MORE BARE KNUCKLES IN THE BOARDROOM: Bringing Back Ethics In Business

The blame for unethical behavior by US companies of late rests squarely, albeit not directly, on the shareholders of those companies. Directly to blame are the directors, elected by those shareholders, who failed to adequately exercise their corporate governance responsibilities.

Too many boards of directors, afraid to challenge megalomaniac CEOs, have surrendered control to individuals who are more concerned about their personal aggrandizement than about the continued prosperity of their companies. It is time for boards to step up to their primary responsibility to increase the value of shareholders investment over time. It is past time for shareholders, and other stakeholders, to demand that they do so.

Directors have to remember that they are ultimately responsible since the CEO and other executives work for them, not vice versa. Yet even companies with boards comprised overwhelmingly of outside directors can have them act as no more than a rubber stamp for the CEO. While directors should, and usually do, work cooperatively with the company management toward the common goal of increasing the company's value, the directors need to take off the gloves and fight for what's right when conflict occurs.

An appropriate amount of tension between the board and the company executives is a good thing. It keeps both groups alert and focused to their part of making the company successful. The board must maintain the balance between frequently contradictory concerns of short term versus long term and shareholder interest versus the desires of the larger community of stakeholders.

In the aftermath of scandal, many groups have offered suggestions to improve boards of directors and their value to their companies. From the UK's Cadbury Committee report in 1993 to the National Association of Corporate Directors (NACD) recommendations to Congress after the Enron scandal, these suggestions are aimed at restoring investor confidence and forestalling further governmental regulation.

I believe that the incentive for boards to do the right thing has to come from the stock exchanges, rather than the government. It is too easy for companies to shift their activities offshore, out of the reach of the US government, but few can afford to not be listed on a major exchange. Consequently, the exchanges should adopt a core of accepted practices, preferably common across all of them, and require listed companies to certify their compliance or explain why they choose to not be in compliance. Well-run companies will already be in compliance. Those companies not in compliance will, or at least should, find their access to capital shrinking as investors move their money to compliant competitors.

Here then are my minimum recommendations for restoring investor confidence in the integrity and ethical behavior of publicly traded companies.

• The board should be comprised of significantly more outside directors than executive directors. The outside directors should be truly independent, not just executives of related companies. While board membership should be seen as more than a retirement hobby, the independence a retired executive brings to a board can be invaluable. It is acceptable, even mandatory, for directors to question management closely.
• The board should include representation of all key stakeholders. It is not uncommon for a major stockholder to have a seat on the board. However, few companies except employee-owned or non-profits include a non-executive employee on their board. The perspective and insight of such an individual, properly buffered from management influence, can be an invaluable asset to any board.
• An independent director should chair the board. The critical function of running the board should not be merged with the executive responsibility for managing the company. Follow-up studies by the Cadbury Committee found that CEO performance statistically improved in companies that separated the two roles. While it may be difficult for a superstar CEO to surrender the chairmanship, it is in the best interest of their company to do so.
• Compensation, nominating and audit committees should consist entirely of independent directors. The compensation committee charter should include regular, formal evaluation of the CEO's performance and the alignment of executive compensation to long-term performance goals. The audit committee must be responsible for the integrity and transparency of all financial reports. The nominating committee must be responsible for setting director qualifications, finding appropriate candidates, and monitoring their performance once elected.
• The independent directors periodically should meet formally without the executive directors. This group should have the authority to openly consult with any employee, customer, supplier, or other stakeholder of the company, independent of management. They should also have the authority to hire independent experts, including counsel, as needed to perform their functions.

C ompanies that adopt these minimum requirements will be better governed. They will better respond to their stakeholders and they will be more likely to fulfill their responsibility to their shareholders of increasing the company's value over time.

Director independence is required for integrity to be maintained and investor confidence to be restored. While the CEO may employ as many advisors as needed, the board members must remember why they are called the Board of Directors, not the Board of Advisors. They must take responsibility for the company's future or accept the risk of being replaced.