William J. Holstein

Beware of Corporate Governance Overreach

April 7, 2009

As a result of years of covering chief executive officers and boards of directors, I’m convinced that there needs to be a very delicate balance between CEOs and directors. That balance is key to making sure that the CEO and his or her management team delivers the best possible business results. This is key to the American ability to innovate and to compete in the world.

But a variety of interest groups have been working to subvert what I believe is an ideal governance model. There are two disturbing trends:

--The Securities and Exchange Commission, Congress and legislators in Delaware—where the vast majority of the nation’s public companies are incorporated—are working to give shareholders a much bigger role in choosing directors. According to an article by Kara Scannell in the March 26 edition of the Wall Street Journal, these would be the biggest changes in corporate governance since the Sarbanes-Oxley Act of 2002. The most dangerous of these proposals, it seems to me, are the ones that have been approved by the Delaware House. One would require that companies include shareholder nominees in the company’s annual proxy statement. (This is significant because right now, shareholder activist groups have no way to communicate with shareholders as a whole.) A second provision would allow corporate bylaws to require that a company reimburse shareholders for the expense of running proxy contests against the board and management. These measures are expected to be approved by the Delaware Senate and could take effect by August.

The central flaw in Delaware’s thinking is that shareholders are always right. In fact, these activist groups represent special interests, whether labor unions, environmentalists, religious groups, pension funds, hedge funds or private equity groups. They are not truly acting on behalf of all shareholders. If Delaware allows them too much clout, the danger is that boards could be balkanized by competing interests.

--A second reform push that worries me is the effort to require that more companies separate the funcion of the CEO from that of the chairman of the board. In many cases, the CEO is also chairman of the board.

But the Millstein Center for Corporate Governance and Performance at Yale University’s School of Management is proposing that the New York Stock Exchange and Nasdaq require companies to appoint a separate chairman after an incumbent CEO/chairman leaves, or explain why not to shareholders.

It’s a myth that separating these roles always leads to better governance and better performance. The reality of how companies perform best is that they need a clear leader. The CEO, with appropriate advice and consent from the board, should be the fulcrum of decision-making. Yes, there should be a lead director and there should be a robust relationship in which the board is empowered to ask questions and challenge the CEO’s decisions. But institutionalizing a split between a CEO and a chairman, and making it a requirement, is not wise or healthy. We don’t want our companies to be crippled by too many competing centers of power.

In short, there is a danger that we Americans will over-react to economic crisis and allow the pendulum of corporate goverance to swing too far. The net effect could be to reduce the competitiveness of American companies at the very moment that we need them to be winning in the world.