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America’s Best & Worst Boards

Chief Executive's ninth study finds good governance is good business, but some companies still don't get it.

It’s not easy being a member of a bad board today. You’re reviled in the business press, your company’s stock price is probably in the tank. You duck calls from institutional investors pressuring you to change, but it’s harder to hide than it was eight years ago when we first began picking best and worst boards for Chief Executive magazine.

Back then, agreed upon criteria for separating the good from the bad did not exist. We drew up a series of factors called “The Hallmarks of an Effective Board” based on our work with the National Association of Corporate Directors and our corporate governance courses at Columbia Business School.

Used for each board analysis, these hallmarks call on companies to diversify their boards, to limit conflicts of interest, and to encourage stock ownership by directors, among other criteria. They now appear on (So do the names of the directors on this year’s best and worst boards.) We’ve also stuck to two fundamental beliefs. First, a strong board is key to a successful company over the long term. Second, the boardroom is one of free enterprise’s last bastions and we like it better with its occasional problems than if it were restricted by a load of detailed regulations.

When we first started this project in 1994, we had no difficulty finding a myriad of companies whose boards didn’t meet our criteria. It was harder to find companies that had begun to adopt forthright corporate governance practices.

Now we find that most good-sized companies have converted to our board composition criteria.

Unfortunately, some companies, such as a number in the so-called new economy, remain blind to corporate governance. Their problems might have something to do with this oversight.

Others selectively adopt good governance criteria. For instance, at Lucent and Xerox, better board action probably would not have stopped problems at these companies, but it might have alleviated their severity. Each company has good products and services, hard-working people, and ambitious goals. But their boards-either too busy or too small-seem unable to cope with the complex problems facing them.

Other firms and CEOs pay lip service to corporate governance. It is hard to tell from a proxy statement or an annual report alone how independent the board has become. We cannot go into the boardroom to witness directors’ participation in corporate affairs.

As a result, we now pay much more attention to the board’s structure. Does it have a functioning corporate governance committee and written principles? Who appoints committee chairman and members-the CEO or the board itself? Is there a formal board process for evaluating the CEO’s performance?

We are sensitive to nuances in the proxy statement’s letter from the Compensation Committee. We consider how directors are paid and how much, and we look for unusual perks. We look at the company’s performance vs. its peers.

In general, corporate governance in America is thriving, and helping companies find safe passage through complex business issues. Our best board picks show this. Directors at two of our selections, Verizon and Texas Instruments, guided major transformations.

A strong CEO alone can run a company effectively for a while with a weak board, but at high risk. But those companies with a competent CEO and an experienced, talented, and independent board have established the basis for long-term success.


Meager-sized Board Misses Lucent’s Major Problems
You have to feel sorry for Henry Schacht, interim CEO at Lucent Technologies, and his board. Just about everything that could go wrong went wrong. This includes the removal of Richard McGinn as CEO; the depressed credit rating; the resignation of a high-profile CFO; and the failure of merger discussions.

Lucent, formerly Bell Laboratories, was spun off from AT&T in 1996 with Schacht, an AT&T director and former CEO of Cummins Engine, as CEO.

The board hired McGinn as CEO in 1998. It fired him in October 2000, and has to take responsibility for what happened during his tenure.

The board is diversified, talented, and hard-working. But its six directors-busy, prominent people-were probably too few for the scope and number of problems they had to handle. There were only two committees. Paul Allaire, who was having his own problems at Xerox, headed the Audit and Finance Committee. All six directors were on the Corporate Governance and Compensation Committee with Franklin Thomas, the retired head of the Ford Foundation, as chairman. The board met 11 times in 2000, and the committees met 11 times. This meant that Allaire and Thomas had 22 Lucent board and committee meetings each while they were each outside directors of five other boards.

Lucent paid its directors well for their troubled work-$100,000 and 5,000 option shares a year. Thomas received an extra $100,000 as senior director. Most of their options are now under water. Maybe it’s just as well.

Xerox Delegates Too Much to the CEO
Since the early 1970s, when Xerox proved a star with the other “nifty fifty” rocketing stocks, it has been considered one of America’s great companies. Alas, no more.

In 1997, G. Richard Thoman was recruited from IBM to become president and COO. In April 1999, he succeeded Paul Allaire as CEO. Allaire, with the board’s concurrence, stayed on as chairman to help Thoman run the company. By May 2000, as bad things came to light-falling revenues, runaway foreign competition, and accounting problems-Allaire took back the reins. Anne Mulcahy, executive vice president, was named president and COO. By then, the stock was falling fast as banks tightened credit. The company faced a cash crunch and widespread layoffs.

Xerox failed to issue its 2000 annual report until July 2001, and it is filled with sad details of this once-proud company trying to regain its balance.

What was the board doing through all of this? They were around, for they attended nine board meetings and 19 committee meetings in 2001. They established a compensation plan for the turnaround, adjusting Allaire’s pay upwards, issuing him new stock options, and adopting a cash long-term incentive option plan that could pay him from $3 to $5 million for the period ending December 31, 2001. Finally, in July 2001, the board named Mulcahy president and CEO.

The board is filled with prominent people who may be spread too thin. Two are celebrity directors such as Vernon E. Jordan Jr., who also serves on 12 other boards. Three are global directors from Japan, Germany, and Sweden. Another director was Patricia Russo who resigned when she joined Eastman Kodak. The outside directors were paid $40,000 in cash, $25,000 in restricted stock, and 5,000 in option shares. In 2001, the directors’ pay was increased by adding $1,500 for meetings not held on board days and $10,000 for all committee chairmen.

Xerox watchers have had a field day placing blame-saying that not only was Thoman an expensive mistake, but that Allaire and the board mishandled the succession. They also fault Xerox’s strategies, out-of-date products, and its sales organization for being confusing and confused. In the end, despite its impressive credentials, the board was too busy and befuddled to assert its authority.

United Airlines’ Board Factions Ground Progress
Anyone who flew United Airlines in 2000 knew that it was a bad year for UAL Corp. Pilot strikes, slowdowns, and labor-related delays cost UAL over $700 million. The problems are not over.

The newly arranged board was supposed to ease the labor pains, but it was complicated: Five “public” directors are elected by the common stock holders, one of whom is CEO James Goodwin. Four “independent” directors are nominated by an Independent Director Nominating Committee and elected by the holders of Class 1 stock. One director comes from the pilot’s union, one from the machinist’s union, and one represents the salaried employees. To complicate things further, there are 10 board committees including Executive, Audit, Compensation, and Labor.

As if that weren’t enough, the directors have also been distracted by extensive, and now failed, merger discussions with US Airways.

One doesn’t get rich as a UAL director-$18,000 retainer, plus $900 for each board and committee meeting attended, as well as a 400-share grant and a deferred grant of 189 shares. The real incentive is free flights for the director’s spouse and children for life after five years on the board.

Now that they can fly the “friendly skies” for free, it would help if the directors representing different factions-staff, unions, and management-could get along.

Too Much Dust on Dillard’s Board
Dillard’s is an old-line department-store chain based in Little Rock, AR. Recently both its stock price and its reputation have slipped-no surprise when you look at Dillard’s directors. The board is a cozy and “old” affair headed by William Dillard, chairman and family patriarch, who is 86. Three other directors are in his age bracket. And with at least eight insiders, the board may need a dose of new blood.

Like many governance observers, we have never been in favor of having two classes of common stock. Dillard’s has managed to select poor directors from both Class A and Class B stock. Four of the directors, elected by Class A shareholders, are required, somewhat loosely, to be independent outsiders. The other eight directors, elected by the Class B shareholders, are insiders. Five, for example, are Dillard family members; another is the CFO. The Dillard family owns more than 90 percent of the Class B voting stock.

When things were going well, it must have been fun being a Dillard’s executive. The CEO, William Dillard II, and the president, Alex Dillard, each got a bonus of $1.3 million in 1999, but lost it last year because of poor results. However, they receive 160,000 shares of stock options annually, which are now under water.

The company needs to make changes, but it finds itself locked in a family-dominated enterprise with an aging group of directors. Good luck!

Veritas’ Board Fails to Meet Governance Basics
We picked Veritas Software for our worst boards list because it has an unworkable board structure typical of many new economy firms such as Amazon and Yahoo. A $1.3 billion Silicon Valley software company, Veritas lost $620,000 in 2000. Its stock price was $13 in 1999, soared to $174 in 2000, and hit a 2001 low of $34 per share.

It has an eight-man board of five insiders and three venture capitalists. The venture capitalists are not paid in cash, but each received 25,000 stock option shares upon being elected to the board, and 6,500 option shares each year. The board met six times last year. It has no ethnic or gender diversity, and lacks a range of experience. Just as bad, there is no evidence of formal reviews of the CEO, the board itself, or directors.

As Veritas and its brethren try to return to good times, will it keep fighting standard corporate governance policies? Those left among its shareholders may not stick around to find out.


Verizon’s Directors Help Bring off a Complex Merger
Verizon Communications was formed by a merger-of-equals between Bell Atlantic and GTE in June 2000. The boards and management of both corporations did an outstanding job implementing a highly complex merger.

Detailed planning went into insuring a smooth transition and a continuity of operation. Careful consideration was given to guaranteeing parity of treatment in terms of compensation, benefits, and status symbols.

Eight of the 16 directors were formerly directors from Bell Atlantic, and eight were from GTE. While this seems a sensible initial board, no attempt was made to insure future parity of representation between the two merging entities. Other mergers, which tried to enforce such limitations on board membership, have hampered their directors’ effectiveness.

Verizon also accorded senior managers pre-merger compensation for the first six months of 2000, then subjected them to the new Verizon criteria for the latter half of the year. This shows a determination to treat each management team member fairly and consistently while making a transition to a unified system.

Made up of active and retired CEOs and institutional representatives, the board boasts strong and diversified management. It has good gender and ethnic diversity.

But it is not flawless. With 16 members, it is large and somewhat clubby. Four members of Verizon’s board also serve on American Home Products’ board; three also serve on Honeywell International’s board. We are not fond of consultants and lawyers serving on the boards of corporations their firms serve. During 2000, Boston Consulting Group, CSX Corp., and two law firms received fee, while members of these entities sat on Verizon’s board.

Board of Texas Instruments’ Bold Restructuring
Texas Instruments is known for good governance. Its board consists of nine members with a balanced mix of skills, backgrounds, and experiences from business, government, and education. Recently, the TI board oversaw a broad restructuring of not only product lines, but of subsidiaries and manufacturing strategies. From 1998 to 2000, TI closed plants and took accelerated depreciation charges in facilities in Asia, the United States, and Europe. It successfully completed a number of major divestitures, sales of businesses, and product lines.

We were impressed that chairman and CEO Thomas J. Engibous gave credit to the board for these accomplishments. “Much of the success we’ve enjoyed over the past few years is the direct result of the bold decisions made by our board of directors in refocusing our business portfolio with numerous acquisitions and divestitures,” he has stated. This effort required directors to invest significant time in understanding TI’s markets, competitors, and strategies.

Results were clear in 2000, the turnaround’s final year, when net income grew 118 percent to $3 billion.

3M Speaks English to Its Shareholders
We chose Minnesota Mining and Manufacturing for its user-friendly attitude to investor relations and communications. Consider the company’s proxy statement. It opens with a five-page section titled: Questions and Answers about the Proxy Materials and the Annual Meeting. The questions cover almost every important aspect of the proxy, and the answers are given in plain English.

Starting with as basic a question as: “Why am I receiving these materials?” it proceeds to more elaborate issues like the difference between stockholders of record and beneficiary owners; it explains voting processes and quorum requirements; and it includes a clear description of vote confidentiality. The proxy’s next two pages are equally comprehendable. They briefly highlight key governance features: board structure, standing committees, and director compensation.

General Motors’ Investor-Friendly Web Site
The reputation of General Motors’ board among corporate governance observers has ben mixed. It has been criticized for its dealings with H. Ross Perot, and for its support of several tradition-bound CEOs. But it was acclaimed for its shake up of top management, its installation of a non-executive chairman, and its adoption of one of the earliest governance charters.

Our selection of GM focuses on a much narrower issue. We were impressed with its Web as it relates to investor relations. Well-structured and organized, the Web site contains interesting and useful reports on finances, operations, and stock performance.

Under “Stock Performance,” for instance, investors can access a host of charts to plot stock prices and compare them with the Dow Jones Industrial Average and other indices. The “Calendar for Investors” lists future events-such as monthly sales and production reports-and permits shareholders to request e-mail reminders of them.

The New York Times Co. Insulates Operations
In our traditional approach to selecting the best boards, The New York Times Co. would not be a candidate. For one, it has two classes of outstanding common stock, a practice we find objectionable.

But the company has admirably insulated its newspaper operations from the pressures of fluctuating markets and radical shifts in stock ownership.

Since Adolph S. Ochs purchased The New York Times in 1896, control of the newspaper has been held by his family, which actively managed the company. The arrangements were formalized in a Trust Indenture in 1997. Its primary objective is “to maintain the editorial independence and the integrity of The New York Times and to continue it as an independent newspaper, entirely fierce, free of ulterior influence, and unselfishly devoted to the public welfare.” This is a noble objective, but also a means of insuring family control over the newspaper and its corporation.

The Trust owns 87.2 percent of the Class B stock, as well as 1.3 percent of Class A. Class B shares are not publicly traded, and their holders elect 70 percent of the board of directors, or nine out of the 14 total. Class A and Class B shareholders, acting as a single class, elect the other five.

At present, four of the nine Class B nominees are part of the Sulzberger family; a fifth-the CEO-is an insider.

Directors at The Times appear to place great emphasis on selecting high-quality directors from both classes of common stock, even when outsider approval for Class B nominations is not required.

Formerly the CEO of F.&M. Schaefer (1972-1977), Robert W. Lear is chairman of CE’s advisory board and a partner of Lear, Yavitz & Associates. Boris Yavitz is dean emeritus of Columbia Business School. He works as a governance consultant and is a partner of Lear, Yavitz & Associates.

A Canadian titan could offer a glimpse of the future of boards


Magna International, a $10.5 billion Canadian manufacturing firm, could shake up the cozy world of U.S. corporate boards with a radical document that redefines its directors’ focus.

When she was named CEO of Magna, one of Canada’s fastest-growing companies, in February 2001, Belinda Stronach affirmed her commitment to the company’s Corporate Constitution, which protects and promotes the interests of all “stakeholders.” The document calls on board members to go beyond financial performance to include a company’s impact on human capital and the communities in which they operate. This includes giving employees and shareholders 30 percent of the company’s pre-tax profits, and directing 2 percent of net income to socially responsible initiatives. Stronach says she considers the Corporate Constitution a cornerstone that’s enabled Magna to become one of Canada’s most successful multinationals.

Magna’s approach is a major departure from the traditional board’s narrow focus on shareholder rights. But it is consistent with a number of important trends including greater employee involvement and ownership, growth in strategic alliances, and the development of global corporations. These trends raise a key question: How can companies be governed so that they serve more than just shareholders’ self-interests?

In the U.S., officials in a majority of states have weighed in by passing laws that allow directors to consider stakeholders beyond financial shareholders in making major decisions. So far few corporations have changed but the pressure is growing.

Edward E. Lawler III and David L. Finegold are on the faculty of the University of Southern California and are co-authors of Corporate Boards (Jossey-Bass, 2001).


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