In String of Corporate Troubles, Critics Focus on Boards' Failings
September 21, 2003
By KURT EICHENWALD
nytimes.com
Enron. WorldCom. And now the New York Stock Exchange.
The connections are far from tenuous among the corporate world's biggest scandals and the tumult that unfolded at the Big Board after the revelation of its chief executive's huge payout. Indeed, a critical theme runs through the disparate events that sent Enron and WorldCom into bankruptcy and that cost the exchange's longtime boss, Richard A. Grasso, his job last week: All can be traced to a failure on the part of a board of directors to handle its responsibilities, legal and financial experts said.
"Corporate governance" — the system of controlling and directing a business — is one of those five-dollar business terms that make most investors' eyes glaze over. It draws up images of staid boardrooms where directors, top-rank professionals who have been elected by shareholders or other owners, pore through corporate strategies, challenging managers on every detail to protect the interests of investors, employees and the community.
But often, the reality is far different. The board chairman, who is the top director, is often the chief executive, or top manager, as well.
Boards themselves are frequently packed with the chairman's friends and associates, who are unlikely to be rabble-rousers. In the end, such directors, corporate governance experts said, are likely to trust their friends and approve management's ideas with few objections.
Concern about the quality of corporate governance has been growing since the 1980's, and in recent years there has been a particular push to enact changes on boards. But the conflicts continue. The result, experts said, can be seen in several corporate disasters in which directors made decisions with results that they did not seem to understand fully until it was too late.
"Go back to all those corporate scandals, and it all comes down to a board that missed warning signals," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. "The question is why, but the answer is easy. They were conflicted. And the same thing happened at the New York Stock Exchange."
At Enron, directors approved a program to lock in the value of the company's investments, even though few of them understood it; the program ultimately helped drive the company into bankruptcy.
At WorldCom, directors approved a loan package for its chief executive, Bernard J. Ebbers, without fully realizing that the company was pouring hundreds of millions of dollars out the door to him.
At the exchange, directors approved a pay package that provided Mr. Grasso with $139.5 million in deferred pay and retirement benefits. Directors now say they did not understand how much money they were actually committing to Mr. Grasso.
The problems created by conflicts and a lack of director independence are far from limited to the companies that have captured the headlines, experts on governance said. Rather, they said, such problems are common throughout the business world.
"At the New York Stock Exchange, we are talking about a board with a combined chairman and C.E.O., with a conflicted board that was mainly handpicked by the chairman and we are talking about excessive secrecy," said Stephen Davis, president of Davis Global Advisors, an international corporate governance consulting firm based in Boston.
"And the fact is, that is garden variety corporate governance in America," Mr. Davis said. "For all the hue and cry about poor governance at the exchange, these kinds of sleepy boards are commonplace all across the nation."
But because the exchange is also a primary regulator for the marketplace — overseeing brokers and establishing listing standards for public companies — failures of corporate governance there can have far greater ramifications.
"Any of the issues you saw in the regular companies, with a board not acting with vigilance in representing the interests of investors, you would see more pronounced and more important at the N.Y.S.E., given the broader scope of interests that they are representing," said Peter Wysocki, an assistant professor at the M.I.T. Sloan School of Management.
It is not as if the exchange was unaware of the relationship between board conflicts and companies in trouble. As several corporate scandals shook Wall Street, the N.Y.S.E., led by Mr. Grasso, issued a call for greater independence of corporate board members. And the Big Board itself was beginning to look at internal changes; among its first efforts was greater public disclosure — on matters like Mr. Grasso's pay.
But those steps have been minor compared with the exchange's vocal support for change at its listed companies. "The exchange was saying all the right things, but in the end it wasn't eating its own cooking," Sarah Teslik, the executive director of the Council of Institutional Investors in Washington, said.
Indeed, critics say the Big Board's governance problems are more complex and harder to cure than at any public company. The conflicts at most companies are largely between the interests of management and those of shareholders. But at the exchange, the conflict is built into the very nature of the organization's structure.
The Big Board is an unusual hybrid. On one hand, it is a private entity created to advance the commercial interests of its members, including investment houses and trading firms. On the other hand, it is also a quasi-public organization charged with protecting investors against abuses by the very same investment houses and trading firms.
In its own description of its responsibilities, the exchange proclaims that its "ultimate constituency" is the investing public. Yet those investors do not participate in selecting directors, and because of the Big Board's limited public disclosures, they have little real knowledge of how the exchange is acting on their behalf.
"I would argue that the customer of the exchange ultimately is the investor," said Gary Findlay, executive director of the Missouri State Employees' Retirement System. "But the structure has been one that essentially serves Wall Street."
The division between the interests of the public and the exchange's members creates an unresolvable governance problem, Ms. Teslik said. "The board can't work with this conflict," she said. "If the regulatory responsibilities get separated out, the governance issues go away. But if you don't separate the regulatory responsibilities, I don't know of a governance structure that can handle the conflicts."
Separation of regulatory functions from other business functions has already occurred at other quasi-public institutions. For years, the National Association of Securities Dealers ran Nasdaq and regulated its members. But starting in 1995, under pressure from the Securities and Exchange Commission, the N.A.S.D. separated itself into three entities: a parent company representing broker dealers, a for-profit exchange, and a not-for-profit regulatory group.
"The regulatory aspect of the business requires a great deal of attention," said Eleanor Bloxham, president of The Value Alliance, a consulting firm in Westerville, Ohio, that advises corporate boards on governance issues. `'And if you have got a board that is thinking of this more in terms of a business entity, then there are a whole additional and conflicting set of issues being dealt with."
But beyond the conflicts, Big Board governance has also been undermined for years by secrecy. With a small group of people running the board — most with backgrounds in the clubby, moneyed world of finance — an objective assessment of the appropriateness of Mr. Grasso's compensation would have been even harder to come by.
"When you get people on the board who are controlling the decisions on things like this, who have hundreds of millions or billions of dollars, they seem to lose perspective on reality," said Russell S. Reynolds Jr., chairman of The Directorship Search Group Inc., a corporate consulting firm.
"They probably don't realize that instead of paying the guy $30 million, they could hire a guy who could do the job just as well for 3 percent of that," Mr. Reynolds said.
Still, some experts said that the tumult at the New York Stock Exchange was a good thing because it would force the exchange to take a hard look at itself and move substantially toward improving its governance.
"I think this is a great opportunity," Peggy Foran, vice president of corporate governance at Pfizer Inc., said of the events of the past few weeks. Pfizer is listed on the exchange.
"It was only going to get better over time anyway, but now it is going to get better much faster," Ms. Foran said. |
