Director General of the Institute of Directors. The IOD is a London-based international organization committed to high standards of corporate governance. The IOD'S Centre for Director Development provides training to help members improve their skill and professionalism as directors.

It is generally accepted, on both sides of the Atlantic, that the key to effective corporate governance lies in the boardroom -- a properly functioning board of directors is the bedrock upon which the principles of current governance are founded. However,notwithstanding agreement on this point, there is a sharp divergence of view and of practice on either side of the Atlantic as to the way in which leadership should be provided to the board of directors.

In more than 70% of the major British public companies the offices of chairman and chief executive are held separately. The basic responsibility of the chairman is to ensure that the board is effective and that it is giving the company the lead that it needs and frequently, individually or together with the chief executive, represents the company to the outside world. The function of the chief executive is to lead the company's executives in accordance with the strategic direction and under the supervision of the board.

In the United States, less than 20% of American public companies have a separate chairman and chief executive, although, in terms of checks and balances on the executive, there is a much higher proportion of outside directors on American boards.

There are, of course, arguments both ways, and, as with all corporate governance problems, a solution will not be obtained by the imposition of a mechanistic formula.

What is undeniable is that effective corporate governance demands a properly functioning board of directors and the performance of this function is likely to be inhibited by too great a concentration of executive power. Whether the safeguards against such a concentration are best provided by splitting the offices of chairman and chief executive, by a strong and independent element on the board, or by, as has been suggested in some quarters, the formal recognition of a lead director among the non-executives is to a certain extent immaterial. What is important is that the board is structured in such a way as to ensure that it is in a position to control the exercise of executive power and in extremis to replace the CEO.
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Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:includes related articles; corporate director
Author:Lipton, Martin; Lorsch, Jay W.
Publication:Directors & Boards
Date:Mar 22, 1993
Previous Article:A position description for the board.
Next Article:The retired CEO: on or off the board?

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