Restoration project: respect for the board: vital to recovery from the Great Recession is reestablishing confidence in the board's ability to serve shareholder interests. Four factors fundamental to board effectiveness require focus.

• Author: Madden, John J.
• Position: GOVERNANCE LEADERSHIP

ONE OF THE MOST striking phenomena arising from the financial and broader economic crisis that brought on the Great Recession is the widespread and increasingly vocal criticism of corporate boards of directors. The criticism comes not only from the traditional shareholder activist community but also from regulators, politicians, academics, and the investing public at large, and centers on claims of boards' failures to adequately serve and protect shareholder interests. While the most severe and widely reported criticism has been focused on some of the country's most well-known financial institutions, the criticism has spread broadly across market sectors.

Despite the substantial reforms adopted earlier in this decade following the failures of companies such as Enron and WorldCom--including the requirements imposed by the Sarbanes-Oxley Act and new stock exchange regulations on the composition and functioning of boards and their committees--and the resulting increased focus by boards on the effective discharge of their responsibilities, the current crisis has brought forward a new and forceful wave of board scrutiny. This enhanced scrutiny has stimulated calls for greater "shareholder democracy"--as investors, regulators, politicians, and market commentators have, to varying degrees, expressed a loss of confidence in the effectiveness of boards in properly serving shareholders' interests. Even the Securities and Exchange Commission, in recently proposing its new regulation on shareholder access to corporate proxy statements for director nominations, prominently cites the "serious concerns about the accountability and responsiveness of some companies and boards of directors to the interests of shareholders" and the resulting loss of investor confidence.

The clarion call now being sounded for shareholder democracy is focused both on how directors should be nominated and elected, and on the authority they have as directors. As directors are well aware, shareholder activists and others have been urging access to proxy statements, annual election of directors, majority voting in director elections, and separation of the chairperson and chief executive positions for some time, as well as the redemption of poison pills and a say in management compensation. Their efforts to date have met with some significant success--by December 2008 almost half of all S&P 500 companies had made the switch to majority voting, only a third of the Fortune 500 still had classified boards, and less than 20% of the Fortune 500 had poison pills in place. And the SEC's recent decision to eliminate broker discretionary voting in director elections will enhance the influence of activists and institutional, or non-retail, investors. The longstanding, although historically largely unsuccessful, effort to separate the roles of chairperson and chief executive in the U.S. has been gaining more support, as have "say on pay" shareholder proposals.

While history shows that periods of excess and crisis in the markets are often followed by reform, the momentum for significant and speedy action can lead to overreaction and inadequate consideration of cost-effectiveness and unintended consequences.

The various initiatives for governance reform currently being pursued, taken together, represent a significant acceleration and expansion of the changes in the relationship between shareholders and boards away from the director-centric model of corporate decision making that has prevailed in the governance of public corporations in the United States for almost a century. And there is no evidence that a more shareholder-centric model, while more democratic in principle, would be more, or even as, effective in building long-term value for the benefit of the shareholders as a whole and in serving the interests of the other constituencies important to a corporation's prosperity.

Moreover, the relative consistency of the several initiatives would seem to call for thoughtful consideration--the more involvement and influence shareholders have over the director nomination and electoral process, presumably the less involvement and influence they would need in the actual management decision making of their company.

Just as recovery from the current crisis requires restoration of business confidence, an important part of that restoration is the reestablishment of confidence in and respect for the effectiveness of boards in serving shareholders' interests. Reestablishment of that confidence is necessary as a substantive matter and, as importantly, to temper the drive for broad-based change until the consequences are fully considered.

Accordingly, it is important for boards to acknowledge this changing dynamic and proactively take the steps necessary to restore that confidence and retain the essential role the board has traditionally performed in the leadership and oversight...