The Next Generation

For decades, CEOs were natural candidates for outside directorships and filled the majority of open board positions. Then came Sarbanes-Oxley, which heaped added responsibilities, as well as new liabilities, on board directors. Now CEO candidates are rejecting most new directorship offers in droves. Others are stepping down from many of their current boardroom positions in the face of mounting workloads and increased risks.

Although such a scenario was predictable, and has recently been well documented, little is known about what has happened to boards in the wake of such decisions by corporate leaders. Who is taking their places on boards? In what numbers? What is motivating members of this next generation of board members? Are active CEOs essential to a highly qualified corporate board?

To better understand the shortage surrounding active CEO board candidates and who is stepping into their shoes, we studied the extent to which Fortune 500 firms are maintaining a cadre of active outside senior managers from for-profit firms on their boards. The study, completed early this year, specifically looks at board composition the year before SOX (2002) and the years for which information was available (2003 to 2005) following passage of this federal law.

Recently, scandals surrounding corporate stock option backdating have become the latest in what is now a parade of board-related debacles, including the “pre-texting” scandal at Hewlett-Packard, that have strengthened the justification that an active CEO might use in declining a board appointment. The recent backdating scandal at UnitedHealth Group, for example, led to the resignations of the CEO, CFO, and general counsel, who are among at least 30 corporate officers and board members who have resigned or have been forced out at more than a dozen companies as a result of this issue.

CEO Exodus
The trend underscores the huge extent to which active outside directors can become involved in another company’s crisis, as cascading disclosures and events heap responsibilities on time-pressed CEOs.

Such time-intensive activities, not to mention the reputational risks, limit the valuable time CEOs who act as outside directors have to focus on their own companies’ problems, which is certainly a critical issue for such leaders today. As one analyst recently put it, “Chief executives are on a shorter leash than ever, facing revived boards and restless shareholders. More CEOs are being forced out.”  No wonder some of the best CEO candidates are now reporting they are too busy managing their own companies or are restricted by employment contracts from serving as outside directors.  A 2006 study by Heidrick & Struggles International and the University of Southern California Marshall School of Business found that 53 percent of CEOs are subject to company regulations that limit  the number of outside boards on which they are permitted to serve, up from 23 percent in 2001.

While a common concern in the corporate world was whether fewer CEOs on corporate boards would have negative consequences for the business organizations that have come to rely so heavily upon them, we asked whether there were any downsides for a CEO who decides to avoid being an outside director?  Clearly, without opportunities to become involved with other boards, a CEO may be in danger of losing touch by limiting him or herself to a secluded information environment, which is not an uncommon problem for top managers who lack outside board experience. The main source of the risk, of course, is that it is not unusual for subordinates to funnel only the positive news up the chain of command.

It’s likely that some CEOs have simply concluded that the risk-to-reward ratio for accepting a director position is no longer compelling.  There is too much inherent financial and professional risk, they presume.  But whether those risks are real or imagined is a subject for debate. In fact, for outside director personal financial risk,  assuming a strong D&O policy is in place, the results of extensive research at Stanford University concludes that the risk “is very low, far lower than many commentators and board members believe, notwithstanding the WorldCom and Enron settlements.” On the other hand, once a major event has taken place, the D&O policy can be quite unsettling in terms of what might not be covered, irrespective of the geometric increase in time that must be devoted to board activities.