The Good, the Bad, and the Ugly
Being selected to serve on a corporate board of directors is not what it used to be. With directors being held responsible for corporate meltdowns such as Enron and WorldCom, public opinion of corporate leadership has fallen to all-time lows. These corporate failures have also resulted in a new legal environment, making the job of the corporate director more onerous, with weightier responsibilities and more potential liabilities than the more honorary positions of years past. It's no longer good enough to just lend your name to the corporate letterhead.
David J. Berger touched on these topics in a talk on current issues in corporate governance at the July 14, 2005, meeting of the Markkula Center for Applied Ethics Business and Organizational Ethics Partnership in a presentation entitled "The Good, the Bad, and the Ugly: Tales from Today's Boardroom." Berger, a partner at the firm of Wilson, Sonsini, Goodrich & Rosati and head of the firm's Mergers and Acquisitions Litigation Department, likened the current climate to the similarly dubbed Clint Eastwood movie. In that spaghetti western, three competitors searched for gold, none of them trusting each other, but all needing to work together because each one of them has a piece to the puzzle of where to find the bounty.
"That's what we've got here in boardrooms today," Berger elaborated. "We have a number of different interest groups, a lot of different watchdogs trying to work together while not really trusting each other and not completely confident that they all have the same interests or visions for the corporation."
In Berger's version, the increasing recognition that a board should have both independent and non-independent directors represented "the good." The "bad" was that officers and directors of failed companies are often unable to get a fair hearing because of the public perception that anyone associated with a company that committed fraud participated in the fraud. Executive compensation emerged as "the ugly."
The Good
With the advent of the stock exchange rules and the Sarbanes-Oxley Act, which emphasizes the importance of independent directors and their role in monitoring the corporation and its management, a lot of boards have shifted to having one non-independent director, usually the CEO. The remainder of the board, typically, is comprised of "independent" directors, i.e. people having no affiliation with the company other than in their capacity as directors. Although having so many directors who have no affiliation with the company may be advantageous for monitoring management, Berger asked, is it really in the best interest of the company in the long run?
In considering this question, Berger first noted that good governance was not an end in itself; rather, it was a means to the end of a "better" corporation, meaning one that operated profitably, ethically, and effectively. Although Sarbanes-Oxley and the stock exchange rules emphasize independent directors as the means to protect against fraud, Berger and members of the audience stressed that independence in and of itself does not equal effectiveness as a board member.
Berger summed up the situation by saying, "We're coming back to a time when we can have a reasoned debate about who it is you want to have on a board of directors and what the qualifications of a director should be. We've gone through a period where the primary qualification that was thought necessary for directors was independence, in large part because of the corporate scandals that eliminated anybody who had any connection to the corporation being on the board of directors. That's cost us a great deal in terms of the types of expertise we want on the board of a corporation. I don't think it's the best way to run a corporation."
Although calls for the reform of Sarbanes-Oxley are now being heard, this does not mean independent directors should be in the minority on a board, Berger said: "We probably want a majority of independent directors on the board, and they need to fulfill certain functions." But equally important, the role of the board itself needs to be looked at. How does it set strategy? How does it get involved in the corporation? How does it set an ethical guideline for the company? "These are all issues that we're starting to think about in a more reasoned fashion, as opposed to a more reflexive fashion," he commented.
The Bad
But finding competent individuals to fulfill the role of director is becoming increasingly difficult in light of recent court cases and plummeting public opinion. Some charge that the risk is only perceived, not real. Skeptics argue that directors are unduly whiny about their plight, while in reality the standard for their liability is gross negligence-far more lenient than the standard of ordinary negligence to which police officers or physicians are held.
But Berger is no skeptic in this case. The reality, he said, is that directors and officers face a far greater risk of liability than they did even 10 years ago, and this is despite changes in federal legislation to limit the ability to bring cases under the federal securities laws against directors. One way to understand this is to look at a case from just 10 years ago involving Worlds of Wonder, the makers of Teddy Ruxpin and other toys.
In that case, investors sued the company, alleging reckless conduct and accounting fraud. Berger noted that the facts of the case appeared very bad. For example, eighteen months after going public at $18/share and peaking at $29/share, the company went bankrupt. Yet in his ruling, the judge noted that because of the complexity of the accounting issues involved, the directors could not be held liable for any accounting irregularities. Similarly, the judge ruled that the directors did not act recklessly because if they had been bent on committing fraud, they would not have provided detailed risk disclosures in the prospectus. And if they knew the company was headed for financial disaster, the judge reasoned, the directors would have bailed out of their substantial stock holdings. Were the case tried today, would the outcome be the same?
Fast forward to this year, and the WorldCom case. While it is impossible to specifically compare two cases given the different factual situations, looking at the two outcomes underscores the changing climate within the judicial system and society in general over the past decade. The directors of WorldCom agreed to settle all claims against them by investors by paying 10 percent of their net wealth after excluding their retirement funds, houses, etc. Under the terms of this settlement, it didn't matter how much time a director spent on WorldCom affairs, whether they profited from sale of stock, or even whether they voted to approve the transactions at issue.
"The payments were just because they were directors of WorldCom," Berger said. The settlement was meant to act as a deterrent to any future board members bent on wrongdoing. But it also acted as a strong deterrent to potentially ethical directors as well, he noted. "The notion that your personal wealth that you have accumulated over the course of your life is at risk regardless of how you acted as a director is something very scary to people considering whether or not to accept a position as a director."
The Ugly
Perhaps the ugliest piece in the whole corporate governance puzzle is the one representing CEO pay, Berger argued. "One of the biggest ethical and governance issues that we face in corporate America today is how to rein in executive pay," Berger said.
The ratio of CEO-level pay to entry-level pay in the 1950s was about 30-1. By 2001, it had grown to over 400-1. Today it is about 450-1. If the minimum wage had grown at the same rate as the average CEO pay from 1990 to 2000, the minimum wage in 2000 would have been over $20/hour.
Berger noted that there are a lot of good reasons to pay people a lot of money. "I like money," he laughed. But it is difficult to justify astronomical CEO salaries to judges and jurors who make substantially less. "Part of the reason people have such low esteem for corporate officers and directors in America," Berger observed, "is because they pick up the newspaper and read that this CEO is getting $60 million, and that CEO is getting $40 million-after they do a bad job and after getting forced out."
Dealing with the good, the bad, and the ugly in corporate boardrooms will no doubt continue for some time. But the true pot of gold will come only through ethical and effective corporate governance, according to Berger. "Governance is not an end in and of itself. Governance is a means to another end," he explained. "What is the end that we're trying to achieve by good corporate governance? Is it ethics in the corporation? Is it a well-performing corporation? Corporations are by nature, profit-driven enterprises. One of the things that boards must do is drive a corporate strategy that makes profits for the shareholders, gives back to the community, and provides opportunities for employees and other stakeholders. The well-governed corporation takes all of these factors into account, and looks for directors who can help guide it in this way."
Mr. Berger is a partner at Wilson Sonsini Goodrich & Rosati, and is chair of the firm's M&A Litigation Department and a member of the firm's Policy Committee.