Law & Governance
Strong Boards, Weak Managers
There are ripple effects. After Jack Welch - perhaps the best CEO of the last 30 years - got GE's board to sign off on a retirement plan that included lifetime dry cleaning, Knicks tickets, and catering, IBM chairman and CEO Lou Gerstner persuaded IBM's directors to agree to a similar plan.
How do we empower board members to stand up to management? There is a carrot and a stick. The stick is the loss of reputation, increased director turnover, and increased director liability that goes along with the types of scandals we have seen lately. Moreover, there is now an increased focus on the performance of board members.
The carrot includes a compensation package that makes directors think like shareholders.
That means payment in company stock, with a sizable lockup period after a director leaves the company. Companies should also consider requiring directors to invest a non-negligible amount of their personal wealth in the company's stock.
Moreover, it is important to reduce the CEO's formal influence over the board. New directors must know who hired them: shareholders, not the CEO. Splitting the CEO and the board chairmanship functions sends the right message: Directors are ultimately responsible for the governance of the corporation.
Finally, although legislation such as the Sarbanes- Oxley Act of 2002 helps empower the board, our system of corporate governance depends on shareholders being active participants. After all, shareholders have voted to approve most of the bad governance provisions found in today's corporate charters and bylaws. Their vote has been largely passive, with support of managementdriven governance proposals as a default. Shareholder passivity is due to a combination of factors, ranging from ownership dispersion (small shareholders have no incentive to expend resources to oppose management) to legal constraints on institutional investor activism.
The good news is that institutional shareholders have started to play more of an activist role. The most important governance changes will come when shareholders as a group insist on better corporate governance and have economic incentives to take action. Reforming the rules for director election is necessary in order to level the playing field. Only then will we establish the right balance of power between the CEO and the board.
About the Author(s)
B. Espen Eckbo is the Tuck Centennial Professor of Finance and founding director, Center for Corporate Governance, at Dartmouth College.
AcknowledgmentReprinted with permission.
This article first appeared in the Corporate Board Member's 2004 Academic Council Supplement, Emerging Trends in Corporate Governance.
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