Tyco's betrayal of board governance.

• Author: Levensohn, Pascal N.
• Position: Board Accountability - Column

From this tangled web of related-party transactions, intra-board lawsuits, personal tax evasion indictments, and other value- and trust-destroying exploits, some recommendations for director accountability readily suggest themselves.

SERIAL REVELATIONS of self-dealing by Tyco International's former CEO, its former general counsel, and individual members of the board of directors paint a shameful canvas of derelict corporate governance in the Tyco boardroom. Under scrutiny from investors and regulators alike, the Tyco board has adopted a finger-pointing and blame-shifting approach in response to the charges leveled against management and the company. This may help some board members save face, but there is no denying that something was seriously awry in the Tyco boardroom for many years.

With powerful rights come equally powerful responsibilities. If public company directors have the right to attractive cash and stock option compensation packages, to the prestige associated with their positions, and to exercise the power corporate strategy, they also have the responsibility to be proactive in their oversight and to ask the hard questions of the CEO before trouble is irreversible. In my opinion, the Tyco board of directors has failed to acknowledge that it abdicated its responsibilities to the owners of the company -- the shareholders -- thereby compromising the board's rights to the benefits of directing the future of this company.

In examining the Tyco governance record, we draw three conclusions that may be helpful to other companies so that they may avoid breeding governance cultures that allow conflicts of interest to flourish: first, that boards must be proactive in their oversight of company management; second, that a board with a majority of independent directors should also include a diversity of skills, favoring directors with operating experience; and third, that aligning director interests with shareholder interests through stock ownership should be balanced by establishing a reserve system for realizing gains that is long-term in its construction.

Even in the context of the acquisitive 1990s, Tyco was one of the most acquisitive, having amassed a collection of companies for a total of over $60 billion in cash and stock over the past decade. Until January of this year, Tyco had brought the conglomerate concept to levels of investor acceptance not seen since the glory days of Gulf & Western, and its management made a science of creating accounting and tax loophole exploitation. Along the way, the company's growth under CEO Dennis Kozlowski generated both controversy and, for some, great success. From January 1996 to December 2001, Tyco's common stock appreciated at a compound rate of 37%, compared to 11% for the S&P 500. Tyco's market capitalization as of December 31, 2001, was $116.3 billion, making it one of the top 20-valued public companies listed on the New York Stock Exchange.

But the Tyco edifice crumbled in 2002. In the six months since December 31, the actions, inactions, and reversals of actions by the Tyco board have cost common equity owners approximately $88 billion in lost shareholder value (through June 24), which is roughly three-times the $33 billion in equity losses triggered by the Enron implosion and almost twice the equity losses in WorldCom year to date.

Accident avoidance

How can a company avoid this type of accident-waiting-to-happen in the boardroom? Three years ago I wrote an article for DIRECTORS & BOARDS ["The Problem of Emotion in the Boardroom," Spring 1999] that analyzed, in the context of the takeover battle for AMP Inc., the disproportionate influence of former AMP CEOs on the AMP board. I expressed the view that former CEOs of companies do not make very good independent-minded directors because "It is naturally very difficult to move a CEO aside, have him remain a voting board member, and proceed to undo major projects that this person has previously done with the board's blessing. When more than one former CEO remains on the board, this problem is magnified. Retired senior executives have a natural tendency to glorify their exploits and to treasure past contributions as well as to protect one another and their reputations. It is therefore extremely risky to keep them at the table."

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