While it may be the most ethically and legally questionable milestone to date, the unraveling imbroglio over investigations into boardroom leaks hardly marks the first time Hewlett-Packard's board of directors has found itself in the corporate governance hall of shame. As far back as the days of company founders Bill Hewlett and Dave Packard, the board was known to be particularly cozy and filled with insiders.
In more recent years, the board hired a CEO, Carleton "Carly" Fiornia—before key members had met her. It approved her outsized compensation, including a $21 million severance package. And it pushed through the infamous Compaq acquisition, a merger that many shareholders, including board member and founder scion Walter Hewlett, vigorously opposed. HP's (HPQ) grade from governance adviser The Corporate Library? A needs-improvement "D."
Now, in the wake of a scandal that included snooping on reporters' phone records (including three BusinessWeek writers) and using e-mail tracking software to try to identify the source of board leaks, HP Chairman Mark Hurd has the opportunity to improve the board's low marks. It won't be easy. Fixing HP's board so that it is squeaky clean in the eyes of investors will require a big injection of new blood, which will be hard to come while there are still-unanswered questions about the investigation. Another problem is the difficulty of attracting top board talent in a post–Sarbanes-Oxley era.
In addition, governance advisers also recommend a number of other image-burnishing steps, from naming new outside counsel to making further changes to its governance procedures.
COMPANY DYSFUNCTION. Most of all, repairing HP's board will require a leader capable of pulling together a team of people to create a cohesive, united board. That job now falls to Hurd, who was promoted to chairman on Sept. 22, rather than the previously announced January, 2007, timeline. Hurd has spelled out what he knew about the probe's questionable aspects and will answer additional questions from a House of Representatives subcommittee on Sept. 28.
Whether he is right for that position is an open question. Some governance experts believe HP may have given Hurd the title of chairman too soon. Naming Hurd as interim chairman instead would have left the door open for an untainted outsider as chairman at a later date.
Hurd's first task as chairman will be reshaping a board that has been called weak, divided, and dysfunctional, into one filled with impeccably credentialed outsiders who have the sort of forceful but team-minded personalities that could have squelched the leaks themselves. At the very least, the board will be looking to find new directors to replace the three board members who have left. Former Chairwoman Patricia Dunn, the vice-chairman of Barclays Global Investors, resigned on Sept. 22. George Keyworth resigned on Sept. 12. Silicon Valley venture capitalist Tom Perkins quit in a huff on May 18, at the board meeting when his fellow directors first learned that Keyworth was the leaker and voted to keep him off HP's 2007 slate of directors.
TIME TO "CLEAN HOUSE"? But the people who fill those spots may not be the board's only new members. Before the current situation erupted, the board had been looking to add at least two additional directors, which could bring the search tally to five. And there could be further replacements, as well.
At least one governance expert goes so far as to recommend a complete sweep of the existing board. "I think you clean house," says Charles Elson, the chairman of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "You do it in a logical, determined, measured way, but I think over the next couple of years you need to reconstitute that board." He suggests starting with those who had the closest connections to past management.
The person who fits that description is Richard "Dick" Hackborn, who was named lead independent director on Sept. 22. Hackborn, who spent 33 years as an HP employee, is the board's longest serving member, having joined in 1992. While his reputation has long been one of instant credibility—he served as chairman in 2000 when an inexperienced Fiorina first came in as CEO—he is known to be close to Perkins and Keyworth and a behind-the-scenes dealmaker.
TOUGH RECRUITING TIMES. Hackborn gets high points from HP insiders for not picking sides, and for trying to stay above the fray. But at a time when the board is in need of cohesion and transparency, a strong lead director unfettered by the politics of HP's past may be what it needs.
"People have an awful lot of respect for Hackborn," says Jeffrey Sonnenfeld, senior associate dean at the Yale School of Management. "But the wise and polite thing to do would be for him to consider his role merely a transitional one and when his term as a director expires, he step down, perhaps as a director and at minimum step down as a lead director." That may well happen. Back in 2000, Hackborn gladly gave up the chairman's title to Fiorina after less than a year.
Whether the board will be looking for three, five, or more new members, the recruiting challenge will be a tough one, despite the prestige traditionally associated with such a post. Indeed, HP will be looking to add experienced CEOs, likely with some technology bona fides, at a time when the pool of eligible CEO candidates is rapidly shrinking. As the demands of board members have increased, more and more active CEOs are saying no to new board posts. According to data from executive search firm Spencer Stuart, top executives from other companies now account for 32 percent of new director placements, compared to 53 percent just five years ago.
STAR POWER. There is one possible recruit: HP can try to convince Chevron (CVX) Chairman and CEO David O'Reilly to join the board again. He had agreed to join HP's board in May, 2004, before deciding in September of that year not to take the position because he had a time conflict with HP's scheduled board meetings. If he felt inclined to join HP's board then, he may be needed even more now. Representatives for O'Reilly would not comment.
Some of the star-power types whose names surfaced, such as former Merck (MRK) Chairman and CEO P. Roy Vagelos, could be the kind of names on recruiters' radar screens. And given the upheaval on the board, some advisers believe HP could use a director with solid credentials, such as Joseph Grundfest, a professor at Stanford Law School and co-director of the university's Arthur & Toni Rembe Rock Center for Corporate Governance. "We now have a small but very real group of directors who have proven credibility with shareholders," says Nell Minow, the co-founder and editor of governance adviser The Corporate Library.
IMPROVING PROCEDURES. The irony of such a recommendation is that former Chairwoman Patricia Dunn was making an effort to improve the board's governance procedures. In bringing Hurd into the CEO job, each board member was required to meet with each of the four CEO candidates. Academic governance advisers were brought in for training on good practices. And in November, 2005, the board introduced a rule that would require board members to win a majority of votes to be re-elected to the board. If they don't, they must submit their resignation.
Still, some believe that Hurd and the board could do even more. For one, the new majority-vote rule only goes so far: The board can still reject a member's resignation, making the rule, which can be rescinded, "pretty slippery," says Minow in an e-mail.
Some shareholders are even proposing a change to HP's by-laws that would allow investors who have held at least 3% of HP stock continuously for two years or more the chance to nominate new directors in the company's proxy materials. The proposal was made by the American Federation of State, County and Municipal Employees Pension Funds; the Connecticut Retirement Plans and Trust Funds; the New York State Common Retirement Fund; and the North Carolina Retirement Systems. The proposal follows a ruling by the U.S. Court of Appeals for the Second Circuit that may make it easier for shareholder-nominated directors to become candidates on corporate ballot cards. The SEC plans review the issue in a meeting on Oct. 18.
Minow also recommends that once new outside board members are named, that the entire board go on a listening tour. "They should go out and hear what the shareholders have to say and what the analysts have to say, and explain why they're bringing a different energy into this boardroom." Some sources close to the matter also say they would like to see a public statement made on behalf of the entire board regarding what they knew about the investigations.
FRESH ADVICE NEEDED. The board should also turn to new outside counsel, say governance experts. In addition to suggesting in an e-mail that the investigation was "within legal limits," Larry Sonsini helped to run an HP board meeting after news of the scandal broke, despite his earlier role.
"It wouldn't be that [hard] to attract top flight talent to this board," says Sonnenfeld, "if they showed a willingness to make changes by changing counsel and bringing in highly credible independent conflict-free parties." Representatives from Sonsini's office could not be reached for comment.
In the end, of course, procedural changes will only go so far. Once new board members are in place, Hurd will have to design a radical makeover of the boardroom's culture and get the group functioning again as a decision-making team. After all, smart decisions are what matter. "There is no structural change that can't be subverted," says The Corporate Library's Minow. "They can change nameplates around, they can give themselves different committee titles, but we only rate boards of directors on the decisions they make. We need to see good decisions."