MF Friday Fool on the Hill. I didn't see this posted here yet, so here goes.
fnews.yahoo.com
FOOL ON THE HILL
An Investment Opinion
by Jim Surowiecki
Know the Board
If you want to clear a room of individual investors quickly, just start talking about corporate governance. The people listening will either flee or, more likely, drift off into comfortable sleep. Unfortunately, while most investors find discussions about the makeup of corporate boards and the appropriate role of such boards either boring or arcane (if not both), neglecting to look at a company's board is a bit like neglecting to look at a company's bank account. In the long run, corporations with strong, independent boards do a better job of selecting managers, guiding strategy, and ensuring accountability. And, as recent events at Iomega (NYSE:IOM - news) and Cabletron (NYSE:CS - news) suggest, strong boards matter most when your need for them is least expected.
In the case of Iomega, for instance, the sudden departure of Kim Edwards as CEO means that the company's future -- and that of its shareholders -- rests in the hands of its board of directors, which appointed James Sierk, a longtime member, as an interim CEO and is currently in search of a permanent replacement for Edwards. Yet it seems safe to say that the vast majority of Iomega investors don't know who's on the board or what their relationship to current management is. Given the fact that Edwards' resignation was described as "a mutual decision," the Iomega board was clearly not a shill for the CEO, as too many corporate boards still are. But in many ways Iomega investors are now navigating in the dark. They knew, and presumably trusted, Edwards, who built the company into a $1.7 billion firm while making the Zip drive into one of the hottest PC peripheral products ever invented. They know much less about the board and how it will go about deciding on a new CEO.
This isn't to say that the Iomega board made the wrong decision in letting Edwards go, since there's a plausible case to be made that companies need different kinds of leadership at different stages of their development, and that Edwards may not have been the right person to push Iomega to the next level. But it is to say that many investors adopt a paradoxical approach when they evaluate companies. Living as we do in a time when the cult of the CEO is in full bloom, we're constantly bombarded with images and articles reminding us that CEOs are the crucial players in a company's success. The ever-more-lavish compensation packages that CEOs receive have as their only justification this faith that the man on top is responsible for increased sales, profits, and market share. (Otherwise his pay shouldn't rise more than that of the rest of management.) Logically, then, the process by which CEOs are selected should be of overwhelming importance to investors, and the willingness of corporate boards to replace CEOs who don't perform should be an important part of evaluating any company. But all indications are that the strength or weakness of a board plays no real role in investor decisions. It is, at best, an afterthought.
What's striking about this is that institutional investors have adopted a very different stance toward the question of corporate governance. In fact, it's safe to say that the mantra of "shareholder value," which CEOs now invoke at the drop of a hat, is almost entirely the product of institutional investors' efforts to make corporate managers more accountable to their boards, in part by making boards more accountable to shareholders. Institutional investors, in other words, understand that a corporate universe in which managers are responsible to no one but themselves is a corporate universe in which capital will be mis-allocated, and in which the long-term health of corporations is put at risk by unlimited managerial discretion.
It's no coincidence that if one looks at the companies whose boards are consistently rated among the country's best in terms of independence -- which means board members are not tied to the company in any way -- and accountability to shareholders -- which means board members can be easily voted out of office -- one finds some of the strongest companies in America, including GE (NYSE:GE - news) , Compaq (NYSE:CPQ - news) , Intel (Nasdaq:INTC - news) , and Johnson & Johnson (NYSE:JNJ - news) . And if one looks at the companies whose boards are consistently rated among the nation's worst, one finds some of the least impressive companies in America, including Dow Jones (NYSE:DJ - news) , AT&T (NYSE:T - news) , and Archer Daniels Midland (NYSE:ADM - news) . There are, of course, exceptions, most notably Disney (NYSE:DIS - news) , but even with regard to Disney CEO Michael Eisner's refusal to plan seriously for succession, coupled with a pliant board, makes that company's future less certain than it should be.
Peter Drucker was fond of saying, "In every major business catastrophe of the last forty or fifty years, the board members were apparently the last people to be told that something was awry." In the last decade and a half, we've made great progress toward preventing that kind of isolation and toward ensuring that boards take an active role in shaping the broad strategic vision of their companies. But there's still much further to go.
In the case of Iomega, for instance, if Edwards was essentially dismissed because his plans for an heavy investment in marketing the Zip did not work, then the board needs to be asked why it didn't advise against those plans before they were implemented, rather than after. In the case of Cabletron, where the CEO was unceremoniously dismissed just six months after being brought to turn around the company and replaced by one of the firm's co-founders, the board needs to be held responsible either for its misstep in picking the CEO or for its cavalier acquiescence in the new CEO's power grab. The mark of a great company is its ability to manage succession well and to bring new leaders aboard without throwing the entire business into turmoil. And the only way to do that is to have an active independent board that can place the interests of the company as a whole above those of any individual manager. |
