The 20th century company meets the 21st century board.

• Author: Augustine, Norman R.
• Position: Putting In Place the Right Board for the 21st Century

An increasingly Darwinian 21st Century lies ahead. Boards must resolve some lingering governance issues and be ready to embrace a board model with distinctive new features.

1. The modern board--on its 400th birthday

   ON DECEMBER 31, 1600, history was made in London when 218 merchants were granted a royal charter to engage in a Far East trading enterprise, which became known as the "English East India Company." This early version of a multinational corporation was different from other chartered institutions of the era in that it was essentially self-regulating. To guide the fledgling enterprise, the shareholders elected a Court of Committees comprised of the governor, the deputy governor, and 24 "committees" -- or what we now call directors.

   The ultimate impact of the enterprise begun on New Year's Eve some four centuries ago is evident today in the extraordinary development of the publicly owned, director-guided corporation. Along with colonists, this concept crossed the Atlantic and took root in the nascent United States of America. The corporation played a major role in the great economic leaps of the burgeoning nation in the 1800s and 1900s, providing the financial framework for prominent industrialists who, as they aggregated immense personal fortunes, built great industries ranging from oil and banking to railroads and telegraphs -- and in the process made shareholders rich. In those days, of course, directors tended to be either the owners themselves or fellow executives from interlocking companies -- the latter of which, in today's America, would be deemed potentially illegal conflicts of interest.

   After World War II, with much of European and Japanese industry in ruins, America's corporations by contrast entered a golden era of profitable growth. Through the 1950s and 1960s, after-tax profits averaged about 10%, and American products set the standard for world markets. Ownership had passed from the powerful families of an earlier era to a highly diffuse set of shareholders. In the boardroom, directors enjoyed a "sea of tranquillity" perhaps best epitomized by the "36-3" maxim attributed to some who sat on the boards of financial institutions: "Pay 3% interest on deposits, charge 6% for loans, and be on the golf course by 3 p.m."

   But the golden era of the boardroom began to tarnish in the 1970s, as resurrected Japanese and German industries challenged American leadership in steel, automobiles, electronics, and a variety of other markets. As a result, directors of American corporations suddenly found themselves contemplating previously inconceivable actions, including widespread employee layoffs.

   Then, in the 1980s, several other trends converged on the boardroom, taking directors out of their largely unseen roles and thrusting them front and center in the forum of public opinion. A series of highly publicized attempts to engineer hostile takeovers and leveraged buyouts forced directors to choose between larger short-term returns for the shareholders -- often resulting in significant human costs in terms of jobs eliminated and even the possibility of eventual bankruptcy -- and the company's long-term prospects.

   At the same time, institutional ownership of stocks grew explosively from about 5% of all corporate equity in 1950 to more than 30% in 1980 and nearly 50% today -- concentrating ownership once again in the hands of a few powerful investors or coalitions of investors. The time-tested means of expressing dissatisfaction with a company's performance -- namely, "If you don't like the way the company is run, sell your stock" -- was superseded by a new phenomenon, "shareholder activism" which was the effort by institutional investors to have a more assertive voice with the board regarding corporate governance and performance. This movement took many forms, but none more prominent than the Council of Institutional Investors Focus List of Underperforming Companies. Boards and managements alike got the message. "This CII list is a list we don't want to be on, and we're doing everything we can to get off it" one CEO was quoted as saying.

   As if directors did not have enough on their plates, the liability explosion simultaneously rocked the boardroom. In the 1991-1994 period alone, according to National Economic Research Associates, class-action lawsuits resulted in more than 300 out-of-court settlements being reached, with some $2.5 billion being awarded to plaintiffs. During this period, I once was offered some very sagacious, if tongue-in-cheek, advice from the head of a large insurance company on how directors can avoid such lawsuits: "Always vote last and always vote with the minority," he counseled.

   Reflecting this convergence of explosive issues, heretofore unthinkable skirmishes between boards and key executives became much more common -- and public. Boardroom "revolts" in such blue-chip companies as General Motors, American Express, IBM, Sears, and Kmart virtually eliminated the notion of the chief executive being all-powerful and unaccountable. And these skirmishes seemed to yield results -- at least as indicated by one admittedly small sampling of five of the most publicized boardroom decisions to replace the CEO. In these instances, the companies averaged a 7% negative rate of return for the two years prior to the change and an 83% positive rate of return for the three years following.

   Whatever else might be said, as we close out the 20th Century the sea of tranquillity that once characterized the boardroom had become an ocean of turbulence.

2. What's new? The 21st Century

   From the tentative beginnings of cross-border corporate activity 400 years ago, we are now being propelled more and more into the instantaneous, global marketplace -- a development which will profoundly affect the boards of companies engaging in that marketplace.

   Globalization of markets has been made a reality principally by two extraordinary developments: The first of these is modern transportation -- and especially the modern jet aircraft that can move people and products around the world in hours. It is now commonplace to find fish from Nova Scotia being sold the next day in Los Angeles, flowers from Holland being marketed in Buenos Aires, strawberries from California being found on store shelves in Tokyo, and tomatoes from Israel being retailed in New York.

   The second key...