Harry Pearce has logged a lot of hours in boardroomsover the years. From his days as vice chairman ofGeneral Motors to his current posts as non-executivechairman of Nortel Networks and MDU Resources,a Fortune 500 energy and construction company, hehas experienced the full spectrum of board structuresand styles. And while many CEOs and somegovernance gurus argue that a company should usethe leadership structure that suits its needs, Pearcesays there is really only one way to go: a strong CEOto lead the business and an independent, non-executivechairman to lead the board.
“I have yet to hear a credible argument from anyCEO on why it is better to have the same individualrunning the company and the board at the sametime,” says Pearce.
In addition to his two chairmanships, Pearce nowspends a significant portion of his time preaching toCorporate America that it is time to separate the jobsof the CEO and the chairman of the board. Last yearhe co-founded the Chairmen’s Forum, a group ofdirectors who meet to discuss the issues unique toindependent chairmen. Recently, the group issueda call to North American public companies to voluntarilyadopt independent chairmanship as thedefault model of board leadership, upon successionof a combined CEO and chairman. “The time isright for the growing number of those actually doingthe job to build knowledge on how independentboard leadership can best work,” he says.
In March, the group, in conjunction with theMillstein Center for Corporate Governance andPerformance at the Yale School of Management,issued a recommendation that boards appoint anon-executive chairman (on a comply or explain toshareholders basis). “The independent chair modelhas been adopted successfully by many companiesin many regions of the globe as a means to furtherensure and empower board independence,” says IraMillstein, senior associate dean for corporate governanceat the Yale School of Management.
The report has created a stir in governance circlesand garnered support from shareholder groups, corporategovernance experts, and a slew of prominentdirectors. Among the more than 60 signatories of theproposal are: Harvey Golub, the non-executivechairman of Campbell Soup and former CEO ofAmerican Express; Jay Brown, CEO of MBIA Inc.;William McCracken, chairman of CA Inc.; GaryWilson, former chairman of Northwest Airlines anda director at Yahoo; and Directorship’s chairman, JeffreyCunningham, who has served as non-executivechairman of Sapient and Bankrate. A number oflarge pension funds have also endorsed the endeavor,including the California Public Employees’ RetirementSystem (CalPERS) and the California StateTeachers Retirement System (CalSTRS).
“It is a full-time job in itself toensure you have best practicesand to manage the board, whichis a substantial responsibility intoday’s business world.” –Harry Pearce
“With a separate CEO and chairman, you end upgetting better management of the company becausethe CEO is not unduly influencing the board’s importantjob to assess the CEO and make a change if necessary,”says Wilson. “It should improve corporate performanceand lead to more competitive CEO compensation practices.”
On one point the Chairmen’s Forum is clear: it isnot looking for current CEO/chairmen to relinquishone of the titles precipitously. The proposal calls forthe board to separate the roles upon succession tothe next chief. “We are not looking to strip currentCEO/chairs of one of their roles, I think that wouldbe too disruptive and would not be productive,”explains Pearce.
Got Oversight?
Not long ago, the primaryrole of the board was largelyadvisory, he says. As variousscandals occurred in CorporateAmerica over thelast several decades, thatrole morphed to includemore monitoring and oversightfunctions. Legislation,new rules from stock exchanges, and decisionsfrom the Delaware courts underscored that transition,and boards turned more independent in their makeup.The pace of that evolution sped up after the fall ofcompanies like Enron, WorldCom, and Adelphia,and the recent financial crisis has made directorshyper-aware of their oversight duties. “Boards werereacting to the various crises and the concerns fromstockholders and the public of whether there was adequateoversight of management,” says Pearce.
In fact, the number of non-executive chairmenhas been increasing steadily. In 1998, 16 percent ofthe S&P 500 had a non-executive chairman (meaningsomeone who was not also the CEO). By 2008,that number had grown to 39 percent. However, thedata is somewhat misleading, since many non-executivechairs are former CEOs of the company oranother related party, and therefore may lack fullindependence. In 2004, the number of independentchairman was just 8 percent. But boards are increasinglyappointing a truly independent chair. In 2008,the figure climbed to 16 percent.
In Europe, split CEO and chairman roles are farmore common. German and Dutch regulatorsrequire it, and in the United Kingdom, 79 percent oflarge companies have an independent chairman.
The principal reasoning behind the push for anindependent chairman is to eliminate the conflict ofinterest that exists when the same person is leading aboard charged with overseeing the managementincluding the chief executive—in effect monitoringhimself. “I don’t fault CEOs. I think it is difficult toassess oneself. The primary duty of the modern boardof directors is to provide oversight of management,”says Pearce. “Realistically, to ask a chairman/CEO toprovide an objective critique of his own businessplans and his own strategiesis asking more of ahuman being than Ithink is possible.”
There is another,more pragmatic reason,Pearce says, that cleavingthe CEO and chairmanroles makes sense. Managingtoday’s large, globalcompanies is a massivelycomplex, challenging, and time-consuming job; splittingthe roles frees up the CEO to focus on the business.He also says the chairman’s job has become moretime-consuming and difficult, especially in light ofgreater compliance and reporting requirements. “It is afull-time job in itself to ensure you have best practicesand to manage the board, which is a substantialresponsibility in today’s business world,” says Pearce.
Another benefit is the dynamic change in the waythe board interacts. “To get the benefit of all theknowledge and skills that outside directors possessyou have to have leadership of the board that drawspeople out,” says Pearce. “The only way you get thatfrom a board is to have an independent chairmanwho wants to draw out each and every director, evenwhen some of those points of view are going to becritical of management.”
Wilson says the change can be immediate. “I havebeen in situations where an independent chairmanis appointed and it is instantaneous how the dynamicin the boardroom changes,” he says.
The Lead Director
Perhaps the main argument against separating thejobs is that in many cases where there is a CEO/chairman,there is also a lead director, who presides overexecutive sessions, provides leadership to independent directors and a check on management, andupholds high corporate governance standards. However,participants in the Chairmen’s Forum say thatwhile appointing a lead director has it merits, it is ahalf measure that often does not go far enough to solvethe conflict-of-interest problem.
“The difference is quite significant. I have served asa lead director and I have served as a non-executivechairman and there is a big difference. The person atthe head of the table leads the meeting. Other directorsdo not look to the lead director in the same waythey look to the chairman.”
Other members of the Forum agreed. “The leaddirector is better than nothing,” said one of the participantsat a recent Chairmen’s Forum gathering. “Buton a scale of 1 to 10, having a [non-executive] chairmanis a 10, and having a lead director is about a 4.”
Wilson, who also is a director at Yahoo, is less sanguineabout the benefits of a lead director. “I thinkit’s almost worse than not having one, because ittends to lull people to sleep with the appearance thatthe board has independent leadership.”
Pearce also dispels the argument that executivesessions without management can provide the typeof oversight required of the board. “You need someonewho the board looks to as their leader to initiatethe kind of frank, candid discussions that are needed.Otherwise, you end up with an executive sessionwhere no one quite knows what to say, and they endup being brief and unproductive.”
Another common argument is that companieswho are recruiting a new CEO will not be able toattract the best candidates if the job does not alsoinclude the chairman’s position. “It’s not necessarilytrue,” says Wilson. “We just did it at Yahoo. It is not abarrier to getting top candidates interested in the position,”he adds, referring to the appointment of CarolBartz to the CEO job in January, widely hailed as astrong selection. Roy Bostock is the non-executivechairman at Yahoo. “When we get separation of bothpositions, it will not be a problem because it takes itout as a competitive issue.”
Adding Some Teeth
The current proposal from the Chairmen’s Forumcalls for a voluntary adoption of the split structure,but the Forum may consider advocating for a rule ofsome kind, and is currently weighing options onjust how that would work. One of the options is forthe New York Stock Exchange and Nasdaq OMXto adopt the Forum’s recommendations as part oftheir corporate governance principles in their listingrequirements.
A second possibility is a rule from the Securitiesand Exchange Commission (SEC) that wouldrequire companies with a combined CEO andchairman to explain in the proxy statement the stepsthey are taking to handle the inherent conflicts ofinterest that arise. “It’s unlikely they would want toaddress that, and it would probably push more companiesto adopt the separate structure,” says Wilson.
Meanwhile, some shareholders are not waiting forcompanies to voluntarily split the post or for the SECor exchanges to adopt new rules. Proxy proposals toforce companies to appoint an independent chairmanare on the rise. As of May 1, there were 48 proposalsto require a non-executive chairman, up from31 at the same point last year. At Bank of America, aproposal to require an independent chairman passedby a slim margin, forcing CEO Ken Lewis to give upthe chairman’s title.
The Chairmen’s Forum has won the support ofsome large investors, including Norges Bank InvestmentManagement, Europe’s largest pension fund.“One of the most important roles the board has is tofire and supervise management. Therefore, theboard cannot be led by management itself,” saysAnne Kvam, global head of corporate governanceat NBIM.
Wilson says some institutional investor groupshave been hesitant to fully back the proposal, but hesays the tide may be turning. “They have not wantedto rock the boat in the past, but they are now in amood that they are more willing to rock the boat,”he notes. “Separating the roles of chairman andCEO is the critical missing piece in the evolutionarypath of boards representing owners better.”
Says Pearce: “When you have been there in theboardroom and you have experienced both models, itis just so obvious that the split roles make sense.”