I want an answer!” The Gadfly refused to give up the mike. “I insist, Mr. Chairman of the Board, that you tell us if any of the director nominees is a member of the company’s Compensation Committee.” He waited for an answer.
“Committee assignments are listed in the annual report.” The chairman’s impatience was growing. “In any case, I don’t see the relevance . . .”
The Gadfly cut him short. “The issue, sir, is whether or not the nominees are competent to serve the shareholders. Past performance should tell us something about that.
“Especially performance on the compensation committee,” he added with a sneer. “Now will you tell us, or must I . . .”
Before he could complete the threat, the chairman conceded, “Mr. Kennedy is on that committee.”
“In fact, he heads the committee does he not?” The Gadfly pressed. “I’d like to ask some questions of Mr. Kennedy.”
“That will not be permitted at this meeting.” (The chairman struggled to regain control.)
The Gadfly ignored him. “Mr. Kennedy, how do you explain your generosity to the chairman and his stooges in the face of absolutely miserable performance?”
I awoke at that moment. It was good timing. I had no satisfactory answer to the question.
The dream happened some years ago, before executive pay became a prominent issue. Even so, it led to some serious soul-searching and, eventually, my resignation from the board of a Fortune 500 company. Compensation was part of the reason. There was no satisfactory explanation for some of the salary and bonus awards. There was no particular relationship between pay and results. Compensation was not an integral part of corporate strategy, nor was it related to the success or failure thereof. It had a life of its own.
The committee consisted of the CEO, his second-in-command, another outside director, and me. Recommendations were prepared and presented by the CEO and his staff based on guidelines from consultants they selected. As a practical fact, the CEO penciled in his own bonus and salary recommendations for the committee to ratify. The numbers for himself and his associates were based on “competitive practice-the dictates of the market.”
The message to the two outside directors was clear. “You want to keep us? This is what it takes.” Disagreement was tantamount to repudiation of management.
Compensation was an obvious, serious, and disturbing issue but, by no means, was it the only one. In fact, it gave rise to a larger question: What did shareholders have a right to expect from their representatives in this or any other matter affecting the value of their investment?
Another question, closely related: Were shareholders to be given the representation they deserved, or were directors really creatures of management? If the latter, director duties could be summed up in one sentence: “Discuss and debate if you must, but vote to suit the CEO.” If the former, definition of responsibilities was required.
Unfortunately, there was no such definition when I took the job. We talked a little about the company’s businesses. There was some background on other board members. Fees and perks were explained; I was offered a schedule of meetings, an annual report, a 10K, and an invitation from the CEO to come on board.
We shook hands without serious discussion of my duties as a director.
Granted, times were different. Scrutiny by directors could be more casual, because scrutiny of directors was rare. Even so, it was naive to accept a job without a clear understanding of responsibilities. What were the business objectives of the company? What benefits were intended for shareholders? What was the strategy and what resources were required to make it work? What was the company’s code of conduct? What provisions did it make for the welfare of employees, environment, customers, communities?
Before accepting a management position, an experienced business person would require satisfactory answers. Moreover, he’d expect a comprehensive description of his job. I agreed to be a director with substantially less direction. It’s not surprising that I woke up to some unpleasant realities.
Compensation was one of many issues, but the absence of strategy was more disturbing. Without strategic objectives, it wasn’t possible to project a payoff for shareholders. Without a strategic plan, it wasn’t possible for the board to measure management performance or to satisfy itself that its decisions made sense. We proceeded from point to point without any clear idea of our destination.
Projects were justified on payout only. The outlook of the businesses to which capital was committed was given little consideration. The possibility of good money chasing bad was uncomfortably real. Too often, results were embarrassing.
The board sometimes prolonged the pain of businesses on the wane. “The company has a big commitment,” executives would tell us. “We can’t just walk away. We have a long history. This is our traditional business.” The directors listened-and sometimes acceded to some dubious reasoning.
CONFIRM AND CONFORM
In discussions with the chief executive before my departure, the board’s lack of influence in strategy and planning was the principal issue. Compensation was a piece of the puzzle. In the CEO’s view, the board’s job was to confirm and conform. Confirm as in confirmation of financial results, regulatory compliance, lawful conduct, moral behavior. Conform as in lockstep agreement with management’s recommendations for investment, spending, budget, and compensation.
The CEO had no patience with the notion that the board had responsibility for strategy and future planning as much as for review of past performance and approval of current projects. Yesterday’s results and today’s projects were the board’s agenda. Tomorrow’s prospects were for management to ponder.
He was as frustrated with my concept of director duties as I was with his. Obviously, we should have had our discussion prior to a decision about directorship. He would not have invited me nor would I have accepted.
Even so, if definition of director duties was a good idea then, it’s a great idea now. More and more, boards are called to account. The consequence of poor performance cannot be ignored. In the past, board membership may have been thought by some to be prestige and perks. Today, it’s serious work.
Beware directors who can’t or won’t take their responsibilities seriously. Beware management that doesn’t want them to take their duties seriously. Directors may be prominent; they may be presentable. But if they don’t participate, if they’re “out of touch,” or “out to lunch,” they’re the wrong kind of “outside” directors.
Prestige doesn’t guarantee performance. In recent years, some high-profile boards of “outside” directors have presided over some bizarre business behavior. Their mistakes have been documented in lurid detail in business journals and best-selling books. Obviously, competence is more important to board performance than composition.
But directors should satisfy another requirement: They should be capable of close cooperation with management.
To put it kindly, directors and managers at times have been wary of each other. Some managers considered board involvement an entanglement to be avoided at all costs. Directors may have been hesitant to speak up. But want to or not, they must work together nowadays to avoid outside intervention. Regulators, legislators, and institutional shareholders are breathing down their necks.
WORKING OUT THE DETAILS
But there’s an even better reason: A talented, well-informed board is an asset to management. The give-and-take in plotting strategy can polish good ideas until they shine. It can sort out bad ideas well before implementation. The combined best judgment of management and a board is the best justification for their decisions.
What of entanglement and interference? Are they not cause for concern? Of course, unless the jobs of management and board are clearly defined. Management sees to the running of the company. The board oversees management. If they function effectively, shareholders profit.
To be sure, there are details to be worked out. A constructive working relationship doesn’t happen by chance. But that doesn’t change the basic premise. Directors and executives are a team. They are held accountable together. It behooves them to work together.
As for the experience that gave rise to my rude awakening, my most profound regret is not that I took the job but that I quit. I can’t prove that staying would have done any good, but I could have raised the possibility of reform with the board. Had it agreed, the CEO might have been compelled to pay attention.
I should have tried. The shareholders deserved at least that much.
What they deserved and what they got, however, were two different things. The company was eventually overtaken and dismembered. The raider was pleased with his end of the deal, which suggests that previous owners might not have been.
In hindsight, my sojourn at that company was a learning experience.
A NEW APPROACH
That’s the best I could claim until we put these lessons to work with our own board. Our management and directors thrashed out a statement of our combined commitment to protect shareholder assets and increase their value over time. That statement also confirms our responsibility for employees, customers, and the communities we serve. It contemplates the relationship between board and management and provides for constructive interaction between them.
Committee charters have been examined. Responsibilities have been updated, and, in many cases, expanded. The Nominating Committee has been renamed the Committee on Corporate Governance. Its duties include evaluation of board performance as well as board interaction with management.
The Compensation Committee’s duties also have been enlarged. Now it concerns itself with management development and organizational depth in addition to pay and benefits. Further, it assists the board in measurement of management performance including chief executive performance.
In other areas, to assure comprehensive oversight, appropriate changes have been made in the charters of the Audit and Social Responsibility committees. It’s clear the Executive Committee acts on behalf of the board, not instead of it. Strategic issues are reviewed regularly by the full board. Time is reserved at each meeting for updates on the strategies of our various businesses. Each business has a performance track that targets expectation five years forward. Specific recommendations are measured by their contribution to that track.
Part of each strategy update is conducted in an executive session to allow for open discussion between directors and the CEO. If there is discomfort with a proposal, it can be voiced openly without concern for embarrassing its management sponsors.
In sum, the board knows its job. Because it does, it performs better and works more effectively with management.
With future goals in mind, the board is better-equipped to commit shareholder resources and maximize shareholder return, whether for capital investment, technical development, or compensation. With a clear idea of the work to be done, it is able to screen and propose new directors more effectively.
With all of that, there’s no claim to perfection. We’ll not please everyone. But when questions are raised at future shareholder meetings, we’ll be able to say with conviction that we work hard to give our constituents responsible representation.
I sleep better for that.
George D. Kennedy is chairman of the board of Northbrook, IL-based IMCERA Group, a $1.7 billion producer of human and animal healthcare products and specialty chemicals. Chief executive of IMCERA from 1983 to 1991, he is also a member of the board of directors of Kemper Corp. and Kemper National, Brunswick Corp., Illinois Tool Works, Scotsman Industries, Stone Container, Critical Care America, and American National Can Corp.