robert w. lear

I've got that ugly feeling that executive compensation is getting out of hand again, although some people think it was never really in hand. The press is running more and more stories of preposterous termination payoffs to fired CEOs, amazing offers to newly recruited executives, and the rise of professional agents who represent executives in salary negotiations.

The numbers resulting from these activities are labeled by reporters as "obscene"-or even worse. The press is having a field day. And everybody knows by now that there is no other subject in the world that can get stockholders riled up as much as "obscene" compensation for the CEO.

The reasons for much of these high blown figures are fairly obvious. The push to put more of the CEO's compensation "at risk" led to a leveling off of salaries and a sharp increase in the number and quantity of stock options granted. The surge in the economy, with the doubling and tripling of some stock prices, produced unexpectedly high capital gains for a large number of CEOs and senior executives. The new Internet and high-tech companies made dozens of multi-millionaires overnight in shortcut fashion. At the same time, the hot economy created a shortage of executive talent, and companies found themselves in a bidding war to hold and to recruit experienced executives. It's not surprising that a lot of paychecks went through the roof.

Compensation committees were in a bind. They felt that they had to keep their CEOs competitive (and so did CEOs) and they had to keep their key executives from running off to greener pastures. Some companies were quite successful in doing so. General Electric, for example, gave huge salary packages to its CEO and his dozen or so top executives. But they made equally huge profits and created great stock gains, while the top-producing executives stayed on to keep producing. I have relatively little quarrel with cases like that and neither do the rewarded shareholders.

What gets to me-and to a lot of my fellow compensation watchers-is all the fancy bells and whistles that seem to be part and parcel of today's compensation programs. I hate to see the following:

•  Absurdly elaborate contracts with all kinds of arrangements for club memberships, personal use of company airplanes, ownership of office furniture, etc. With big cash salary and bonus, do you have to sweat the small stuff?
•  Extravagant termination payouts with no penalty for sub-par performance. Sometimes it seems to pay better to be fired.
•  Low or no interest loans to buy company stock. Where does this stop?
•  Substitution of restricted stock grants for underwater options. Repricing is even worse, I guess.
•  High bonus awards, in stock or cash, granted when competitive corporate performance lagged. This is sinful, but it happens all the time.
•  Writing almost any type of voluminous, hyper-detailed compensation contracts for CEOs that require a battery of lawyers to interpret. Read a few proxy statements and you'll see what I mean.

What can be done to settle executive compensation down to sensible levels and to common sense terms? Not much right away, probably. Once agents and superstars are in the picture (witness professional athletes' contracts, if you will), it's very difficult to return to old, simpler days. Major revisions will have to wait until a significant downturn occurs. But that doesn't mean that companies have to lose their compensation equilibrium.

I know one thing I would do if I were the CEO or a director of a flourishing corporation today. I would assemble the best talent available for my compensation committee and my executive compensation specialist in my human resources division.

I would put through an intensive training and tutorial program that brings them up to speed on executive compensation programs. I would bring in some creative compensation consultants and ask for some ideas to reformat the company posture. I would challenge the company to come up with the best possible executive compensation program as soon as possible.

You may not bring forth a revolutionary idea that changes the compensation world. But you have an excellent chance of avoiding a too-complicated, difficult-to-understand compensation program that pays its executives too much money for too little results. And you will know you have done the right thing.

Assertion: Most CEOs can build a good board of directors within their tenure in office.

Question: So, why don't more CEOs and companies do so?

The answer is, that until the last few years, the task was not all that urgent. It was easier to drift along in the same old way with the same old kind of directors your predecessor had (and his predecessors, too). Why take the time to find new, independent directors who might rock the boat? Why seek a broad range of talent, experience, background, and representation? Why tamper with your committee organization, your agenda set-up, your board-meeting procedures? "If it ain't broke, don't fix it," was the standard operating procedure. However, unless you have been living in a salt mine, you must have heard that things are different now. Corporate governance has been yanked out of the closet by the institutional investors, by the press, by the U.S. Securities and Exchange Commission, by changing global competition, and, happily, by a large number of enlightened CEOs and corporations.

Last month in CE, Boris Yavitz, former dean of Columbia Business School, and I wrote an article entitled, "America's Best And Worst Boards." It was the culmination of a lot of board watching, proxy reading, and seminar attending. We listed the criteria we thought made for good boards, and we gave examples of companies that met these new standards and those that did not. But the exercise left us with the questions: Why don't more CEOs and companies have better boards? And, how do you go about creating one?

Here is my suggested seven-step program for executives:

• As CEO, decide resolutely that you want to do it. Don't wait for someone else to start the process; it works best when you are the catalyst and advocate.
• Appoint a committee on hoard affairs composed of your brightest, most independent, respected directors. You can be an ex-officio member.
• Charge the new committee to construct the framework of an "ideal" board. for your company in terms of size, organization, talent, experience, demographics, and compensation. In addition, advice from an outside consultant may be appropriate.
•  Prioritize and timetable the steps required to make the transition from where you are to where you want to be.
• Recruit the new directors needed. The committee on board affairs also can act as the nominating committee and can actively participate in the recruitment and selection processes. Many companies find it helpful to use a professional director-recruiting firm.
• Determine which of your present directors should retire or not stand for reelection. This is the hardest job of all and may take several years to complete. It might involve the implementation of a director-evaluation program. It requires full accord among the CEO, the chairman, and the committee on hoard affairs.
• Work unceasingly to keep your directors participative and informed, your board meetings pertinent and useful, your governance programs up to speed.

Once you have a well-balanced, conflict-free, independent board in place, it is possible to indulge in a number of advanced exercises favored by many corporate governance pundits. It will he easier to institute an objective board evaluation of the CEO, and, in turn, a continuing assessment of the board itself. A "lead director" can be appointed, or, if the circumstances warrant, a non-executive chairman of the board can be elected. And, certainly, you largely have removed yourself from the target lists of institutional shareholders.

The transformation into a board composed primarily of truly independent directors is not without its problems. Board meetings change from a pattern of information presentations to one of answering difficult questions and defending positions. Preparation for hoard meetings may involve new kinds of data, more justification for proposed projects, and broader managerial participation. At times, the CEO will not get what he or she wants. Experienced, talented directors are not always easy to work with.

This blueprint does not apply to all CEOs and all companies. In their heydays, I simply can't see Lee Iacocca at Chrysler, Harold Geneen at ITT, or Steven Ross at Time Warner adopting such a corporate program. But their successors will be-and are-different. The newer, younger CEOs coming on board American corporations are much more amenable to a new corporate governance approach.

As a chief executive, if you take the lead and follow these suggestions, I think you have an excellent chance of winding up with a good hoard-even a great board during your tenure. If you don't do these things, your directors may have to do them for you. As many ex-CEOs will tell you, the first alternative is better.

Formerly the CEO of F.&M. Schaefer (19721977), Robert W. Lear is chairman of CE's advisory board. He also teaches at Columbia Business School, where he is Executive-inResidence. He is an independent general partner of Equitable Capital Partners and holds directorships with Cambrex Corporation Inc.; Scudder Institutional Funds; Korea Fund; and Welsh, Carson, Anderson, Stow Venture Capital Co.

One of the most difficult jobs facing CEOs and chairmen of the board these days is deciding how to remove an underachieving, non-performing, or disruptive outside director-and do it gracefully, without unusual commotion. The director in question may be a nice person who has faded physically or mentally, who has not kept up with the growth and complexity of the corporation, or who simply turned out to be a bad appointment.

I have seen four removal methods tried that have met with varying degrees of success:

1. Set an age limit for directors and wait until the offending director reaches it. However, this ducks the issue and may take years.

2. After checking with a majority of the board, meet with the director (or ask a senior director to do so) and ask him not to stand for re-election. Unfortunately, many CEOs can't or won't do this, and most directors are loath to take on the assignment. More often than not, hurt feelings and hostility result from this approach. It works best when there is a strong and secure CEO as chairman.

3. Have the directors evaluate each other's performance, perhaps with anonymous ratings. Then, use the negative findings to force a resignation. I know of several companies that have tried director self-evaluation programs, but the only ones reported to be successful were those with an unusual CEO and board culture. In any case, the "fired" director still leaves with hurt feelings and hostility. The Conference Board, in its recent survey on "Corporate Boards and Corporate Governance," contends that "a formal process of performance assessment (of individual directors) is an idea whose time has not yet come."

4. Establish a project to review and reappraise the fundamental makeup of the board. Decide upon the ideal blend of talents and experience, of committee service, of director information and communication, and board meeting procedures. Appoint a committee on the board to review the material and recommend changes. In the process, find a way to "reorganize" an unwanted director out of existence by reducing the number of directors or changing committee charters. There still will be some hostility, but the removal can be wrapped in a restructuring reason.

One of the best ways to accomplish the reappraisal process is by using an outside consultant who, after full briefing, can hold interviews with each individual director. It is not necessary to bring up the subject of an underperforming director; invariably, the issue is raised as part of the answer to making meetings more efficient and the board more effective.

Where do you find consultants capable of carrying out these delicate interviews? It isn't easy, but I suggest CEOs seek advisers who have had board exposure, business school faculty members, or retired executives who are directors of other companies.

Another opportunity to get a message through to ineffective directors sometimes arises after the CEO has had his performance evaluation by the board. If the CEO has an individual follow-through session with each board member, he can say, "You told me things I could do to improve myself; here's something you can do to make things better for the board."

It may not always be necessary to remove a difficult director. I know of one instance in which a director, seemingly anxious to prove he had carefully read all the financial statements, would take up an agonizing amount of board time seeking answers to his detailed questions. The CEO asked him if he would be willing to meet with the vice president of Finance before the meeting. The director did so, the meetings went better, and the directorship was saved.

The climate is right to improve the overall quality of board members. We have seen several cases in which institutional investors have insisted that boards be upgraded. For example, it was reported that IBM was encouraged to add directors with technical skills as replacements for some directors who lacked them or who were inside directors. I predict that more and more companies each year will be called upon to defend or change some of their directors.

It just doesn't make sense to put up with Old Joe or Old Susie who doesn't do the homework; doesn't ask the hard questions; accepts the easy answers; and hasn't kept up with the changing world of technology, globalization, and corporate governance. Directors' chairs are getting harder to fill with talented, experienced, independent board members who have the time to serve, who are without conflicts of interest, and who work to make the company better.

Formerly the CEO of F.&M. Schaefer (1972-1977), Robert W. Lear is chairman of CE's advisory board. He also teaches at Columbia Business School, where he is Executive-in-Residence. He is an independent general partner of Equitable Capital Partners and holds directorships with Cambrex Corporation Inc.; Scudder Institutional Funds; Korea Fund; and Welsh, Carson, Anderson, Stow Venture Capital Co.