The result is a profile of the federal agency most visibly aligned with markets and risk—a story both inspiring and impressive but daunting in its implications for boards of directors and their companies. As Schapiro embarks on her second year in office, the SEC’s 29th chairman commands a laundry list of initiatives that include crucial legislative proposals, with proxy access prominent among them. Her challenge will be to convince Congress that the agency’s shift to a self-funding—and therefore independent platform—will help restore public confidence in its ability to be an effective market overseer. And, of course, in the process, to rebuild its battered reputation.

To make that happen, Schapiro, the four commissioners and the SEC’s staff of 3,700 will need to reorganize themselves to mend the weaknesses in infrastructure exposed by the financial crisis and the criminal wrongdoing of investment scammers such as Bernard Madoff. The agency started the new year off with a bang on “Super Wednesday,” January 13, 2010. During an open meeting that morning, the Commission voted 5-0 on two high-profile matters:

• Proposed a rule to prohibit broker-dealers from providing customers with unfiltered, or naked, access to an exchange or alternative trading system as well as other measures to reduce market access risks. It also approved a new Nasdaq rule that requires broker-dealers offering sponsored access to Nasdaq to establish certain controls over financial and regulatory risks.

• Published a concept release inviting comment on the current market structure for trading U.S.-listed equities, a move that sparked both commissioners and staff to be most vocal during the meeting in urging, encouraging and even courting public remarks.

Then, in an afternoon press conference that same day, the Commission:

• Unveiled what the SEC called the most sweeping reorganization in the Division of Enforcement since 1972, including the establishment of a new Office of Market Intelligence to analyze tips according to internally developed risk criteria to identify potential securities fraud.

• Announced a series of enhanced “whistle-blowing” measures, including three levels of cooperative agreements, to encourage individuals and companies to be more proactive in the agency’s investigations and enforcement actions.

The ramifications for public company boards of the reawakened and newly charged SEC are numerous, particularly in the areas of risk management, compensation, shareholder communications and director qualifications, among others. Yet, even though Bernie Madoff is in jail and the recession is officially over, there is still a great deal of angst, as U.S. public companies and their boards eye ever-changing global economic and market risks. As they witness the prospects of additional regula-tory burdens targeting boardrooms and C-suites, the reaction is not enthusiastic across the board. Depending with whom you speak, you might hear bravos and encomiums, or lukewarm acceptance mixed with outright consternation.

“We’re going in the wrong direction,” says James A. Unruh, founding partner of Alerion Capital Group, former chairman and CEO of Unisys and currently an outside director of CSG, Prudential Financial, Qwest Communications and Tenet Healthcare. “Let’s face it. As public companies, we have dropped the ball in terms of some risk management. This means boards have to be more diligent in their oversight and management of risk.” But, he says, this should not not occur at the demand of the government. Unruh cites  “say on pay” and chairman/CEO splits as examples of where regulatory reforms are singling out issues that might be best left to directors.

“Shareholders are not well-informed enough, despite the spate of recent Congressional and SEC proposals and rulings enhancing shareholder communications,” he said, echoing what others have said: “If the shareholders are unhappy, they should vote against directors or sell their stocks. We need boards that are more transparent, but the solution is not to allow shareholders to make all the decisions.”

What we also discovered in putting the list together was that in some instances, it became impossible to separate the captain from the team. This year’s D100 is a case in point: Our editors and board of advisors were nearly unanimous in our selection of President Barack Obama as this year’s most powerful corporate governance influence. And yet, to do justice to the seismic shift his policies have brought about in the boardroom, we also had to recognize the many other  “New Voices” in the Administration who are now leading the greatest financial reform of American business since the 1930s.

So, we ask that in the pages ahead you pay more attention to who counts, and less to how we count, in arriving at our final selection of individuals and institutions that have met the requirement to be “most influential.” We think you’ll agree it’s an intricate and impressive mosaic where the whole equals much more than the sum of its parts, which may or may not be greater than 100.

Regulators & Rulemakers

Team Obama
It is often written that reasonable people may disagree, and with Americans and their Presidents, it is practically a way of life. But even an unreasonable person could only conclude that this President and his Administration are having a profound and lasting influence over the boardroom. President Barack Obama has demonstrated an enormous capacity for calm in uncertain times. His relative youth leads to frequent comparisons to John F. Kennedy and his communications skills to those of Ronald Reagan. But it is his aggressive response to the unparalleled economic challenges that greeted him at the dawn of his young presidency that harkens back to an earlier figure of towering influence,  Franklin D. Roosevelt.

FDR’s massive social and financial reform programs—the creation of Social Security as part of the New Deal, the establishment of the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Company (FDIC)—helped restore confidence in the nation’s banking system coming out of the Great Depression. One could plausibly take major portions of FDR’s New Deal and substitute his name with President Obama’s.  The implementation of the $787-billion American Economic Recovery Act one month after Obama took office, coupled with his handling of the Troubled Asset Relief Program (TARP), which sought to strengthen the financial sector by buying up the assets and equity from troubled banks, has clearly helped the nation avoid further financial disaster and put the economy on the path to recovery.

And finally, turning again to the FDR playbook, Obama assembled a team of wise men and women, formidable economic and business minds, whose decisions are having a lasting effect on the role of the corporate director. Preeminent among them was the choice of Rahm Emanuel as chief of staff. Described as a veritable “influence machine,” within the Administration and Congress, the former Congressman from Obama’s home state of Illinois is known as a hard-charging, brutally candid, sometimes combative, acutely intelligent man who can get things done and knows the ways of the Capitol and the boardroom.

The Enforcers
Perhaps second only to Obama in terms of her influence on boards and corporate governance, career regulator Mary Schapiro heads up the 75-year-old SEC. Before the crisis, the agency’s very existence was in question: “Obsolete,” “out of touch,” and “behind the times” were just some of the many terms uttered by detractors. The Commission, under former chairman Christopher Cox, was pilloried for missing the Madoff scandal.

As former SEC chairman and Directorship 100 Hall of Famer, Arthur Levitt described her: “She has the skills, the intellect, and the character to be a superb SEC chair.” But Schapiro will face a new kind of challenge in the role, not just that of proving her own qualifications, but also instituting a significant remodeling of the SEC itself, as she works to bring it into the new regulatory era.

Moving swiftly to address regulatory concerns in the wake of the financial crisis, the SEC has rolled out a series of proposals that could embody the biggest change to the rules of the game for directors in some time. Schapiro, who is no stranger to the boardroom, having served on the boards of Duke Energy and Kraft Foods, has overseen proposed rule changes on proxy access, broker voting, say on pay, and new requirements for disclosure on executive compensation and director qualifications. It’s now up to her and fellow commissioners Kathleen Casey, Elisse Walter, Luis Aguilar, and Troy Paredes to determine the final regulations that emerge from the proposals.

Other key players Schapiro has brought into the SEC include Senior Advisor Kayla Gillan, Chief Accountant James Kroeker, and Director of Enforcement Robert Khuzami. Gillan was a founding board member of the Public Company Accounting Oversight Board (PCAOB) and former general counsel to CalPERS. Kroeker joined the SEC as deputy chief accountant in 2007 from Deloitte and Touche where he had been a partner in the firm’s national accounting services group. Kroeker recently said that the proposed road map for the convergence of International Financial Reporting Standards,pushed to the back burner amid the larger issues of market reform, would be restored as another top priority. Khuzami is a former federal prosecutor, has pledged to improve the SEC’s enforcement performance by creating specialized units to provide “structure and resources for staff to ‘get smart’ about certain products, markets, regulatory regimes, practices and transactions.”

TARP Overseers
Another example of Obama’s preference for brains over politics was his reappointment of Sheila Bair to chair the FDIC. Another fiscally conservative Republican, on Bair’s watch alone this year, 94 banks have failed, creating a new challenge:  how to replenish the fund. Bair has also been an integral part of the team overseeing TARP. Neil Barofsky is a former New York assistant attorney general confirmed by the Senate in December as special inspector general. Dubbed the “TARP Cop,” his job is to figure out how and where the $700-billion TARP funds are spent, reporting directly to the President and providing updates to the Congressional Oversight Panel chaired by bankruptcy expert and Harvard Law School professor, Elizabeth Warren. COP’s first report, released in February, casti-  gated then-Treasury Secretary Henry Paulson for his performance and lack of transparency, reporting that the Treasury Department  had overpaid by $78 billion for the assets it bought from banks.

Interestingly, while Obama sponsored and was a strong proponent of  “say on pay” legislation while a senator, since appointing Kenneth Feinberg special master of compensation, he has appeared unwilling to make the issue a top priority. Feinberg, who has immersed himself in some of the country’s most troublesome and high-profile cases, is considered a superb choice, both in terms of skill and temperament, by Capitol Hill insiders. His most noteworthy case was the 33 months of pro-bono work he did following the 2001 terrorist attacks to determine how much each victim would receive from the federal government’s September 11th Victim Compensation Fund.

Feinberg may in fact be perfectly suited for a job that most compensation specialists see as thankless, and possibly as a “no win” situation. As the Obama Administration’s comp expert, Feinberg was called on to monitor the compensation of executives in what were once some of America’s most prestigious corporations, now TARP recipients, including American International Group (AIG), Bank of America, Citibank, Chrysler, GMAC, and General Motors.

Fed to the Rescue
To prevent American capitalism from spiraling deeper into the abyss, nine months after President Obama made his first Cabinet announcement, he re-nominated Ben Bernanke as Federal Reserve chairman. The former Princeton economics professor was selected by Bush in 2005 to succeed Alan Greenspan. In 2008 after the market crashed, Bernanke invoked emergency powers, slashed interest rates, and spent trillions of dollars to right the financial system. Just last month, he declared the recession “likely over.” Though he seldom gives interviews, Bernanke is never far from the public eye and has been a stalwart in the transition between presidential administrations and in the effort to stem the economic slide.

When then President-elect Obama named his economics team, it included players who, like Bernanke, were already steeped in the crisis details, demonstrated a studied understanding of Depression-era economics, or some combination of both. Enter Treasury Secretary Timothy Geithner and Chief White House Economic Advisor Lawrence H. Summers. Geithner, who is currently pushing legislation to provide more systematic regulation of financial institutions, including new limits on executive compensation, recently told one interviewer that he is optimistic major reforms will be passed.

Prior to his appointment replacing Henry Paulson, Geithner was president of the Federal Reserve Bank of New York and part of the team central to the critical negotiations that resulted in Bear Stearns being tucked into JPMorgan Chase, Merrill Lynch going to Bank of America, Lehman Bros. disappearing, and Citigroup and other struggling banks getting a lifeline.

Summers, the former Harvard University economist who became its president following his tenure as Treasury Secretary to President Clinton, is director of the Cabinet’s National Economic Council. The group was established in 1993 to coordinate and ensure that the President’s economic policy agenda is carried out.

Rounding out the team, Paul Volcker, the former Fed chief under Clinton, was selected to chair the president’s economic recovery advisory board. And Christina Romer, a former UC Berkeley economist, who administration sources suggest is well- regarded by both parties, chairs the Council of Economic Advisers. Her appointment was seen as a further triumph of brain over politics in Obama’s approach to talent recruitment.

Such is the case with the iconic business duos presented here. These eight famous pairings—one of them infamous for its failure in the final act—present a spectrum of the unique qualities and dynamic teamwork necessary for the effective management of extremely innovative, complex organizations. A variety of top-tier combinations reveal several variations on the theme that two heads are better than one: some, like Richard Sears and Julius Rosenwald, were marriages of necessity; others, such as Sanjay Jha and Greg Brown, co-CEOs of Motorola, were partnered in hopes of salvaging an ailing organization; still others, like Warren Buffett and Charlie Munger, seemed fated to cohabitate in the same corporate host.

The delicate balance required for a successful top-level tandem power structure is no easy achievement, as evidenced by a string of dissolutions; keeping two big personalities in harmony requires a set of unique personality traits on both sides. “It all depends on how they behave and if they can keep their egos in check,” says Harvard Business School Professor Joseph Bower, author of The CEO Within. “It works remarkably well if you also have strong board members who are able to make it work.” The challenge, as Bower sees it, is living up to the age-old adage of “diversity in counsel, unity in command”: however many leaders a company has, it has to move forward decisively. But while having a single visionary at the helm is often just what a company requires, the breadth of experience and wisdom offered by a pair of equally guided leaders can also have its advantages. “As long as there is cooperation, a pair will bring greater assets than can come from one person’s intellect,” adds Bower.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”  – Warren Buffett, chairman and CEO, Berkshire Hathaway

Today’s activist shareholders urge boards and CEOs to seek a second opinion or appoint a devil’s advocate that can result in what some believe is a bifurcated structure, as evidenced by the recent push for splitting the roles of CEO and chairman. One of the common arguments for not splitting the roles is that it creates confusion about exactly who is in charge. Another is that it hinders the company’s leadership to communicate with one, clear voice. Yet another is that the two get in each other’s way, one reining in the other, forcing a compromised and dulled strategy. However, great business duos learn to sidestep these traps and work together for the greater good of the organization. They improve each other’s ideas without watering them down. They move in concert without stepping on each other’s toes.

The question of what is the optimal executive leadership structure is one the board must answer and be answerable for (though many of the following examples took place before the boardroom had the significance it has today); a director could not find a better starting place from which to view the issue than by looking at the following examples of tandem business success.

“Communication is the cornerstone,” says Belmont University Prof. Jeff Cornwall, who studies business organizational structure. “Successful partners are able to feel comfortable tackling difficult issues without being afraid of hurting each other’s feelings.” Certainly, when addressing high-impact challenges on a day-to-day basis, the best pairings have had a tendency to avoid sugarcoating the issues at hand, and a no-nonsense approach is also required. Says Cornwall, “Partners must have a similar work ethic, and they should have similar values, but not necessarily similar personalities.” Such advice, along with the examples offered below, affirms John Rockefeller’s maxim that friendship founded on business is preferable to business based on friendship. With such an appropriately sober attitude in mind—and with the implicit advice offered by history’s great duos—one should move confidently in building a capable leadership team.

Warren Buffett and Charlie Munger: Berkshire Hathaway
The partnership between Warren Buffett and Charlie Munger has been well documented throughout the pair’s 50-year professional relationship, but for traders, investors, and general profit-seekers at large, their formula for success remains elusive. In their leading roles at Berkshire Hathaway, the two have led investors (and themselves) to steady returns virtually unparalleled in the investment community. Their methods, as the two attest, are deceptively simple, yet their successes have been without peer.

Buffett and Munger are unified in their ability to generate profit for investors in their funds, and the two men share similar investing values that revolve around the simple tactic of targeting undervalued assets and obtaining them. As Chairman and CEO Buffett put it in last year’s letter to shareholders, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” However, the individuals behind Berkshire’s success have demonstrated their unique characters, even as they have waged a common investment crusade. Buffett, with his tireless, common-sense approach to investing, his emphasis on wise governance, and his seemingly infinite humor and wisdom, is the prototype for would-be fund kings. His annual shareholder letters offer up world-class insight into the methods by which steady returns are generated, all tinged with the folksy warmth that is no small part of the man’s appeal.

These companies are finding out what corporate giants such as Dell, Exxon Mobil, AT&T, and EDS have long known: that when it comes to business, Texas is number one.

What puts Texas first? It has a pro-business tax climate that ranksthird, a low cost of living, a relatively solid economy, and alitigation environment that ranks 10th on our list. Texas also ranksfirst in the number of Fortune 500 companies located there.

The Lone Star state tops our annual Boardroom Guide to the Best States for Business. The guide is an outgrowth of our annual Litigation Guide, which assesses the litigation climate in each of the 50 states (Page 28). We decided to produce a more comprehensive resource for boards by adding data on the economy, tax climate, cost of living, education, and other measures to arrive at the ranking.

What puts Texas first? It has a pro-business tax climate that ranks third, a low cost of living, a relatively solid economy, and a litigation environment that ranks 10th on our list. Texas also ranks first in the number of Fortune 500 companies located there. We used the Fortune rankings as one measure of attractiveness to large companies and an indication of strong infrastructure. Texas’ central location and time zone also make it an ideal hub, especially for companies with a national distribution or customer footprint. Recently, companies such as Toyota and Caterpillar have located portions of their business in Texas.
“Our commitment to low taxes, predictable regulations, and a fair tort system are setting an example for the nation and creating a magnetic force for the businesses and jobs that are vital to maintaining Texas’ competitive advantage in the global marketplace,” says Texas Governor Rick Perry.

“It’s not surprising that Texas does well in these types of rankings,” says Hartley Powell, national leader of the global location and expansion services practice at KPMG LLP. “They have been very successful over the years at broadening their base from energy into areas such as high tech and manufacturing.” Powell says Texas has a quality labor force and a good tax structure for business.

Rounding out the top five states overall are Virginia, Utah, South Dakota, and Nebraska, home to Warren Buffett’s Berkshire Hathaway. Virginia has recently become a favorite business destination. Last year, Computer Sciences Corp. left El Segundo, California, for Falls Church, Virginia. “Virginia is a very good state for business,” says Powell. “They have been aggressive and have done a good job attracting companies to the state.” In our ranking, Virginia is in the top 10 on quality of life, higher education, economy, and the state litigation ranking, making it a very balanced state across the board.

One up-and-coming state, according to some of the experts we talked to, is Tennessee. The Volunteer State ranks 9th on our list, with the lowest cost of living in the nation and a litigation climate that is third best. In 2005, Nissan moved its North American headquarters from California to a suburb of Nashville.

Tax Climate

One important component of any business relocation effort is the tax structure of states being considered. “In the last few years, tax climate has become more important as companies have become more cost conscious,” says Powell.

The rankings use a tax-climate measure put together by the Tax Foundation, a non-profit, nonpartisan research group that has been assessing tax conditions since 1937. Joseph Henchman, director of state projects at the Foundation, says the group’s rankings include more than 100 factors related to the tax structure and burden of each state. He says the factors measure how simple, neutral, transparent, and stable a state’s tax system is. At the top of the Tax Foundation’s list is Wyoming, which ranks 16th overall on our list. “Wyoming does well from a tax perspective, more for what it doesn’t have than for what it does,” says Henchman. The Equality State does not have a corporate income tax or a personal income tax. Two other states, Nevada and South Dakota, do not have a corporate income tax. “That tends to be a magnet for companies to want to do business there,” he notes.

Apart from low rates or the absence of certain taxes, Henchman says companies are looking for simplicity in complying with state tax laws. “Colorado has every tax, but it has low rates and they are broadbased,” says Henchman. Spending on compliance with state tax laws can be nearly as expensive as the taxes themselves, he says.

The Bottom Dwellers

States at the bottom of the list for tax climate include New Jersey, New York, and California. Companies doing business in these states are there for other reasons, such as access to capital or a skilled workforce. “Businesses have located there for other reasons, but increasingly they are leaving these states because of the tax and regulatory burden,” says Henchman. He says California is experiencing what he calls a “brain drain” to nearby states like Nevada and Arizona. States with complex state tax laws, according to the Tax Foundation, include Ohio, Michigan, California, and New York.

The lowest performing states in our ranking overall are West Virginia, Rhode Island, Kentucky, New Mexico, and Hawaii. To be sure, West Virginia does not have a lot going for it when it comes to attractiveness to business. The state ranked next to last on higher education—based on the percent of the population over age 25 who hold college degrees—the economy, and the state’s litigation climate. The lone bright spot for the Mountain State was cost of labor, where it ranked third. Another low-ranking state, Rhode Island, performed poorly on litigation and tax climate, but change may be coming. “Rhode Island has a high corporate income tax, but the legislature is working on trying to do something about it,” says Henchman.

With the rankings, a caveat must be noted: States can vary dramatically from one part or city to the next, and, while a state might not perform well in the state-by-state rankings, there may be areas that are very attractive to specific industries. Alabama is a good example. While it only ranks 37th on our list, it has been extremely successful at luring auto manufacturing to certain areas of the state. “Companies don’t really locate business in a state, they locate them in a community,” says Powell.

Methodology

The state rankings in the Boardroom Guide to the Best States for Business were compiled using eight major indices of attractiveness to business. The Litigation Climate ranking is our own measure, assembled with the help of the Foundation for Fair Civil Justice. Because of its importance to directors, this measure is weighted at twice the score of the other measures, which are equally weighted. The other components are: a measure of large-company attractiveness and infrastructure based on the presence of Fortune 500 companies; a measure of business tax climate conducted annually by the Tax Foundation; a cost-of-living ranking from CNBC Best States for Business 2008; a cost-of-labor ranking from the Bureau of Labor Statistics; an indicator of state economic performance from the Bureau of Economic Analysis; an indicator of higher-education prevalence by the Census Bureau; and measure of quality of life from Forbes. States were ranked from 1 to 50 on each measure and then scored based on the rankings.

With little fanfare, Delaware’s famed Court of Chancery dismissed a claim by Citigroup shareholders against current and former directors and officers that they had breached their fiduciary duty by failing to properly monitor and disclose risks arising from problems in the subprime lending market that resulted in massive losses.

It is the best news to come out of the crisis for board members who have had little to celebrate, say some lawyers. In his ruling, Chancery Court Chancellor William B. Chandler III made it clear he was not about to let the Delaware Courts become an instrument of the public’s emotional need to find a scapegoat for the financial mess. “Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future…” he wrote in his findings.

It is likely not the last word from the Delaware courts on who is or is not to blame for actions preceding and during the current financial crisis. But subsequent decisions can be expected to hew to Delaware’s sober, level-headed posture that has earned it its place far atop the corporate legal system for the last 200-plus years. Delaware lawyers and judges are adamant that the state will stay true to form and not engage in knee-jerk reactions to the nation’s financial crisis or potential threats of federal intrusion into corporate governance. “Even in this environment, we’re not in a panic,” says Delaware Supreme Court Chief Justice Myron T. Steele. “We’re not going to abandon fundamental principals that have served us well, or the methodology in applying these principles to keep the federal government at bay.” In fact, the Delaware courts have a history of keeping emotion and public passion from corrupting its decision-making process, say lawyers. Perhaps no decision demonstrated that fact better than the one handed down in 2005 by the Chancery Court in the case against the board of directors at Disney.

Delaware Rules

As Hollywood legend Sidney Poitier relaxed in the rotunda of the understated Georgian-style courthouse in southern Delaware, he could have been one of the out-of-town lawyers who frequently parachute into the state for corporate disputes in the Court of Chancery.

But Poitier, in his charcoal suit, was one of the star witnesses in a three-month trial that gripped the nation. The actor was in the rural community of Georgetown to be grilled about his actions as a director of The Walt Disney Co. He was on the hot seat, along with other directors, for awarding a kingly $140 million severance package to former Disney president Michael Ovitz, after Ovitz had served only slightly more than a year in the job.

As a director of Disney, Poitier was overseeing a Delaware company and, as such, was bound by the state’s corporate laws. The California-based entertainment giant is among the 63 percent of Fortune 500 companies and more than half of the companies on the New York Stock Exchange that have filed their certificates of incorporation in the state.

Delaware law governs the internal workings of these companies, including directors’ duties and liabilities. Because it is so dominant, Delaware state law is the de facto corporate law of the country. Over the years, court cases have drawn captains of industry to the state, from Texas oilman T. Boone Pickens, to Oracle founder Larry Ellison, to former Hewlett-Packard chief executive Carly Fiorina.

One-time FBI director Louis Freeh, a lawyer who heads a consulting firm in Wilmington that deals with corporate governance, ethics, and compliance matters, says in terms of jurisprudence, little Delaware is “leagues above its weight class…by every measure.”

“Delaware law is so powerful that I’ve been in Europe in the offices of general counsel and they’ve had a pile of Chancery Court opinions on their desk,” says Freeh, who also is a director of Bristol-Myers Squibb, a Delaware corporation.

Indeed, the state aspires to be the Tiffany & Co. of the incorporations business, says Steele. Its high-quality product is the state’s enabling corporation law that is nurtured, protected, and preserved by the state lawmakers. The state Division of Corporations, Court of Chancery, and Supreme Court are the service departments. “The state’s great advantage is its well-developed body of law dating to 1911 that is based on real cases focused on specific facts. Legislation divorced from specific facts that is applied across the board to every situation is unlikely to produce right or fair results,” says Steele.

Like Tiffany’s, Delaware works hard to protect its brand. Since 1899, when Delaware’s legislative body, the General Assembly, passed its management-friendly corporations act, leaders and lawyers have kept a watchful eye on the golden goose. Taxes and fees paid by corporations chartered for decades in the state have represented as much as a third of the state’s annual revenues. To stay on the cutting edge, Delaware has tweaked its constitution and corporate laws, and expanded the powers of Chancery Court.

Such seemingly opportunistic behavior has left Delaware open to a chorus of critics who, for years, have attacked the state as being the handmaiden of Big Business. They point to Delaware law, which gives directors broad powers to run the business and affairs of a corporation. In 1974, William Cary, a former chairman of the SEC, famously wrote that in its zeal to get revenues Delaware was leading a “race to the bottom” in corporate standards.

Delaware defenders counter that state lawmakers and courts always have done an exemplary job of weighing the needs of both management and shareholders to create stockholder wealth. “My personal sense is one of the reasons investors and managers trust Delaware is that everyone gets a fair shake and cases get decided on their merits,” says Vice Chancellor Leo Strine Jr., a judge in the Delaware Court of Chancery.

As the country grapples with its biggest financial crisis since the Great Depression, even some critics are saying Delaware has kept to the high road. “For a long time, Delaware was seen as very much tilted in favor of management in its law,” says William Clark, a partner at Drinker Biddle & Reath in Philadelphia, who wrote the 2007 shareholder- friendly statute for North Dakota. “But the courts have been moving to impose duties on directors that reflect the concerns of shareholders.”

As further evidence, Clark points to some proposed pro-shareholder amendments formulated by the state’s corporate lawyers that are expected to be introduced in the General Assembly in the coming weeks. They would give institutional shareholders more flexibility for proxy access.

One amendment would allow corporations to adopt bylaw provisions that would permit shareholders in an election of directors to have their nominees included in the corporation’s proxy materials. Another proposed amendment would allow companies to enact bylaw provisions to reimburse shareholders for proxy solicitation expenses. “That’s huge,” Clark says. “It’s a significant change to Delaware’s image of being pro-management.”

Building on the Past

Through a lucky twist of history for the state, Delaware managed to keep its ancient Court of Chancery–or court of equity–when other states were jettisoning them. Chancery Court, unlike a court of law, is based on principles of fairness. In medieval England, when the common law courts became bogged down with procedure, losing parties sometimes would appeal to the king, saying they should have won under rules of fairness. These appeals were turned over to the king’s lord chancellor.

The modern court is believed to have had its first major corporate litigation in 1911. Judges in the trial court try both fact and law. It does not handle criminal, tort, or family law cases. It is not bound by strict statutes of limitations. The court may issue temporary restraining orders, injunctions, or other forms of relief. Today, about 70 percent of the filings with the court are corporate or commercial law. Because the five judges spend about 80 percent of their time on these matters, corporate lawyers say they don’t have to spend time educating the judge. “In Delaware, you have a judge who knows the law as well as anyone,” says Stephen Radin, a partner at law firm Weil, Gotshal & Manges in New York. “That’s the beauty of Delaware–you’ve got a high level of judges.”

The court must be politically balanced and judges are appointed, not elected. When a vacancy occurs on the court, the state’s judicial nominating commission identifies qualified candidates and submits names to the governor. The governor makes the nomination, which must be approved by the state Senate.

The court develops its understanding of the boardroom by interacting with directors at director conferences and similar events, says Chandler. “These functions enable us to hear from actual directors about the concerns and problems they face, and it gives directors a chance to hear directly from the judges, in less formal settings, our views about the most problematic types of conduct by boards or the types of issues that we frequently see in court,” he says.

Corporate Fiduciaries

In the end, the state courts found that the Poitier and other Disney directors did not breach their duties of loyalty and care when they gave Ovitz a “breathtaking” golden parachute. While Chandler had harsh words for the Disney board, he ruled that Eisner and the board had made their mistakes in good faith, availing them of the protection of Delaware’s business-judgment rule. The rule shields companies, directors, and officers from liability as long as they uphold their duties of care and and loyalty.

The business judgment rule precludes the court from secondguessing decisions presumed to be made by informed, honest, and disinterested directors who are acting in the best interest of the company and its shareholders. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware and a director at HealthSouth, says the rule is paramount. “On any board, most decisions you make are subject to the business judgment rule. So directors are keenly aware of Delaware law. Delaware law plays a role in every boardroom.”

The business judgment rule can be rebutted if it can be proved the board violated one of its fiduciary duties through fraud, bad faith, or self-dealing, says Chandler. The fiduciary duties owed by directors of Delaware corporations are duties of due care and loyalty. The duty of good faith falls under the duty of loyalty, the Supreme Court found in 2006. The duty of loyalty mandates that directors unselfishly protect and act in the best interest of the corporation and its shareholders.

Under duty of care, officers and directors must conduct themselves as an ordinarily prudent person would in his own affairs, including considering all material information reasonably available, Chandler’s 174-page opinion on Disney reads. Chandler reaffirms that attention to the best interest of the company is conduct the court continues to expect from directors. “Judges of this court expect directors to act with complete fidelity to the corporation, mindful of their role as stewards of the corporate enterprise seeking, honestly and in good faith, always to advance its best interests,” he says. “The definition of a good director begins with one word: Loyalty. Actions that are rooted in good faith judgments, made with integrity and conscientiousness, will be respected by judges, and are the cornerstone of our deferential business judgment rule.”

Directors Under Scrutiny

The job of director has become increasing difficult and risky. As shareholders have watched their wealth vaporize in the stock market, some have predicted that angry shareholders will be looking for directors’ heads on platters. “Given that so many American workers now depend on equity investments for retirement, it’s only natural to expect independent directors to come under scrutiny when a major corporation suffers a serious setback,” says Strine.

One form of scrutiny is likely to be litigation over whether directors lived up to their fiduciary responsibility to monitor the corporation’s management, he says: “Current events suggest that there will be an increasing focus by investors and plaintiffs on how boards used their time and talent to ensure that their corporations had procedures in place to ensure legal compliance and manage fundamental risks.”

Some lawyers say they expect more lawsuits involving the socalled Caremark standard, which refers to a 1996 derivative litigation in which plaintiffs wanted to hold directors liable for an alleged failure to exercise sufficient oversight. In a derivative lawsuit, a shareholder plaintiff sues directors or management on behalf on the company. The landmark decision created an incentive for companies to have effective compliance programs in place.

“Caremark was a seminal case on the duty of oversight,” says A. Gilchrist Sparks III, a partner with Morris, Nichols, Arsht & Tunnell in Wilmington. “You don’t want directors to be so risk averse they’re not going to be entrepreneurial or that you’ll scare away directors from serving.”

In the same month that the Court of Chancery dismissed most of the claims against Citigroup, Strine allowed a derivative case brought by shareholder plaintiffs of American International Group against former chairman and chief executive Maurice R. Greenberg and three former inside directors to proceed. Plaintiffs want to recover money from AIG as a result of damages suffered when it was revealed that AIG’s financial statements overstated the value of the corporation by billions of dollars. The plaintiffs allege that Greenberg and his inner circle orchestrated widespread illegal misconduct.

“At this stage, a fair inference arises that Greenberg and the Inner Circle Defendants employed their expertise in illicit ways that ultimately resulted in billions of dollars of harm to AIG,” Strine writes in the opinion. “Moreover, the pleading of direct involvement by Greenberg and the Inner Circle Defendants in many of the specific alleged wrongs gives rise to a fair inference that the defendants knew that AIG’s internal controls and compliance efforts were inadequate.”

In January, in a separate case, the Delaware Supreme Court upheld a Chancery Court ruling which found plaintiffs had failed to show that directors of Viacom, including Chairman Sumner Redstone, had breached their duty of disclosure by making material misstatements, omissions, and misrepresentations in the prospectus, as well as their duties of loyalty and good faith. Duty of disclosure is not independent, but falls under duties of care and loyalty.

“Delaware law is so powerful that I’ve been in Europe in the offices of general counsel and they’ve had a pile of Chancery Court opinions on their desk.”                                                     – Louis Freeh, Bristol-Meyers Squibb

Chandler says he doesn’t expect an onslaught of litigation similar to the Citigroup case in which shareholders alleged a failure of board oversight in making certain investments. “Am I expecting an avalanche? I haven’t seen it so far,” says Chandler. What he does see is a potential for more deal-related lawsuits, such as the recent Rohm and Haas Co. v. Dow Chemical Co. In that case, Rohm & Haas asked the Chancery Court to force Dow to complete a $15.4 billion merger. The case was settled just as the trial was about to begin. Deals such as the Dow and Rohm & Haas merger, in which there are significant changes in the financial markets between the time the merger agreement is inked and the consummation of the transaction, could lead to more lawsuits, he says. “There’s money out there for these deals to get made, but then the economic downturn can make these deals look bad,” Chandler explains. Such lawsuits could take two forms. The target company might want the deal enforced. On the other hand, purchasers might pull a so-called MAC, seeking to back out because of a material adverse business or economic change involving the company to be acquired.

Chandler says there could also be more litigation involving executive pay, a hot-button shareholder issue today. “I can see increasing litigation over some exotic forms of poison pills,” he adds.

Constant Attention

While Delaware’s lawmaking process leans toward the judge-made law in Chancery Court and the Supreme Court, the General Assembly also has a role in keeping the laws flexible and responsive, lawyers say. Consider the current amendments to the corporate statute proposed by the Delaware State Bar Association. The proxy reimbursement amendment is in response to a 2008 Delaware Supreme Court decision in CA Inc. v. AFSCME Employees Pension Plan, which involved reimbursement for reasonable expenses in connection with nominating candidates in a contested election of directors.

Another amendment deals with the 2008 Chancery Court ruling Schoon v. Troy. In that case, Vice Chancellor Stephen P. Lamb ruled a former director was not entitled to advancement of legal fees and expenses in connection with breach of fiduciary duty claims under an amended bylaw. The proposed amendment to the DGCL says that the right to indemnification or advancement provided in the certificate of incorporation or a bylaw can’t be eliminated or impaired after an act or omission that becomes the subject of an investigative action, lawsuit, or proceeding. However, the right can be eliminated retroactively if the indemnification provision at the time of the act authorizes it.

There is also an amendment that proposes to expand the power of Chancery Court. Under Delaware law, only shareholders can remove directors. The amendment would permit the court to remove directors in limited emergency circumstances following conviction of a felony or a judgment for a breach of fiduciary duty.

Elson, Steele, and others have been concerned that measures related to the federal bailout and stimulus bill encroach on governance matters that have historically been handled by the state. But Steele isn’t worried. “We’re still the Tabasco of spice, the Coca-Cola of soft drinks,” he says.

Delaware’s Top Law Firms

Though Delaware is thick with lawyers of all varieties (about 18 per 10,000 residents, third in the nation behind New York and Washington D.C.), it is the absolute Mecca of business law, home to almost 100 corporate law firm offices.

For corporate legal counsel and representation of all types— including audit, mergers and acquisitions, intellectual property, corporate governance, litigation, and bankruptcy—Delaware could be a one-stop shop.

Here are some of its biggest and bestknown firms:

As Delaware’s largest law firm, Richards, Layton & Finger has built its staff of more than 150 attorneys through over a century of providing quality legal services in six different practices to a number of influential clients. Today, the firm’s top attorneys include Robert J. Krapf and Gregory P. Williams.

Young Conaway Stargatt & Taylor has worked with clients ranging from international corporations to small businesses and individuals in need of legal advice and assistance. Its legal staff of 112 has managed many groundbreaking cases, helping to shape the state of Delaware law for more than half a century. Attorneys Bruce L. Silverstein and Robert S. Brady have distinguished themselves in Delaware corporate law.

With almost 100 attorneys, Morris, Nichols, Arsht & Tunnell guides Fortune 500 companies and not-for-profits alike through the intricate pathways of corporate law. Morris Nichols attorneys drafted the Financial Center Development Act of 1981, a piece of legislation that allowed national banks and credit card companies to start work in Delaware. Top governance lawyers at Morris Nichols include A. Gilchrist Sparks III, who was recently named Delaware Lawyer of the Year in corporate law by the Best Lawyers in America Guide.

Having opened its doors in 1826, Potter Anderson & Corroon is Delaware’s oldest law firm and one of its stalwarts. Two of its attorneys, Donald J. Wolfe Jr. and Michael A. Pittenger, authored “Corporate and Commercial Practice in the Delaware Court of Chancery,” the first-ever treatise on the Chancery Court.

M&A powerhouse Skadden, Arps, Slate, Meagher & Flom includes a Wilmington office in its global empire, home to approximately 60 attorneys. Though M&A is a primary focus, the office also works in the practice areas of litigation, restructuring, and class-action litigation. With four offices spread throughout Delaware, Morris James and its staff of 54 attorneys work with clients of all sizes across a variety of practice categories. Founded in 1931 as a two-man practice, the firm has evolved through the years to become a crucial player in Delaware law.

Ashby & Geddes is a Wilmington-based firm best known for its expertise in litigation; its nearly 30 attorneys also conduct a corporate reorganization and insolvency practice. It has earned the highest-possible rating of “AV” from Martindale-Hubbell, the country’s leading legal ratings agency.

AIG, Fannie Mae and Freddie Mac, Citigroup, Bank of America, General Motors and Chrysler—and even formerly sterling corporate citizens like Goldman Sachs and JP Morgan—are all learning what it means when Uncle Sam is a significant shareholder or creditor. And it goes way beyond getting pilloried for flying in private jets to Washington or becoming a punch line for late-night comedians for sending sales executives to cushy retreats within days of grabbing the government lifeline. These companies worry that after accepting a government infusion, Uncle Sam could start to look more like another relative—Big Brother.

With mountains of taxpayer money on the line, politicians are under tremendous pressure to provide a watchful eye on the business practices of companies the Treasury has rescued. Taxpayers are angry and vocal that they are being called upon to come to the aid of companies that they see as having pursued foolish risks to enrich executives. The media is carefully watching for any sign or movement from the so-called “bailout” companies that could be construed as insensitive to the public mood.

The financial terms under which the bailout has been structured demonstrate the enormity of the government’s self-imposed obligation. In addition to the $700 billion Troubled Asset Relief Program (TARP), the Federal Reserve has committed further billions to AIG, Citigroup, and Fannie and Freddie, including a pledge to buy $600 billion worth of mortgage-backed securities

“I think the government sees this situation as an opportunity to re-do the market, to insert reforms without huge opposition.” –Paul Hodgson

from the government-sponsored enterprises. All told, federal rescue packages will add up to trillions of dollars, and with this kind of financial commitment the government will necessarily bring a certain level of expectation as to how businesses will operate.

The reality is that the bailout, the sweep by Democrats in the fall elections, and pent-up frustration on the part of shareholders— especially vocal groups like shareholder activists and union-run pension funds—are converging to present the biggest changes to the rules of the game in some time. These changes will impact everything from setting CEO compensation, to proxy access, to how a board director oversees the management of risk. At the extreme, there is the distinct possibility that boards could go back to the days of rubber-stamping, only this time it won’t be the CEO running roughshod, it will be regulators, shareholders, and the media.

“I think the government sees this situation as an opportunity to re-do the market, to insert reforms without huge opposition,” says Paul Hodgson, a senior research associate at The Corporate Library, a corporate governance research firm. “In normal times, most of what the government tries to do in terms of the market comes up against huge lobbying efforts, but in this case such lobbying efforts won’t be effective and won’t be taken seriously.”

The result is that regulators are pursuing two separate but related objectives: one to ensure that businesses receiving aid walk a straight and narrow line in adhering to the terms and spirit of the agreements; and another to try to prevent the feds from breaking the Treasury piggy bank to bail out troubled businesses in the future.

TARP’s Tethers
So far, the strings attached to the bailout have been relatively tolerable to companies that have gone to Washington with outstretched palms. As evidenced by the rush of financial services firms to recharter themselves as bank holding companies, the terms were a reasonable price to pay to qualify for the funds. The original provisions of the program required participants to: 1) ensure that incentive compensation for senior executives does not encourage excessive risk taking; 2) administer clawback of any bonus or incentive paid to a senior executive based on materially inaccurate financial statements; 3) refrain from giving “golden parachute” payments to senior executives; and 4) place a limitation of tax deductions on executive compensation in excess of $500,000 for each senior executive. However, tucked into the agreement was another provision that would allow the Treasury to unilaterally revise any part of the agreement.

And there’s the rub. Now that criticism of the program has reached a deafening level, a new administration is in place with the stated goals of transparency and responsibility, and many charge that the program has been largely ineffective at spurring banks to resume lending, directors can anticipate revisions. “The chance that the Treasury will alter those agreements is almost a certainty,” Gilbert Schwartz of the law firm Schwartz and Ballen, and a former advisor for the Federal Reserve, told Bloomberg. In January, a report from a bipartisan congressional oversight committee issued a scathing criticism of the Treasury’s handling of the rescue fund, just as Congress weighed release of the $350 billion second half of the fund. Congressional members promised the second go-round will come with much more stringent requirements for those companies that accept funds.

Just what the changes will look like is anyone’s guess, but an indication came in a bill filed by Chairman of the House Financial Services Committee Barney Frank last month. Among other provisions, his bill requires participants to divest their private aircraft or aircraft lease arrangements, make new disclosures about how the bailout funds are being used, and set a cap on executive pay and bonuses for executives—and to be sure no one misses the message, it would be retroactive to existing program participants. “If they don’t like it, they can give the money back,” Frank told Reuters. Meanwhile, the continued deterioration of some banks has significantly weakened what little negotiating power they have. Surely some bank executives, particularly those who had a choice whether to take funds, may be thinking they have just fallen for the old bait-and-switch. At the extreme end of what else could be in store are corporate governance requirements that would mandate such specific changes as the separation of the CEO and chairman roles and specific limits on CEO pay and bonuses.

“When we get through this difficult period, which we will, our next task must be to address the problems in our financial system through a reform program.” –Henry Paulson Jr.

Whatever form these provisions take, they will affect boards at most major financial service firms and the participating auto companies, General Motors and Chrysler. But they could have a wider impact on the corporate governance practices of all companies. First, the second wave of TARP may be expanded to include other industries such as home-builders and struggling manufacturers. Second, once mandated by federal law, more stringent corporate governance practices, accompanied by the imprimatur of Uncle Sam, may be considered standard for governance “best practices,” opening all companies to criticism if they don’t adopt them.

Reining in Risk
The second shoe to drop on Capital Hill will also have a significant impact on all industries—a regulatory agenda intended to rein in “excessive risk taking” in an attempt to prevent future versions of the current crisis.

The complexity, risk, and general messiness of the government’s mass sponsorship can be summed up by the complexity, risk, and overwhelming messiness of the securities that the Treasury is buying up. Those same mortgage-backed vehicles that brought down U.S. bank stocks by an average of 56 percent in 2008 and led to worldwide asset losses of trillions of dollars are now part of Uncle Sam’s personal investment portfolio. The American taxpayer—not to mention a throng of dissenting legislators, regulators, academics, and pundits—doesn’t like the idea of “too big to fail” now that it has seen the consequences, and doesn’t want to be in the position of taking equity or debt positions in U.S. companies in the future.

Said former Treasury Secretary Henry Paulson Jr. when first proposing the bailout to the Senate, “When we get through this difficult period, which we will, our next task must be to address the problems in our financial system through a reform program that fixes our outdated financial regulatory structure and provides strong measures to address other flaws and excesses.” To do so will not be easy, and it will draw opposition from many, but significant change is an inevitability for which all corporate directors must prepare. To many, this second avenue is particularly troubling. Critics argue that the next crisis will look nothing like the current crisis and that new regulatory burdens put in place to prevent the next problem will be ineffective in that pursuit, leaving costly regulation that could potentially hinder the competitiveness of U.S. business in the global economy.

Finding a Balance
Captains of industry have long maintained that the superiority of American capitalism owes itself to the singularly unregulated nature of its markets; it is because the government stays out of the private sector that this sector flourishes. This line of thinking establishes a linear scale in which “prosperity” and “intervention” are on opposite ends, a scale considerably weakened by the damages wrought by the investment strategies that led to the credit crisis. And taking into account that the highly regulated industrialized nations of Europe were also dragged down in what quickly became a global problem, it becomes plain that a successful market system will require a more delicate balance between regulatory guidance and the natural vigor of free enterprise.

“The key to a productive market,” says Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, “is to find a balance that maintains wise regulation and investor and consumer protections without stifling creativity and innovation in the creation of new financial products.” Talbott believes that the role of government regulation in the market operates much like a swinging pendulum, with the ultimate goal being equilibrium in which the government has a steady but soft hand on the market. Both on the Hill and on Main Street, people are pointing to examples of a pendulum that has swung too far in either direction, with the “hands-off” approach that may have exacerbated the mortgage crisis on one side, and the passage of Sarbanes-Oxley, which has been criticized as too costly and overbearing, on the other.

Such a need for balance is echoed by Martin Lipton of law firm Wachtell, Lipton, Rosen & Katz, who believes that “a certain amount of government participation is necessary and desirable in the market…the correct thing is to strike that balance in government participation without stifling business transactions.” Lipton acknowledges the success of certain aspects of the bailout so far, but also believes that the government should and will withdraw itself as soon as is feasible. “Their response to the crisis has been very effective: they are in effect nursing the sick children and encouraging the healthy children,” says Lipton. “I don’t think the government wants to be in this situation, and they don’t intend to have a long-term investment in these institutions; all the revisions have been essentially short-term, with a view towards returning business to the free market as soon as the [banks] can repay the loans.”

But there is apprehension in the financial community as to the risks posed by a government that takes too intrusive a position in a reeling economy. Much like criticism that the passage of Sarbanes- Oxley weakened the U.S. market by driving certain sectors of business out of the country, there is fear the government will attempt a comprehensive reform of the financial system that will create a harmful regulatory environment that could further weaken the economy.

Professor Allan Meltzer of Carnegie Mellon’s Tepper School of Business airs this concern, warning that the government has been woefully vague in both its immediate and long-term approaches to the credit crisis: “The weakness in government policy is that the Federal Reserve and Treasury have been unclear on just how they plan to address the crisis, and their actions reflect this uncertainty. For example, they made every effort to save Bear Stearns, but they then allowed Lehman Brothers to fail, without ever giving an explanation for their rationale.” Meltzer believes that such indecisiveness breeds uncertainty and that the government would be best to keep out of the market; for those of his mindset, the best balance is one where government allows the natural forces of capitalism to run their course.

“It’s clear that the regulatory agencies are not aligned with the financial world as it exists today.”  –Martin Lipton

From Regulation to Legislation

Those wary of government intrusion worry that a more active regulatory climate will develop or is already here. The most apparent change on the horizon is a restructuring of the nation’s regulatory bodies, most especially the Securities and Exchange Commission, which has come under heavy fire in recent months. Excluding the agency’s decision to temporarily restrict short-selling, the SEC was relatively inactive while Paulson and Federal Reserve Chairman Ben Bernanke charged through Washington to sell the bailout package. “The SEC is an inept organization,” says Meltzer, “because it didn’t do much, before the crisis or during.”

Others aren’t so harsh, but agree that the agency’s role is due for a re-appraisal. “It’s clear that the regulatory agencies are not aligned with the financial world as it exists today,” says Lipton, “and there is a crying need to merge the SEC with the Commodity Futures Trading Commission.” Lipton says that one of the greatest motivators of the financial crisis was the failure to regulate the credit default swaps, and that a consolidation of the SEC and CFTC could better oversee the markets for such vehicles.

The most significant step that the government will likely take in restructuring regulation is to ensure the proper management of the high-risk derivative deals that have had such a devastating impact on the global market. More important, says Talbott, expect to see a new risk regulator, most likely within the Federal Reserve, “responsible for assessing companies’ risk positions across the board and what the overall impact on the financial system would be in the event of an individual firm’s collapse.” Talbott also sees as possible the establishment of a new regulator designed to handle the insurance industry. A second very real possibility is the prospect of a series of sweeping legislative moves that could be this financial cycle’s Sarbanes-Oxley. The most likely candidate for reform, says Talbott, is the mortgage system, which proved utterly unable to respond to the freefall of housing prices that hit in 2007. “For every step,” he says, “from the kitchen table on up, you will see legislative proposals to try and amend the system. Most especially, you will see efforts to protect consumers and to strengthen mortgages in general.”

The Board View
A more interventionist government will of course have a strong effect on the financial marketplace at large, from entry-level employees on up, but nowhere will its new challenges be felt as strongly as in the upper levels of corporate governance. For boardrooms that have already taken on new responsibilities, liabilities, and criticism, these trends will only intensify. Indeed, directors may want to consider Uncle Sam a new addition to their board, though the federal government simultaneously acting as activist investor, lawmaker, and regulator breeds uncertainty and possibly outright fear in many directors.

The first hint of alarm was the executive compensation limits posed by TARP. Though these limits weren’t particularly sweeping, applied only to financial firms that accepted TARP funds, and were not overtly prohibiting any given level of compensation (a loss of tax credit is the only real penalty), it would be foolhardy to view the move as merely symbolic. It would be equally shortsighted to ignore the very real possibility that such restricted limits are merely a prelude. “Executive compensation is being restructured and will continue to be restructured so as to relate it more closely to performance,” says Lipton. This includes incentive programs, the structuring of stock options, and a very real effort to implement clawbacks throughout the public compensation system. This is not merely a response to an angry and distrustful general public opinion; it is the government’s way of aligning a company’s pay structure to its contribution to the general economy. However ham-fisted an approach it may seem to directors, it appears unavoidable.

Perhaps the greatest fear for directors is that compensation restrictions will similarly reduce the available pool of talent, as a government- guided pay plan makes the difficult and time-consuming executive’s job increasingly unappealing. The result, according to Lipton, is that “boards are going to have to pay more attention to executive compensation; the board will have to work closely within regulations to enable the company to attract the best management available…compensation policies shouldn’t prevent companies from doing that.” Boards are also going to have to develop a thorough comprehension of just what the rules are for compensation, and they’re going to have to find creative ways—especially through stock options and related devices—to continue to attract top-tier executives. As Meltzer explains: “Bureaucrats make regulations, but markets decide how to circumvent them. If regulations are burdensome, there will be a way around them.”

The second big issue for boards in the wake of the bailout will be a widespread redefinition of risk that must be undertaken if companies are to successfully navigate the new market climate. Trillions of dollars later, it is evident that the risk culture that prevailed in the years leading up to the housing crash was unable to prevent or even stem a market collapse. With too much focus on achieving higher and higher yields, and too little understanding of the vehicles that were developed and deployed, the old risk culture has been toppled and a more sober version likely will be taking its place.

“Bureaucrats make regulations, but markets decide how to circumvent them. If regulations are burdensome, there will be a way around them.” –Allan Meltzer

“Board members have to recognize the importance of risk management,” says Lipton, “and they have to focus on strategic thinking with management to determine what the ‘risk appetite’ of each company is.” One of the peculiarities of the post-bailout blame game is that directors and executives are taking the heat for risks they themselves did not engage in. The most egregious moves in the risk area were largely the work of mid-level managers and traders who relied on quantitative formulas rather than experience, and simultaneously provided pristine financial models as proof of these strategies. The upper echelon, meanwhile, may or may not have had the quantitative skills, or may have lacked the decisiveness to question the risk taking that by all accounts was driving immense profits. This of course does not excuse directors; smart risk culture starts at the top and board members at all kinds of companies need to be absolutely insistent that the message of wise risk taking persists throughout the organization.

Here, too, there is the potential danger of a pendulum effect. Like the banks that have tightened the vise on lending, businesses could become too risk averse, impeding their competitiveness and that of the U.S. economy on the global playing field. Good risk culture requires that companies not yield to a pressure that at times exceeds even that levied by the government regulators: that of profit-hungry shareholders. Boards must understand that for continued success—and a stable contribution to the larger American economy— their companies must be geared towards long-term value, not just for the quick buck that some activists clamor for.

The Imperceptible Horizon
While most agree we have passed the early days of the credit crisis— marked by realization, acceptance, and finally, absorption— there is still much territory to cover in the months and years to come. For individuals and groups who have lost so much of their worth, and even livelihood, in the wake of the crisis, it’s tempting to hope for a quick resolution of the crisis and a return to “business as usual.” However, it is clear that this latest crisis is no minor pothole, and, once noted in the history books, will likely be described on a scale somewhere between 1987 and 1929. Even after the global economy rights itself, and government loans have been repaid, boards should note carefully that there will remain fundamental changes to the way Uncle Sam approaches the marketplace that will not be soon undone.

Goldman announced that it was going with Lakshmi Mittal, the chairman and CEO of ArcelorMittal S.A., the world’s largest and most global steel producer. “He has a keen understanding of the global economy, having operated in virtually every corner of the world,” said Lloyd C. Blankfein, chairman and CEO of Goldman. As the bank continues to expand worldwide, that keen understanding will be invaluable as the board charts the company’s course.

Goldman’s board selection is just one of the most recent examples of a trend that is reshaping both the composition and the culture of American boards. There is a movement underway to diversify boards that adds a strategic context to the traditional diversification goals of gender and race. Boards are looking to add members with global business experience or, better yet, directors who were raised, educated, and trained outside of the United States.

This trend reflects the idea that the board should be more in touch with the markets where they conduct business and with the customers that live there. Large U.S. companies now generate a greater portion of their revenues from outside the United States than ever before. For example, Jeffrey Immelt, CEO of General Electric, says that the company will derive 60 percent of sales outside the U.S. by 2012, up from about 55 percent expected this year. Moreover, the company’s overseas business is growing at twice the pace of its U.S. operations.

GE’s global ambitions are reflected in the directors it has named to its board. In addition to those directors born or raised outside the United States—such as Claudio X. Gonzalez, who was born in Mexico, Sir William Castell of the United Kingdom, and Andrea Jung who, while born in Canada, is fluent in Mandarin—the company has sought individuals whose business experience and knowledge identifies them as the new class of “globalists.” The board also counts as members A.G. Lafley, CEO of Procter & Gamble, and Sam Nunn, a former Congressman who is considered such an expert on international affairs that Georgia Tech, where he is now a professor, named its School of International Affairs after him. “Companies like General Electric, PepsiCo., Procter & Gamble, Citigroup, State Street, and others understand that they need a board that reflects their business practices,” says George Davis, U.S. co-managing partner at Egon Zehnder International, a global executive search firm. “The more enlightened companies with global businesses are approaching their boards differently, and are looking to put more global expertise and knowledge of international markets on the board.” And it’s not just large companies that are building global boards; medium sized companies are also looking for global diversity, he adds.

Rita Foley, a director at Dresser Rand and PetSmart, says the globalization of the boardroom is imperative. “More and more revenue is coming from outside the U.S. Our role is to poke and steer strategy and that means a key role for globalization. If we are going to be effective global competitors, than it is going to take a global board.”

According to Davis, the S&P 500 now derives 42 percent of its revenues outside the United States, but only six percent of the directors of those companies are from foreign countries. “There is a mismatch here,” he says. More surprising is that some of the largest companies haven’t diversified at all. In fact, nine of the 30 Dow Jones Industrials have all U.S.-born directors. “We have to be sure that we are not myopic with our lens,” says Davis.

Strategic business decisions should determine when and how any board approaches efforts to globalize. “As soon as you have a clear strategic intent to operate beyond your domestic borders, that’s the time to add directors to your board from those geographies where you’re going,” says Richard Hossack, head of the governance practice for Delta Organization & Leadership, a part of Oliver Wyman. “This isn’t really that different than if you were a start-up board: you need to be thinking about [candidates] who can build strategic alliances and who understand financing, manufacturing, government relations…and it’s not enough to parachute in a couple of new directors,” he says. “You have to play a role as a global director, so you need to act like a global director. Hold board meetings in these new territories and make sure you meet local government officials and key customers, tour the facilities, and meet employees.”

Building One BRIC at a Time

Yet adding board members from foreign countries is no easy task. First, there is the practical aspect of having someone from the other side of the globe attend board meetings and correspond from thousands of miles away and over several time zones. Then there are difficulties finding qualified individuals in locales where the board doesn’t have as much knowledge, not to mention the cultural and language barriers that exist. (See “From Brazil to Dubai.”)

The most desirable global directors are from the so-called BRIC emerging markets: Brazil, Russia, India, and China. Some of these countries have a greater supply of potential directors than others. Justus O’Brien, co-managing partner of North American Board Services at Egon Zehnder, says that it can be more difficult to find qualified directors in China, while in India there is a much larger supply of qualified candidates.

“It’s not as mysterious as it may sound to build a global board. It’s not that different than building any great board.” –Justus O’Brien, Egon Zehnder

“It’s not as mysterious as it may sound to build a global board. It’s not that different than building any great board,” O’Brien told directors attending Directorship’s Global Boards Forum in New York in September. “What is needed is simply a clear-eyed assessment of the current and future needs of the business.” Underlying that assessment should be a plan for board transitions, such as the addition of newly promoted inside directors, or the scheduled retirements of current directors. A more diverse board also offers some assurance that “cultural group think” is broken, O’Brien says. Many corporations, including Alcoa, have adopted the Business Roundtable’s “Principles of Corporate Governance,” which includes a plan for the departure and replacement of directors that stipulates a mandatory retirement age and term limits.

The due diligence that must be performed on potential board members from around the world can also be more challenging, since boards typically know less about the individuals or don’t know people who can vouch for them. “The due diligence process needs to include a deep legal and background check,” says O’Brien.

How do you define global experience? In the past, boards might have sought out international experience by putting together an advisory board. If a company was considering moving into two or three large markets, it might have created an advisory board with individuals who had knowledge of these markets, but were not necessarily board-caliber business leaders. That has changed. “Globalism in the board room is at a strategic level. It’s not about marketing,” says Davis.

It’s true that boards are seeking foreign nationals, but that is not the only aspect of building a global board. Companies are adding Americans that have run large divisions in Europe, Asia, or South America. They are also adding individuals who are internationalists. That means they have a keen understanding of the global economy, not just one region of it.

“The reality is that all significant businesses are operating in the global economy,” says William George, a professor at Harvard Business School and a director at Goldman Sachs, ExxonMobil, and Novartis. “It’s extremely important to have people on the board who have a deep understanding of different global cultures and how they do business there.”

One example of the perspective that global members can provide is that the U.S. accounting system is currently in the process of shifting to an international standard. Mary Pat McCarthy, U.S. vice chair at KPMG and director of KPMG’s Audit Committee Institute, says that global members who have been working with the International Financial Reporting System (IFRS) can provide some insight on its positives and negatives. “Creating a global board is an enabler to competing in the worldwide economy,” she says.

The Board Field Trip

Not surprisingly, large foreign companies with businesses in the United States are looking to put Americans on their boards. Harvard’s George was the first person from a non-German speaking country to gain a board seat at Novartis, headquartered in Switzerland. When he joined the board and it listed on the New York Stock Exchange, it also changed its official business language from German to English. “They were making a statement that they wanted to be a global company, and the U.S. is a very important market,” says George. Novartis has since added fellow American Anne Fudge and Marjorie M. Yang of the United Kingdom to its board.

The language shift to English at Novartis shows just how much of an impact going global can have on a board. Not only did the language change, but there were other subtle shifts in cultural aspects of the board as well. For example, George says that when speaking German, the board used a more formal tone. They addressed each other in the German equivalent of mister, professor, or doctor and used last names. With the change to English, they began addressing each other by their first names.

“Creating a global board is an enabler to competing in the worldwide economy.”

–Mary Pat McCarthy, KPMG’s Audit Committee Institute

George admits that logistically it can be tricky to add foreign nationals to the board. Directors have to increase travel time and language remains a real barrier, but he says it is worth overcoming the logistic hurdles to bring board diversity. “That’s part of the commitment,” he says. “We are not talking about part-time board members. And they are not just calling in to the meetings. Board members are really taking the time to attend meetings.” He says that the job of director has expanded enough that board members take their roles and their time commitment very seriously. He also thinks board members should be paid commensurately for this more demanding regimen required of global boards. One technology solution that may also help global boards to communicate through different time zones are board portals, such as Diligent Boardbooks and Nasdaq’s Directors Desk, that facilitate virtual meetings in a secure environment.

Egon Zehnder’s Davis says that boards shouldn’t put too much emphasis on the logistical barriers to creating a global board. “Tactical thinking gets in the way of a global board. They get too worried about the travel, language, and cultural differences. You have to find creative ways around them.”

Occasionally, board meetings are held overseas in the home countries of one of the global members. George says there is also a trend of boards setting up trips as long as a week to visit far-flung operations or to get a better sense of what is happening in a particular country. For example, the Goldman board traveled to the Middle East and visited Saudi Arabia, Dubai, and Israel, where they met with dignitaries and politicians. The board of ExxonMobil traveled to France and Japan in recent years. And Novartis is planning a trip to Singapore. “Don’t think they are boondoggles,” says George. “These companies are very serious about globalization and the time is very well spent. Everyone is there.” He says American companies realize that they have to have a broader perspective on how these countries work. “You can’t view everything through an American lens.”

One of the reasons that the Japanese fell behind in the 1990s is that they didn’t have enough diversity in their management ranks or on the board, according to George. He thinks U.S. companies could face the same fate if they don’t learn from those mistakes. “American global companies are coming around to this way too slowly.”

Egon Zehnder’s O’Brien agrees: “Boards will find that they are lacking real global perspective. They need to diversify their cultural perspective to break the cultural group think.”