The One-Tier Board (IVOR nr. 85) 2012/3.5.5:3.5.5 What is the status of the discussion about non-CEO chairmen? What roles does a lead director have?

The One-Tier Board (IVOR nr. 85) 2012/3.5.5

3.5.5 What is the status of the discussion about non-CEO chairmen? What roles does a lead director have?

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As mentioned earlier, the US was used to having companies with a sole leader who combined the function of CEO and chairman. Since 1994, following the changes promoted by GM and CalPERS, and especially since 2002, subsequent to Enron and WorldCom, there has been a strong lobby, led by Ira Millstein and the Blue Ribbon Chairman's Group, to have separate non-CEO chairmen. However, the Business Roundtable, the association of CEOs, has raised doubts and objections against this trend. As mentioned before, 30% of the larger listed companies have non-CEO chairmen and the other 70% have a combined CEO/ chairman, but do have a lead director who presides over the executive sessions. Pressure groups, such as Risk Metrics, are attending shareholders' meetings to get boards to agree to split the functions of CEO and chairman. This is the third important structural change in US boards after the switch to a strong majority of independent directors and the adoption of executive sessions. Activists argue that oversight of the CEO by an independent chair might have helped mitigate the risk-taking that contributed to the recent financial meltdown.1

Risk Metrics, now called Institutional Shareholder Service, in its February 2010 report entitled "U.S. Season Preview on Governance", implies that an even greater use of outside directors is the appropriate response, specifically the use of an outside chairman. The report calls 2009 a breakthrough year for advocates of an independent chairman, inspiring it with the hope that it would continue to earn more support for these proposals. Risk Metrics cites investor advocates who had noted that no large financial firms had an independent chairman before the crisis and had argued that such companies were too large and complex to be run by a combined CEO and chair. Risk Metrics are putting pressure on large companies to move to the non-CEO chairman model within 3 years. Many companies such as Microsoft, Intel, Citigroup, Sara Lee and NYSE/Euronext have already introduced it.

Discussion on a separate chairman to balance the CEO

Traditionally, in US public companies, the CEO heads the management team overseen by the board and is also a member of the board. Those who favour preserving this traditional structure of duality argue that a single leadership fosters more operational efficiency, facilitates interaal communication with the board, and ultimately allows better business performance. The Business Roundtable, for instance, believes that most American corporations have been "well served" by a structure where the CEO also operates as chairman of the board, since it bridges management and directorship levels while ensuring that both act with a commonality of purpose. On the other hand, detractors of this practice observe that separating the roles gives boards an organizational basis for acting independently of management and avoiding dangerous instances of CEO imperialism and avoids a conflict of interest for the CEO who otherwise monitors himself. These arguments are discussed hereafter.

The arguments for having a separate chairman used by the Chairman's Forum2 can be summarized as follows:

(1)

Experience in countries, such as e.g. the UK and Canada, has shown that the model of a separate chairman works well. The CEO is accountable for running the company in the interests of the shareholders. This is a separate and time- intensive responsibility. The independent chairman curbs conflicts of interest, promotes oversight of risk, manages the relationship between the board and the CEO, and serves to know the views of shareholders. The idea of the separate chairman is a logical next step in the development of an independent board.

(2)

In the context of the economie crisis peer independent chairmen believe that lead directors are not considered the equivalent of board chairmen by the board or shareholders. "He who sits at the head of the table runs the meeting."

(3)

The responsibilities of managing a complex enterprise are not necessarily the same as those required to lead the board in overseeing management. Moreover, given the time and effort required to manage in today 's context, managing and promoting the business is a very different function from leading the board.

What 's next?

In view of the present crisis and the many bank failures, the need for a next step is apparent. US corporate governance has come a long way from managerial capitalism to independent board monitoring and executive sessions. Notwithstanding the improvements, many boards are still led by a person with a potential conflict of interest, being required to monitor himself, as CEO and to monitor senior management. The next step is to have a separate independent chairman.

The main arguments in favour of a separate chairman are that the CEO as chairman is the leader of the monitoring body, and has a conflict of interest, when monitoring himself; and that the growing demands on management, i.e. strategy, process and shareholder contact, require two persons.

Objections to a separate chair refuted3

"US boards are well served, so why fix what is not broken" say the objectors. The response is that in the many scandals over the last 30 years the main cause has been insufficient monitoring by the board. The majority of fmancial institutions that failed in the recent crisis had a combined CEO/ chair. Moreover, foreign institutional investors want the roles to be separated.

The objectors point to a dearth of evidence that separation of the roles positively impacts share price. The proponents respond that there is no evidence to the contrary. The evidence is, as with all corporate governance changes, neutral. It cannot hurt, but might help.

The objection is that it creates potential confusion and duplication. In the opinion of the proponents of a separate chair it creates a well-delineated division of functions.

The objectors fear potential animosity between the CEO and the chairman. The proponents respond that better monitoring means that difficult questions will not be avoided. Rubberstamping the activities of executives is not what is required. Improvement of oversight functions is what is needed.

One leader is sufficient for decision making, say the objectors. The response is that a group usually takes wiser decisions than one individual on his own.

The objectors argue that a separate chairman creates extra cost. The proponents respond that having a separate chairman can ensure that executives are not overpaid or "paid for failure".

The objectors say potential disruption could occur if the CEO becomes demoralised. The timing of the change is difficult. The advice of the Chairman's Forum is to change when the CEO changes. Its view is "beller late than never".

The objectors say CEOs prefer the combined role. The proponents say independent monitoring may not be popular with CEOs, but it is efficiency enhancing. Just because one constituency does not like it, is no reason not to do it.

The objectors say that in practice the separate chair is unworkable. The response is that 72.8% of interviewed directors with experience with an independent chairman are positive.4

The objectors say that having a lead director is just as good. The response is that the experience is different. A lead director does chair the executive sessions, but not the full board meetings. "He, who sits at the head of the table leads". This also gives the chairman the possibility of asking the views of officers other than the CEO and to take time out if the chair senses disagreement.

Objectors say that one size does not fit all. True, say the proponents, but it fits most. 72.8% of interviewed directors say that if a company board explains to shareholders and they agree, there can be an exception to having a separate chair. It does not have to be mandatory. When companies deliberate about which structure to adopt, they should take into consideration factors such as their culture, stage of development, performance, concerns by investors, etc. No one model provides an absolute guarantee of business success.5 In a family business where the CEO holds most of the shares there does not have to be a separate chairman, is the general view, even of the defenders of the separation of the functions of the CEO and chairman.

Another issue about the non-CEO chairman model is whether a CEO who sits on the board with about 8 to 12 independent directors would not be overpowered by them. The answer given to me by Professor Ira Millstein of Yale University is that board dynamics do not weaken the CEO. The CEO knows the business better than any other board member. His proposals are being discussed. That gives the CEO the power to convince and gives him prestige. Usually things go somewhat as follows. The CEO's proposals are being discussed; he has all the information to defend his plans. The CEO is supported by his officers, who altend the board meeting and show support by their presence and body language. If the CEO is not sure of their support, he should inform the board in advance about any dilemmas he and/or his officers have or first try to convince the officers with his arguments. The CEO prepares the board meetings with the chairman and will know before the meeting whether any independent directors have doubts about his proposals, in which case he can try to convince each of them before the meeting. He can also ask the chairman to adjourn such an agenda point.

The most recent legislative proposal from the SEC would require disclosure of a company's leadership structure as well as the rationale for believing that such a structure is the best for the company.6 This approach is, of course, a "comply or explain" concept, which is now confirmed and repeated in the Dodd-Frank Act of 21 July 2010.7

With these developments and with pressure through shareholder proxy resolutions it is reasonable to assume that in a few years separation of the functions of CEO and chairman will be more widespread.8

Functions and qualifications of the separate chair

The functions of a non-CEO chairman are to (i) convene and preside over board meetings and executive sessions; (ii) lead the board and uphold high corporate governance and ethical standards; (iii) establish the operating procedure for the board and committees; (iv) organize the board agenda with assistance of the CEO, board committee chairs and corporate secretary, and provide sufficient time for discussion of agenda items and focus the board's attention on relevant matters, limit distraction and discord, and work towards consensus; (v) supervise circulation of proper, timely and relevant information to the directors; (vi) ensure that all directors contribute at the meeting; (vii) communicate effectively with management on a regular basis and act as sounding board for the CEO; (viii) take the lead in board evaluation and succession planning of the CEO and other directors; and last but not least (ix) ensure good communication with shareholders.

The qualities required of the non-CEO chairman are independence and the courage to ask questions, to have experience in a similar industry and the ability to commit enough time, e.g. 2 to 3 days a week, not necessarily at the office, but full time in times of crisis, to be a good communicator, and have a sense of modesty and humility.

Clear documentation of functions and qualities

It is important to clearly document the duties of the chair and the CEO to avoid duplication and/or conflict and put this information on the website.

Timing of change to separate non-CEO chairman

Timing the change from imperial CEO — combined CEO/chairman — to CEO and independent chair is not easy. The CEO will see change as an insult. Probably the best moment is when a new CEO is appointed, although this too may be seen as criticism and offering a new person a downgraded job. Risk Metrics, now called Institutional Shareholder Services, is advising some large corporations to make the change before the end of three years.

Appointing a lead, presiding or senior independent director

When boards do not choose to separate the chairman and CEO positions, a lead, presiding or senior director can be appointed. He should meet the independence requirements onder the applicable listing standards. The responsibilities of the lead director (or other equivalent designation) would include chairing executive sessions, but not the full board, i.e. the independent directors plus the CEO/ chairman, serving as the principal liaison between management and independent directors, and working closely with the CEO/chairman to finalise board meeting agendas. In practice he has a veto on setting the agenda. The lead director would also be in charge of approving the information flow to the board and of other operational aspects of board functioning, of the evaluation of the CEO and he would take over the CEO office temporarily when it is unexpectedly vacant.9

The separate non-CEO chairman does have a stronger position than a lead director: (i) the chairman shapes board dialogue and sets the tone and the agenda; he determines which of the officers other than the CEO should be involved in the dialogue; he also ascertains whether there is disagreement among the executives and it is easier for him to stimulate other independent directors to be active in the discussions; (ii) the chairman has visibility and can, if necessary, communicate independently with other parties; and (iii) the chairman has board leadership of the board. Moreover, if there is a non-CEO chairman the other directors will feel less inhibited in challenging the CEO in a full board meeting.10

The trend to have at least a lead director, even if the CEO is also Chairman, may also be explained by the fact that NYSE rules11 now require that an outside director should preside over executive sessions of the boards of listed companies. Thus, companies whose CEOs function as board chairmen — almost 70% of listed companies — do need lead or independent directors to comply with this requirement.

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