‘Corporate governance has become so important that it should be dealt with as an integral part of the management of a company. It now deserves the attention of the entire board. ‘
So says John Wilcox, chairman of Georgeson. Although others might not be quite so enthusiastic, corporate governance has become a fact of life for most companies. The current wave of best practice measures may have originated in the US, but the principles are now being exported to capital markets across the globe. Its meaning has expanded to encompass anything and everything to do with the rights of investors and the responsibilities of boards of directors to their shareholders.
In the US, pension funds like Calpers have helped drive the debate forward. With index-linked approaches locking it into its investments, the mighty Californian pension fund wasn’t in a position to just ditch underperforming companies in its portfolio. Instead, it had to try to change the way those companies were being run. Calpers’ high-profile campaigns in the States have also led to a few quivers in the boardrooms of its non-domestic investments – usually without good reason.
Things seem to have moved on in the US, though. The high-profile public disputes over shareholder resolutions are slowly being phased out. Criticisms of management have to some extent been replaced by a more dialogue-based approach, as companies have become aware of the need to be accountable to their shareholders.
Indeed, some underperforming companies have started to take the initiative. Rather than wait for outside pressure to force them into improving their corporate governance stance they are initiating discussion by laying down their own principles.
It is not a wholly new concept, of course. General Motors was one of the first companies to seize the corporate governance bull by the horns in 1993, albeit after fighting off critics for far too long. The company had been underperforming for years and both investors and the media were at last making plain their concern that management was not doing enough to fix the problems.
In response, General Motors’ directors decided to overhaul the board, ousting the chairman and chief executive. And, in order to prevent the recurrence of similar problems in the future, the board decided to undertake an analysis of different corporate governance models with a view to implementing a best practice approach.
The resulting report laid out 28 specific corporate governance principles. These would ensure the board was ‘performing its responsibilities with the same discipline and dedication that it expects of management,’ said General Motor’s new chairman, John Smale. The guidelines included an annual evaluation of the CEO; splitting the roles of chairman and CEO; increasing the number of outside independent board members; and linking the CEO’s compensation package more closely to performance. The report expressly stated that ‘on matters of corporate governance, …decisions will be made by the outside directors.’
GM did not shy away from the task there, though. The report went on to recommend changes to the format of the annual meeting to improve communication channels with investors. The meeting would be scaled down to focus on fundamentals like the election of directors and a series of shareholder information meetings would be organised to give shareholders time to ask questions and obtain more information.
The GM document has become something of a blueprint for other companies wishing to review their corporate governance principles. During 1993-1994 Calpers challenged 400 of the largest companies in its portfolio to undergo the same level of self-analysis. Shareholders have a right to know the structure by which a board operates and how it intends to fulfil its obligations to its shareholders, Calpers said. And it stressed that the process of review would help companies to better understand their corporate governance structure; to evaluate how well they were serving the interests of their shareholders and to begin considering changes that could be constructively made. ‘We hope to stimulate board self-examination, constructive thinking and cross-fertilisation of good ideas from one board to another,’ Calpers added.
A significant number of companies took up the challenge. They were judged by Calpers on a range of criteria. For example, how recently the review of their corporate structure had taken place; whether it was conducted by corporate officers or the board of directors; whether the company was willing to share its positions on governance issues with shareholders; and how important the company considered corporate governance to be.
Full marks from Calpers depended as much on the director’s involvement in the review of the guidelines as in their actual content. Over 60 per cent of companies polled were found to have a satisfactory to excellent corporate governance model. The other 40 per cent either missed the point or failed to respond altogether.
Many of the guidelines followed almost exactly the same format as General Motors’ document – not necessarily a good thing, according to a recent Investor Responsibility Research Centre (IRRC) study of the guidelines developed by boards at S&P 500 companies.
‘If a board of directors blindly accepts the guidelines of another company, it may be blindly accepting the reasoning behind the process necessary to develop such guidelines and, consequently, entirely miss the point of the exercise,’ says the report. Similarly, companies who release guidelines in the midst of a crisis could well be simply going through the motions of reviewing their corporate governance structures, says the report. RJR Nabisco, for example, released its corporate governance principles in the wake of a vicious proxy battle giving way to accusations that the whole thing was a public relations exercise rather than a genuine reforming process.
Some other companies were already a step ahead of GM. When Calpers called up specialist chemical and medical products maker Mallinckrodt Group, for instance, to find out if it was following GM’s 28 principles, chairman Morton Moskin could reply that it already had a document of its own. And unlike General Motors, Mallinckrodt Group – which also won Wharton Business School’s Board of the Year award last year – had codified its ‘principles of corporate governance’ on its own initiative rather than under pressure from shareholders. The company had established a corporate governance committee, made up entirely of outsiders, to ensure that board procedures and performance would be continually evaluated.
Another company ahead of the game was Campbell Soup, which wrote its corporate governance principles into its proxy statement in 1993. ‘The impetus for doing so came from inside the company, specifically from the CEO,’ says IR officer Len Griehs. ‘We wanted to show shareholders that we were serious about corporate accountability and to lay down the principles that we were working to.’
The same governance guidelines have appeared in Campbell’s proxy statement every year since then and the company also produces a brochure outlining its governance principles. And they seem to have had the desired effect. Campbell Soup’s board was ranked the best in the US by Business Week this year and its governance guidelines ‘among the most stringent and far-reaching in corporate America.’ These include, for example, the requirement that all directors stand for annual election; that all executive officers own Campbell Soup stock equal to 1/2-3 times their basic salary; and that there be no interlocking directorships.
Producing a set of governance principles removes them from just being empty words, according to Griehs. ‘It forces a company to act on what it says and it provides shareholders with a means of bringing a company to account.’
Others seem less convinced. John Wilcox of Georgeson, one of the early proponents of governance principles, has pulled back from the idea. ‘It is enormously important that these sensitive issues are discussed but putting them into a formal document could well have the opposite effect and mean that they can just be filed away and ignored,’ Wilcox says.
He suggests that companies should concentrate instead on sharpening up their proxy statements. ‘The important issue is to improve communication channels between companies and their shareholders and the proxy statement is the ideal vehicle for doing this,’ he maintains. ‘Presently it is usually written by lawyers and is more about disclosure than communication. Shareholders need to know how their board is working and how the directors feel about, and what they are doing about, governance and performance issues.’
Ralph Ward, editor of The Corporate Board journal, has his doubts, too. In his book, The 21st Century Corporate Board, Ward says that the General Motors governance guidelines fell short in several key areas. ‘Despite some solid reforms, many of the governance tools to be used were carefully left blank. Items such as the committee structure, board size, mix of inside and outside directors, and former chief executive board membership waffled with “as the board may consider appropriate” qualifiers.’
But according to a recent survey, governance committees are nevertheless all the vogue right now. In Korn/Ferry International’s 1996 study of boards of directors, nearly half (49 per cent) of the 1,000 directors polled said that their boards had established formal committees to review corporate governance. That’s up from 41 per cent in 1995. Large industrial companies – with $5 bn and over in revenues – were found to be the most likely to have formed a governance committee, at 69 per cent.
‘The corporate governance committee can act as a central meeting point between the company and institutional investors and financial analysts,’ said one of the directors polled. ‘Every company is likely to encounter a crisis at some point and setting up a corporate governance committee is a sensible way of making sure that you are equipped to deal with it before you’re in too deep,’ commented another.
Wilcox disagrees, believing that this should already have been filled by the audit committees, nominating committees and compensation committees that have been established by most companies. ‘Most questions arise out of issues of nominations to the board and of executive compensation, which should already be dealt with.’
When a really big problem arises, a company needs to communicate directly with its shareholders, Wilcox says. Take ADM, for which Wilcox acts as proxy solicitor. The ‘supermarket to the world’ is currently under investigation for price fixing, ‘Prior to the annual meeting, we brought key company personnel together with three main investors putting forward shareholder proposals – Calpers, the state of Florida and the City of New York – and they will meet again next month,’ says Wilcox. ‘These people wouldn’t have been happy being fobbed off with some corporate governance committee.’
Although, according to the IRRC’s report on corporate governance guidelines, that’s exactly what ADM tried to do, releasing guidelines in January 1996 in the face of investor concerns that there were too many insiders on the board. Unfortunately for ADM it all backfired. The fact that the company’s guidelines specifically stated that the board should be made up of a majority of independent directors put the reality that a number of proposed new board nominees had links to the company into an even worse light that it would have been already. (For a fuller report on ADM, see the proxy story in this issue.)
Morrison Knudsen took a different approach. The Idaho-based company sacked its chairman and chief executive William Agee last year amid losses topping $500 mn. Allegations flew thick and fast in the media. Agee was reportedly siphoning off thousands of dollars from the company – to a pregnancy counselling service run by his wife, to give just one example among many.
The Morrison Knudsen board eventually dealt with the crisis facing the company by adding seven non-employee directors to the board and promising that the positions of chairman and chief executive would henceforth be separated. Until then, Agee had held both positions.
‘The idea was to create enough checks and balances so that a similar situation couldn’t arise again in the future,’ says Doug Brigam, investor relations officer at Morrison Knudsen. As for a governance committee or a governance document, ‘It just didn’t seem appropriate. In the middle of a crisis, our shareholders wanted to see that we were ready to act instead of just theorising about our principles,’ he says.
Morrison Knudsen apart, the fact that companies are taking positive steps to improve their corporate governance profiles – rather than simply reacting to demands from angry shareholders in a crisis situation – signals an important departure in the corporate governance debate. But the creation of corporate governance guidelines – and of corporate governance committees to ensure they are carried out – should not be viewed by companies as a corporate governance strategy in itself.
‘Creating a theoretical model is easy,’ says Georgeson’s John Wilcox. ‘Finding practical solutions is the more difficult, and much more essential issue.’
In crisis situations, in particular, companies need to convince shareholders and analysts alike that they are able to act decisively as well as theorise about their principles. The real question indeed, is whether addressing the governance issue as a theoretical matter, in isolation from shareholder or other pressures, will actually help a company either to avert or to deal more effectively with a real life crisis.
Perhaps the fact that no commentators seem able to produce examples of governance crises facing companies which have prepared well for them in advance, indicates that implementation of carefully considered structures, policies and practices for meeting the demands of good governance 1990s style really is a sensible course. To be sure, rigorous analysis of the issues in the absence of short-term pressures might just make it a good deal easier to diffuse and contain crises if and when they do arise.
Chemical Reaction
‘We have had our own internal corporate governance guidelines since the 1980s but we decided to formalise and publicise them three years ago so that our shareholders could have a insight into the board’s understanding of its duties and responsibilities,’ declares Cole Lannum, IR director at Mallinckrodt, the St Louis-based specialty chemicals company that won the 1995 Wharton School Board of the Year award. Mallinckrodt’s board was singled out as ‘a superb example of what can be accomplished when a board acts productively to add value.’ And the company was found to exhibit ‘a complete understanding of the board’s responsibilities to shareholders, management and employees.’
According to the judges, much of Mallinckrodt’s clarity of vision came from its governance guidelines, published each year in the annual report and proxy statement and available in extended form upon request. It lays out an explicit statement of the board’s duties and responsibilities, the board’s view of what management’s responsibilities are and the board’s view of how the board and management should interact.
The guidelines include statements to the effect that the optimal size of the board should be 12-13 with an absolute maximum of 16; the board should be made up entirely of non-employee directors, apart from the chairman, the CEO and the COO; and directors should have a mandatory holding of the company’s stock.
Deciding whether the roles of chairman and CEO should be split is left up to the board. But if those around the table favour a combined approach then they must also select an intermediary to interact between the board and CEO. The intermediary assumes an active role in the appraisal of the chief executive’s performance.
The guidelines also include formal procedures for selecting new director candidates, including a list of qualifications, periodically reviewed by the corporate governance committee. The committee is responsible for screening all prospective board candidates and for making recommendations for approval by the board.
‘I think the fundamental difference between our guidelines and those of some other companies is the way they were put together,’ says Lannum. ‘For companies just trying to appease their investors, the issuing of guidelines is mere window dressing, and is going to have no practical application. We positively wanted to put them forward and therefore it’s the spirit, and not just the letter, of the document that has meaning.’
Mallinckrodt’s governance principles have also evolved over time: ‘We didn’t just wake up one day and think oh we should get ourselves some principles,’ quips Lannum. And that is the basis of his main advice to companies looking for a model for corporate behaviour: Don’t go in search of the holy grail. There is no one perfect set of guidelines out there. What may be appropriate for one company may be wholly inappropriate for another.
‘A document that is generically put together will remain just a document rather than providing shareholders with genuine confidence in the board,’ adds Lannum.
Guidelines on Guidelines
Matt McGeary is not wholly convinced. He has seen an increasing number of corporate governance guidelines appear at S&P 500 companies over the last two years and yet many seem to have missed the mark.
‘The whole point of developing corporate governance guidelines is to have the board sit down and consider these issues,’ says McGeary, senior analyst at the Investor Responsibility Research Center in Washington. He believes that what actually emerges in the final document is not as important as getting directors to think about the structures and practices the company has in place. If one approach does not work at a particular company then so be it. But tell the investment community how you reached that conclusion.
McGeary’s suspicions that such discussions are not taking place at many of the companies which have released guidelines are backed up by the similarities between the documents. IRRC started to see a lot of guidelines released in 1995 and that was the impetus behind a bigger study this year. Unfortunately, many are ‘nearly exactly’ like the General Motors’ guidelines. ‘In fact, more than 40 per cent of all guidelines gathered by IRRC use the same language and categories as GM,’ says McGeary. And that hardly suggests that each company has thought deeply about the process.
It seems that the ease of copying GM’s widely lauded approach is too much of a temptation for many of the companies looked at by IRRC. As McGeary says, when Calpers gave out its grades for approaches to corporate governance the quick-fix option for those at the bottom of the pile was to look to the lead of GM. Others have followed suit.
The opposing line is that those companies had such guidelines or policies in place for a couple of years before GM hit the headlines. They simply had not written them down and publicised such policies. McGeary acknowledges the possibility of such an argument but you get the feeling that he remains doubtful.
IRRC’s study of board practices reveals that a number of companies have recently overhauled their guidelines – these include Allergan, Ceridian, Chrysler, Compaq Computer and NorAm Energy. For those thinking of implementing or reviewing their own guidelines, what is popular this year?
‘A lot of the institutions which look at guidelines, such as Calpers, are stressing board performance and accountability,’ says McGeary. ‘For example, the concept of an independent lead director will be pushed again.’ In such cases, one of the independent directors is nominated as a spokesperson for the other independents on the board. No extra powers are conferred on the ‘lead’; it is merely a role of organising meetings between the independents and ensuring they are active.
McGeary also thinks that there will be more of a focus on board evaluation of the CEO, the board as a whole and individual directors. ‘A lot of institutional investors are speaking favourably about this process,’ he says. The theory is that if the board is constantly evaluating its own activities – both separately and as a group – it is less likely to run into trouble.There is, however, opposition from companies to the evaluation of individual directors by other members of the board. As McGeary points out, in a large corporation you may have several CEOs from different companies sitting around the same table: ‘There are some pretty big egos out there.’
Charming Charming Approach
Being targeted by Calpers as one of its poorest performers last year forced Charming Shoppes to rethink its governance strategy. The company had declared devastating pre-tax losses of $112 mn and been forced to close down hundreds of underperforming stores, eliminating about a third of all personnel. In addition it seemed to be fighting a losing battle to convince the banks to provide working capital to stave off bankruptcy.
The first step the company took was to appoint a new chief executive, Dorrit Bern. She managed to convince the banks that the company was capable of making the necessary changes to turn things around and they agreed to a working capital deal. Bern also got rid of much of the company’s senior management team, replacing them with hotshots from her former company, Sears Roebuck.
In line with Calpers recommendation to separate the chairman and chief executive positions, the board appointed a new chairman, too. Joseph Castle, a non-executive board director for the previous seven years became chairman; and two new outside directors were appointed. The only remaining member of the board who was an employee of the company was Dorrit Bern.
‘This marked a major change in our philosophy,’ says Bernard Brodsky, Charming Shoppes’ IR director. Bern was the first female ever to have sat on the board and the board decided that diversity would become one of its governing principles for the future. The company also decided to align the directors’ interests with its shareholders by encouraging them to shift cash compensation into stock equivalents.
‘We didn’t want to put anything in writing though,’ says Brodsky. ‘The idea of fixing a set of principles in stone just didn’t seem particularly valuable. Shareholders want to know that a company is going to do whatever is best for its future. That requires a certain degree of fluidity that a set of rules doesn’t allow for.’
Although having a diverse board is important, Brodsky notes, a company’s priority should always be to appoint the best candidate; having a set rule on the matter might get in the way of that goal.
As for establishing a corporate governance committee, Brodsky is also rather sceptical: ‘We have compensation and audit committees to deal with specific issues, and as for more general governance matters, well that’s the responsibility of the whole board.’ The board, he points out, is kept purposefully small – presently it has only six members – all of whom would be essential components of a governance committee.
And committee or no committee, Charming Shoppes’ corporate governance changes seem to be getting the right results. First quarter figures showed the company was breaking even and now, a year after its initial meetings with Calpers, it is starting to show profit.
Eaux so Ethiccal
Not so long ago Lyonnaise des Eaux was being hauled over the coals for its poor corporate governance record. The French utilities and urban development group was alleged to have benefited from what one might term very close links between politicians and executives.
More recently, its corporate governance approach has been grabbing headlines for entirely different reasons. Brussels-based consultancy D?minor lauded Lyonnaise des Eaux as one of the top five French companies for good corporate governance and disclosure in a survey of Europe’s largest companies this fall. So what has happened in the intervening period?
The simple answer is that top management decided things could not go on as they were and actively sought to put the house in order. From late 1994 and throughout 1995 the company was subject to an ‘ethical’ drive to sweep out bad practice and make its story more appealing to both investors and customers.
Patrick Ayoub, head of investor relations at Lyonnaise des Eaux, says that the reforms came in three stages. First, in November 1994, there was a ‘quick fix’ option to prohibit political financing at any level within the company. Since this was the nub of much of the criticism being levelled at Lyonnaise around that time, Ayoub believes it was symbolically important for the company’s internal policy to be put in order before the French regulatory authorities pushed through a bill to the same effect in early 1995.
Next up was the creation and distribution of a code of ethics to all members of the workforce. Ayoub says that managers went through ‘extensive’ training to ensure that they fully understood the code which governed both everyday working practices and internal reporting measures. Each business within the group appointed an ethics coordinator to report back to headquarters.
Finally, top management signed letters of compliance with the ethical code as an example to the rest of the workforce and an assurance to international investors that something positive was being done to root out any bad practice. Ayoub says that it was important to move from an ‘oral to a written culture’ and the group reacted quickly to the move. ‘If you have a commitment from top management then the rest of the workforce will follow,’ he says.
That ethical code does not just mean that everyone in the company is bound to behave themselves, though. The company has been revitalised with a culture of openness which offers significant benefits to investors. The reorganisation resulted in the appointment of foreign, non-executive directors to balance the board; the creation of three board sub-committees responsible for overseeing audit, remuneration and ethical policies; and the appointment of a director of ethical policy within the group. Those members of management caught up in the allegations of corruption and the like have been ousted.
Just take a look at the company’s latest annual report to get an idea of the cultural shift. There is a three-page description of the activities and policies of the audit, remuneration and ethics committees. Indeed, there is even some information on the compensation of board directors and other senior officers – something which remains rare in France. Chairman Jerome Monrod has even allowed his own remuneration to be detailed separately, including his stock options.
Lyonnaise des Eaux’s reforms may not be ground-breaking stuff by Anglo-Saxon standards, but among peers in France they have provided a leading light. Significantly, the company’s moves were implemented before the release of the Vienot report on corporate governance in the summer of 1995. And they go further than Vienot’s recommendations, too. Considering where it was around two years ago, the transformation of Lyonnaise des Eaux has been fairly radical. Mind you, as Ayoub points out, ‘Even if it was insinuated that there were a few black sheep in the past it does not mean that the integrity of all our employees should be questioned.’
