Using directors as consultants.

• Author: Martin, John D.

Carefully consider the 'costs' of entering into such a relationship as well as the benefits. Here are some key trends and issues.

Outside director pay and perquisites are being scrutinized with increasing frequency by shareholder activists, corporate advisory groups, and the financial press. Consulting fees being received by board members is an area of particular and growing interest, not only to outside observers but also to some board participants as well. For example, the Investor Responsibility Research Center reports that in 1996, for the first time, shareholder proposals in proxy statements included prohibitions on non-employee directors receiving consulting fees from the companies on whose boards they serve. Furthermore, in 1995 a commission formed by National Association of Corporate Directors (NACD) to study director compensation recommended that boards adopt a policy stating that a company should not hire a director or a director's firm to provide professional or financial services to the corporation.

At issue is director independence. A director's independence can be called into question if the director or his or her employer has a business relationship with the firm that extends beyond normal director responsibilities. The cost to shareholders when board independence is compromised can far outweigh the dollar value of any compensation received by senior executives. A board that is beholden to its management may approve projects that destroy shareholder value, may overpay managers, or may look the other way when managers are performing poorly.

Nell Minow, a principal at the LENS Fund and member of the NACD study commission, summarized the issue of director independence as follows: "A director is a monitor, an advisor, a sounding board, a reality check, a resource, and a market test. What he cannot be is a hired gun. A consultant has a customer - management. The customer is always right. A director, on the other hand, has a fiduciary obligation to the shareholders. It is his job to tell management when it is wrong. No one can serve in both roles at the same time."

Concerns about outside director independence are not new. However, increased activism on the part of shareholder rights groups and large investors such as the California Public Employees' Retirement System (CalPERS) have recently focused the public's attention on these concerns. Public pressure has prompted some firms, including General Motors Corp. and W. R. Grace & Co., to adopt corporate governance guidelines requiring a majority of "independent non-employee directors." These plans, which define independent non-employee directors as directors who have no significant relationship with the firm other than their board responsibilities, limit opportunities for outside directors to maintain other business relationships with the firms on whose boards they sit. Others, such as American Express Co., have adopted policies that explicitly prohibit using directors as paid...