Re-empowering the board.

• Author: Parker, Hugh
• Position: Corporate governance

The key to improved corporate governance lies in finding new sources of truly independent directors. An idea worth exploring is to 'professionalize' the board.

"When an institution malfunctions as consistently as boards of directors have in nearly every major fiasco of the last forty or fifty years, it is futile to blame men. It is the institution that malfunctions." - Peter Drucker

Partly as a result of some well-publicized "major fiascoes" in the higher echelons of corporate America and partly as the result of persistent initiatives by such shareholder activists as Robert Monks, steps have been taken in recent years to obviate some of the more egregious boardroom malpractices. But many of these have been largely procedural or cosmetic changes aimed at improving the perception of boards' effectiveness rather than attacking the problem at its root.

So, what is the real problem?

The Romans made an important and still valid distinction between 'autoritas' (authority) and 'potestas' (power). In most American companies there is a dangerous imbalance between the actual power of the CEO and his management on the one hand, and the nominal authority, on the other hand, of the board by which he is officially appointed and to which he is legally accountable. The practical result of this imbalance is that the typical CEO today is vested with executive authority equivalent to that of the president of the United States, but without the countervailing restraints of an independently elected Congress.

In the absence of such restraints, the CEO's delegated authority can become absolute power. The board's authority, vested in it by statute and bylaws, becomes effectively powerless. That is the root of the problem that must be addressed.

Any program aimed at bringing about significant changes in the present practices of corporate governance will require many years of sustained pressure and effort by shareholders. The essential first step, however, must be that the institutional investors, now holding 55% of corporate equity, declare their full commitment to that goal. Without that commitment, no significant progress can be achieved. Theirs is the only leverage by which boards of directors can hope to take back their legitimate power, power they have ceded by default to ambitious and strong-willed CEOs.

Before acting to reverse board disempowerment, it is necessary to analyze and understand the factors that have caused it in the first place. Such a complex problem must be attacked holistically if it is to be resolved at all. Picking at its component parts - e.g., by simply increasing the ratio of outsider to officer directors, or creating new oversight committees - will not be enough. The long-term objective is nothing less than a fundamental reform of boardroom attitudes and practices. This will level the playing field on which directors engage their CEOs.

Why Boards Are Ineffectual

In spite of all the attention focused in recent years on the quality of corporate governance and in spite of steps taken to improve them, boards today are still only marginally more effective than they were 10 years ago. On a scale of 1 to 10, they collectively may have moved from, say, 2 or 3 to maybe 4 or 5. There is plenty of scope for significant further improvement. Here are some of the underlying reasons for this systemic weakness of boards of directors.

Reason 1: Boards of directors, both in the U.K. where they were invented in the early 19th century and in the U.S. where they were adapted and adopted later, have rarely if ever fully and effectively performed the basic trustee role for which they are legally accountable to the shareholders. By tradition and long habit, boards of directors in both countries have always been more or less honorary and powerless bodies of which little effective action has either been wanted or expected. Board meetings have typically consisted (and still do) largely of routine rituals through which they are led by chairmen and CEOs. They can and generally do control the agenda. In short, while boards may have the legal authority, CEOs have the effective power.

Reason 2: This traditional imbalance suits most CEOs perfectly. The very title "chief executive officer" confers on that officer near-absolute authority and power, especially when combined with the title of chairman. Attempts by some boards to regain some of these powers have so far only succeeded in crisis situations - e.g., by the General Motors board in 1993. But even then, instead of consolidating their newly regained power, the aroused GM board formulated a set of "guidelines" that are largely symbolic. Although clearly intended to give the impression that the new GM board is firmly in control, these guidelines are worded so tentatively and flexibly that the old imbalance of real power remains virtually unchanged.

Reason 3: Combining the offices of board chairman and CEO in one person virtually guarantees that the board will be ineffectual. A strong and effective board can only be so under the leadership of a strong and independent chairman - a combination that few CEOs are likely to welcome. There are a few absolute rules about effective corporate governance. Perhaps the most crucial one is the imperative of separating the roles of chairman and CEO. An independent chairman must, when necessary, be able to look his CEO in the eye and say, "My board and I do not agree on this issue with you and your management." This clearly will never happen if the two offices are combined.

Reason 4: Most U.S. boards are simply too big. In 1994, 80% of the Fortune 500 companies had boards with 12 or more members, and 40% had 15 or more. The reasons for these high boardroom numbers seem to be:

(a) a general misunderstanding of what a board is supposed to do;

(b) a belief that a lot of distinguished names and rifles will impress investors;

(c) a desire by the CEO to include as many fellow-CEOs and old friends as possible; and

(d) pressures to make a board look fully "representative."

A fifth unspoken and often perhaps subconscious motive...