They sit in a corporation's inner sanctum. They settle into high-backed chairs around burnished mahogany conference tables. And what they say and do is often an enigma to anyone outside those closed doors. They are the directors in the boardroom, a collection of names, egos, and experience that serves as the critical link between a public company's owners--its shareholders--and management.
That, at least, is the theory. In practice, too many boards have been mere "ornaments on a corporate Christmas tree," as a landmark study of boards by Harvard business school professor Myles Mace once put it--decorative and decorous baubles, with no real purpose. Little more than a claque of the CEO's cronies, they would quietly nod and smile at their buddy's flip charts and rubber-stamp his agenda for the corporation.
Somehow, directors forgot--if they ever knew--that they were in the boardroom to act on behalf of shareholders and oversee that collection of hired hands known as management. Directors watched idly at one seemingly invincible corporation after another--from Eastman Kodak and General Motors to IBM, Sears Roebuck, and Westinghouse Electric--as their companies faltered and declined. Only when the directors were prodded by investors and activists, only after their companies and CEOs were publicly pilloried, were many finally goaded into action--what some call "governance by embarrassment."
Slowly but surely, however, a quiet revolution is going on in America's boardrooms. The directors around the conference table are waking up. They're taking the job more seriously. They're becoming more active in reshaping the board and its oversight responsibilities. They're getting involved in corporate strategy and management succession. They're objectively evaluating the CEO's performance--and their own.
In that spirit, BUSINESS WEEK decided to take a peek behind those closed doors and perform an evaluation of its own. The result is our first ranking of the best and worst boards in Corporate America. The rankings reflect both the informed opinions of shareholders and governance experts and an objective assessment of the composition, structure, and guidelines of each board. The list contains some surprises on both sides, and it's bound to provoke controversy. But as the move to improve corporate governance focuses increasingly on the director, these rankings represent a new way to shine light on the long-obscure doings in the boardroom.
If progressive boards are taking a more active role, no one is arguing that they should micromanage a company's affairs. Rather, institutional shareholders and governance experts want boards to exercise more active oversight, subjecting strategic plans to rigorous scrutiny, holding the boss to high performance standards, and assuming responsibility for management succession. It's what John M. Nash, president of the National Association of Corporate Directors (NACD), calls the NIFO method of governance: nose in, fingers out.
There are still many firmly entrenched CEOs and old-line directors who resist modern governance. And there are plenty of cynics who still regard most directors as the boss's marionettes. "In most cases, boards are a joke," grouses a money manager for a corporate pension fund. "They spend little time understanding the business or knowing much about management performance other than reported results. They do what's necessary to minimize the possibility of being sued."
Yet at a growing number of companies, fortunately, that gloomy view seems outdated. In today's fast-paced and fiercely competitive markets, smart CEOs want their boards to be more than clubby panels of yes-men. They want knowledgeable, talented directors to serve as sounding boards and advisers. "More CEOs are viewing their boards as a resource," says Donald S. Perkins, former CEO of Jewel Cos. and a director on 10 corporate boards. "They are not only comfortable but anxious to bring questions to the board for which they don't have the answers."
Some of the pressure for improvement also comes from heightened scrutiny of boards by the press and public, combined with a healthy dose of fear of litigation against directors. But above all, good-governance momentum is coming from powerful institutional investors and money managers, usually working quietly and behind the scenes. Indeed, the most crucial new development in governance is a little-noticed decision this year by TIAA-CREF, the nation's largest pension fund, to assess governance practices regularly at some 1,500 companies in which it owns a stake.
Why should investors care? In the contentious arena of corporate governance, no issue is thornier than the question of whether there's a link between the quality of a company's board and the quality of its market performance. After all, shareholders don't give a hoot how often a board meets, how glittering the resumes of its members are, or what probing questions they ask the CEO. What matters is how much money the company returns to shareholders. "A lot of corporate governance suffers from procedural frills," argues Robert C. Pozen, general counsel for Fidelity Investments, the world's largest mutual-fund company. "It's missing the boat. There isn't a correlation between those things and investment performance."
But academics are increasingly finding just such links. Several studies have shown that companies in which directors own significant amounts of stock outperform those that don't. One has found that the stock market more highly values companies with boards of independent, outside directors. "It doesn't take a rocket scientist to figure this stuff out," insists Charles M. Elson, a governance expert at Stetson University College of Law. "The more boards a director sits on, the less effective he'll probably be. As the empirical evidence comes in, it will back up the hunch."
Obviously, not all well-governed companies do well in the marketplace. Nor do the badly governed always sink. But even the best performers risk stumbling someday if they lack strong and independent boards of directors. That is, after all, what has happened again and again at companies as diverse as American Express, Archer Daniels Midland, Sears, Morrison Knudsen, and W.R. Grace--all of whose boards were cozy and passive. But to prove the benefits of good governance, you have to, in a sense, prove a negative, says John Pound, a governance expert at Harvard University School of Law: "Perhaps the biggest story today is the dozens of companies that aren't going to become a General Motors or a W.R. Grace because more proactive boards and shareholders will prevent major mistakes."
Preventing mistakes before they happen is the rationale behind TIAA-CREF's new focus on governance practices. "We're looking at governance first and then performance," says Richard M. Schlefer, an assistant vice-president at the pension fund for teachers and professors. "If a company has a governance structure that doesn't withstand scrutiny, we don't want to wait until there is a problem to get involved."
So which boards are more likely to navigate the future with fewer mishaps? And which boards may be headed for trouble--if they're not already in the soup? To find out, BUSINESS WEEK surveyed 295 of the nation's largest pension funds and money managers, as well as experts in the field of governance. They were asked to identify corporations with the most and least effective boards. Then, respondents were asked to grade the boards on a scale of 0 (poor) to 10 (excellent) in four categories: accountability to shareholders, quality of directors, independence, and corporate performance. A total of 61 replied, a response rate of 21%. Responding money managers and funds currently manage $1.64 trillion in equity assets.
Then, the 212 companies singled out by poll respondents were subjected to another round of scrutiny. Their boards were measured against a set of guidelines or best practices articulated by corporate-governance experts. Points were awarded to boards that met the criteria. Points were subtracted for failing the tests. In the judging of board independence, for example, a company scored points if it had no more than two inside directors; no insiders on the board's audit, nominating, and compensation committees; no outside directors who directly or indirectly draw consulting, legal, or other fees from the company; and no interlocking directorships.
The results? Sitting at the top of BUSINESS WEEK's honor roll is Campbell Soup Co., which is helping to redefine the role a modern board of directors should play in a well-managed corporation. Its published governance guidelines are among the most stringent and far-reaching in Corporate America. Among other standouts are the boards of such powerhouse corporations as General Electric, IBM, Compaq Computer, Colgate-Palmolive, and Chrysler. It's no accident that the boards at three of these top companies ousted their chief executives for poor performance. Nor is it a surprise that their new CEOs have made a radical difference in the fortunes of their enterprises.
And the worst? The board at scandal-ridden Archer Daniels Midland Co., which has been widely assailed by outsiders for its cronyism and passivity under the iron hand of 78-year-old Chairman Dwayne O. Andreas. For institutional investors who watched ADM writhe in the spotlight of a federal price-fixing investigation over the past year, the defects of the company's board seem all too apparent. Most of the institutional investors believe that directors, co-opted by family ties, business links, and longstanding friendships, put shareholder interests behind those of Andreas. On Oct. 15, the $13.3 billion company pleaded guilty to two federal price-fixing charges and paid a record $100 million fine. Throughout the crisis, ADM's confused and erratic public reactions only cemented the directors' image as poster children for bad governance. "Their response to shareholders has been abysmal," says Kayla Gillan, general counsel for the California Public Employees' Retirement System (CalPERS).
Even recent efforts to downsize and revamp ADM's board to give it a majority of outsiders have drawn heavy criticism. Three new directors resemble many current members: They either have Washington connections or represent big family shareholdings. Notably missing: any heavyweight CEOs to counterbalance Andreas. "They're trying to carry on as in the past, with minimum concessions to public relations," sniffs Roland M. Machold, director of the State of New Jersey's division of investments.
Champion International, H.J. Heinz, Rollins Environmental, NationsBank, and AT&T also emerged as companies with ineffective boards. These boards tended to fail the tests of independence or accountability. Fully half the 18 directors on the Heinz board, for example, are current or former executives. Chairman and CEO Anthony J.F. O'Reilly, along with his vice-chairman, Joseph J. Bogdanovich, sit on the board's nominating committee--the panel that most governance observers agree should be composed entirely of outside, independent members. At Champion, only three of the board's dozen directors are insiders--but eight outside board members fail to own even $100,000 of company stock, an investment that would more closely align their interests with those of shareholders. Chairman and CEO Andrew C. Sigler sits on five boards, including two--AlliedSignal Inc. and Chase Manhattan Corp.--in which the chief executive also serves on Sigler's board.
Also among the worst boards are several companies in which chief executives have faced particularly harsh criticism in recent months for what some regard as major strategic blunders. These include AT&T and Quaker Oats. AT&T's board, moreover, has been attacked for allowing Chairman and CEO Robert E. Allen to control the recent search for his successor. It doesn't help that six of AT&T's nine outside board members appear overextended, serving on four to eight boards each. Five of them own less than $100,000 in AT&T stock. And the board is without a single independent director with experience in high technology, a shocking omission for a global telecommunications giant.
The study turned up some anomalies. A few of the nation's top-performing companies, for example, garner impressive scores from investors in the survey but do less well when their boards are examined against the governance guidelines. And some companies viewed as laggards by the funds and experts do surprisingly well in the boardroom analysis.
Why the discrepancies? In some cases, directors under duress experience a sort of foxhole conversion. Boards at some companies in difficulty have been among the first to embrace many of the governance principles now emerging as standards from such groups as the NACD. Westinghouse Electric Corp. is a good example. Years of lackluster performance caused the board to review its governance policies and issue a set of guidelines for the board in 1994. Westinghouse has since begun regular self-evaluations of the board and ditched director pensions--a perk believed to undermine independence. But there's still no sign of a turnaround at the company.
At the opposite extreme, it may be possible for a company to perform well even if it has a board that doesn't appear to measure up. Consider Coca-Cola Co., one of the world's most rewarding investments. Impressed with Coke's stellar returns, money managers ranked its board as the most effective after Campbell Soup's and General Electric's. But Coke also got the lowest score of any of the top 25 when BUSINESS WEEK measured how well its board adhered to governance guidelines.
Surprisingly, for example, Coca-Cola's 13-person board lacks a single outside director with experience in consumer marketing. Five of Coca-Cola's directors serve on five or more boards each, including CEO Roberto C. Goizueta, who sits on seven. Two directors missed over 30% of board meetings last year. At least three directors are execs at companies to which Coca-Cola pays consulting, leasing, or bank-lending fees. Coca-Cola discloses, for example, that it paid SunTrust Banks Inc. more than $800,000 in leasing and credit fees last year. SunTrust Chairman and CEO James B. Williams sits on Coca-Cola's board, and Goizueta is a director on Williams' SunTrust board.
Moreover, Coca-Cola pays directors entirely in cash, not stock, and lavishes on them retirement benefits, health and dental coverage, and life insurance--the sort of golden goodies that some believe promote board passivity and a pro-management bias. Directors also fail to stand for election every year, making it harder for shareholders to express dissatisfaction with them. While none of these policies is clear evidence of a weak board, neither are they the attributes of a top-quality, highly independent panel accountable to shareholders. Still, no one can argue with Coke's performance.
The board of NationsBank Corp., nominated by some funds as among the best, also failed to hold up to scrutiny. Not only is it oversized, with 20 members, but it is also among the most clubby and incestuous. Five NationsBank directors serve on the board of Bassett Furniture Industries Inc. Another five are directors of Sonoco Products Co. Three more serve on the board of Ruddick Corp., a diversified holding company in Charlotte, N.C.
Eight of the company's outside directors who are fully employed elsewhere also serve on three or more other boards, stretching their time commitments. NationsBank Chairman Hugh L. McColl Jr. is a director on five outside boards. The chairmen of four of those companies sit on McColl's board, the most interlocking directorships of any major company studied.
Two directors--Delta Air Lines Inc. CEO Ronald W. Allen and Slane Hosiery Mills Inc. President John C. Slane--failed to show up at over 25% of the board's meetings last year. Five directors fail to own at least $100,000 in company stock. What's more, five of the company's outside directors are top executives or owners of companies that do business with McColl's bank. One example: NationsBank paid $15 million in rent last year to a joint-venture partnership managed by a company in which Director Thomas G. Cousins is chairman and CEO. These business dealings are fully disclosed by NationsBank, which maintains that its lease payments are no more or less favorable than what it would pay an unaffiliated firm. Still, the board clearly flunks BUSINESS WEEK tests of accountability, quality, and independence.
A small but growing minority of boards today--especially those among the BUSINESS WEEK best--have become far more responsive to shareholder concerns. "The message of enhancing shareholder value is now part of most boardroom conversations these days," says John B. Neff, a director at Chrysler Corp. who managed the $15 billion Windsor Fund for many years. "Chief executives know that if they don't do the job, they may well find shareholders knocking at their door."
Some boards aren't waiting for their big investors to come knocking. At Avon Products Inc., for example, individual directors and top executives regularly meet with big shareowners. During a recent governance review, Chrysler directors met with 40 of the auto maker's institutional shareholders. Senior managers were present at the beginning of many of these sessions, but then excused themselves so shareholders could have a frank discussion of governance issues with directors. "With few exceptions, corporate boards are much more responsive to our concerns today than even three years ago," says Kurt N. Schacht, general counsel for Wisconsin's Investment Board.
And boards are doing more than just hand-holding. After Chrysler's meetings with shareholders, for example, the company ditched its pensions for directors, imposed a minimum ownership requirement of 5,000 shares for directors, and began to pay board members their fees in stock. Since its start in 1982, Compaq Computer Corp., another governance leader and No.4 on the BUSINESS WEEK list, has boasted a nonexecutive chairman in venture capitalist Ben Rosen, banned consultants who draw fees from the company as directors, and conducted regular reviews of board and individual director performance.
No company has gone further than Campbell Soup, which was once under duress from shareholders for being a lackluster, family-dominanted sleeper. It took an early lead in governance by publishing progressive guidelines for its board in 1992, two years after gaining a new outside CEO in David W. Johnson. Unlike so many toothless corporate feel-good statements, Campbell's governance standards are tough, specific rules designed to assure that the board is a vital player in company affairs. "There are a number of companies that have established boardroom principles but have not acted on them," says Dennis C. Carney, a managing director at SpencerStuart and a governance expert. "Campbell has followed its governance policies to the letter."
Among other things, those progressive guidelines require the board to evaluate the performance of Johnson at least annually in meetings of independent directors without the CEO. They require the board to annually review and approve Campbell's three-year strategic plan and one-year operating goals. The rules ban interlocking directorships, bar former Campbell executives from being directors, and prohibit board members 70 years of age or older. Moreover, directors are required to own 3,000 shares of company stock within three years of arriving on the board. Campbell's CEO is allowed only two outside board seats. (Johnson has one, at Colgate-Palmolive Co.)
The rules also impose annual self-evaluations of the effectiveness of the board and its committees. Even more surprising, Campbell requires that the results of these assessments be publicly disclosed. Why would any company want to display its board's dirty laundry for outsiders to see? "Sunlight is the best disinfectant," declares Johnson, quoting Justice Louis D. Brandeis.
Boards at many companies now claim they evaluate their own performance. More often than not, these evaluations yield little substance and even less followup. Concedes an ex- CEO and director on several top boards: "I've been in two situations where the board invited comments from directors. Only 2 of 14 people handed in something, and it was so bland, it was not helpful."
That wasn't true at Campbell. After its 1995 self-evaluation, for example, the board decided that it wasn't devoting enough time to long-range strategic planning; that some colleagues didn't speak up enough in meetings; that the quality of some committee reports needed upgrading; and that the company had to spend more time broadening and diversifying the skills of directors.
The company quickly responded. It beefed up the frequency and length of sessions devoted to strategy, began to rotate directors on the committees to broaden their skills, launched orientation sessions for each new committee member, and upgraded the quality and substance of committee reports. The board also drafted a list of explicit director requirements, calling for "active, objective, and constructive participation" at meetings. "The impact of putting that down on paper was enormous," says John M. Coleman, Campbell's senior vice-president for law, who attends all board meetings. "It changed the dialogue in the boardroom."
As more boards examine the best practices of such governance leaders as Campbell Soup, Compaq, and Chrysler, the dialogue among directors in the boardroom will become more involved and animated. No one--especially not a CEO in search of better performance--could argue with that.