Changing Governance Of Boards

Changing Governance Of Boards

Judy Olian

(Judy Olian is Dean of Penn State's Smeal College of Business and a leading expert in strategic human resources management.)

In an attempt to preempt government mandates, the New York Stock Exchange proposed to the SEC new governance rules for NYSE listed boards of directors. General Electric took note and is leading the charge in reforming the governance practices of its board and indeed, goes further than the NYSE recommendations.

Board independence is a central feature of GE's changes. Eleven of GE's 17 directors, or approximately 2/3rds will be independent from January, 2003 on. Directors qualify as independent if they have not been GE employees for the prior five years, and their business with GE constitutes less than 1 percent of their company's revenues. The independence rule is more stringent for audit committee members who must receive no compensation from GE other than for their membership on the board.

The new guidelines are designed to prompt board members to engage proactively in GE's business. Members are expected to attend 100 percent of the meetings, hence board attendance fees have been eliminated. Board members cannot spread themselves too thin—no more than 2 additional boards for sitting CEOs or 4 for non-active members. Board members are expected to get to know the business by making at least 2 annual field operation visits without the presence of corporate management. They are also encouraged to connect directly with GE managers to address any concerns.

Non-employee directors of the board will hold at least 3 annual sessions without management or the CEO. GE's board and each of its committees will also conduct an annual self-evaluation including assessment of the contributions of individual members. Finally, 40 percent of board compensation will be cash and the rest will be deferred stock units payable only a year after members leave to discourage short-term thinking on the board. GE's revised governance structure sets the bar for other boards of directors given GE's influence across the globe. It's about time, in light of numerous incidents of board ineffectiveness and a pretty low opinion of board members from people who should know. The McKinsey Quarterly just published a survey of 200 U.S. corporate directors active on some 500 boards, illuminating areas where directors sought change. The most striking finding is that 45 percent of respondents rated their board colleagues as average or poor performers. A third of McKinsey respondents said that their boards have an ineffective process for controlling potential conflicts of interest. Forty percent were also critical of the level of in-depth understanding of risks confronted by their companies—hardly a pat on the back from the very people running boards.

McKinsey respondents are concerned about succession of the CEO and the top management team. Yet the vast majority note that they are not engaged enough in succession planning and 64 percent have no solution "if the CEO gets run over".

GE's revised governance procedures do not include term limits. Instead, GE chose annual re-nomination of each board member until they reached mandatory retirement age after the member's 73rd birthday. Exceptions can be made for particularly valued board members even after retirement age. In contrast, in the McKinsey survey while 90 percent of respondents favored annual re-election of board members, a majority (62 percent) endorsed term limits.

Regarding the roles of chairman and CEO, 75 percent of the S&P 500 companies have a single person serving in both roles. In Europe the reverse is true with the majority of boards governed by a non-executive chairman. The board directors responding to McKinsey's survey were critical of the U.S. practice—69 percent favored splitting the CEO and Chairman roles, and 73 percent advocated appointment of a lead director. While non-executive chairmen of boards meet the independence test, the down side is that many are too removed from the day-to-day to develop in-depth understanding of the business strategy, the talent and operations unless they graduated from the inside. That's the dilemma. The GE structure still combines both roles of Chairman and CEO, and the proposed NYSE rules are silent on this point.

The public is crying out for boards that exercise more effective stewardship of shareholder interests. Independence of directors is a move in the right direction, but that isn't enough. The challenge is to appoint independent directors who will commit to becoming thoroughly informed about the strategic drivers of the business, the risks, and the integrity of the financial operations. They will also need to develop intimate knowledge of insiders to make informed decisions about performance, rewards, and succession.

Directors are looking into the mirror, mouthing "heal thyself". GE's new governance procedures are an important step towards recovery provided directors make the commitment. It's a serious job.