Re-Examining the Role of the Chairman of the BoardPublished: December 18, 2002 in Knowledge@Wharton
The scandals at Enron, Tyco and other U.S. companies have taken concerns about corporate governance to a new level.
As executives, board members, investors and regulators weigh various measures to prevent misbehavior, one suggestion has intrigued many – that the positions of chairman and chief executive officer should be held by different people, along the lines of the model typically used by firms in the United Kingdom. Such a division of power, the thinking goes, could provide the kinds of checks and balances that would make it harder for senior executives to financially ruin their companies.
Faculty members at Wharton and a board member of a major U.S. corporation say that while there are some circumstances in which such a division of authority may make sense, it is by no means a surefire way to keep companies on the straight and narrow. They say it is far better for companies to install a strong, independent-minded board and adopt an array of guidelines to improve corporate governance, such as those recommended in 2002 by the New York Stock Exchange (NYSE). However, a prominent British executive says the model used by virtually all companies in the U.K. – separating the two posts – offers an excellent way to guard against an over-concentration of power and he urges U.S. firms to adopt it.
Tempest in a Teapot
Michael Useem, management professor and director of Wharton’s Center for Leadership and Change Management, points out that the CEO and chairman’s posts at Enron were held by different people – Kenneth Lay and Jeffrey Skilling – in the months leading up to the disaster at the energy company.
"Despite the separation of the CEO-ship from the chairmanship at Enron and the presumption of better oversight from the non-executive chairman, the company suffered a massive failure,” Useem says.
According to Useem, research has shown that the performance of U.S. companies in which the chairman and CEO positions are held by different people is no better than that of firms in which those posts are held by the same person. “The issue of separating the CEO and the chairperson’s jobs,” he says, “is really a tempest in a teapot.”
Lew Platt, former chairman and CEO of Hewlett-Packard and a current member of the board of directors of Boeing, agrees. “To be honest, I don’t think it’s necessary,” Platt says, adding that such a division of responsibility is no guarantee against future scandals in executive suites.
Robert E. Mittelstaedt Jr., vice dean and director of Wharton Executive Education, concurs that the benefits of dividing the two roles are unclear. Still, he notes that the question of whether the jobs should be held by different people “is going to get asked a lot more frequently today than in the past, partly because of the belief of some people that the abuses of recent years might have been more difficult to pull off with less concentration of power. The question is: Under what circumstances is it appropriate to separate the roles of chairman and CEO, and does the separation add value for shareholders?”
By tradition, it has long been the norm in the United States for one person to wear the hats of both CEO and chairman. A chairman/CEO reigns supreme at 70-80% of the companies in the Standard & Poor’s 500, according to Useem. Typically, a chairman is responsible for coordinating the activities of a company’s board of directors and of overseeing issues related to governance. By contrast, the CEO is a company’s point person who oversees a firm’s day-to-day activities and performance.
The Cadbury Committee Report
In Britain, many companies were once organized like their corporate cousins in America, with one person serving as CEO and chairman. In 1988, for example, one person held both jobs at 349 of the Fortune 500 companies and 328 of the FTSE 500 companies in Britain, according to a paper by researchers at Cardiff University in Wales and Purdue University in the United States.
But in 1992 a seismic shift took place in Britain with the publication of a report by the Cadbury Committee. The committee, which was made up of executives, finance experts and academics, was headed by Sir Adrian Cadbury, at the time CEO of the Cadbury confectionary empire. The British government established the committee to address issues related to governance in the wake of several corporate scandals in the late 1980s and early 1990s. Many observers attributed those scandals to ineffective governance and the wielding of authority by all-powerful chairmen/CEOs.
Among other things, the committee’s report, titled “The Code of Best Practice,” recommended that boards of directors of public companies include at least three outside directors as members and that the CEO and chairman posts be held by different individuals. The committee’s recommendations were voluntary, but today nearly all publicly traded companies in Britain separate the roles of chairman and CEO, according to Paul Judge, who began his career at Cadbury Schweppes and later led the buyout of the company’s food businesses to form Premier Brands. The few British companies that do not adhere to the recommendations must explain their reasons to officials of the London Stock Exchange, which adopted the committee’s recommendations.
“The separation of the chairman and chief executive is almost universal now in Britain,” says Judge, who today is vice president of the Chartered Institute of Marketing and serves as chairman of a number of companies and not-for-profit organizations. “Generally, the committee’s recommendations were well accepted. There were some cases of particular personalities who didn’t want to do it, but they are now retired. It’s the right way to do things, because when the chief executive also runs the board, there are no checks and balances. I’m strongly in favor of this model. It does work.” As evidence, Judge says no Enron-like debacles have occurred in Britain since the committee’s recommendations were adopted.
The Power of Two Hats vs. One
Even if separating the jobs of CEO and chair were desirable in many or all circumstances in the United States, getting a CEO to give up being chairman – or convincing a prospective CEO to agree to wear only one hat – would be a hard sell. The Wharton experts say that potential CEOs covet the authority conferred by both titles. According to Mittelstaedt, “The tradition is that the chief executives in the U.S. are totally in charge. Top executives aspire to become chairmen and CEOs, and they believe that if they don’t get both of those jobs it’s a slap in the face.”
When candidates for a chief executive position are being recruited by a company, Useem adds, “the candidates will ask for the chairperson’s job along with the title of CEO. They would be very concerned about the message they were being given if the recruiting directors or the executive search firm said, ‘We want to offer you the CEO-ship but not the chair.’”
There are times, however, when dividing the positions between two individuals has merit. “When H-P spun off Agilent [a move that was announced in 1999 and completed in 2000] it made sense to have two different people hold the chairman and CEO positions because H-P had relatively green CEOs for both jobs,” Platt recalls. “Today, those CEOs are chairmen of both those companies. So I think separating the two jobs can be the right model [in some cases], as when a relatively new CEO is paired with a chairman who is more seasoned.”
Platt himself knows what it means to wear only one hat at a time. A longtime H-P employee, Platt was elected president and CEO and a member of H-P’s board in 1992. In 1993 Platt was named chairman, succeeding David Packard, who retired. In 1999 Carleton S. (Carly) Fiorina, a former executive at AT&T and Lucent Technologies, was named president and CEO of H-P. It was not until 2000 that Fiorina assumed the added duties of chairman.
Mittelstaedt points out that U.S. companies appear most willing to accept separate chairs and CEOs during times of stress “when they need the most experienced people possible.” Such a crisis took place at General Motors in the early 1990s when the CEO was fired. In the wake of major financial losses, General Motors’ board in 1992 elected John F. Smith, Jr., CEO and president following the resignation of Robert C. Stempel. At the same time, John G. Smale, retired chairman and CEO of Procter & Gamble and a GM director since 1982, was named GM’s chairman.
Rather than place their faith in the dubious benefits of separating the chief executive and chairman to prevent high-level shenanigans, companies would be better off putting a broad array of strict measures in place, according to Platt and Useem.
Holding Up a Higher Standard
The NYSE took a major step in this direction on Aug. 1, 2002, when its board approved a set of proposals that it said would hold exchange-listed companies to a high standard of corporate governance. The proposals, which have been sent to the Securities and Exchange Commission for review, would give corporate boards greater independence and investors more say in how their companies are governed.
Among other things, the proposals would require that:
· Corporate boards of NYSE-listed companies have a majority of independent directors. (Companies with a controlling shareholder are exempt). An independent director is one who has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company.) In addition, no director who is a former employee of the company can be considered independent until five years after his or her employment has ended.
· Listed companies have audit, compensation and nominating committees composed entirely of independent directors.
· Non-management directors meet at regularly scheduled executive sessions without management present. Especially noteworthy is that the independent directors would be required to designate a lead director who will preside at the sessions.
· Shareholders approve all stock-option plans, except “employment-inducement” options, option plans acquired through mergers, and tax-qualified plans such as 401(k)s.
“CEOs are going to have to learn how to work with that lead director,” Useem says. “I think that arrangement will ultimately work out fine. Just a couple of years ago many CEOs would not have liked the idea because a lead director could have been viewed by a chief executive as a contending power or even a contentious force. But now, since it’s going to become a matter of widespread practice driven by the stock-exchange regulations, chief executives will say, ‘OK, I’m going to have to accept and work with that situation.’”
In general, Platt approves of the new NYSE proposals but says many companies have long had similar measures in place to help ensure good governance. “At Boeing, we have a very, very strong board,” Platt says. “The board meets in executive session without the internal management people being there, and I chair that executive session.” Platt also serves as chairman of Boeing’s nominating and governance committee. “Historically, we’ve decided not to have a so-called ‘lead director,’ but whoever chairs the nominating and governance committee fills that role.”
Platt notes, though, that a position of lead director could be beneficial at some companies if the director presides over meetings of the independent directors, as outlined by the NYSE. “That’s a good way to do it. That gives board members an opportunity to open up and express concerns.”
But, Platt emphasizes, “At the end of the day there’s nothing like a strong board that operates independently, asks good questions and does its homework. All these new ideas that people are talking about are steps that were taken by the best boards pre-Enron.”
As a result of the stock-exchange proposals and the Sarbanes-Oxley Act of 2002, which created the Public Company Accounting Oversight Board and deals with a host of issues related to governance, Platt says, “we will have to tweak some things at Boeing, but that’s about all.”
The NYSE proposals and Sarbanes-Oxley provide a good test for companies that wish to evaluate how committed they are to good governance, Platt adds. “If a company looks at these ideas and says, ‘This is a new world for us,’ then that company probably wasn’t doing what it should have been before.”
In the end, Useem says, all the regulations in the world will not guarantee good governance. “Good governance comes down to the quality and character of people who are chairpersons and chief executives.”
Nonetheless, Judge predicts that U.S. companies will eventually come around to seeing the benefits of the U.K. model. “The American practice [of one person being chairman and CEO] will almost certainly change. The board is the key determinant of the company’s direction and the chief executive is the implementer. It’s important that the board be run well. That is an important job. It can’t be squeezed into the margins of a chief executive’s busy schedule.”