Welcome to the revolution. After years of paying lip service to reform, Enron Corp. and the ensuing wave of business scandal has finally produced a dramatic change in corporate governance. CEOs who ignored criticism of their boards during the 1990s are rushing to institute changes. Directors are waking up to their responsibilities as representatives of shareholders, not merely cronies of chief executives. Most important, investors are rewarding companies with good governance and punishing those without it. The governance revolution has a ways to go, but it is building momentum. If the dramatic decline in trust in Corporate America is ever to be fully restored, this movement must succeed.
To measure its success to date, look at BusinessWeek's fourth annual ranking of U.S. boards of directors. It lists the best boards, the worst boards, the most improved boards, boards that need work, and even a "hall of shame." The most progress so far is in the restructuring of the boards themselves. Companies are fast replacing insiders with independent members. Key board committees, especially audit and compensation, are increasingly made up completely of independent directors. Business ties between directors and companies whose boards they sit on are being terminated. Outside board members are calling their own executive sessions while hiring consultants to help them in making independent decisions. Companies are making sure that directors possess substantial amounts of stock, not just options, to give them serious stakes in the outcomes of their decisions. And they are limiting the number of boards that directors may sit on, making sure they have the time and energy to focus on company issues.
There are certainly pockets of resistance. Xerox Corp. had two audit-committee members who missed meetings last year, even as the Securities & Exchange Commission was looking into its accounting practices. Qwest Communications International Inc.'s founder, Philip F. Anschutz, who maintains extensive business dealings with the company, sat on both the compensation and nominating committees. Qwest is currently under investigation by the SEC for using "swap" transactions to boost revenues.
Even among the best boards, there is work to be done. Few have seriously tackled the issue of CEO compensation. While the markets have taken the bubble gains out of stock prices, boards of directors have been slow to take them out of CEO pay packages. There are exceptions. Shareholder anger led CEO Christos M. Cotsakos of E*Trade Group Inc. (ET ) to return $21 million of his $80 million salary package. (The head of the compensation committee who gave him the original package had business ties to E*Trade and has resigned.)
Boards are making progress on other tough issues: banning loans to officers and directors and reporting faster on insider stock transactions. But other reforms are behind schedule: changing the way stock options are valued and expensed; separating the offices of CEO and chairman, and giving shareholders a real voice by ending the practice of super-majority votes for key policy changes. Shareholder resolutions should be binding as well.
The Justice Dept., state attorneys general, regulators, and investors are not letting up on the drive for better corporate governance. Corporate America is off to a good start in cleaning up its act. The stakes are too high for it to fail.