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Restoring Confidence
CEOs Emphasize Trust and TransparencyFebruary, 2003 by Fred Rose We lost it somewhere in the 1990s amid the soaring stock market, the cultish faith in emerging technologies, and the promise of "new economies." That’s when intelligent management theory blew up. Again and again we heard that "the old rules don’t apply," as if fictional space hero Buck Rogers had landed in the boardroom with management techniques wildly detached from the past. Everything could expand without limits, we were told. Inventories moved at the speed of light. Sales mushroomed magically. Money could be raised at the snap of a Palm Pilot, and debt could disappear with a partnership. Employees happily grabbed paper instead of paychecks. Then, Buck tumbled. The full effect of his fall has yet to be understood. Tales of fraud and loose accounting mark the headlines. Red ink stains corporate accounts. And, in many ways, we’d like to think of Buck’s boardroom visit as a bad dream. It’s tempting this close to events to underestimate the scale of occurrences. Says John Gunn, MBA ’72, president and chief investment officer at Dodge & Cox, San Francisco—based investment managers, "I don’t think people have a proper perspective on what happened in this market. About $8 trillion went to money heaven; so an awful lot of people are saying, ‘I must have been misled.’" Losses in the U.S. stock market alone equaled nearly a year of national economic output. Savings for retirements and college educations were dashed, and investor confidence was knocked. The route to recovery demands tough management decisions. It asks for sharp corporate insight as much as national political preoccupation. And company by company, management by management, this is a time when business heads must ask: How can we lead better? What is the route to recovery? And then, What is management for the 21st century? With such questions in mind, we turned to some of the Stanford Graduate School of Business’s most distinguished graduates for a sampling of thoughts and experiences from the world of the chief executive’s office. The leadership experience of the graduates with whom we spoke totals decades. The alumni come from diverse industries and different interests. Interviews were conducted separately over several weeks. While the views aren’t always in accord, it was agreed that a vital strategic moment is at hand. There are at least two parts to this problem for CEOs. The first are steps of recovery, boosting troops, and rebuilding the credibility of leadership. Secondly, the lessons of the last few years need to be absorbed and applied to the future. The immediate problem "is close to a total lack of confidence that investors have in the integrity of the system," says Richard Kovacevich, MBA ’67, chairman, president, and chief executive of Wells Fargo & Co. CEOs, "we—we collectively—have to do whatever it takes to restore public confidence so that they can rely on and believe the accuracy of our public reports. What that means is that we’re going to have to do some things that are going to turn out to be excessive–because in order to correct a problem, you usually have to overreact to restore that confidence. "Most of us, I think, are appalled and outraged by what has happened," says Kovacevich, who will be honored with the Ernest C. Arbuckle Award later this month by the Stanford Business School Alumni Association. "We all suspected that there were some bad apples, but obviously the extent of it is far greater and far more extensive than certainly I ever thought." Nor, in a global era, is this a problem solely for U.S. managements. "Anyone who tells you that these things can’t happen in Europe clearly isn’t talking sense, because if it can happen in America, it can happen anywhere in the world," warns Rod Eddington, SEP ’91, president and chief executive officer of British Airways PLC. How dramatic must changes be to restore confidence? Hank McKinnell, Sloan ’66, MBA ’67, PhD ’69, chairman and chief executive officer of Pfizer Inc., contends that substantial progress already has been made. The laws and regulations that have emerged since the stock market boom, McKinnell says, comprise "an historic revision of the framework within which corporate governance occurs. " What’s needed now, he says, are efforts to educate the public about "exactly what’s expected of a chief executive officer; we need to talk about the principles of ethical corporate management, experience, vision, and foresight." That’s a tough order. CEOs, as Jeffrey R. Immelt, chairman and chief executive officer of General Electric Co. and a graduate of Harvard University’s MBA program, lamented recently, "are down there at the bottom of the heap with telemarketers." If the 1990s were the time of grand strategies and digital dreams in the chief executive office, the opening years of the 21st century are demanding more nuts-and-bolts work. Trust and integrity are the stuff of details. Directors’ scrutiny of operating issues is more thorough, report CEOs who are Stanford Business School graduates. And that’s an important return to basics. "Ultimately, the buck stops with the CEO," notes Constance H. Lau, MBA ’79, president and chief executive officer of American Savings Bank in Honolulu. "While we’re supposed to go through all this grand thinking, it is also our responsibility to see that the organization functions properly and is focused on customer needs and that the people act with integrity." Fraud by the few—be they at Enron, WorldCom, or Global Crossing–has battered employee faith just as it has investor trust. CEOs say they are pressed to reach out more to colleagues. "I guess I’m amazed at the fact that it’s almost impossible to communicate too much, " says Kovacevich of Wells Fargo. And it’s true of companies large and small. Robert Moog, MBA ’84, chairman and president of tiny University Games and AreYouGame.com, says he is paying special attention to support of colleagues by sending missives noting exemplary work. The two closely held San Francisco Bay Area firms jointly employ about 80 people. CEO themes today often deal with touchy matters far different from the cheerleading "return on investment–all else be damned" swagger of the boom market. Kovacevich focused on ethics, the abstract topic so much on minds across corporate America, in an email to all hands at Wells Fargo. "It’s important we all understand that the honesty, trust, and integrity essential for meeting the highest standards of corporate governance are not just the responsibility of senior management or boards of directors. We all share that responsibility," he wrote, adding that "corporations don’t have a conscience. People do. Corporate ethics is the sum total of the thousands of ethical decisions all of us make every day." Essays on ethics aren’t executives’ usual stock in trade. "This isn’t what you were trained to do," Kovacevich says. "When I went to Stanford," he recalls, "I don’t remember people saying that this is where you’re going to be spending time—on these sorts of issues–and these are the courses you should take." There are those, of course, who stand ready to help–for a fee. Advice on governance and disclosure is a growing business. Standard & Poor’s has launched a corporate governance practice. Rival Moody’s Investors Service has said it is building a similar consulting practice. "Clearly, there is a healthy skepticism about numbers these days," says Jack Schuler, MBA ’64, chairman of Stericycle Inc. and Ventana Medical Systems Inc. Schuler says, "Audit committee meetings are completely changed from what they were two years ago, both in terms of length and in terms of detail." Eddington at British Airways estimates that the audit committee on his board is spending about twice as long on the accounts as it once did. Lau reports that at American Savings Bank she has taken an activist, inside approach to disclosure. "We have always had internal control systems, but now, in addition to internal controls, we also have brought in disclosure controls, where we require every executive to sit with their operating managers on a continuing basis, but at least every quarter, to talk about the things that would require disclosure but also to talk about emerging issues or even potential issues." With this approach, she says, "we can be much more anticipatory." Disclosure has a hard-nosed advantage–in addition to its moral strength. "It’s not a sense of wanting to change the world or wanting to go to heaven," Hamid R. Moghadam, MBA ’80, chairman and chief executive officer of San Francisco—based AMB Property Corp., told Fortune magazine, but because "you want to make yourself attractive to the people who supply you with capital." Moghadam told Stanford Business, "I think there’s a public trust in my hands and in the hands of the team here to do the best we can and be truthful about what we do. I think the public is willing to forgive us for mistakes that we may make strategically, but they’re not going to forgive anyone more ethical lapses." As a founder of the industrial property investment and management company, Moghadam says, "I have never sold a single share of stock. I know—I went to Stanford Business School–that you’re supposed to diversify. But we’re long-term owners of the business–for good or bad…. I think the thing that is going to work best is the brand of the ethical and transparent company, to be the people in the white hats." In pursuit of the white hat role, Moghadam has for some time made disclosure a byword. AMB each quarter issues supplementary information with its financial statements that lately have mushroomed to nearly 35 pages from 4 or 5 pages a few years ago. The company expenses its stock options, a much-debated step advocated by reformers. "We did it before Coca-Cola, but no one seems to remember," Moghadam brags. AMB has committed to reporting each quarter’s financial results before General Electric—long one of the earliest-reporting companies. AMB now routinely makes its numbers public just one week after the close of quarter and several days before GE. Moghadam says swift reporting is a matter of healthy management. "Frankly, I think that good companies with good systems should be able to close their books quickly," he says. "The ones that take two months are likely spending that time cooking the books." Measures such as faster, more forthright disclosure and better communication go a long way to settle CEOs’ "Step One" concerns for recovery. But "Step Two" is a thicket of nuance and debate. No terrain is more heavily disputed and more subject to foot-dragging than corporate governance and boards of directors. In an effort to move reluctant companies, the New York Stock Exchange has invoked new standards demanding a majority of independent directors on the boards of all listed companies as well as the independence of those on audit committees. "Independence" is itself an oft-abused notion. Directors with a variety of business or family ties to either a company or its management have been deemed "independent" in the past. But, with the new rules, executives at major customers and suppliers are out, for instance. A survey by McKinsey & Co., the New York—based consulting company, last year suggested that those who sit on corporate boards were well aware of the system’s weaknesses. Some 200 directors, who sat on a total of 500 corporate boards, said more than a quarter of their " independent" colleagues on boards weren’t truly independent. Nearly a third of all directors felt their boards had, at best, an ineffective process for dealing with conflicts of interest. And 41 percent of those surveyed weren’t satisfied with their boards’ oversight of chief financial officers, while 31 percent felt that their boards’ reviews of the CEO weren’t adequate. The ample awareness of weaknesses and dissatisfaction among directors on boards suggests that other forces—such of those of management and traditional deference to powerful chairmen-CEOs–make major structural changes hard to achieve. Stanford CEOs are considering some of the important ideas now being bruited about. But what, if anything, needs to be done? There are differences of opinion, in part along theological lines of free-market forces versus regulation, and doubts about the wisdom of new laws and rules for their own sake. McKinnell of Pfizer argues that legal and regulatory changes to date are sufficient. Gunn of Dodge & Cox contends that market forces are sufficient to punish the foolish and the incompetent. Notes Lau, laws and regulations never entirely suffice. "You never can cover everything in a procedure or system. Directors need a strong moral compass." Getting a lot of attention these days is a mechanism used for a decade by Minneapolis-based biomedical firm Medtronic, where Schuler is lead director and chairman of the corporate governance committee. "Lead" or "principal" directors are supposed to guide the independent directors by acting as a conduit for opinions. Schuler says he has found the plan a good one. "Ideally, you want to be able to discuss everything publicly in the full board forum. But there may be people unhappy with agenda issues that didn’t come up or how they were handled, " Schuler says, adding that he is approached by fellow directors at least a couple of times before meetings with items for attention. The concept has gained popularity of late, although grasped at times with the sudden conviction of a sickbed conversion. Among those who have adopted the structure are General Electric and Houston-based energy marketer Dynegy Inc. and natural gas services provider El Paso Corp. The notion of separating the positions of chairman of the board and chief executive officer is also gaining increasing attention. Currently, about 75 percent of the companies that make up the Standard & Poor’s 500 Index have a single occupant who bears both titles. Andrew S. Grove, chairman of Intel Corp. but not at the same time its ceo, has said, "The separation of the two jobs goes to the heart of the conception of a corporation." Grove, a GSB lecturer, has posed this thought: "Is a company a sandbox for the CEO, or is the CEO an employee? If he’s an employee, he needs a boss, and that boss is the board. The chairman runs the board. How can the CEO be his own boss? " British and Canadian practice has long kept the posts separate, which Eddington of British Airways applauds. "I’m chief executive of British Airways," he notes, but "the board is chaired by a non-executive chairman. I think that’s absolutely right." Moghadam, who holds both posts, opposes separation. Generally reform-minded, he argues that "the traditional independent chairman in the British model–all they do is run a very formal meeting process. They see that they enforce Robert’s Rules of Order and put things in legal form. They don’t know enough to make sure the real issues come before the board meeting." He continues: "The problem, I think–with much of the legislation and these governance issues–is that everyone is trying to solve last year’s problem. The fundamental problem is not what boards of directors are told about; it’s what boards of directors are not told about. " To maintain track of its CEO, the Medtronic board does a very formal review each year, covering about 15 issues for which each director applies a numerical rating to the CEO’s performance. There are written comments as well. None of this is directly related to compensation review but is intended to keep the board abreast of the head officer’s work. In effect, too, it’s useful training for changes at the top. "Succession is the heart of it all," says Schuler. "The board earns its keep– perhaps 30 to 40 percent of its pay–in maneuvering a transition of CEO and selecting a successor. " Like changes at the Kremlin, it brings risk. Market and employee confidence can be won or lost. Boards often are dominated by former CEOs who stay at the directors’ table. At Medtronic, tradition requires that a departing CEO step down from the board. Law, regulations, and even ritual can’t do it all. In the end, it depends on a relationship of trust–moral people, as Lau notes, acting frankly and in good faith. Most revolutionary theories of corporate governance are within the power of most boards to enact. Yet, they have avoided them. Instead, staggered boards, golden parachutes, and other legal defenses dating from antitakeover provisions invoked since the late 1990s have, in many cases, further sheltered boards from the people they represent–the shareholders. Can the gap between boardroom and shareholder be narrowed? The future must be loose enough to allow innovation, says McKinnell. And, if there is to be a future, notes Schuler, CEOs and the boards they serve must keep a clear eye on the course. "If they don’t realize that 80 percent of their conversation has to be about strategies–on products, on customers, on employees and management–then they’re missing the boat." After all, he adds, "a great audit committee does not ensure a great company; although a great company needs a fine audit committee." |
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Executive
Accountability
