How were you able to avoid the siren call of the mid-2000s that was the subprime mortgage market?
In the early 2000s, Fannie Mae and Freddie Mac were very, very competitive and basically were reducing the profitability of the basic mortgage business, so that you couldn’t generate a good return. At that point the industry was starting to move toward subprime. We looked at how subprime worked over a long period of time. The assumption we made is that even if you assumed you got your money back from the house, the operating expenses during foreclosure and foreclosure-management in a downturn eliminated any profitability. In other words, our analysis was that it would end in tears. As a result, we elected to sell our mortgage business and stay away from subprime. That was a key decision we made in 2001 and 2002.

Walk us through the decision to become involved in the TARP program.
The regulators encouraged us, as you know, to participate in the Troubled Asset Relief Program, (TARP) and take TARP money. If you recall—and everybody forgets this—the TARP investment was originally designed to only go to the strong banks. It wasn’t to go to the weak banks. In that promotion, if you didn’t take TARP money, then you could be perceived as a weak bank. For example, National City didn’t receive TARP money and they got a lot of notoriety about being a weak bank.

Do you think there will be a permanent change on how executives are compensated or how compensation is communicated?
When I look at our proxy statement, it’s extraordinarily transparent on how the CEO and others are paid. And we’ve essentially eliminated all of the perks. There is no country club or airplane usage. Any airplane usage has to be fully reimbursed at 100 percent basis. So that’s very important. That’s a good trend. I think the government will continue to stay involved, but the philosophical statements that they’ve made will get down at some point to the specific ratios. But we expect to repay TARP, so I don’t think we will be significantly impacted by it. I think the way people are paid will change, and I think transparency will continue to be very bright. The way we pay our people around here, much of it is long term and much of it—two thirds of it—is incentive based. So you win when the shareholder wins, and we think that’s the way it should work.

What about the rules being considered to provide greater transparency on some of the more complex financial products?
I think the derivative world is a world that clearly needs more transparency, as do the players that are in it. The hedge funds are now a major part of our financial system. To the extent you want to understand systemic risk, you need to understand the positioning of the hedge funds as well as the insurance companies because they are so large.

We’re dealing with this new, much lower yield environment. What will be the unintended consequences of people trying to chase ways to get more yield?
People will always look for yield, but I think people will look more on a risk-adjusted basis than they did before. People chased yield throughout the early 2000s and, to some extent, lost their company. It’s interesting; people say the market didn’t work, so we need stronger regulation. I do think we need stronger regulation, especially in the area of systemic risk. I don’t think there’s any question that we—as a country or an industry—didn’t understand or manage the systemic risk as well as we should have by far. There’s no question about that. But the idea that people went out on the risk curve in the credit space the way they did with subprime, for example, they’re not going to go back out there. We were talking to a newspaper and the reporter said, “The market didn’t work.”

The market didn’t work? You want to go ask Lehman Brothers whether the market didn’t work? You want to ask Bear Stearns or Merrill Lynch? People took too much risk, and nobody could have foretold that the housing market would have fallen the way it has. But I think if you step back, you can tell there was too much risk and if you leverage yourself 38 to 1, you have too much risk. And people won’t go back to that. This market taught a lot of people a lot of lessons.

Do you think Lehman Brothers and Bear Stearns  and some of the other large banks that had problems were handled fairly by the Treasury and the Fed?
I think the Fed and the Treasury did an extraordinary job. I think there was more systemic risk in play than anyone knew. When Bear Stearns was sitting on top of a massive swap book I don’t think anyone wanted to know or could fathom how the failure of that book worked its way around the world. I think by putting Bear Stearns in safe hands it clearly saved us from a tremendous amount of damage. And I will tell you, if AIG had failed I think all of Wall Street would have failed the next day.

How should a board like yours be looking at risk?
You’ve got a significant portion of the talent on the board on the risk committee, and that has worked very well for us. We have a number of risk committee meetings—more than any other committee—and we give them a tremendous amount of information. There’s a lot of discussion at the risk committee, and they probe management regularly, but they’re not trying to tell us what to do. We have answers to the general questions that they have and that’s important.

Has your relationship with your board changed at all as a result of the financial crisis?
I don’t think so. I think the chief executive has an obligation with the board to be totally transparent. A fellow who was on our board years ago told me, “All surprises are bad.” That’s true for the most part in life and it is clearly true with the board of directors. Whether we’re going through good times or troubled times, we’re jointly trying to manage the company, and so if there’s a difference between where the CEO and the board want to go, then you have a significant problem. If you are not keeping the board fully informed about what’s happening in the company, then you have an opportunity to have a gap and then surprises, and those are bad. Communicating with the board is something that’s been important to me since I got the job. Some times are better than others, but communicating and being totally open with the board allows you to build your reputation or your relationship with the board on an integrity basis. To the extent that a board doesn’t trust the CEO or it doesn’t trust the management, then it’s time to make a change.

You recently announced an increase to your dividend. How are you able to do that when many companies are making cuts?
We have a very strong balance sheet and we have a very large capital program. What we try to do is maintain our dividend and have small, incremental growth in it, which is less than the growth in our earnings. And we’ve been able to do that. While earnings have been somewhat flat—like everyone else, we have been affected by the economy—we continue to batten down the hatches and work our way through this downturn in the economy.

What’s the board’s involvement in the planning process as you plot your way through an environment like this?
I just came off our board retreat. We did something different this year. It takes us 10 years to build a nuclear plant, it costs $10 billion, and the plant will operate for 60 to 80 years. So that’s the kind of timeline we have to have in our minds. So what I did with the board that was different than the past is, I said let’s not worry about the next five years. Instead, I suggested that we focus for five to fifteen years out, and try to imagine what the business will look like. We brought in some people that had views that are different from ours, to help challenge us, so that we don’t find ourselves drinking our own Kool-Aid.

You have earned a reputation as an environmentalist energy company CEO. Wouldn’t it be a lot easier to not address the environmental side? Because in some ways, it makes you a target for both sides of the debate.
It really does, and in some interesting ways. But you know, I actually believe, in my role—we’re the third-largest generator of electricity in the country, the third-largest generator of coal, the third largest generator of nuclear power— and part of my mission is to educate the public on these issues. There’s an amazing lack of understanding of how we generate energy in this country. And so one of the things I strive to do is to get out and tell a story. Now the environmentalist part of it is that I actually believe our mission has changed. In the 20th century, our mission was to provide easy access to electricity in the United States. In the 21st century, our mission is going to be to help our communities become the most energy efficient. We’ll have to change our regulatory business model to do that. We are going to retire and replace every power plant we own between now and 2050. But the country—and the scientists believe this is a problem that needs to be addressed—wants us to have a low-carbon generation fleet. There couldn’t be a better time in history for me to make that transformation, because I’m going to have to replace them with something, so let’s replace it with something that’s low-carbon.

Does your board support your stance on these issues?
We have a rich debate on them. Some of the directors approach the global warming issue slightly different than I do. But I welcome such a different view, because it crystallizes the conversation. You have different points of view that lead to robust conversation, but it also leads to a policy that really reflects a lot of optionality and recognition of:  “Well, wouldn’t you do this anyway, without global climate?” or, “Shouldn’t you pursue this option versus that one?” I’m also a big believer in bringing outside speakers in with various points of view. I have a long history of doing that. And I’m a big believer in having diverse points of view on the board and engaging these diverse points of view.

You have a new CFO. What does it require of you and the board when you have a high-level change like that?
I think one of the important things, is that any time you change the CEO, CFO, or COO, it’s really important to have clear communication about why there’s a transition and it’s important to introduce your new person to the primary constituents that they’ll be addressing. So that is one of the things that we did. It was a seamless transition. We had the perfect replacement in Lynn [Good], who was a controller of Cinergy and CFO of Cinergy immediately before the merger with Duke.

How has the role of CEO, generally, changed over time? Do you think there’s a new paradigm for the CEO’s job?
I do. And the advantage for me is that I’ve been a CEO for so long, I have a good sense of the operation, but probably more importantly, I have incredibly strong people in operating roles that really complement my capabilities, but also complement the demands that I have—on me. I’ve started to think that I have two roles: One is the traditional running the business—in military terms, it’s “the general.” I also think that another aspect of my role is external. And this role is about building relationships and collaborating. Business people are used to talking to other business people, but I think the real alliances of the future is when businesspeople are reaching out with NGOs, with environmental groups, with consumer groups, with people outside and with differing points of view. I think that collaborative, working-together role is a key part of what I do. I think the other part, and what I really enjoy now in this very transformative period, is looking at new technologies. I believe I’m a “scout,” so part of my mission is to look at new value propositions and make sure we understand these disruptive technologies and are incorporating them in our business model.

There’s a lot of effort underway to give shareholders more say in what’s going on. Is there a danger that the pendulum swings too far?
The pendulum is swinging, and there is a risk that it swings too far. And a lot of this is a reaction to the economy, and returns are down, and stock prices are down, and it’s a reaction to some excesses that occurred primarily in the banking industry, and bank boards didn’t perform particularly well; in fact, they didn’t understand the products they were selling and investing in. So I think this is a natural thing, and I think we need to be careful to keep it centered.

What are your thoughts on CEO pay and the debate over compensation?
I think it’s changing and I think you will see a push to tie pay more closely with performance. I just signed a contract for five years; I get no cash salary, no cash bonus, and most of the stock I get paid is at the end of the five-year period. And, the way that it works is that part of my stock compensation doesn’t occur until two years after that. So I’m incented to make sure I have a really strong team performing well after I leave.

Directorship interview conducted by Joseph McCafferty.

We recently sat in on a conversation between Magnus Böcker, president of Nasdaq OMX Group and Kevin Kelly, CEO of executive search and leadership advisory firm Heidrick & Struggles, which trades on Nasdaq. The two shared their views on what leading companies must do to persevere during times of uncertainty. They also discussed what trends are shaping today’s corporate leaders and boardroom agendas and their own organizations.

Kevin Kelly: Magnus, have you found your management style changing as a result of the global crisis? Internally, how have you dealt with your people, your budgets, and your customers?

Magnus Böcker: The traditional thing to do under these circumstances is to make sure you have the right cost discipline and see if there are things that you haven’t dealt with that you should. At Nasdaq OMX, we have a tradition of good cost-discipline and already run very lean operations. So that part has not changed . The lesson learned over the last eight months is that the business model of exchanges is very strong. It has functioned well, even amidst trading volume that is more than double that of a few years ago. We’ve been open every day, we’ve been trading and providing an avenue to capital for companies. At the same time, the credit markets have been dysfunctional.

One of the things we are doing is looking at ways we might be able to leverage this environment and see if there are new opportunities. We’re using the exchange model to see if we can add value to the market for interest rate-swaps and other instruments and markets that we probably never would have been able to go into unless we had this crisis. Kevin, tell me, how has it changed the way you see things?

K.K.: There are a couple things that we are doing differently. One would be communication. I think leaders in any organization try to communicate effectively, but we’ve definitely ramped up the communication. Number one, internally to all of our consultants and employees across the globe, we make sure they know that the operating team is doing everything possible to weather the storm. Because we’re in over 60 countries, we’re in touch frequently, so they don’t have to guess what’s going on. We convey what’s happening in real time—partly to steady nerves, partly to ensure our crew benefits from the great advantage we have over our clients— about best practices across all geographies and all sectors. Number two, we have a constant dialogue around the world about how to best manage the shortterm. The dialogue is between our regional leadership and the operating committee, and it covers costs, as you mentioned, and making sure that we preserve cash. As in any organization, cash is king right now, so it’s crucial we stay on top of our operations around the globe on a day-to-day basis. Another aspect of this would be short- versus long-term thinking. We all have two- to three-year plans that we have in effect or that we would like to execute, but the current economic situation has kind of thrown a spanner in our long-term thinking. It’s hard to forecast what’s going to happen to the market tomorrow, let alone three months from now.

M.B.: You highlighted something that I agree with completely. That is that our staff, our customers, and our partners are demanding more information. I think that’s a very relevant point, that when everybody sees all this information out there and much of it is negative, we need to be more proactive in the way we’re communicating. We are going out to listed companies in a way we didn’t before, telling them what’s going on, trying to use communication as a tool to tell them what we’re doing and that the world goes on.

Now Kevin, you talk to a lot of CEOs. What are they concerned about right now? How about the board?

K.K.: With all of this debate and dialogue, when we talk to potential CEOs for jobs, we hear concern about the scrutiny put on CEO compensation today. But it’s not only that. One CEO who could run a major financial institution said to me, “Kevin, forget the $500,000 comp, because it’s not about compensation. The reputation I’ve built up over time is worth much more than $500,000. The risk of taking on this job is too high.” Boards are of course very interested in the short-term. They’re also preoccupied about succession planning; not just for the CEO, but for one or two levels down in the organization. And they need to make sure the firm as a whole has the talent pool that’s going to enable it to succeed. We’ve had probably a six-or-seven- year run where the focus on quarterly results caused a lot of turnover at the CEO and board level. You can’t build a long-term, sustainable strategy when you’re flipping over CEOs and executive teams every 24 to 36 months. Everyone is still figuring out this recession, and how to work our way out as fast as possible. So it’s important that boards are really clear about the overall direction of the organization. It’s also crucial that they support their CEO and leadership team. Every CEO faces agonizing choices, like do they yield to short-term pressures and just cut costs? Or do they pursue innovative ideas so as to come out of the downturn ahead of their competitors? Away from the storm, the right answer is obvious, but taking the long view is easier said than done when the wave right in front of you is the biggest you’ve ever seen. Boards can do a lot to build the confidence of the organization’s leadership. Exposure to risk needs to be managed with extreme care right now. But most organizations will work their way out of this downturn by finding new ways to stay competitive. Apple increased its R&D spending during the dot-com crash and made the iPod. But that means a degree of risk-taking. Managing that is one of the most important tasks of leadership right now because innovation depends on the prevailing culture of the organization.

I see it with my own board. You have a group of very smart, free advisors, who are willing to help. Whereas I may have talked to a couple board members every three or four weeks before, in the last few months I’ve had more frequent dialogues. On a real-time basis, I’m getting their input on the decisions we’re making as an organization.

What has your experience been in this area?

M.B.: There’s no doubt that you see changes happening at the board level when we have these difficult economic periods. We see more engaged board members, and that is a positive. They want to know, what’s the top project? What are the key figures to follow? I would say that from talking to a lot of the companies that are listed with us, the general theme when you talk to CEOs and CFOs is that it’s back to basics—they are following cash flow very closely. The board is keen to know more about risk management. They want to know more about how are we doing with acquisitions and following up with previous investments.

K.K.: What is your view about having a separate CEO and Chairman?

“I have more frequent dialogues and I’m engaging [the board] in decisions that we’re making as an organization and getting more input on a realtime basis.”

—Kevin Kelly

M.B.: That is the structure that we have at Nasdaq OMX. I’m coming from a European tradition, where, as you know, there’s a very clear and distinct separation of the chairmanship and the CEO. So, I’m very supportive of it. We have been supportive of the philosophy of separating the CEO and the chairmanship for a very long time. We see that as good corporate governance, and we’ve taken a strong position on it.

K.K.: I’m in the same situation. I have a chairman who’s been extremely supportive of me. A lot of the dynamic in any organization hinges on who the chairman is. I spent the last three years in London, so I have seen up close how well this works there. We may see a trend in the United States towards dividing the two roles, just given the size and scale of some of the organizations today. Given the time it takes to actually manage these, I think it makes sense to split the chairman and CEO jobs.

M.B.: Kevin, is this a generational issue? Do you see this becoming less of an issue when younger executives are promoted to CEO who have less of a traditional background and are more operational, more performance-oriented?

K.K.: I think you’re right, because the average age of CEOs is coming down. One of the questions that goes to the future of the CEO is, given the global reach of most organizations today, and the time that it takes, the endurance and tenacity you need as a CEO, how can you be expected to run the board too? So I think it is a generational thing. In my personal experience, the chairman can also serve as advisor, guide, and coach along the way, and this is a trend that will continue.

M.B.: Is there a new CEO for this environment and what are the characteristics?

K.K.: What’s fascinating about this is that we will see an evolution of a whole new group of leaders across the globe, who differentiate themselves by succeeding through this financial crisis. There has been so much change over the last seven or eight years and everything moves at a much faster pace, even the communication tools and real-time technologies, as Nasdaq well knows. But it takes a long time to fully know the business. Jack Welch said that it takes five years before any CEO—even an internal candidate— can get a full grasp of their organization. So my belief is that the CEO of the future will be somebody who has the international component and background and can also understand different cultures— especially with bigger and more complex organizations. There is another component, too. CEOs can’t be dictatorial today; they have to be leaders who can bring people along. So I think not only does he or she need to have the IQ, but also the EQ, the emotional quotient, and then a third quality is the CQ, or the cultural quotient, to maneuver through different markets and cultures across the globe. I think those are the critical success factors going forward.

There is so much information out there that it can almost be overwhelming to the CEO of a large organization. Now at Nasdaq, which thrives on this technology and these information streams, I can image it would be difficult to keep from drowning in it.

M.B.: Maybe it’s because information is the lifeblood of the company that we don’t get too stressed about it. In the industry we’re in, there is a constant stream—I wouldn’t say overflow—but we have a very intense informational flow, and that is part of our world. Therefore, I think we get less caught up and less stressed about it. But it is getting more intense, especially with everything going on in Washington. We don’t only have ordinary business information, we have a new government coming in and, with all the things happening around that—the new players, the new issues—that is creating enormous amounts of information to digest. But our existing infrastructure helps us to see what’s relevant and what’s not. I think it’s a very important question, and we have addressed it. There will always be things that fall between the cracks, but we feel actually quite okay.

But Kevin, I’m curious, is there something about business leaders—let’s say the candidates that your firm recruits—is there something about business leaders that enables them to graze over this avalanche of information and make sense out of it, that perhaps lesser leaders don’t have? 3

K.K.: Well I recently had a discussion with a CEO who just retired, and I asked him how he was spending his time. He told me that it’s amazing how long it takes to actually read a magazine cover-to-cover or the newspaper cover-to-cover without getting distracted and, based on numerous conversations with CEOs, I think it comes down to discipline. Today we’re inundated with information. I mean you have Blackberries, you have your computer, you have mobile phones. The expectation is that if you don’t reply or respond to somebody in 30 or 40 seconds, no matter where they are across the globe, you’re not getting back to them in a timely fashion. So having interviewed a couple CEOs about how they manage their time and whether they expect CEOs to work even harder in the future, I don’t think that’s actually possible. You can’t think about what you want to do with the organization longer term and also let your Blackberry rule each day.

M.B.: I think we all know the feeling.

Magnus Böcker

Magnus Böcker understands that a successful business strategy can be likened to running a marathon—patience, endurance, and mental fortitude are needed for both. His success as a runner, having finished a New York City Marathon in less than four hours, has abetted his professional endeavors. As president of Nasdaq OMX Group, Böcker is well-equipped with experience in the European and international capital markets. While CEO of OMX from 2003 to 2008, Böcker oversaw the integration of seven national exchanges in northern Europe into one. Today, Nasdaq technology supports more than 70 exchanges. He is a member of the board of the World Federation of Exchanges (WFE) and also serves as chairman of the board of Dustin Group, a privately held electronics retailer in Sweden.

Kevin Kelly

In full swing working on his second book, Top Jobs—How They Are Different and What You Need to Succeed, Heidrick & Struggles CEO Kevin Kelly writes of his own experiences as he explores what it takes to lead a global organization in the 21st century. Fluent in Japanese, Kelly joined Heidrick & Struggles’ Tokyo office in 1993. He was regional managing partner of Asia Pacific and then Europe, the Middle East, and Africa before being named CEO in 2006. Kelly believes a new approach to leadership and talent is necessary to succeed in today’s tumultuous economy and he coaches today’s top corporate chiefs on just that.

Asked what ever possessed him to take the job for a dollar a year when former Goldman Sachs CEO and then Treasury Secretary Henry Paulson asked him to take the job,Liddy told Kroft, “First, I think, like much of your audience, ifsomebody calls and says, ‘Could you please help your country?’ peoplesay, ‘Yes.’ With respect to a dollar a year, I knew I’d have to makesome tough decisions. I didn’t want in any way, shape, or form peopleto question my integrity, my honesty as to why I was doing it.”

The former longtime chairman and CEO of Allstate insurance company gave up retirement and stepped off Goldman Sach’s board to take the AIG job, which he acknowledged was in some ways worst than he thought.

“Did you have any idea what you were getting into?” Kroft asked.

“In some regards, I did, and in some regards, I didn’t. Socertainly understanding how to restructure a company, I’ve done thatbefore. The political issues, how you relate to the Federal Reserve orTreasury, or the Congress, that’s new and sometimes terrifying to me,”Liddy said.

“Especially the Congress,” Kroft remarked.

“Especially the Congress, yes,” Liddy replied.

Congress raked him over the coals for paying out $165 million inbonuses to some of the very people who helped wreck AIG. The bonusdeals had been signed before Liddy got there.
 
“It’s difficult to sit there and have 30 or 35 people throwingbarbs at you, and really not appreciating that you’re on their side andyou’re trying to help,” Liddy said.

Asked if he knew how bad things were at the company when he took the job, Liddy told Kroft, “No, no, not at all.”

Not long after he arrived, AIG reported the largest quarterly lossin U.S. history – more than $60 billion during the final three monthsof last year and since then he has worked to sell off assets.

“So you are, in effect, the liquidator?” Kroft asked.

“Well, I don’t think it will be called AIG, but there will bepieces of this institution left. But that’s the only choice we have.That’s the only way we can pay back the government,” Liddy said.

Asked if all of the government money will be paid back, Liddy said, “That’s what we’re committed to doing.”

]]> http://www.directorship.com/aigs-liddy-tells-cbs-we-own-it/feed/ 0 http://www.directorship.com/soros-stimulus-having-intended-effect/ http://www.directorship.com/soros-stimulus-having-intended-effect/#comments Thu, 01 Jan 1970 00:00:00 +0000 News Editor http://www.directorship.com/?p=2775 Billionaire investor and economic thinker George Soros told a Frankfurt newspaper that the economy’s downward motion is easing up and that the various stimulus packages are beginning to having their intended effect. According to Reuters, in an interview with the Frankfurter Allgemeine Zeitung daily paper, Soros claimed that most countries were on their way up, but that Asia would emerge more quickly than the United States.

“The economic freefall has been stopped, the collapse of the financial system averted,” said Soros. “National economic stimulus programs are starting to take effect. The downward dynamic is easing.”

Soros warned that the recovery efforts would only make up for about half of the losses sustained in the recession, and that stagnation would take effect for a period. He also claimed that the U.S. dollar, having been devalued heavily against the Euro in recent years, would not lose much more value.

Soros reaffirmed that China, whose GDP in 2008 was second worldwide only to that of the United States, would soon be a powerful economic force on the global stage. He predicted that Asian countries on the whole would “find out of the crisis” before the United States managed a full recovery.

In an interview with Bloomberg Radio, Feldstein also said it would be difficult for the U.S. central bank to clean up its balance sheet from the toxic mortgage-related securities that it has purchased from ailing financial firms. These securities will be difficult to sell, thus limiting the Fed’s ability to deflect the threat of inflation.

Feldstein served from 1982 to 1984 as chief economic advisor to Ronald Reagan, as well as chairman to the Council of Economic Advisers during that period. He currently serves on Obama’s President’s Economic Recovery Advisory Board.

Ackermann, in an interview with Germany’s Bild Zeitung newspaper, emphasized that there was a difference between certain compensation practices being legitimate or merely legal, and that banking managers should make the same sacrifices as the public at large.

Bank managers at Deutsche said last October that they would be forgoing bonuses; months later they reported record quarterly losses of about $6 billion for Q4 2008. Ackermann himself took a pay cut of 90 percent, reducing his 2007 salary of €14 million to €1.4 million last year.

Speaking of the global financial crisis, Ackermann predicted that the economy wouldn’t resume growth until 2010. The crisis would likely keep “us occupied for some time yet,” said Ackermann.

Lewis projected a strong BofA, saying that he regretted taking more Troubled Asset Relief Program (TARP) funds than his bank required, and saying that he was “anxious” to pay back the government. BofA took a total of $45 billion from TARP, including $20 billion to cover losses incurred when it acquired Merrill Lynch at the beginning of the year.

Lewis said in the interview that he believes the second half of 2009 will mark the bottom of the financial crisis. “We’re at a point where you’re seeing mixed signals…some housing sales a little better than you’d think, or some car sales not being quite as bad as you’d think,” said Lewis. “It signals that you’re getting close to the bottom.”

Lewis also defended the controversial acquisition of Merrill Lynch, a merger move that has drawn ire from shareholders who believe they were duped as to the financial strength of the acquired investment bank. Critics had previously seized on Lewis for BofA’s buying of Countrywide Financial earlier in 2008.

“[The acquisitions of Merrill Lynch and Countrywide] will prove to be two of the best acquisitions we’ve ever made if you’ll judge us over two or three years rather than two or three months,” said Lewis.

Pension fund trustees certainly have little to cheer about. What can they do now?
We currently advise 11 large funds that own shares in many companies around the world, including many financial-services firms. We’re engaging with these banks on their risk management, strategies, and the ways in which they pay themselves. If these questions had been asked earlier by more people, we would not be where we are today. We often behave as though banks were operating independently, as if they didn’t have owners. It is in pension funds’ longterm interests to have a dialogue with the companies they invest in. This process of engagement involves direct board-level contact and is most effective when it is collaborative. We do have robust conversations, but most companies appreciate and benefit from a dialogue with their long-term shareholders. This seems rather obvious, but companies that are well managed and do the right thing tend to do better in the long run.

How do we end this downward spiral?
Part of it is lack of confidence and trust, and the problem that no one (including the banks) seems to know how much the banks are worth. Globally, there’s a real opportunity for big pension funds and insurance companies and the banks they invest in to work together. There is also an opportunity for more collaborative and longer-term thinking. Everyone’s retrenched and lending on a very short-term basis, but it’s in their rational self interest to begin working with one another.

But somebody’s got to go first?
Absolutely. The large funds should get together and demonstrate some leadership themselves and start the dialogue. Part of the reason I’m here [in the United States] is to talk to prospective pension-fund clients. We offer a service through Hermes EOS to empower pension funds and enable them to work together to be better owners of companies.

Are you optimistic about corporate governance changes as a result of this environment?
It’s essential and long overdue. The United States has possibly the worst governance environment. Shareholders’ rights are stronger in the U.K. and pretty much every other country. The United States is lagging and that has contributed to the current problems. Shareholders lack key rights and the large pension-fund owners of U.S. companies could do a better, more responsible job with majority directors elections, access to the proxy, and say on pay. Our experience in the U.K. is that such rights improve the quality of the dialogue between companies and their shareholders to mutual benefit. Funds will also need some encouragement to exercise their rights. I expect this will happen with the [Obama] administration.

Do you think CEO compensation problems are restricted to a few widely publicized, egregious cases, or are the excesses widespread?
This is a consequence of lack of oversight, a lack of shareholder rights, and a lack of transparency. CEO pay must be aligned with the interest of shareholders and customers. Are there models? The only model for Hermes EOS is what is in our clients’ best interests—better managed, more valuable companies to invest in. We are not pushing any particular compensation model. The right model is that which encourages long-term, sustainable financial and business success.

Should there be a cap on executive pay?
I would hope that wouldn’t be necessary if the large, long-term shareholders were acting in their own rational self-interest. This should occur naturally. We don’t want government and regulators to intervene, so we should get our own houses in order and create a more efficient market that reflects the interests of participants. We should also look to local best practices. We were talking to several banks over the past two years and challenged them about the ways they were paying traders. They claimed that there was a market for executive talent that required a certain level of pay. We strongly encouraged banks to work together to produce a best-practice model for their industry and their market.

In your view, has U.S.-style litigation had any effect outside of the United States?
I don’t think it’s spreading. Such litigation seems unique to the United States because of corporate law and the relatively poor level of shareholder rights. Although we should expect shareholders to take action when they have been defrauded, many securities class actions are opportunistic and distracting to corporate management. Also, as a long-term shareholder, it is rather like suing yourself. You take money out of one pocket, give some to the lawyers, and put the remainder back in another pocket.

Is there a particular shareholder bill of rights to which you subscribe?
We support local best practice. There’s no one ideal set of rights, although the best governance systems facilitate good corporate management and accountability to the owner. The problem with “corporate governance” as it is too often interpreted and practiced is that it has become an exercise in compliance, rather than good corporate management and ownership. Companies need responsible and interested owners, rather than box-ticking traders of their shares.

How have corporate frauds, such as the one the former CEO of Satyam admitted to, affected how Hermes looks at governance in countries such as India?
India is a really interesting example because quarterly reporting has brought such a short-term focus and pressure to companies, perhaps even more so than in the United States. Small adjustments, or a small lie, become magnified over time as the adjustments continue. Weak corporate management may try to maintain growth in earnings to meet the expectations of asset managers with a short-term focus. This is very different than the challenge we provide to companies through Hermes EOS. The conversation that CEOs and CFOs frequently have with the City of London or on Wall Street is very short term and generally not about the substance of the businesses they are running.

Short selling has also been blamed for creating a short-term focus. Has it become a big problem?
Short selling is not in itself bad, but it needs to be properly controlled and there should be more transparency. Also, those people who are facilitating short selling by lending their stock should do so in a managed way, monitoring the lending volumes and corporate actions. This sort of rational, self-interested control by pension funds and other long-term end owners of companies is esssential if we are to avoid heavy-handed regulation in this area. The best regulation will provide additional transparency and create open and transparent markets, which are necessary for restoring trust in our financial system. It is then for the market participants to behave responsibly and at the very least, avoid doing damage to the financial system on which we all depend.

Should we do away with quarterly reporting?
I don’t see the benefit of it. What’s more important is that the end investors should take control of the situation and demand better terms from management for their money. As we look ahead, I hope that pension funds and other institutions will rise to the challenges presented by the credit crisis and help build a more stable and sustainable platform for growth.

In the interview, Cox largely exonerated his agency for not making any big moves during the credit crisis, while implicitly accusing the Treasury and Federal Reserve of being too quick to act. “When these gale-force winds hit our markets,” said Cox, “there were panicked cries to change any and every rule of the marketplace: ‘Let’s try this. Let’s try that.’ What was needed was a steady hand.”

Cox also deferred general blame for the source of the credit crisis, saying that the SEC is not responsible for bank stability: “The SEC is not a safety and soundness regulator.”

The interview marked Cox’s first since news of the Madoff scandal broke. Cox will be replaced by Mary Schapiro as part of the regulatory change of the new presidential administration.

You have been mapping U.S. recessions and recoveries since the 1960s. At least one former Fed chief says the U.S. economy is now in a recession. Do you agree?
Yes. We have been, believe it or not, in a decline in the U.S., and are in a recession, for about a year. The best indicator of this is the U.S. Composite Index of Coincident Indicators, which confirms this view. This index peaked in October 2007 and has been declining mildly but steadily since then. This is somewhat similar to our last two recessions in 1991/1992 and in 2001, but already this one is longer at 12 months than the last two, which lasted eight months each.

What are some of the indicators that you look at to determine how long and deep a recession is going to be?
We look at the U.S. leading index, the coincident index, and the lagging index. We want to compare the present to past periods, so we look at the same indices each time: Changes in working hours lead employment, new production of orders and contracts lead goods and services, construction contracts lead construction, and these sequences repeat themselves time and time again.

This cycle has been compared to the period leading up to the Great Depression. How is it similar and how is it different?
That’s a great exaggeration. This downturn is very, very different, and so was the preceding boom. We have an unemployment rate of 6 percent, which doesn’t compare with a rate that was three or four times larger than that in the 1930s. The decline is still very much milder than it was then. Government reaction has also been much better. During the Great Depression, wrong policies were applied that aggravated rather than improved economic conditions. If there are similarities, it is in the housing sector. Like now, housing prices fell, which is a rather rare and ominous occurrence.

So instead of comparing our current economic crisis to the period before the Great Depression, you think it is more analogous to what was happening prior to the recession of the mid-1970s?
Exactly. Only in the 1970s, it was more severe than what we’re experiencing right now. The recession in the mid-1970s was a combination of two of the worst things: inflation and negative growth, referred to as stagnation. And we don’t have that. At least not yet.

Is there a correlation between the size of a boom and the resulting bust?
Absolutely. More often than not, there will be positive correlations. The larger the boom, the larger the bust. That is often the case, yet not always.

What do you make of the government’s response to the current crisis?
I would say it was earlier than usual and, for the most part, well done. That is one reason to hope that it will not be so bad, because we have more and better policy. Another factor that is less well known–and it’s important–is that the American economy has changed greatly since the Great Depression. It used to be that manufacturing and goods production was more important and now it’s production of services. And services are far less cyclical than goods—particularly durables—and less vulnerable to recession. The government sector is also much larger, and government is least cyclical of all the sectors. It is true that policy has improved somewhat, too. So, in general, we have what some people have called the great moderation of business cycles. When we look at business cycles early in the post World War II period, and in the 1960s and 1970s, there were much more severe recessions and they lasted longer.

Some argue that the current crisis is not so much due to lack of liquidity, but to investors’ lack of confidence. What do you think is the cause of the current market turmoil?
It’s probably more a lack of confidence. But we had a long period—an overly long period—where we had too much liquidity. Too much of anything is never good.

What do you make of the massive volatility in the stock market?
The stock market is an opinion maker and shaper. It has a strong effect because people lose or win in the process and they watch it closely. It’s also important to know that the stock market itself is not a reliable indicator of the broader economy. It is part of the leading indicators, and it deserves to be included, but it is not a reliable indicator in the way that new orders and contracts are. The stock market is very subjective and so it reflects expectations rather than reality, and it creates a lot of uncertainty and pessimism when it goes down the way it has.

What are some of the things that economists are getting wrong?
We are always getting something wrong. It’s awfully difficult to forecast and we probably don’t deserve as much blame as we get. The best I can tell you is that we have probabilities and no certainties at all.

Is there anything that you have seen in this current cycle that surprises you?
What surprises me is the disruption of what has been called “the great moderation.” The expansion during the 1990s was the longest on record and it lasted 10 years from the trough to the next peak. And now we are in 2008 and we’ve only had an expansion of about seven years in between and already the decline is 12 months long, so we don’t have a clear moderation. Instead, we have a shorter expansion and a somewhat more severe recession. People talk about this all the time. The media talks about the rising severity and have forgotten moderation. It’s important not to exaggerate.

What are you working on today?
I’m still working on developing the same kind of indicators used in the United States for a variety of other countries in central Europe and Asia. The United States still has a very big impact on the rest of the world’s economy. We should be careful not to exaggerate that, either. In the case of the Great Depression, our recession spread around the world. But it’s too early to tell what the effect of this period will be. Unlike what some headlines are declaring, we are not necessarily “facing the abyss.”

The latest iteration of the bailout plan proposes that the U.S. government take control and fiscal responsibility of up to $700 billion in mortgage securities at the taxpayer’s risk. The proposed law, which was shut down by the House of Representatives initially on September 29, has faced steady opposition from legislators on both side of the aisle that consider the proposed bailout hasty, financially hazardous, and unfair to the U.S. taxpayer.

O’Neill, who served under the Bush administration for just two years, has earned a reputation as a vocal and often contentious figure in Washington. His tenure as secretary was marked by frequent dissent directed toward the Bush Administration’s policies, which led to his forced resignation in December 2002.

The former secretary has predictably been highly critical of the White House’s response to the recent credit crisis. In an interview last week with ABC News, O’Neill blasted Bush’s understanding of the financial crisis: “I don’t think he understands or knows much about any of this and it shows.”

A modified version of the bailout bill was approved by the Senate last night and will now go back to the House for a vote. The new version of the bill includes a slew of tax proposals and cuts, pushing the bill’s length to more than 400 pages.

While some litigation trends in the United States are troubling for business leaders and directors, what is happening in many countries around the world can be downright scary. As the pace of globalization intensifies, board members and corporate officers open themselves up to personal liability in far-off jurisdictions. We sat down with Suzan B. Friedberg, assistant vice president, foreign general claims at American International Underwriters, and Steve Whelan, executive vice president at AIG Executive Liability, to delve into some of the trends taking shape in Europe, Asia, and South America. They shared some good advice on what directors can do to manage their global liability exposure.

Do you see significant storm warnings ahead for directors?

Steve Whelan: The trend we are seeing is regulators engaging in more consumer-protectionism than was the case in the past for U.S.-based companies doing business overseas. You’re starting to see markets adopt U.S.-style litigation. A clear example is in Italy where, effective June 30, you will see consumer class actions for the first time. Germany adopted class actions in 2006. In Canada, they adopted Bill 198 a few years ago, which is similar in intent to Sarbanes-Oxley. The rationale? More and more countries are looking to protect shareholder rights.

You’re still saying that the U.S. remains the largest litigation market?

Suzan Friedberg: From a D&O perspective that’s true, but I will say that other jurisdictions, particularly Australia, are becoming very litigious and they’ve had a couple of developments that are fueling class actions. Unlike in the United States, litigation funding is not a function of contingency fees, but through litigation funding firms, which operate on the same type of basis but fund a class action in exchange for a percentage of the recovery. The plaintiffs’ attorneys are getting a regular fee. These litigation funders are really nothing more than investment companies.

What activities overseas can create liabilities?

S.W.: Our original perspective was that if you served on a board in a foreign country that would be the only place you would see liability. But there are many alternatives for overseas plaintiffs now. If you participate on a board which has a subsidiary in another country, you are at risk. There is also the chance of exposure if your stock trades on a foreign exchange or if you have a large percentage of investors in another country. If an action or decision is made in a foreign jurisdiction, it could lead to a claim against the director, regardless of his or her location.

So what you’re saying is that wherever you go— to put it in litigation terms—you’re still in West Virginia?

S.W.: That’s really the crux of it. A lot of this is coming from clients themselves. You’re seeing companies get hit on multiple fronts. Look at the case of CP Ships, for example. A suit was brought and settled against it in the United States, and then several other actions were brought in Canada, where the company is headquartered and operates in multiple provinces. In the Shell case, there was a U.S. settlement and then settlements in foreign countries. The real issue is that companies have gone global and their shareholder base is now global as well. U.S. companies, in particular, no longer have a majority of shareholders in this country. They’re spread out around the world.

In the circumstance you’re describing, director liability is a growing problem, but aren’t they covered by D&O insurance?

S.W.: There are a couple of different trends. One is an increase in the number of claims outside the United States. We starting to see more regulatory involvement and more legislation passed to permit class-action litigation. That leads to another subject: a U.S.-based company buys a U.S.-based directors’ insurance policy, but what if they are sued in a foreign jurisdiction that prohibits the use of non-admitted insurance? That’s the issue now. The U.S. policy is an admitted policy in the United States, but it is not an admitted policy in Brazil, China, or India, which are three countries that clearly state in their laws that they prohibit the use of non-admitted insurance.

Can you clarify the difference between admitted and non-admitted insurance?

S.W.: Some foreign jurisdictions require a licensed and admitted policy form that was approved by the insurance regulators in those countries. A policy in the United States that is on an admitted basis means admitted in the U.S. but is not necessarily recognized as admitted insurance in several countries abroad. So therefore, if you are sued in those jurisdictions you are facing the potential that the regulators deem the U.S. insurance policy to be non-admitted, meaning it is invalid.

“Nothing isolates or insulates from potential litigation. If you’re operating in any foreign jurisdiction, you face many kinds of potential liabilities.”

Steve Whelan, AIG Executive Liability

Are they simply saying they want you to buy insurance in their locality?

S.W.: Yes, in many instances it has to do with securing a policy in local jurisdictions so that premium taxes are paid to the appropriate authorities.

What do directors need to be on the look out for, and where are the courts that can be unfriendly?

S.F.: Our own legal system poses a lot of risks for companies doing business here. But one should be cautious with regard to liability in China. There are also big litigation risks in Australia and in Germany for insured claims. Then there are regulators involved in securities-related matters in Hong Kong, Taiwan, and Singapore, where we don’t really see private shareholder suits but the enforcement is really by the government.

S.W.: Just to add to that from the D&O front, many of the countries outside the United States do not have a lot of case law, so we don’t know how they’re going to react to the type of litigation we frequently see here that they are now adopting.

Is there an equivalent of the plaintiffs’ bar? Are plaintiff lawyers getting more aggressive overseas?

S.F.: In Australia, the attorneys are paid by the litigation funders, so they’re the ones who are getting the large returns like the plaintiffs’ bar gets here. In the United Kingdom, we haven’t seen the same type of class actions we are starting to see elsewhere, and my understanding is that the class-action statute hasn’t been tested.

S.W.: I only know of one case in the U.K. In Italy, since they’ve adopted class actions as of June 30th, there is a case that’s going to go forward there. It’s in the premature stages, but also why we want to be out in front of these issues.

Are you recommending that companies should avoid certain markets? Or are these issues so embedded that they can’t be avoided if you’re global?

S.F.: Any company going into a new country needs to do its due diligence— that’s just good practice. You weigh the pros and cons and make decisions accordingly. If you do business in Latin America, you might have kidnap exposure. In the United States, you would have litigation exposure. In Australia, you would certainly have litigation exposure. And in Europe, you’re going to have regulators breathing down your neck. Companies generally are responsible in doing due diligence before entering new markets.

Directors and officers might not know that they have litigation exposure in some markets if they don’t have a major facility there, but a claim can be made anyway. Yes?

S.W.: That is the case. There was a company that in 2007 had their offices raided and 40 people arrested for evading import taxes. What they were doing was shipping product from the United States to an island and then shipping the product from the island to their customer and avoiding the import tax. In that case, it turns out, it was not actually a subsidiary of a U.S. parent company that created the problem; it was a sales office that represented less than 1 percent of the total revenue of that company. From our perspective, the larger the operation in any given country, the longer the decision-making process and the larger the risk; but nothing isolates or insulates from potential litigation. If you’re operating in any foreign jurisdiction, you face many kinds of potential liabilities.

S.F.: When we have companies that are domiciled in the Netherlands, France, or Australia and they do business here, they’re subject to criminal investigations, just like any U.S. company. So it goes both ways.

Are there cases where what is deemed a civil act in the United States may be deemed a criminal act in another foreign jurisdiction?

S.F.: The corporate manslaughter act that recently went into effect in the U.K. is one example. The act was geared mainly to go after the corporation, but there’s a lot of talk right now that even though it’s geared toward corporate liability rather than individual liability, you would need to have someone who individually was proved negligent or ignored a situation and it is possible that you could have a criminal case.

If a company is significantly sized and wants a worldwide policy, is that out of reach?

S.W.: Our policy has been for years a worldwide policy where permissible by the law. There are three issues that a client would need to be thinking about: First, am I operating in a country that does not allow non-admitted insurance policies? Second, you need to pay appropriate premium taxes to local jurisdictions, so you need to figure that out, which we do by securing a policy on a standalone basis or tied into the U.S. policy. The third issue is coverage. Our D&O policy in the U.S. differs from what is required by other countries around the world. Two countries are worth noting: In Germany, you have the dual board based system where there is a supervisory board, and their job or their duty is to bring action against the board of directors. If you read the policy, that is an insured action which is excluded from the U.S. policy. In France, there’s a provision in that policy that should the policy be non-renewed you must provide a minimum of five years of runoff or tail policy— again the U.S. policy does not have that provision in it.

Do you believe that many U.S. companies have insufficient coverage given the global liability issues we’re discussing?

S.W.: I think there are more clients who are placing a separate limit policy or going through our Passport service and doing a shared policy with the U.S., because they know if they are sued in a foreign jurisdiction, many jurisdictions are not clear if they take non-admitted policies.

Are there cases overseas where the coverage was proved to be inadequate?

S.W.: We do not have a case where a policy written by AIG has failed to provide coverage in an overseas jurisdiction at this point. To go back to the beginning of our conversation, the trends are changing. The regulators are becoming much more active enforcing laws that have been on the books for years that have not been enforced. There is not a case that I know of where a U.S. policy has failed, but nobody wants to be the first to find that out. We’re averaging between 12 and 15 new clients per month particularly on D&O, securing some type of coverage outside of the United States. A foreign-based underwriter is also seeing the same type of multinational activity.

Where are the greatest risks abroad?

S.W.: I can tell you the countries our clients have expressed the most interest in: Brazil, India, France, Germany, Switzerland, Japan, China, and Russia. The main reason for appearing on this list is that many of those countries do prohibit the use of non-admitted insurance. Clients are also very concerned about indemnification laws in these foreign countries. If they’re not permitted to indemnify their individuals and they’re not sure about nonadmitted insurance, then the individuals in those countries may be left to fend for themselves. That is a grave concern to our clients.

What are the main things that directors need to consider regarding liability risks overseas?

S.W.: The three main things are: do I have operations outside of the United States? Do I have a board of directors in those jurisdictions? And what are the indemnification laws in these foreign jurisdictions? The only secure way to be sure you can get insurance proceeds into a country is to make sure you have an admitted policy, whether it’s a standalone policy or shared with a U.S. policy. Finally, once you have made sure you’ve met your admitted status, make sure that you’ve paid your premium taxes to the foreign jurisdiction.

Securities and Exchange Commissioner Paul Atkins recently announced that he would be stepping down from his post when his replacement takes office sometime after his term ends on June 5. A Republican appointed by President Bush, he spoke with Directorship about his views on some of the key issues the commission has faced and the challenges that lie ahead.

What do you see as the primary issues facing the SEC as you prepare to leave?

We have a lot of things on our plate right now. One of the most important is trying to implement the summary mutual fund prospectus that we put out a few months ago (which would require funds to issue a user-friendly summary of fees, conflicts-of-interest, and other key facts). That proposal, together with the work that we are doing with the Labor Department on 401(k) disclosure, affects the most investors.

“With respect to Bear Stearns, that was a classic run on the bank. It’s tragic, when you think of the shareholders. Some people call it a bailout, but I’m not sure shareholders would see it that way. It was also another real body blow to New York as a world financial capital. It’s hard for employees; a lot of those jobs may not come back, or if they do they may go overseas.” -Paul Atkins, SEC

There’s also the whole fallout from subprime and the credit market issues. We have to get it right, especially with respect to the credit-rating agencies, which now fall squarely within our remit after the law Congress passed in 2006. We are in the midst of trying to take a studied approach. The Chairman [Christopher Cox] has talked about how we are conducting examinations regarding this issue. We should have results soon, maybe even next month.

We’re also working through the President’s Working Group with other financial services regulators on what happened in marketplace, and what adjustments must be made, especially in light of the Fed’s (Federal Reserve Board) opening up the discount window.

With respect to Bear Stearns, that was a classic run on the bank. It’s tragic, when you think of the shareholders. Some people call it a bailout, but I’m not sure shareholders would see it that way. It was also another real body blow to New York as a world financial capital. It’s hard for employees; a lot of those jobs may not come back, or if they do they may go overseas.

I do take seriously the problem of capital market competitiveness. That was happening even before the subprime crisis. A lot of the problem is geographic and related to time zones. You can interact with more people around the world during the business day from cities other than New York, such as London. So we in the U.S. have to be smart about regulation, and subject it to cost-benefit analysis, notice and comment rulemaking, and all that, so that imposing burdens is not just decided by the seat of the pants.

Do you see a need for more regulation?

Coming out of the subprime crisis, we’ve seen where a lot of people did not do what they should have done on the risk management side. A lot of risk management theories were not up to snuff. Investors were complacent in using the ratings of credit rating firms, both market professionals and a lot of other folks. Things perhaps got out of hand at the credit rating agencies as well. It seems that they couldn’t keep up with the deal flow. We can strengthen our regulatory oversight to avoid these problems in the future.

Do you mean more regulation specifically of the credit rating agencies?

Sean Egan (the co-founder of Egan-Jones Rating Co., a smaller rival to the major credit rating agencies) is talking of better disclosure, so investors can see the conflicts of interest. For example, they can see if the agency is issuer-paid or subscription-based. Maybe we should look at that. There are a lot of things that can let investors figure out what they are using and that not every rating is created equally. That is definitely something we need to look at.

But there’s no way we can have anything like what some Europeans want, which is to have government review ratings in a substantive way. They’ve been talking about that, about having an ability to appeal ratings downgrades to a government-sponsored tribunal. That would be unadvisable. Ratings are opinions, and the First Amendment applies. But clear disclosure of conflicts is one way to go about it.

More broadly, we need a real rethinking of what’s going on with ratings, especially on the structured-product side and with municipal securities. Investors were sometimes complacent about ratings, and would buy only on the basis of the yield and the rating. They did not always look behind to see what else is going on. It’s very different with corporate debt, where you can use the stock price to get another view. The conflict comes into play because the sponsors creating structured products often consult with the ratings agencies in advance. That can be problematic because the income stream that comes to the rating agency from the other end may create an incentive to rate the product highly.

How do you think investors will look back on the commission under Cox’s tenure, and yours? Many of them have been angry at what they saw as anti-investor decisions, like the one on access to the proxy?

It depends on which investors you’re talking about. There are politicized investors out there who want to use the proxy rules to game the situation. Some institutional investors look for added leverage to put pressure on issuers behind closed doors to get parochial interests advanced, to the detriment of other investors. I think sunshine is a great disinfectant. There’s a lot to be said for openness, especially if someone is purporting to speak on behalf of shareholders. Who are you and which shareholders do you represent? The proposals for proxy access are like this; the proponents see some investors as more equal than others.

That’s why we have proxy rules in the first place, so everyone knows who’s putting pressure on the company and can vote accordingly. It’s true that the 13D rules (requiring disclosure of ownership greater than 5 percent) and other rules may have had the unintended consequence of protecting management in some cases. That is unfortunate in some respects, but the solution is not less disclosure or greater “proxy access” for some. What keeps management on their toes is the threat of a takeover.

My druthers are on the side of a more transparent process. That’s why we’re trying to figure out ways to drive down the cost of proxy solicitation. Electronic solicitation has made it very inexpensive. Transparency could help to put an end to pressuring management behind closed doors, which is bad for most shareholders anyway.

Do you think the advocates of greater proxy access will prevail if a Democratic Administration comes to power next year?

Politicized investors will try to use political process to get what they want. But investors are not monolithic. You have politicized investors, and most retail investors, who don’t necessarily care about proxy access, and also corporate pension plans, insurance companies, and mutual funds. If we can get things adopted like the summary mutual fund prospectus, that would most likely be much better than so-called proxy access for the average investor out there.

A USA Today survey of the pay for the top 50 largest companies in the Standard & Poor’s 500 showed the median compensation last year was $15.7 million. The analysis included data compiled by Salary.com for those companies that filed proxies by the end of March.

Boards of directors are increasingly linking pay to performance. “This is a jump-ball year,” Jeffrey Cunningham, chairman and CEO of Directorship magazine, told USA Today. “We get the message. Directors are at the negotiating table with their CEOs, looking for rationale pay schemes; no funny business, no games–just pure performance-driven pay planning.”

The story also points out that compensation lags market performance and that attitude is being reflected particularly in the hard hit retail, home building, and finance sectors.

“Bonsues are definitely following profits, especially in the retail and financial sectors,” said Ira Kay of Watson Wyatt, a compensation consulting firm.

]]> http://www.directorship.com/exec-pay-rises-as-stocks-fall/feed/ 0 http://www.directorship.com/tales-from-the-deal-world/ http://www.directorship.com/tales-from-the-deal-world/#comments Thu, 01 Jan 1970 00:00:00 +0000 Jeffrey M. Cunningham http://www.directorship.com/?p=4419 Peter Solomon has served on 21 boards in his life. He now sits on only one. New independence rules have forced a choice between serving on boards and advising clients, and the choice, he says, is an easy one to make. It is just one more development in the corporate arena and on Wall Street, which Solomon, 68, has studied during his 44-year career. In 1989, he left Lehman Brothers, where he had been chairman of merchant banking, to found his own firm. According to Dealogic, a M&A data firm, so far this year Peter J. Solomon Co. ranks sixth in U.S. M&A advisory for the retail sector. He has also worked two stints in government: first as New York deputy mayor of economic policy and development under Mayor Edward Koch, and then as counselor to the U.S. Treasury in the Carter administration. In a wide ranging interview, Solomon talked with Directorship about how the deal world really works, the private-equity sector, his early days at Lehman, and the sometimes chilling impact SOX has had on the boardroom.

Was there a lot of tension between traders and investment bankers at many firms in the early days?

In truth, of course. Goldman Sachs was built by traders to a large extent so they didn’t have that tension as much as Lehman. The absence of that dichotomy was very helpful to Goldman Sachs. They did have a lot of problems in the 70s, though. They almost went bankrupt because of Penn Central [which collapsed in 1970, embroiling Goldman in a commercial paper scandal.] But they never had the revolution that occurred at Lehman and some of the other firms because Gus Levy was a trader. He was the number-two person in the firm and in some ways the public persona of the firm. The reason Lew Glucksman [of Lehman] was viewed so badly by the investment bankers was not because he was a trader, but because he almost bankrupted the firm by trades that he didn’t tell the partners about in the late 60s and early 70s. He entered into a series of repos. One was IBM Credit Corp. I believe we were forced to take back those securities at a huge loss. I became a partner in 1971. I was net negative at Lehman by 1975. It was a difficult time.

What were those early years at Lehman like and what made them difficult?

We were unincorporated and we were a partnership that had no capital. Incorporation changed Wall Street and then the capital raised by Salomon in 1981 [in an initial public offering] changed it yet again. Those two things forever shifted the relationship between partners because they now were employees and their capital was not at risk. Before that, all the partners of Lehman would sit together in the same room on the third floor so they could keep an eye on each other, because if your partner caused you to lose money there was unlimited personal liability…that was incredible.

How did you end up working in the White House?

[Patrick] Moynihan [the Harvard professor turned senator from New York in the seat now held by Hillary Clinton] had pushed me very hard to go to Washington and I finally called him to turn down the job…and he said, “ You’re an idiot.” And I said, “I really like being called an idiot by the junior senator from New York.” He laughed, actually. Then he said, “I want you to go to the White House or to the Treasury…I want you to view this as your PhD in government. A guy like you needs to know how the Treasury and the White House works.” And he said there would never be another Democratic president. He saw this as an anomaly. It’s going to be very hard to elect a Democrat and you’re never going to get another chance to really go to Washington.

Let’s talk about the role boards played then, compared to the one boards play today.

I’ve been on 21 public boards. I’m now on one. There’s no question that boards were clubby, but they weren’t exclusively clubby, and it doesn’t mean that all boards were, either. Some boards were very unclubby, very tormented, very embattled, and very antagonistic. SOX has shined a light on boards. Even under SOX, though, we’ve had the options scandal so how can you argue that all SOX is appropriate when during this period you have boards committing acts that were totally avoidable?

The point is that boards have changed considerably. Now, I have a lot of opinions, both pro and con. First, I think the increased responsibility of boards is a good thing. Two, I think SOX, like anything, in its first three or four years created a horrendous situation—the time spent covering one’s fanny, looking officious, and the fees of the service firms were outrageous—but like all things, that has settled down.

Why did you leave the boards that you were on?

I have left my boards because I cannot be an investment banker and be independent. But I think you might find—if you were to ask the Phillips Van Heusen board or the Office Depot board if they were better or worse off having someone on their board who really understands your business and has a relationship with you—that they would agree it doesn’t make sense [to limit it]. But if there has to be a bright line, and I can be your investment banker or I can be your board member, what choice do I have?

Is the liability of being on a board overstated?

I believe it’s overstated as long as there’s no self-dealing. So, if you conduct yourself appropriately, you’re protected sufficiently by the rules. I do think there’s an issue and I’ve read a little bit about this. I do think there’s been a change in the role that directors play. They need to be wiser and play more of a role as a monitor.

The average tenure of a board member is two to three times the average tenure of the CEO because CEO tenures are so short. Does that have an effect?

There’s definitely no alignment. I’m a little out of date because I’ve been off boards for the last two or three years, but I didn’t like the tension or the antagonism that I was starting to see between management and the board.

There are fewer investment bankers, or those who understand capital markets, sitting on boards today. Are boards making decisions around M&A without having close counsel?

This is an incredibly important point. Because directors are less experienced in the financial world, there should be someone in the boardroom who says to them, if you start thinking about an LBO, and you bring in a transactional adviser on the financing, they’re more likely to advise you to do an LBO. Why would they do that? Because they get a better fee if they sell you to Carlyle than if they sell you to General Motors. For instance, if you do a billion-dollar deal, the adviser gets a one percent fee or $10 million. But if you sell to KKR or Carlyle, the adviser gets that plus a fee of two or three percent on the financing, so there you are.

The economic cycle has started to turn south. What will happen to all of these financial deals when there is no longer a buyer sitting at the table?

I think you’re starting to see that now. No one knows the timing or place. The risk premium today is 300 to 400 basis points. So while the markets are backing up, it’s still half of what it’s been traditionally. We still have a long way to go. In the LBO business to be specific, companies that have been borrowing are likely to be in violation of their covenants – when those deals go south, those people may be fired, and at least in some cases, put in jail.

We do this every 10 years?

I know, but the firms don’t do anything about it. I guarantee that the guy would have been fired in the past, but today you don’t know. The point is these fellows were making loans earlier this year, giving options, doing a covenant-light deal—a five- to seven-year deal with no covenants. What are they thinking? What are they thinking?

Are there any clear winners or losers?

Not really. At the moment, the Blackstones of the world appear to be the winners because they have other people’s money and they have their loans on top of the bankers’ loans. There are some rumors around…I don’t know this to be true, that the major firms are going back to the LBO guys and saying, “We don’t want these loans on our balance sheets. Take them back.” That is going to be an interesting dance to watch.

You’re arguing the case against the PCAOB. Tell us what the issue is and why you got involved.

I was asked to join a legal team that is looking into the composition of the PCAOB. This five-member board, very interestingly and exotically, has enormous power and is appointed by the commissioners of the Securities and Exchange Commission. At a minimum, we should have Congress, or the President, or Chris Cox, the current chairman of the SEC, appoint these individuals to this board. We’re not a parliamentary democracy. Congress cannot choose to do anything it wants and it cannot, in our view, deprive the president of the United States of the opportunity to appoint these individuals or, at a minimum, have the SEC chairman appoint individuals to this board.

In litigation, we say there are victories and there are developments. We had a development in the district court in March where the district judge ruled against us and also ruled in our favor. Only a lawyer would say something like that. What he said is that the plaintiff is on to something here; the decision should have been the chairman’s, but the judge saw no real injury to these particular plaintiffs. We have filed our notice of appeal and we’re optimistic that the D.C. Circuit, which tends to be very sensitive to these foundational issues of separation of power, will listen. We think the court will rule our way, which would declare unconstitutional the composition of the PCAOB.

Tell us about the current Supreme Court. What’s in store for business?

It is a new day at the Supreme Court with the leadership of this great, young 52-year-old John Glover Roberts, Jr. What I see happening is a greater sensitivity to common-sense issues of fairness and efficiency. In the last week, I have begun referring to this Supreme Court as our ‘Chicago School Supreme Court,’ cutting across the usual philosophical and ideological lines. This is a very business-sensitive court. You have Justice Souter, who tends to ride along the liberal wing of the court, writing an opinion that was so very strong. The ruling in the case was that if you’re going to sue a large company, you’re going to have to be very particular in spelling out a factual basis for the complaint. Why? Because these suits are protracted and costly. He went on at length to praise by name individuals in the Chicago School, [a brand of economic theory associated with Milton Friedman that favors free-market libertarianism]. Recent cases are illustrative of a very savvy, business-sensitive court that is much more skeptical about litigation in the civil arena.

You commented that “the Constitution is business’s friend.” Would you translate that for us?

Think about what Henry Paulson [Secretary of the Treasury] has said about class-action [lawsuits] and their dangers. The Constitution speaks to class action and it’s called due process. Think of punitive damage awards and the Constitution. One of the areas that the Constitution speaks to is what is quaintly called the dormant commerce clause or the somnolent commerce clause. A long time ago, in 1824, the commerce clause was important because it prevented states from closing down their marketplaces in order to protect local industries. It’s part of the genius of our Republic. Justice Robert Jackson said a half century ago that every farmer and craftsman has the assurance that his or her product can get to market. As vigorously interpreted, the Constitution protects businesses against protectionist legislation that state legislatures are very quick to enact.

Who do you admire most among historic Supreme Court justices?

My default position is John Marshall, who was a quasi-legitimate midnight appointee in 1801. It was a bitter time, and there’s a new chief justice, who is a federalist and a rising star. John Marshall was John Adams’s John Roberts. Marshall then proceeded to serve on the court for more than 30 years and to build the court into this magnificent institution that held firm against the vicissitudes of the day. They too needed to speak with one voice, to find unanimity rather than cacophony.

How much progress have we made as a society on tort reform?

It is a constant battle because tort reform and the strength of the judiciary is going to be determined, by and large, by the states. The conversation between Alexander Hamilton and Thomas Jefferson continues to echo through the corridor of time. I’m pleased to say that this Supreme Court tends to be much more Hamiltonian, that we are a national marketplace. That’s a good thing, strengthened by the arrival of Justices John Roberts and Samuel Alito, but you’ve got to be prepared to fight in Sacramento and Austin and other state capitals.

Why do we have judicial hellholes and why can companies be dragged down into jurisdictions?

Very simply: You do business everywhere and can be sued anywhere.

You’ve had a succession of careers that is extraordinary. Which has been the most interesting?

Obviously, the most challenging time was the Whitewater investigation as it evolved into Lewinsky. because it was impossible to effectively explain to the American people what was going on and why. Congress passed a law. That law then ushered in this thing called the independent counsel. The attorney general initiated this investigation when she read that law and said, under this law, I must investigate whether Bill Clinton, Monica Lewinsky, and others have violated the law. I don’t think—and I’m painting now with a very broad brush—that the American people ever understood that basic foundational fact. I was not a rogue prosecutor. Instead, a charter came pristinely from the attorney general of the United States to a three-judge court that reviewed that charter and said here’s your job: to find out whether the president of the United States committed perjury or obstructed justice or intimidated witnesses. It was all lost in a miasma of irrelevancies.

Board members spend a lot of time paying attention to the Delaware Chancery Courts. What can we take from that?

The Delaware Supreme Court and the Chancery Courts have been protective of the business judgment rule. The Disney litigation showed that as long as diligence is shown, directors can sleep at night. The problem for large corporations in light of Enron is excessive litigation. There needs to be a culture of integrity, rather than the endless rule of regulation that has become the American way. We need a culture of integrity and honesty, but we also need to get Washington off our backs.

His client list has always included the biggest names in Corporate America: General Motors, Disney, Tyco, American Express, and Westinghouse, among others. At the age of 81, he shows no signs of slowing down. Yale has called him a principal architect of modern international corporate governance. Editor-at-Large Aaron Bernstein sat down with Millstein in his Manhattan office to talk about the evolution of corporate-governance theory.

Much of the debate about corporate governance today seems to reflect the questions of control that Berle and Means raised 75 years ago in their book, The Modern Corporation and Private Property. Do you agree?

Yes, they identified the issue and pointed out the separation of ownership and control. They said that the diffusion of ownership led to the need for the protection of shareholders, because they were too diffuse to protect themselves. This led directly to the 1933 and 1934 Securities Acts [which laid out modern securities law and established the Securities and Exchange Commission].

That was a protect-the-shareholder model, set up to defend against pillage and mayhem, so the system did not result in total control by management. But it was very different than today’s governance efforts, because it gave no power to shareholders. It was only protective.

Still, the central concept, even then, was that the board should oversee the company for shareholders. This is an idea that goes way back to 1864 and the Companies Act, which created the rights of shareholders to elect directors. Our states’ acts were modeled on that.

As ownership diffused the board became even more important. But the board really was a tool of management. Shareholders had no ability to do anything about the board. Only one person even thought about this issue early on. That was William Douglas [who later became a U.S. Supreme Court Justice], who wrote an article in the 1934 Harvard Law Review called “Directors Who Do Not Direct.” It addressed the question, “Is this the right way to run a company?” But no one noticed.

No one cared back then and for years after because U.S. companies ruled the world, all the way through the post-war period. At that point, after World War II, you had global statesman running companies, people like Thomas Murphy of General Motors, [Reginald] Jones of General Electric, and [Irving] Shapiro of DuPont. I entered the scene at that time.

Boards didn’t see any need for oversight in those days?

No, it was an era of business statesmanship. Management still dominated the scene and boards were self-perpetuating institutions that someone once likened to the Catholic Church, where the cardinals pick the pope amongst themselves. I was in anti-trust at the time and I thought that kept them under control. If the anti-trust laws kept companies from getting too big, that would control management’s power.

Then everything started to change as the cozy post-war world began to break up under competitive threat from Germany, Japan, and other countries. We were the major consumer market of the world so U.S. companies became the focus of major competition in the late 1970s and 1980s.

In this new context, anti-trust failed as a control device over management. At the same time, the new competitiveness U.S. companies faced led shareholders to question the cozy relationships between managements and boards.

When did you start to focus on the governance issues involved in that relationship between boards and management?

It really began in the late 1980s with Harvey Goldschmid [a Columbia University law professor who served as SEC commissioner from 2002 to 2005]. We set up the Institutional Investor Project at Columbia and brought together investors to talk about the subject. We pointed out the ownership agglomeration that had happened as more shares were held by institutional investors, and said that they wielded a lot more power as shareholders if they got together.

But shareholders still had little capacity to elect the board. The only way they could run against the board selected by management was to mount a major proxy fight.

Then raiders like [Carl] Icahn arrived, called heroes by some, and suddenly the corporate suites were under attack. But even so, boards were still supine. Gradually we turned our attention to boards as it became clear that jawboning by shareholders did not accomplish much.

This was the beginning of a serious governance movement. The Council of Institutional Investors and other shareholder groups came about, but at first, shareholders really still did not have the power to do much or to change the board. But in the 1990s there was a lot of pressure on boards to be more responsive to shareholders. Both the Organization for Economic Co-operation and Development and the National Association of Corporate Directors issued best practices for boards, for example. As a result, the realization dawned that the job of the board was to oversee management.

At what point did it become more acceptable for boards to fire CEOs?

One tipping point came in 1992, after [GM CEO Robert] Stempel was removed. That helped make it more acceptable for boards to remove management. I started getting called in by boards to help change the CEO at a number of companies—American Express, Westinghouse, a bunch of them.

One was a major airline that I don’t want to name, which was very instructive. The board told the CEO he had to go, and he came back and said, ‘You can’t do that, you can’t fire me.’ They came back to me and said, ‘What do we do?’ I said, ‘That’s ridiculous, of course you can fire the CEO, you’re the board!’ And eventually, that is exactly what happened.

Soon shareholders started to really go after boards to adopt guidelines. So their attention turned from changing managers to changing boards. Slowly boards started to respond, mostly over the past five or six years or so. Even in the late 1990s, we were in a lot of boardrooms talking about the need for oversight of management.

Where do we stand today? How much more needs to be done in your view to improve corporate governance?

I think we’re moving into the next generation of CEOs, those who know that the board oversees them and they accept that. I recently went to two different board meetings where I found the CEOs understood the different relationship with the board and were content with it. And they also know their primary duty is to the shareholders.

This new generation has been shaped by the Sarbanes-Oxley Act and the knowledge that the corporate world has changed. The model we promoted [of board oversight] has come about.

In the last few years, the pension funds and other activists have turned their attention to putting people on boards. Majority voting in my mind gives shareholders the veto they need, and I think that’s enough. It’s just too complicated to have shareholders directly involved in the nominating process. What if five shareholders, each with 5 percent of the stock, nominate a different person? You’d get a mess if shareholders had a formal role in the process. The veto works pretty well.

The veto and “say on pay” are leading to better communication between boards and shareholders. One way to make it work is for the governance committee of the board to talk to major shareholders about different issues—who they want to nominate, for example, and executive pay. It’s informal advice and consent.

That’s how “say on pay” really works in England, and it’s a model that can work here in the United States. But we’ve still got a long way to go before we get to that stage, because U.S. boards and their lawyers are wary about talking to shareholders.

What do you think about critics, such as Robert Monks, who argue that very little has really changed in the ways companies are run?

Monks doesn’t sit on boards anymore, so he doesn’t see the change. I think there’s a real difference in attitude today, although there’s a long way to go still. There’s no comparison to where we were in the 1960s and 1970s, or even through the late 1990s. That era, of the imperial CEO, is over.

But as I get older–I’m 81–I’m more concerned than ever about the need for great CEOs, great leaders. The board’s job is to pick a great CEO and then let him operate. Monitor him and fire him if he falls off the cliff, but don’t try to run the company. I don’t want boards managing the CEO. Boards need to be able to remove the CEO, to not overpay him, and to get him to focus on performance. But those are externals to the real job of a company, which is to deliver the goods—to perform. That’s the CEO’s job, not the job of the board.

So how do you achieve the right balance of power inside the company?

The best way to do that is to separate the job of chairman and CEO. The idea of a lead director is dissembling to me. [Wachtell Lipton partner] Marty Lipton and [Harvard Business School professor] Jay Lorsch have been pushing that idea to deflect the issue and save the CEO’s power. It’s a complete play into management’s hands. The problem with the lead director idea is that he who sits at the head of the table runs the board. So if that person is the CEO, the lead director can’t lead.

You do need to have the CEO on the board though. The rest of the board needs to know what he thinks.

We’re organizing a session for separate chairs at [the Millstein Center for Corporate Governance and Performance at] Yale this fall, to bring a group of them together to exchange ideas. We hope it will lead to an ongoing program. We’ve got two sessions going, one for independent chairs of companies, which will be headed by Harry Pearce, [former vice chairman of General Motors] and another for independent chairs of mutual funds, chaired by John Hill and [former TIAA-CREF General Counsel] Peter Clapman.

Here, in his own words, is the story of innovation, America, and the future of our economy as we know it today. (First of a three-part series.)

First, I want talk about what an unusual country the United States of America is. If you look at the statistics, people living in the U.S. give almost twice as much money as a percentage of income than any other country in the world. This giving, this caring, is so different than almost any other country on the planet.

The second thing that is so unique about this country is its willingness to change its face. By the middle of the century, this European-based country will be an African-American, Latin American, and Asian-American country. A peaceful change—with the willingness to hand over the reins and the realization that in states like California, Arizona, and New Mexico the majority of people’s ancestors will have come from Latin America—is one of the things that has kept this country so resilient.

The third thing, that you might not think about as much, is the gene pool. Why is the U.S. different than most other countries? Our ancestors were risk takers. It might have been 10 generations ago. It might have been one. It might have been you. But someone made the decision to leave where they were and come here. So it’s a very unusual country and it’s a very resilient country because of these things.

How Democracy Unlocks Value
Democracy is a dependent variable. It is not an independent variable. If you look at history from an economic standpoint, you find that there is not any great correlation between economic growth and democracy. However, there is a tremendous correlation between sustained economic growth and democracy. And therefore it’s very difficult to impose a democracy on a society that doesn’t first have sustained economic growth. As you look at Japan or Korea or other countries around the world as examples, you will find that where democracy has flourished, you’ve had economic growth for a long period of time, creating middle classes and prosperity.

In this context, I want to look at China. In the U.S. in 1800, 95 to 98 percent of the people were involved with agriculture or lived on farms. A hundred years later, half the people in the U.S. were involved in agriculture, so one person’s output fed two people. Today, a half of one percent of the people in the United States. work in agriculture, and each person feeds 340. So we’ve had a substantial increase in productivity. In China, if you assume at least six or seven hundred million people are involved in agriculture today and they are moving to the cities. But they only can absorb 25 to 30 million people moving a year. Think of all of France moving every two years: everyone has a new school, a new house, a new neighborhood, and you want to try to keep order and assimilate people into the systems. What a challenge it is when you try to move from an agrarian society—whether it’s India or China, or elsewhere—to a non-agrarian society, without having jobs for the people to do.
 

And so, more than a billion people in the next 20 years will leave agriculture, and we’ll have much more efficient production, but we need to find things for them to do to be productive and absorbed into that society.

The Largest Asset Class
What is the world’s largest asset class? In 2006, the Federal Reserve put out the household balance sheet. The largest category was real estate, and except for a very short period in the mid 1960s, and a very short period in the 1990s, real estate has been the major asset class, according to the Federal Reserve and the financial markets. But this information is totally incorrect. The work of Gary Becker, who won a Nobel Prize in 1992, shows that the major asset category is the productivity of individuals. He estimated at the time that productivity was about three-quarters of all assets. There’s recent work that has suggested it’s as much as 90 percent.

When focusing on this major asset, there are three ways to build [productivity] for any country, university, or company. You can go get others that live someplace else and move them to your country–and at the Milken Institute, we’ve estimated that a half a trillion dollars worth of human capital has moved into the United States every year for almost 30 years; you can improve the quality of life so people live longer and healthier lives, or you can increase their education and, particularly, their ability to continue to learn over time.

Healthcare and education are the two largest sectors of the world’s economy. Now work done a number of years ago–and it’s going to be updated shortly by Kevin Murphy and Bob Topel from the University of Chicago with the Milken Institute—attempted to estimate what it would be worth in 2005 to the U.S. economy if we could actually eliminate heart disease, cancer, stroke, and other diseases. What is it worth to the economy? In the case of heart disease at the time, the estimate was $48 trillion.

What Is a Cure Worth?
Now obviously, a human life is priceless. We’re only talking about the economic value of eliminating these diseases as a cause of death and suffering. People have longer lives, healthier lives, and as we all know, if a family member or coworker comes down with a life-threatening disease, it doesn’t just affect them, it affects a number of people. If we had a company that told you they had a cure for cancer, we wouldn’t be looking at billions, we would be looking at trillions in value.

I want to tell you how optimistic we should be about the opportunities in science. I met a young man in 1993, a medical doctor at Johns Hopkins named Jonathan Simons, shortly after I was diagnosed with prostate cancer. And in one day’s work in 1993, Simons, one of the more brilliant men in our country—in the world—could read 500 letters of the human genome. That’s one day’s output for a highly educated individual. Today in 2007, if you spend $5,000 to buy a machine, it can in one day do the output of what six million Jonathan Simons could have done in one day. You need six million of him to equal the output of a $5,000 machine today. That is the power of innovation.

Go to Part Two

You have walked into some unbelievable challenges. How did courage manifest itself?
I’ll admit I have a fatal attraction to tough things, and the great thing about being in a crisis situation is that you need to make changes. The reason you’re in crisis is because something has broken down, so you have to decide how you want to handle it or if you want to move on.

I was at MCI—and remember we made all of our margin from this wonderful product called long distance—and I was going before the board to ask for hundreds of millions of dollars more to invest in long distance. I said, “Look, we all know this is dead. Why are we going forward? Let’s just kill it and move on to a new business.” And every one of them said, “Thank God.”

How do you draw upon your strength when you’re sitting in a boardroom and everything you hear is wrong?
Whether it’s boards or senior executive teams, they succeed or fail on their social structure.I absolutely go nuts [when I hear] the governance idea that the board is supposed to be the policeman of the CEO. You’ve got twelve smart people; you’re all supposed to be working together. You’re supposed to be able to say, “I screwed up.” You’re supposed to work together. I think when you’ve got that chemistry and you create an environment where people push back—and there have been times when I have pushed back hard and times when I have been pushed back hard—that’s a better environment.

How do you find the right kind of chemistry among board members?
I went to MCI WorldCom and we had this little accounting problem. I had met some of the [board members] in the bar the night before, and I looked around and said, “It’s really nice to meet you all. Of course, you’ll all be leaving. How would you like to handle it?” I got a couple of dumb looks, and I said to them, “What do you expect me to do?”

It’s rare that you get a chance to build a board from scratch. You need to blend skills, so it’s not about getting nine or twelve people who think alike. You need people who know different things. Whenever I was in technology, I always liked having someone from a consumer brand on my board because they bring a different perspective. I generally think it takes six months to a year to recruit a board member, and you’ve got to work at it. There’s no substitute for personally throwing yourself into it. I’m of the belief that you’re always working on three or four board members at a time. Like anything in life, you’re building a pool and a pipeline.

How does one assess a candidate’s courage and truthfulness?
Instincts take you a long way. If it feels right, it generally is. When you first have a conversation, do you get a sales pitch or do you have a candid conversation? You know there’s some management leadership that you’re going to have to work with, and if that chemistry doesn’t work, it’s pretty unlikely that it’s going to be a great experience.

What goes through your mind the night before you walk into a difficult situation?
At Compaq, I had no qualifications for the job [as CEO], and I simply couldn’t get through the rehearsal [for the press conference]. I finally said, “Look, this is just not who I am. I don’t want a script. I don’t want slides. I just want to take questions.” I’d never been in a press conference before. If you try to fake it, that puts incredible pressure on you. You just can’t do it. The truth always sets you free. I thought to myself, “Answer the questions you know and don’t answer the ones you don’t know. Just be yourself.” MCI was no different: If you fake it, no matter how much you prepare, it just doesn’t come off right, especially in times of stress.

How do you convince yourself and others to do the right thing?
Two things create credibility: one is you have to have some substance, and the other is that you can’t be lazy. There is no excuse for lack of preparation.

WorldCom was a tragic story. Most [employees] had lost everything. On the first day, I went in and said I wanted to raise every customer metric we had. I said I didn’t care what the P&L looked like, or what the press said; that’s what I wanted to do.

The second thing I said is that we were going to get out of bankruptcy in 100 days. If I had known [how hard it would be], I would have never said it. One of the hallmarks of success is that you communicate and you communicate, and when you think you’ve communicated enough, you communicate some more. You use every form: conference calls, webcasts, voicemails, e-mails. On the first 100 days I was there, I visited 50 sites and 50 customers and didn’t stop. Things like that matter. It is common sense.

Did you ever just blow it?
Oh yeah. And it’s very simple: When you get more worried about personal PR in the marketplace and worry less about what really matters, that to me is a lack of courage.

What do you see on the horizon for the governance role of tech specialists?
As a career technologist, [I think there should be] a technologist on the board who can interpret when an IT plan doesn’t make sense. I think we also have a stereotype about age in board positions that should change to allow younger people through the doors. The second thing all great boards should have is a risk committee. Whether it’s formal or [whether] someone on the board does it, having a tech voice on the risk process is really important.

 
Life is too short for board members who lack courage to speak up, isn’t it?
I would offer a non-nuanced view: Yes! Let’s be real: The CEO has a real obligation to create an environment where directors speak up.… I do think part of it is that we have this PowerPoint mentality toward running a board, but we need to allow time for discussion. That’s what I like about a balanced board: If the expert speaks up, that makes it easier. Great failures result from lack of courage in the boardroom.