New world order in the boardroom.

• Author: Freidheim, Cyrus F., Jr.

How will corporations be governed in the future? Here are the powerful forces that will drive change, and how the best boards will respond.

In life there are many occupations and activities we assume people are prepared for, with no training whatsoever. Fatherhood jumps to mind. And our golf courses are filled on weekends with do-it-yourself athletes.

Boards of directors fit into this category, until recently. The press and large institutional shareholders about a decade ago began demanding that corporate boards change. Rightly or wrongly, boards were widely seen as effective, cozy clubs that did little more than attend presentations and receive the hefty fees and lofty perks that membership afforded.

In response, boards began to change. The percentage of insiders began to drop dramatically, and some boards began to take a more activist approach. There was a spate of news articles praising those activist boards, and people could point to examples such as General Motors, IBM, and Kmart where the boards were willing to take dramatic action when the CEO was not.

Yet, if you look a little deeper, it doesn't seem that things have gotten demonstrably better. There doesn't seem to be a month that goes by without someone asking, "Where was the board of directors?" in the aftermath of another company failure. We often seem closer to the old days than the dawning of some new era.

As managers and investors wrestle with the changes that are cascading down on companies and their boards, we must ask two questions:

First, is something fundamentally wrong with the governance system?

Second, will the system we have lived with for centuries work for the future?

These are important questions and they deserve more than an off-hand response. The following observations are based on two major research projects that included interviews with 100 CEOs and directors in several countries, conferences on governance that Booz*Allen jointly sponsored with the Kellogg School of Northwestern University, in addition to my own experience with a number of boards in several countries over my 30-year consulting career.

The results of this research suggest it is time to institute a new world order in the boardroom. The reasons why are not hard to understand.

We face, quite frankly, a world-class problem. Our capitalist system depends on the wisdom, values and action of boards, and yet:

* Corporate failures large and small are frequent, despite an elegant roster of directors.

* Despite the attempt at reforms, the majority of boards, though better informed, continue to be membership clubs where submissive behavior is the norm, except in crisis.

* We are struggling to align the legitimate interests of owners and managers/employees.

* Business is now global, but boards remain national.

To understand, it is important to put the problem into an historical context. This context not only explains today's conflicts, but it also provides a way out of the morass.

The Four Stages of Corporate Evolution

We see governance evolving over four periods:

The Age Of Dynasties. This age runs from the beginning of time through the Depression. During this period, the interests of owners and managers were almost perfectly aligned.

The Age of Hired Kings. Born with the U.S. Securities Act of 1933, it died somewhere around 1973. This was a time when share ownership became dispersed and professional CEOs, who often owned little or no stock in the company, achieved extraordinary power, often without the consent of owners. During these four decades, the link between owner and manager was ruptured.

The Reformation. This 20-year period, circa 1973-1993, was characterized by the rise of institutions as substitute majority owners, and by the struggle to reconnect ownership and management

The Future. We don't know whether this will be a Renaissance, in which owner/manager interests become realigned, or whether it will become an age of Reconstruction, which grapples with new realities of competition, alliances, and global businesses, all of which demand new forms of governance.

What is clear is what it takes to govern effectively has changed dramatically. Those companies with effective boards, we believe, will be competitively advantaged. Those who fall behind, do so at their peril.

But before we explain what needs to change, let's review how we got to where we are today.

The Age Of Dynasties

Some form of governance has been around forever. Leaders have always had their advisers. The Pharaohs had their councils; Christ had his 12 apostles (the optimum board size?); and Louis XIV had his ministers.

The first period of governance, the Age of Dynasties, lasted for centuries and ended with the Great Depression. This period was characterized by a close alignment of owner and management interests. That isn't surprising since the owners either were the managers or had direct control over the managers they hired.

This period saw the evolution of the family enterprise. Business everywhere was a family or state affair. The Medicis, the shoguns, and the barons all owned and controlled their businesses.

With the advent of the public equity markets, ownership mutated into its current representative form. For the Western world, that occurred sometime in the late 18th Century. Public equity markets introduced stakeholders who, while outside the family's inner circle, still wanted to be represented. Stock markets became important in the U.S., Europe, and the Commonwealth countries during the last 100 years of the Dynasty period. This was in contrast to what was happening in Asia, which maintained a family style of ownership and governance. While stock markets were developing in the West, Japan saw the evolution of powerful zaibatsu, and the Taipans were coming to power in Hong Kong.

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