Duty, honor, company.

• Author: Bruce, Harry J.
• Position: Boards of directors - Includes related article on corporate governance perception - Cover Story

Boards don't need reform so much as they need a renewed sense of their responsibilities and powers and a willingness to exercise them on behalf of the shareholders.

Like most American executives who came up through the managerial ranks during the 1960s and '70s, I had no preparation, formal or informal, for the issues of corporate governance that ultimately confronted me when I became CEO. The business schools of that time did not teach corporate governance, nor was the subject considered appropriate for on-the-job executive training. If managers thought about governance at all, they probably assumed that it was somewhat of an arcane or even occult art practiced only by lofty initiates in some sacred chamber off limits to those who actually ran the company. I believe most of us on the senior-management track just assumed that if we ever made it into the boardroom we would pick up whatever we needed to know once we got there by discretely observing the veteran directors and gradually assimilating their behavior. The focus was entirely on director style because directors seemed to have little to do with matters of substance.

By the time I became a CEO in 1983, however, the unrelenting buildup of challenges threatening U.S. corporations had rendered the classic don't-speak-until-spoken-to standard of director behavior obsolete. In my own industry, railroad freight transportation, the shock of deregulation in 1980 unleashed competitive forces that no living railroad executive had ever experienced. Members of the airline fraternity had already taken a dash of cold water a year earlier, while a year later, in 1981, a whole slate of blue-chip trucking firms began folding as their overwhelmed managers floundered in the turbulence stirred up by aggressively competitive new startup carriers.

Nor were industries in non-regulated sectors of the economy spared; they suffered shocks of their own as better-managed overseas competitors successfully challenged U.S. dominance in autos, electronics, steel, furniture, footwear, clothing and athletic equipment. And let's not forget one of America's premier home-grown industries, mass merchandising, which reeled as brash domestic newcomers such as Wal-Mart and Venture snatched market share away from those comfortable titans, Sears, Montgomery Ward, and Kmart.

It would be reassuring to report that the boards of directors of America's threatened corporations became alarmed at the inability of their managements to deal with the new challenges of the 1980s and moved swiftly to replace their unprepared CEOs with more capable leaders.

But this is not what happened. For a substantial period during the 1980s, the board's historic responsibility for replacing ineffective management was usurped by a new genus of corporate player, the leveraged-buyout specialist, who used borrowed money collateralized by the target corporation's own assets to buy control of an underperforming company and replace its top management as well as its board. Sad to say, it was raiders, not directors, who ignited the current concern over governance reform. Most directors had to be led to reform by realizing that inattention to CEO performance could cost them their own jobs in a hostile takeover. As Samuel Johnson remarked,"The prospect that one is to be hanged in a fortnight concentrates the mind wonderfully."

I know it concentrated mine. As our management team strove to modernize its deregulated railroad, and as we approached January 3, 1989, the date when our parent company, IC Industries, would spin the railroad company off to the shareholders as a free-standing, publicly traded corporation listed on the New York Stock Exchange, I realized that assembling an effective board would be among the most important decisions I would make as CEO.

Ultimately, I was successful. A compact board of six outside directors, all of them experienced CEOs in their own fields, turned out to be virtually the ideal number. They communicated easily, absorbed information well, deliberated effectively, and did an excellent job of guiding the enterprise through the challenges and opportunities that arose.

But other companies were not so fortunate. Elsewhere in Corporate America, leveraged-buyout firms were identifying underperforming companies and supplying them with new ownership, management, and governance. Still other companies with sleepwalking managements and passive directors were too far gone to attract this type of rescue. They filed for bankruptcy, or even liquidated, often after a series of ill-considered and futile attempts at radical downsizing, restructuring, or employee ownership. Another class of companies too large to be taken over simply treaded water as shareholder value eroded. Where, one wonders, were the boards of General Motors, American Express, Sears, and Eastern Airlines?

Approximately 10 years after the tocsin sounded, other voices were asking similar questions. Managers of the larger pension and investment funds, activist Wall Street lawyers, and a growing number of academics began reviewing the historic role of the board of directors. Soon the nation's news media joined the chorus of those asking how directors get their jobs, view their jobs, and perform their jobs.

What can be learned from this long-overdue re-examination of the board and its work? Primarily, that while corporate governance can be complex, any intelligent director should be able to navigate through the complexities if he or she remains mindful that under all the complexity lies a fundamental simplicity known as fiduciary duty. This basic duty is made up of three components:

* Directors are there to hold the CEO and his associates accountable for preserving and enhancing shareholder value.

* The chief tool they use to exercise this accountability is their power to hire, evaluate, and replace the chief executive officer.

* And, existing law gives them all the power they need to carry out these functions.

The following reflections are an attempt to elaborate and illustrate those fundamental ideas.

'Empowering' the board

What does "empowering" the board mean? The power of the board has always been there. The problem was that in many cases it simply wasn't being used. Power not used is power lost. Now who will "re-empower" the board? Certainly it will not be the CEO. How can he bestow what was never his to bestow in the first place? The board's authority and powers do not flow from the CEO. They are derived from centuries of court decisions - first in Great Britain and then in the U.S. - which have ruled that directors of corporations have a fiduciary responsibility to the shareholders under which they owe the duty of loyalty and the duty of care. It is shareholder investment which legitimizes management's power and the director's authority to monitor and oversee the way management exercises that power.

The phrase "Empowering the Board" dates from the January/February 1995 issue of the Harvard Business Review, where it was used as the title of an article by Harvard Business School Professor Jay W. Lorsch. This article also suggests that boards appoint a "lead director." While the article makes a number of helpful observations, it sidesteps the question of why boards need energizing by a lead director when they already have the authority to take all necessary governance measures, including that of replacing the CEO.

Perhaps what boards really need is not so much a new structure or additional titles but rather a renewed sense of their responsibilities and powers and a willingness to exercise them. As governance guru Nell Minow is fond of saying, "Any smart lawyer will tell you there are limits to structural solutions." The CEOs known to...