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The power and the process.

Boards must change. They cannot continue to be constrained by old-style structure and tradition. Here are some suggestions for revitalizing the board.

In the last few years, the foundation of the world economy has been altered dramatically by a series of enormous changes -- the onset of economic tripolarity among the United States, Japan, and Europe; the end of the Cold War; and the rise of economic issues to the top of the global agenda. Surely, no period in recent history has seen such a rapid and disorienting shift in global dynamics. As a result, executives in the '90s will spend more time responding to change, managing discontinuity, and dealing with uncertainty and complexity.

Those companies and their boards of directors that recognize the new international order -- and carry out the required changes -- will probably survive; many, indeed, will prosper as new industrial leaders emerge.

However, in a rapidly evolving international economy, those institutions that are not changing their ways of doing things and, most important, their thinking, are clearly headed for extinction. The Roman orator Cicero once said of a friend: "He remained the same when the same was no longer fitting."

The question for today is this: Will corporate governance remain the same when the same is no longer fitting? Will companies and their boards recognize that the management processes and governance practices of the global corporation must be dramatically different? Will they simply try to fine-tune or will they see the need to break loose from policies, attitudes, and governance practices that are no longer fitting?

Despite the fact that corporate governance has become something of an "in" topic these days, it remains rather arcane and abstract for most people. It's a lot like having a root canal -- essential to go through but hardly fun. Still, I'm sure everyone agrees that corporate governance has become the subject of lively discussion, and even controversy, as individuals and institutions examine the legalities, realities, and shortcomings of the way boards govern publicly held companies.

And when it comes to controversy, the prize for generating a lively discussion goes to Irving Olds, the former chairman of U.S. Steel, who opened a speech by declaring: "Directors are like the parsley on fish -- decorative but useless."

Hard to Define

One trouble with corporate governance is that it's hard to find a working definition for what it is. Experts who have researched and written about it agree that it's hard to define, but they also say it's something that every corporation concerned about its future place in society and the economy has to address and to practice effectively.

In a narrow and legalistic sense, corporate governance is the company directors, singly or collectively, carrying out their fiduciary responsibilities to the shareholders. These duties are summarized by the Business Roundtable. They are:

-- Overseeing of management and board selection and succession.

-- Reviewing the company's financial performance and use of resources.

-- Overseeing corporate social responsibility.

-- Ensuring compliance with the law.

Given these responsibilities, and the fact that directors are held accountable within the law to govern the corporation effectively, one can conclude that governance is an important activity and responsibility. So, what's the problem behind all the debate about the governance process?

In theory, there is no problem because, by law, directors have all the power they need to do their jobs on behalf of the shareholders. But in practice it often doesn't work that way.

And the reason can be found in a study by Jim Gillies, the former dean of business of York University in Toronto. Having served on over 30 boards during his career, Professor Gillies defines the problem this way: While corporate boards have power de jure to carry on their fiduciary responsibilities, they have not exercised it de facto.

I believe this goes to the heart of a general feeling that the role of directors in the governance of the modern corporation has been largely perfunctory -- marginal at best. And here, I may even be too generous in my view because, in the opinion of Peter Drucker, far too many are "an impotent and ceremonial legal fiction."

For years, many boards have lacked cohesion, operated within limited time frames, have had limited knowledge about operations of the business, and have held varying views within their ranks about what the corporation should be doing. Most important, directors have had a rubber-stamp mentality averse to "rocking the boat" or "criticizing the CEO" to whom they have all too often been beholden for their position on the board. The old style has been for boards to confirm and conform. This situation, I believe, is no longer tenable legally or morally. Shareholders expect and deserve more from their boards and so do other stakeholders.

The recognition that boards of directors need to become both more active in handling their expanding responsibilities and more responsive to a growing public dissatisfaction with certain aspects of corporate behavior and performance has fueled the governance debate that has involved -- among others -- legislators, regulators, academics, and company directors themselves.

Growing Pressure

There is also growing pressure to make boards more responsible for their company's performance. Directors' actions -- or lack thereof -- are being questioned far more than in the past and more frequently in the courts. For example, more and more directors are becoming personally liable for their actions and the actions of the company. There is a clear trend to make directors even more responsible for dereliction on the part of the corporation in such areas as environmental pollution, failure to pay into pension funds, certain severance obligations, failure to remit taxes collected, and other critical areas of responsibility. In the Province of Ontario, where Northern Telecom Ltd. has its corporate office, board members face more than 100 provincial and federal laws governing liability.

While there are pros and cons to this development, it does focus much needed attention on board members and their duties. As their legal responsibilities expand, it is imperative that directors operate more effectively as the senior governing body of corporations.

In fact, there are monumental implications -- and expectations -- for directors arising from the expanding definition of fiduciary responsibility, the increased importance of ethics in the activities of the company, the added legal liabilities, and the pressure from large institutional investors for high-level performance on the part of corporate boards.

Standards Are Rising

In short, the standards against which the performance of directors is measured are rising. Directors are being held accountable for ensuring that executives are competent to manage in the changing global environment, that strategies proposed by the corporation are effective, that shareholder values are maximized, and that the social and ethical responsibilities of the company are met.

I believe that the intensity of the debate on corporate governance in recent years reflects a deep-seated public concern with the present system. This is especially true in the U.S., where some of the most vaunted bluechip companies are now in serious trouble. It's enough to scare the hell out of anyone, and accusatory fingers have pointed in many directions. Some have blamed top management's shortsightedness and rigidity. Others have laid the blame on high wages and lack of productivity among American workers. Still others have diagnosed the problem as a lack of coherent industrial policy and business/government cooperation. Until fairly recently, what has been most striking in the debate is the almost universal exclusion of that major symbol of industrial power -- the boards of directors.

Dr. Gillies and others suggest that a successful corporation in the 1990s must draw on the experience and wisdom of its board in order to succeed in a rapidly changing global marketplace. Obviously, if that is to happen, boards must change. They cannot continue to be constrained by structure, process, and tradition.

The Problem Areas

But getting boards to change will not be easy. And why is that? Let me attempt to offer a few thoughts based on my own experience:

* First there's the problem of accountability and responsibility. To whom is the board accountable? By law, it's the shareholder. But in reality, most directors feel beholden to the management that appointed them, notably in situations where the chairman of the board is also the CEO of the corporation. This doesn't make for a lot of creative tension between the CEO and the board. Board members feel a sense of loyalty to the CEO who appointed them, and there's a great reluctance to voice an opposing view or cast a dissenting vote. This results in perfunctory performance, nodding assent, and rubber-stamping of management decisions.

* Legally, boards have the power to govern, but they do not have the process. The fundamental task of governance today is to get some real de facto power into the hands of the board. You can't do it by changing the law, because the law gives directors all the power they need. So, you have to do it by the way the board operates and by the way you organize and structure the board to exert its influence in governing the company.

* Traditionally, the environment in which boards operate is not conducive to open discussion, questions, and an exchange of views. Board meetings for the most part are stiff, formal, controlled, and short. The climate in the boardroom is guarded, legalistic, and with minimal dialogue. For most CEOs, boards bring little added value to the business.

* The composition of boards and the competence of directors is another problem area. Boards are often too large and their members lack the competence to make a difference. For the most part, they are fairly uninformed about activities inside the company. They don't add direct intellectual or substantive value to management. The whole point of having an independent board representing the investors is to get an objective point of view, new perspective, and additional expertise. Too many boards are stacked with members who are there for the prestige, recognition, and rewards.

* The behavior of boards is still guided by an old code of conduct that stresses being "a good guy." Don't push. Avoid a hassle. Don't cause confrontation. These boards operate on the assumption that management sets the strategy and business priorities for the company; that the board is there because it is required by law to oversee more-or-less routine matters -- like declaring the quarterly dividend.

* Directors have access to limited independent information. Unless they can legitimately have conversations with management independent of formal meetings, where executives make short, superficial presentations, directors cannot be informed enough to do their jobs effectively.

* There is also the issue of expecting one board to do too much, particularly when it is responsible for governing complex companies with operations and people spread across the globe. Directors, especially those who are also CEOs of their own companies, have limited time to sit on boards. This is a very practical problem that can affect performance as the globalization of markets and competition speeds up. Complexity grows and so does the need for directors to spend more time on the big global strategies that are vital to the continuing survival of the business.

These are some of the big problems that will have to be addressed and corrected as part of speeding up the transition from the old-style board to a corporate-governance process for the global 21st Century enterprise.

Road to Empowerment

I would like to offer a few suggestions for improving the effectiveness of corporate governance at the board level. The big challenge where governance is concerned is to empower and revitalize the board. To achieve that goal, I suggest the following:

* Separate the position of board chairman and CEO. The chairman is responsible for the performance of the board and the CEO for managing the corporation.

* Strengthen the role of the nominating committee in the selection of directors who are professionally competent, independent, motivated to govern the enterprise effectively, and who are properly compensated for doing so.

* Set out concrete terms of reference for the board and its committees, job descriptions for directors, and an effective process for evaluating their performance annually. In addition to selecting board members, the nominating committee's role could be expanded to include evaluation of board performance as well as board interaction with management.

* Consider establishing multiple boards -- a two-tier structure -- to deal with different issues and aspects of the business needing special attention. There could be an inner board, which has the formal legal responsibilities, and a number of second-tier advisory boards made up of outside experts on issues that the CEO and top management think would help them in their decisionmaking, such as a science and technology board.

* Change the culture of boards -- and board meetings -- to make it possible for open, frank, and productive discussion of major issues and proposed decisions. Provide directors with the information they need to do their jobs better; give them direct access to management, customers, investors, employees, and other stakeholders as required.

* Involve boards in the strategic planning of the corporation as part of ensuring that the continuing success of the enterprise. Shareholders, governments, and other stakeholders expect boards of directors to be responsible for ensuring that companies are governed in ways that will ensure their competitive success in the 1990s and beyond.

Defining A New Model

What I am suggesting are not small changes in corporate governance. The ideas I offer have ramifications and implications that extend far beyond the actions of directors themselves. They involve nothing less than creating a new role for the chairmen of boards of corporations; new relationships among chief executive officers, board members, and chairmen; new methods of board organization and operation; new criteria for selecting and evaluating the work of board members; new types of expectations from boards; and larger responsibilities with respect to boards and their performance.

The challenge of corporate governance is not simply a large-scale conceptual and philosophical issue. It is an immediate, practical issue: choosing first steps and concrete actions to improve corporate governance and define a new model for boards of directors.

Dr. Paul G. Stern is nonexecutive Chairman of Northern Telecom Ltd. He relinquished his position as CEO of the telecommunications equipment company on March 1, 1993. Prior to his appointment as CEO of Northern Telecom in March 1989, Dr. Stern held top executive positions with Unisys Corp., Burroughs Corp., Rockwell International, Braun AG, and IBM Corp. He also serves on the boards of BCE Inc. Whirlpool Corp., Dow Chemical Co., and Vailart Associates. This article is adapted from his keynote address at a seminar on "Creating a Corporate Governance for the Global 21st Century Enterprise," conducted by the Wharton School's SEI Center for Advanced Studies in Management, where Stern serves as an advisory director.
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Title Annotation:board of directors
Author:Stern, Paul G.
Publication:Directors & Boards
Date:Mar 22, 1993
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