It's Getting Tough to Fill a Boardroom

These days, outside directors are thinking twice before accepting a seat

Jim Chapman is the kind of independent director who helps shareholders sleep at night. He's a professional corporate watchdog creditors bring in to serve on the boards of debt-laden companies. His most recent cases: Southwest Royalties Inc., a Midland, (Tex.)-based oil and gas provider and Davel Communications Inc., a Tampa-based pay phone operator. After doing this for seven years, he's getting nervous. As revelations of corporate misdeeds mount, regulators, legislators, and litigious investors are blaming directors for letting so much slip by.

The pressure keeps mounting: Starting from Aug. 14, chief executives and financial officers of almost 1,000 of the largest public companies will have to state under oath that their books are accurate. Although the onus is mostly on corporate execs, some directors are concerned they might also become more exposed. That's because books must first pass muster with the directors on their audit committees. Other new rules proposed by the New York Stock Exchange would require directors to meet regularly without management.

All this means much more work and potential personal liability for people like Chapman. His lawyer recently told him he should have his "head examined" for sitting on six boards. For now, Chapman has no plans to resign from any of them. But as lawsuits against board members pile up, he is reviewing his director and officer insurance policy. "It makes you think: Why would you ever want to be a director?" he says.

It's a treacherous new era. Until now, top executives and professionals gladly accepted prestigious directorships. "It was not too long ago that when you got an invitation from a CEO you said, `Sounds terrific. It would be a pleasure to serve,"' says Michael A. Miles, the retired former chairman of Philip Morris Cos., who sits on the boards of Morgan Stanley (MWD ), Dell Computer (DELL ), and AOL Time Warner (AOL ), among others. But with a rising threat of lawsuits or criminal prosecution if things go bad at a company, people are thinking twice before signing on. Says Miles: "Now you say, `I'd like to consider it. Would it be all right if I spoke to a couple of other directors, the outside auditors, and your general counsel?"'

Some directors are even heading for the exits. Right now, a major concern of directors is the liability coverage they get through their companies. The trouble is most policies are void if the company commits fraud--leaving directors uninsured even if they had no role in the misbehavior. A May, 2002, McKinsey & Co. survey of nearly 200 directors who sit on almost 500 boards shows that 25% turned down a new offer or quit in the past year, at least in part for liability reasons. More than 80% of them feel there is a "significant" threat of liability and that it has increased in the past year. Says Robert F. Felton, a McKinsey director: "A lot more directors are saying, `I don't want to do this anymore."'

The pressure could become especially great on chief executives: Their own boards want them to focus fully on their day jobs. Besides, say experts, there's a growing feeling that some people sit on too many boards to be effective. Executives are "being advised not to spread themselves too thin" and to make sure they're comfortable with any company on whose board they serve, says Richard J. Sandler, a partner and co-head of the capital markets group at law firm Davis Polk & Wardwell.

The comfort factor has never been more important. In the past, directors rarely faced serious consequences for corporate failures. Now, the Securities & Exchange Commission is on a tear: In the first nine months of fiscal 2002, it has asked federal courts to bar 71 officers and directors from ever serving on a public company board again, vs. 51 requests in 2001. And the AFL-CIO has asked the SEC to add Enron Corp.'s directors to the list.

No one could blame potential directors for shying away. However, that puts companies in a major bind: To satisfy new regulations, they need qualified outside financial experts to serve on audit committees. Some headhunters report a spike of as much as 25% in searches this year from companies seeking to replace insiders with independent directors. But few are biting. "It's more difficult than ever to find candidates because of the corporate governance environment," says Thomas J. Neff, U.S. chairman of the executive search firm Spencer Stuart.

One way to attract quality directors may be to pay them more for the risks they're running. Outside directors of large companies on average earn about $150,000 in cash and stock. That's up 75% since 1996, according to pay consultant Pearl Meyer & Partners. Still, if a director wants an individual insurance policy on top of the company's, it could cost more than $100,000 for up to $2 million in coverage. "Currently, the expectations are going up faster than the compensation," says Charles D. Ellis, senior adviser to consulting firm Greenwich Associates.

Somehow or other, Corporate America is going to have to make an increasingly thankless job appealing. "Most directors I know work extremely hard for their shareholders--far beyond what they are compensated [for]," says Daniel W. Dienst, a restructuring specialist at CIBC World Markets (BCM ) who sits on the board of Metal Management Inc.

Executives need only look at their stock prices to know what investors think of them. But they need good, aggressive directors to help restore their credibility. And it's a seller's market.

By Emily Thornton and Louis Lavelle in New York

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