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How Corporate reforms could backfire - Chief Concern - compliance with Sarbanes-Oxley Act creates shortage of corporate directors

Chief Executive, The, May, 2003 by Tom Neff

There will be unintended consequences for Corporate America if reformers overreact and radically change the way companies govern themselves. In a perverse way, reformers may trigger a crisis that would weaken, rather than strengthen, governance. Why? A supply crunch is emerging as boards attempt to comply with the Sarbanes-Oxley Act and the mandates of stock exchanges. Experienced, sought-after directors--i.e., active CEOs--are increasingly skeptical about serving on boards.

We at Spencer Stuart know from the unprecedented 200-plus board searches we are now conducting that many desirable directors believe the risk-reward ratio of serving on a board is far from compelling. As a result, the supply of active CEOs available for boards is drying up. Many who have served on boards for years are leaving.

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Despite the headlines, governance failures are not widespread. Of Standard & Poor's 500 companies, less than 3 percent have had serious governance or ethical problems of the kind that made Enron, Adelphia and WorldCom infamous. Most of the companies with the worst problems were high-growth businesses. When a company seems highly successful, it is unlikely that even astute directors will discover errant management, especially when management is actively seeking to deceive them.

Yes, some corporate reform is needed before investors will trust corporations and CEOs again. But in their rush to bring about change, reformers don't understand the practical limit of what boards can do. With six to eight board meetings per year, most lasting only a few hours, it is difficult--if not impossible--for boards to detect problems that management wants to hide.

The Enron case taught us that directors must watch unusual trends, such as spectacular growth in a volatile market, and they must stay vigilant even when a company seems to be performing well. But the Enron scandal didn't teach anybody how to find fire where there is no smoke.

In addition to the damage caused by the scarcity of qualified directors, the cost and time required for longer and more frequent board meetings can distract directors from the real work of focusing on strategy, competition and profitability. Oversight is sensible. Micromanagement is disruptive and counterproductive.

The most difficult directors to find are those willing to sit on audit committees. Although Sarbanes-Oxley requires public companies to have directors with "financial expertise" on their audit committees, fewer than 3 percent of S&P 500 boards comply with this mandate. The real trend may be in the opposite direction of what reformers intend--many qualified directors are abandoning audit committees to avoid lawsuits or criticism.

Many reformers also assume there is an infinite supply of qualified directors. They're wrong. Balancing men, women, minorities and technical experts does not necessarily create better governance. To perform well, boards need hands-on management experience in order to provide valuable oversight and guidance to the leaders of a corporation.

Other reform measures are simply misguided. Term limits and mandatory retirement ages increase director turnover and diminish a board's collective understanding of the business it oversees. What is needed instead is a rigorous performance evaluation to remove noncontributing directors.

Another proposal aims to restrict the number of boards or audit committees a retired executive can serve on. Again, this can create more problems than it solves. Obviously, retired CEOs and CFOs have more time for board service than their active counterparts. Similarly, mandating that a CEO cannot also serve as chairman of his board, as some reformers are advocating, would lead to early retirement of topnotch CEOs, or rejection of CEO offers by highly qualified candidates.

There is no single formula for governance success. It will take time for boards and CEOs in the post-Enron era to develop a new balance for operating in a nonadversarial environment. Reformers should recognize that not all companies are sick and that some of the medicine being prescribed may be worse than the disease.

Tom Neff is Chairman, U.S., of executive search firm Spencer Stuart and is based in New York.

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How Corporate reforms could backfire - Chief Concern - compliance with Sarbanes-Oxley Act creates shortage of corporate directors

Chief Executive, The, May, 2003 by Tom Neff

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