Reform: Business Gets Religion

But do the changes being implemented go far enough--and will the good-governance fervor last?

Raytheon Co. (RTN ) has embraced corporate governance with gusto. In a spate of recent speeches, Chairman Daniel P. Burnham has admonished fellow executives to make their boards of directors more accountable to shareholders. And on Jan. 14, the defense-electronics giant jumped on the latest governance fad by naming a lead director. With the power to call board meetings and rally the outside directors, former Senator Warren Rudman (R-N.H.), a Raytheon board member since 1993, will become a new power center independent of management.

Raytheon's conversion is no accident: The Securities & Exchange Commission sanctioned the Lexington (Mass.) company for violating disclosure rules last year and is now probing its accounting. Raytheon is still smarting from the embarrassment of having had L. Dennis Kozlowski, Tyco International Ltd.'s (TYC ) disgraced former CEO, head its audit committee. Kozlowski resigned the post last June, just before he was indicted on charges of tax evasion.

But it doesn't take a scandal to get a company scrambling aboard the reform bandwagon. Throughout Corporate America, companies are adding more outsiders to boards, beefing up crucial committees, and recruiting financial experts to bolster their audit panels (table). CEOs, meanwhile, are preening over their newfound credibility. Disney (DIS ) Chairman and CEO Michael D. Eisner, who has long packed his board with friends, gushed that his seven-point board overhaul evinces Disney's "commitment to maintaining a leadership role in corporate governance."

The reform wave is worth watching closely, because the SEC has just handed corporate boards a whole lot more responsibility. On Jan. 22, the Commission voted to charge board audit committees with screening tax-shelter schemes, rather than laying down an absolute ban on accountants selling such shelters to audit clients. The controversial move reflected a conviction that strong, independent boards can prevent wrongdoing on their own--and that new regulations telling companies exactly how to behave are often unnecessary. To a large extent, the agency is betting that the type of governance reforms sweeping through America's boardrooms can prevent a repeat of the recent white-collar crime wave. Says Commissioner Cynthia A. Glassman: "Over the last year, some boards weren't paying the attention they should have. So now all boards have to make sure they step up to the plate."

On Jan. 23, the SEC was expected to give boards even more power by making them the final arbiters of complaints from attorneys who suspect fraud within a company. The agency had proposed a rule that would require lawyers with evidence of wrongdoing to quit and alert the SEC if management and the board failed to act. But after fierce opposition from law firms, the agency decided to put off voting on the rule until it can evaluate the potential impact on attorney-client privilege.

While shareholder activists roundly criticized the latest SEC rulings for placing too much trust in directors, many governance experts believe that the drive to recruit and empower outsiders as shareholder advocates will nonetheless have lasting benefits. "Independent majorities of directors combined with independent nominating committees will shift the balance" of control, says Charles M. Elson, who heads the University of Delaware's Center for Corporate Governance.

Corporate America's rush to reform is keeping it just one step ahead of regulators. The New York Stock Exchange and NASDAQ have proposed new listing standards that will require stricter definitions of independence for outside directors, more muscular nominating and compensation committees, and adoption of governance codes.

Many of the boards that will carry out those mandates are likely to be improvements over the rubber-stampers of the past. BMC Software Inc. (BMC ) in Houston has added two new outside directors and ordered a new board committee to assess how well the company is abiding by 40 key governance principles. At General Electric Co. (GE ), two longtime directors recently stepped down to reduce the clout of insiders. Motorola Corp. (MOT ) has appointed a top governance executive and added two outside directors with financial skills. And CFOs and retired accountants are fielding headhunter calls as companies from AT&T (T ) to Sun Microsystems Inc. (SUNW ) seek green-eyeshade expertise for audit committees.

Despite this progress, other governance gurus fear that companies are checking the boxes rather than taking changes to heart. "There's no structure that can't be subverted," warns Nell Minow, editor of the Corporate Library LLC, a governance-research service. A myriad of factors--the caliber of new directors, whether they remain vigilant, how much information management will cede--will determine whether new boards live up to investors' hopes.

The next major test of Corporate America's enthusiasm for reform will be the upcoming proxy season. It's already shaping up as one of the most explosive in years. Labor groups, pension funds, and shareholder activists hope to capitalize on business' scandal-weakened state to press for new limits on executive compensation and new clout for shareholders.

On most of these proposals, management isn't budging. GE, for example, is arguing before the SEC that the company can block a proposed shareholder resolution calling for separating the jobs of chairman and CEO. The company maintains that it has already met the intent of that plan by appointing a presiding director.

On compensation, companies aren't giving much ground, either. While some 176 companies now plan to expense stock options--subtracting the options' value from quarterly earnings--that idea is still anathema in Silicon Valley. "I have accounting heartburn," grouses Scott G. McNealy, CEO and chairman of Sun Microsystems, which opposes expensing. Dozens more companies are expected to fight resolutions that would give executives stock options only if the companies' shares outperform those of competitors.

The huge number of resolutions will make this year's proxy statements look like phone books. But shareholders also will face a raft of new board candidates. That should be a breath of fresh air. And the shameful images of 2002's scandal parade should put some backbone into supine directors. But the battle for reform will be waged behind closed doors, one boardroom at a time. Corporate America still has a long way to go to justify the faith that Congress and regulators are placing in its hands.

By Amy Borrus and Mike McNamee in Washington, with William Symonds in Boston, Nanette Byrnes in New York, Andrew Park in Dallas, and bureau reports

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