Reflections of a
Non-Executive Chair*
H. Stephen Grace, Jr., Ph.D.
*This is an unedited version of the article that appeared in THE CORPORATE BOARD May/June 2005, pp 11-13. Hard copies of the actual article are available by contacting hsgrace@hsgraceco.com.
Readers of The Corporate Board understand quite well that one's experience as a Non-Executive Chair could give rise to a variety of reflections. My reflections in this article focus on the issue of the equivalency or interchangeability of the Non-Executive Chair and the Lead Director positions within the governance structure of a corporate organization, and incorporate the insights gained from two recent experiences. The equivalency or interchangeability of these two positions has been a topic of considerable interest among most persons concerned with corporate governance. While some would say the question of equivalency is tied to the issue of the Chief Executive Officer and the Chair positions being held by the same individual, I would say, not so. Each issue has its own subtleties and intricacies that distinguish the two.
The context within which the equivalency of the Non-Executive Chair and the Lead Director positions is addressed is their effectiveness within the system of checks and balances inherent in the governance structure of a corporate organization. I, and members of the Advisory Board of Grace & Co. Consultancy, Inc., have long believed and have made clear in our writings the critical importance of a governance structure's checks and balances. Lord Acton got it right when he said, "Power corrupts, and absolute power corrupts absolutely." He further got it right in his powerful essay "Nationality" published in the Home and Foreign Review I (July 1862), where in his opening statement, he set out:
"Whenever great intellectual cultivation has been combined with that suffering which is inseparable from extensive changes in the condition of the people, men of speculative or imaginative genius have sought in the contemplation of an ideal society a remedy, or at least a consolation, for evils which they were practically unable to remove." (Italics are mine.)
Lord Acton discusses the forces at work that drive men to seek as a solution the all-powerful State, and warns against them. Interestingly, Acton was joined over the years by others including J. R. R. Tolkien who, in his trilogy The Lord of the Rings, sought to attenuate what he saw as the reemergence of nationalism. The conceptual appeal of a governance structure which permits an absolute consolidation of power in order to address issues in an expedited manner is appealing, but flawed, as Lord Acton pointed out and as history has demonstrated. Some of mankind's darkest hours were those that involved an absolute consolidation of power such as Hitler's Nazism and Pol Pot's attempt to return Cambodia to an "Agrarian Society."
Lord Acton's observations are equally applicable to the governance of corporate organizations. As little as 40 years ago, a board comprised only of insiders who, because of their experience, could potentially move in the most expedited manner on behalf of the Corporation, was accepted as an appropriate form of corporate governance. In such a structure, it is not necessarily the case that abusive governance practices will arise, and in many cases they did not. But it is most certainly more conducive to problems, and history continues to demonstrate that the gravity of these problems can be significant.
In the work of our sister firm, former Senior Executives are called upon to examine, evaluate, advise and, at times, testify regarding Management's actions. (Certain clients refer to our work as "retrospective prudence audits", wherein we evaluate the prudence or appropriateness of Management's actions, or lack of action.) We have come to recognize what appear to be common factors in a number of these problematic situations - governance structures which permitted an individual or a small group of individuals to consolidate power, to veil or shroud their actions from the view of others, and to manipulate and intimidate individuals inside the structure. This may be by outright coercion or by overly generous compensation (at the company's expense.) What was lacking was a rigorous set of checks and balances, characterized by transparency, within which those involved in the governance structure not only understood their own responsibilities, but also the responsibilities of the other participants in the governance structure and were positioned to insure that the individual parties satisfactorily addressed their respective responsibilities.
Our recent experience as examiners and advisors has confirmed what we learned as members of senior management - simply relying on "Tone at the Top" is not sufficient. Several tone-oriented quotes from CEOs are shown in Exhibit A. While the quotes may have reflected the respective CEO's thinking at a point in time, the serious problems these firms subsequently encountered indicate that something in addition to their announced intentions is required.
The importance my colleagues and I place on the system of checks and balances within the governance structure of a corporation drives right at the issue of the equivalency or interchangeability of the Non-Executive Chair and Lead Director positions. Are these two positions equivalent in insuring rigorous systems of checks and balances, and systems which are characterized by transparency?
A First Influencing Event
While I have been fortunate to have been a member of senior management in a broad range of business structures - general and limited partnerships, joint ventures, holding companies and the operating subsidiaries - two events in the past year have provided invaluable additional insight into the issue of the equivalency of the two positions. The first involved my serving as the Non-Executive Chair of the Financial Executives International ("FEI") for the 2003-2004 year. FEI is an organization of over 15,000 Senior Financial Executives - CFOs, Treasurers, Controllers - of business enterprises meeting certain size requirements. FEI is a leading spokesperson for business and industry on matters of accounting, finance and financial management. FEI's Code of Ethics is embedded in the Sarbanes Oxley Legislation's Code of Ethics. FEI's technical committees interact closely with The SEC, The FASB, The IASB, The AICPA and other regulatory bodies and professional organizations.
There is no doubt in my mind that my sensitivity to the Chair position was heightened by the increased focus on governance. Further heightening my sensitivity to the role was the fact that we had brought in a new President/Chief Executive Officer only three months before I assumed the Chair. While possessing an excellent combination of skill sets for the position, the new President/CEO had a limited knowledge of FEI's organization, its structure and its history. FEI's President/CEO is the only member of the management team to be part of the Office of the Chair (a group akin to an executive committee of a company.) That position is also the only member of the management team to be a member of the FEI Board. My belief is that a properly structured CEO selection process conveys to the independent members of the Board a responsibility for the success or lack thereof of a new CEO.
From the outset, and throughout the year, the value or the leverage from holding the Chair position, versus the position of a "Lead Member" of the Office of the Chair or a "Lead Director" of the Board was made clear to me. My ability to represent the 15,000 + members of the organization, as well as to assist the President/CEO was enhanced by holding the position of the Chair. (The "Duties of the Board Chairman" of FEI are set out in Exhibit B.) The definition of the responsibilities of the Chair put in place a constructive relationship between the Chair and The President/CEO. Both the President, new to her role, and I, as the Chair, had a well-defined framework within which to interrelate. Simple operational adjustments were easy for me to make. For example, as Chair, I set the format for the operation of the Office of the Chair ("OOC"). In the past, the OOC had met telephonically every two weeks, and had followed a somewhat standardized agenda, involving reporting on various activities of the organization. The President and I agreed that, in the initial year, weekly telephone calls would be held, with three of the four monthly calls being devoted to issues identified by the President and me. The fourth monthly call would follow the standardized reporting format. This adjustment, which was only necessary for the initial year, was of considerable value to the President and the rest of us on the OOC. In fact, shortly after a significant amount of time on the OOC calls began to be directed toward the reorganization of FEI's governance structure, the President thoughtfully requested that sufficient time be made available to discuss the planning, operational and human resource issues requiring daily attention. Had I served as a "Lead Director" and had to approach the new President in her role as both the CEO and Chair and suggest that we change the format and content of the OOC calls, the change would have been much more difficult.
My responsibility for controlling the agenda of the weekly OOC calls insured that the issues important to those of us charged with the oversight of the organization were in fact being addressed. Yet, at the same time, the President/CEO certainly had input into this agenda, as was mentioned above, when she requested that more time be allocated to pressing operational issues.
My role in the Office of the Chair was only the beginning. The leverage of holding the position of the Chair was clear in a number of other ways. As the Chair, I controlled the agenda of the Board meetings. Again, the ability to influence the items to be discussed on the agenda, and the amount of time to be allocated to the discussion of these items is significant. Even where certain items are discussed with regularity at Board meetings, the amount of time and attention paid to these is largely subject to the discretion of the Chair. In connection with the Board meetings, I had the ability to control the material that was distributed to the Board and the Board committees.
The Chair's responsibility for controlling the meeting allows the Chair to exercise influence not available to the Lead Director. The decisions concerning who are permitted to discuss or comment on various issues, the order in which they are allowed to set forth their views, the amount of time they are permitted, and the ultimate decision as to how the issues will be addressed, lie largely with the Chair.
The Chair's ability to appoint committees is another area of significant influence. As a Board member independent from the management team, the Chair has the ability to appoint committees that will help insure that an objective, balanced view is brought to the issues under consideration.
An important objective of FEI during my year as Chair was the achievement of certain improvements in our longer range planning. My familiarity with the members of the organization aided me in identifying a committee that did an outstanding job of working with the President and her Senior Management Team on our three-year plan. Modifications were put in place that will continue to benefit the organization for a number of years.
A very important objective for FEI during my tenure was the reconsideration of FEI's own governance structure. Several years previously, FEI's Board had been increased to incorporate a large number of member leaders in order to address what were perceived as communication shortcomings. There was general agreement that this structure was unwieldy and needed to be modified. Not surprisingly, there were a number of approaches raised by various FEI leaders regarding what would be an appropriate restructuring of the governance process. Even once the restructured size and make up of the Board and the Executive Committee had been determined, there was considerable discussion over the proper manner for selecting these individuals. This division of views was present among the Board members, and as Chair, I was deeply involved in these discussions, and appointed various committees to consider different issues. FEI's President and her Management Team were able to assist all the parties in these discussions. Given her short tenure in the President/CEO role, it always seemed to me advantageous that FEI's President was able to remain largely neutral in these discussions, and be supportive of all the involved parties.
A Second Influencing Event
The second event of the past year concerns my being invited to consider a Board position on the reorganized parent corporation emerging from one of the large recent bankruptcies. While a number of our Board of Advisors, as well as I, have worked with troubled or Chapter 11 companies, I was impacted by the breadth and depth of the Board's responsibilities in this situation.
The reorganized corporation was to be owned almost entirely by the former creditors. These owners, in literally all aspects, would be absentee owners. Once the ownership positions in the reorganized firm were determined, these owners would be off on assignments addressing other troubled credits for their respective employers. At the same time, the management of the organization would largely lie in the hands of hired professionals, many of whom were being paid for their services on an hourly basis.
The owner-agent problem was quite apparent. The interests of the owners were potentially sharply at odds with those of the professionals involved in the day-to-day management of operations. The plan of reorganization called for the firm to be liquidated through the sale of various groups of assets. In such a case, normally the owner's position would be maximized by completing the sales of these assets in as short a time as possible, allowing for reasonable selling efforts. On the other hand, the income of the professionals would be maximized by lengthening the time required for the disposition of the assets.
The entire responsibility for the oversight and control of the management team and its related professionals, lay with the Board. Literally, they were the only checks and balances in the governance process, given the absentee ownership that more than likely would develop. To me, this situation mandated the Board be led by a Non-Executive Chair. Permitting the professional who served as CEO of the reorganized firm to also serve as Chair would be to create a minefield of problems. There is literally no way, in such a situation, that an independent director serving as lead Director could be as effective in positioning the Board to address their responsibilities as could an Non-Executive Chair.
This is not to say that many of those who perform such professional services would do anything other than attempt to operate in the most effective manner on behalf of the owners. However, it is to say that in those cases where the management and the associated professionals chose to maximize their own interests, the Board would stand as the only set of Checks and Balances to prevent such an occurrence. In many such instances the balancing of those interests is a judgment call. Without involved and committed Board leadership, those judgments are more likely to be decided in a court of law.
Conclusion
My reflections set out here seriously question the interchangeability of the Non-Executive Director and the Lead Director positions. The Non-Executive Chair stands ahead of the Lead Director in aiding the implementation and operation of a governance structure's checks and balances. The Non-Executive Chair is better positioned to support and assist a CEO in transition. The requirement for a Non-Executive Chair appears almost mandated within certain organizations.
H. Stephen Grace, Jr., Ph.D., is president of H.S. Grace & Co., Inc., and past chairman of Financial Executives International (FEI), an organization of 15,000 upper-level financial executives. He may be reached at hsgrace@hsgraceco.com.