Scrutiny Makes U.S. Corporate Boards More Accountable

By Victoria Colette Reynolds

Corporate scandals among several U.S. publicly traded companies in the early part of this decade spurred shareholder activism. One result is that boards of directors are more transparent in their decisions and more independent of the company managers they advise.

Shareholders, when they buy stock, buy a piece of a company. And a company that sells stock has a board of directors with a legal duty to provide value to shareholders.

Shareholders elect directors of the board to advise and monitor the chief executive, management and officers. To that end, directors should not be employees of or consultants to the company, nor should they have quasi-financial connections, such as ties to charities the company supports.

"The push for independence [of board members from company management] is the predominant change you've seen in the face of U.S. boards in the last 10 years," said Charles M. Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

"As a director, your only link to the company should be as a stockholder," he said.

CATALYSTS FOR CHANGE

To address cronyism among big-business directors and accounting scandals of the day, the Securities and Exchange Commission (SEC) and New York Stock Exchange set requirements for board directors and company officers in the 1970s.

"With the blessing of the SEC, the stock exchanges now require that boards have a majority of outside directors and that compensation committees, nominating committees and audit committees be totally outside, independent directors," said Jeffrey Sonnenfeld, a dean of the Yale School of Management and founder of the Chief Executive Leadership Institute. "That cuts through the cronyism."

But today's shareholders call for greater board accountability, said Dennis Johnson, manager of corporate governance at the California Public Employees' Retirement System (CalPERS) in Sacramento.

As required by fiduciary laws of "duty of care" and "duty of loyalty" to shareholders, institutional investors like CalPERS demand board accountability and performance. Vigilant and vocal about its interactions with the 7,000 public companies worldwide in its $240 billion pension-fund portfolio, CalPERS identifies companies it sees as underperforming or led by unaccountable directors.

Significant change has occurred since the days when timid shareholders tolerated the "Wall Street Rule," which tacitly dictated, "Vote with management, or sell your shares," said Nel Minow, founder of the Corporate Library in Portland, Maine.

LEGISLATION AND REGULATION

In the wake of a takeover era in the 1980s, a wave of legislative, regulatory and cultural changes jolted formerly passive boards. Corporate scandals of the last 10 years - involving Enron, Global Crossing, Tyco, Adelphia Communications and WorldCom-MCI - led to passage of the Sarbanes-Oxley Act of 2002.

As the most far-reaching legislation for improved financial standards, securities analysis and auditing since the 1930s, Sarbanes-Oxley spurred warp-speed changes, Elson said. The legislation includes board-composition rules.

When the law first went into place, there was "kicking and screaming" among companies and their boards, said Doreen Kelly Ruyak, spokeswoman for the National Association of Corporate Boards. Requirements that boards oversee financial controls of the company they direct were difficult to meet, especially for small companies. The number of hours board members work on their duties went from 110 per year to 250 per year from 2004 to 2007, according to surveys by the association.

Nevertheless, Kelly Ruyak said, public companies believe in the additional oversight. She spoke of one private company, not bound by the law, that applied Sarbanes-Oxley rigor to its board's doings. It soon uncovered fraud that would have brought the company down within a year.

SHAREHOLDER SCRUTINY

"Shareholders have learned they have to ask tough questions," Sonnenfeld said.

Activism has sparked changes in the board structure and composition of such large companies as Verizon Communications, Time-Warner, H.J. Heinz Co., and Wendy's.

Executive compensation is the focus of activist shareholders today. "There has been a tremendous increase in the degree of disclosure," said Anthony Horan of JPMorgan Chase & Co.

Kelly Ruyak said boards devoted to transparency usually succeed by making compensation decisions known to shareholders. "Sometimes, it's a matter of saying, 'Here's why we pay what we pay,'" she said.

MAJORITY VOTE

Today, some shareholders are pushing for policies that require board members to be elected in a process that would require more than 50 percent of shareholder votes.

Some shareholder groups are making big differences with their votes. At the annual meeting of Washington Mutual on April 15, 2008, shareholders cast a 51 percent vote to require separation of the board chairman and chief executive posts then held by Kerry Killinger, whose chairman's seat is now filled by an independent director. Shareholders also withheld votes for reelection of director and finance committee chair Mary Pugh, prompting her on-the-spot resignation.

"In my view, that was the single biggest moment in corporate governance of the past decade," Minow said. "That's never happened before, and I think we will see increasing use of this option by shareholders."

Source: U.S. Department of State

judythpiazza@newsblaze.com