A New Era in Corporate Governance

Directors and investors are demanding reform. Companies had better prepare for it.

Make Directors Independent—and Accountable

Improving a board’s performance entails more than separating the roles of CEO and chairman. Significant reforms, ensuring greater independence and accountability, have already occurred in the composition of boards. Recent NYSE and Nasdaq rulings increase the independence of boards and require listed companies to change certain board practices—for example, by improving the audit committee process and retaining auditors and compensation consultants. Meanwhile, the US Securities and Exchange Commission (SEC) is exploring ways to promote “shareholder democracy” by making it easier to elect independent board members directly. (Although this proposal is proving to be very controversial and the final details have yet to be worked out, the SEC will almost certainly allow long-term shareholders of a company to propose an alternative slate of a few directors if the company is resisting the wishes of its shareholders.)

Still to come, however, are changes in board practices and behavior that will be essential if directors are to provide independent oversight of executives. Most of the directors we surveyed said that they still depended on management to set the agenda of board meetings. Few respondents felt that they really knew what was going on in their companies, and most believed that this state of affairs would become increasingly unacceptable. The overwhelming amount of material that directors must master before board meetings, coupled with a lack of time and a culture that precludes open and unstructured discussion, has left many board members feeling that they could offer little more than marginal, pro forma counsel. As a result, some directors want real-time performance information unfiltered by management (see “Information Technology’s Role in Governance,” at the end of this article), new meeting formats that foster more open discussion, and the freedom to interact, unfettered by management, with the leaders of business units.

Increasing the accountability of directors is equally important. Although they report that nearly one-third of their peers are barely adequate or worse as board members, rare—until recently—was the board that evaluated its own performance, whether of individuals or as a whole. In this respect, the change has been dramatic: the percentage of S&P 500 companies conducting board evaluations jumped from 37 percent in 2002 to 87 percent in 2003 (as reported in these companies’ 2003 proxy statements; the Spencer Stuart Board Index, 2003; and Korn/Ferry’s 30th Annual Board of Directors Study). These evaluations include everything from the composition of the board to the length and quality of its meetings. Boards taking this approach feel that it gives directors a forum to reflect on their effectiveness as a team and exposes the short- and long-term issues they face.

Evaluations of individual directors are also becoming more common—but less so than evaluations of boards—and tend to be done with a light touch. To help ensure that individual directors take part in the oversight and governance of the company, and to clarify their roles and responsibilities, many boards are considering more formal evaluations, which examine the contributions of directors to the boardroom: their professional experience, the roles they play, their participation in committees. These more formal evaluations also cover the teamwork of individual directors by asking how well they interact with other board members and with management and how conscientiously they prepare for and contribute to board meetings. While many boards have opted for nonbinding self-evaluations, others have experimented with appraisals that not only incorporate peer and management feedback but also provide an objective base of information for deciding whether consistently underperforming directors should be reelected. These are important steps forward in what is undoubtedly an extremely delicate issue.

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