Splitting the CEO and the Chair

Harry Pearce has logged a lot of hours in boardrooms over the years. From his days as vice chairman of General Motors to his current posts as non-executive chairman of Nortel Networks and MDU Resources, a Fortune 500 energy and construction company, he has experienced the full spectrum of board structures and styles. And while many CEOs and some governance gurus argue that a company should use the leadership structure that suits its needs, Pearce says there is really only one way to go: a strong CEO to lead the business and an independent, non-executive chairman to lead the board.

"I have yet to hear a credible argument from any CEO on why it is better to have the same individual running the company and the board at the same time," says Pearce.

In addition to his two chairmanships, Pearce now spends a significant portion of his time preaching to Corporate America that it is time to separate the jobs of the CEO and the chairman of the board. Last year he co-founded the Chairmen's Forum, a group of directors who meet to discuss the issues unique to independent chairmen. Recently, the group issued a call to North American public companies to voluntarily adopt independent chairmanship as the default model of board leadership, upon succession of a combined CEO and chairman. "The time is right for the growing number of those actually doing the job to build knowledge on how independent board leadership can best work," he says.

In March, the group, in conjunction with the Millstein Center for Corporate Governance and Performance at the Yale School of Management, issued a recommendation that boards appoint a non-executive chairman (on a comply or explain to shareholders basis). "The independent chair model has been adopted successfully by many companies in many regions of the globe as a means to further ensure and empower board independence," says Ira Millstein, senior associate dean for corporate governance at the Yale School of Management.

The report has created a stir in governance circles and garnered support from shareholder groups, corporate governance experts, and a slew of prominent directors. Among the more than 60 signatories of the proposal are: Harvey Golub, the non-executive chairman of Campbell Soup and former CEO of American Express; Jay Brown, CEO of MBIA Inc.; William McCracken, chairman of CA Inc.; Gary Wilson, former chairman of Northwest Airlines and a director at Yahoo; and Directorship's chairman, Jeffrey Cunningham, who has served as non-executive chairman of Sapient and Bankrate. A number of large pension funds have also endorsed the endeavor, including the California Public Employees' Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS).

"With a separate CEO and chairman, you end up getting better management of the company because the CEO is not unduly influencing the board's important job to assess the CEO and make a change if necessary," says Wilson. "It should improve corporate performance and lead to more competitive CEO compensation practices."

On one point the Chairmen's Forum is clear: it is not looking for current CEO/chairmen to relinquish one of the titles precipitously. The proposal calls for the board to separate the roles upon succession to the next chief. "We are not looking to strip current CEO/chairs of one of their roles, I think that would be too disruptive and would not be productive," explains Pearce.Got Oversight?

Not long ago, the primary role of the board was largely advisory, he says. As various scandals occurred in Corporate America over the last several decades, that role morphed to include more monitoring and oversight functions. Legislation, new rules from stock exchanges, and decisions from the Delaware courts underscored that transition, and boards turned more independent in their makeup. The pace of that evolution sped up after the fall of companies like Enron, WorldCom, and Adelphia, and the recent financial crisis has made directors hyper-aware of their oversight duties. "Boards were reacting to the various crises and the concerns from stockholders and the public of whether there was adequate oversight of management," says Pearce.

In fact, the number of non-executive chairmen has been increasing steadily. In 1998, 16 percent of the S&P 500 had a non-executive chairman (meaning someone who was not also the CEO). By 2008, that number had grown to 39 percent. However, the data is somewhat misleading, since many non-executive chairs are former CEOs of the company or another related party, and therefore may lack full independence. In 2004, the number of independent chairman was just 8 percent. But boards are increasingly appointing a truly independent chair. In 2008, the figure climbed to 16 percent.

In Europe, split CEO and chairman roles are far more common. German and Dutch regulators require it, and in the United Kingdom, 79 percent of large companies have an independent chairman.

The principal reasoning behind the push for an independent chairman is to eliminate the conflict of interest that exists when the same person is leading a board charged with overseeing the management including the chief executive—in effect monitoring himself. "I don't fault CEOs. I think it is difficult to assess oneself. The primary duty of the modern board of directors is to provide oversight of management," says Pearce. "Realistically, to ask a chairman/CEO to provide an objective critique of his own business plans and his own strategies is asking more of a human being than I think is possible."

There is another, more pragmatic reason, Pearce says, that cleaving the CEO and chairman roles makes sense. Managing today's large, global companies is a massively complex, challenging, and time-consuming job; splitting the roles frees up the CEO to focus on the business. He also says the chairman's job has become more time-consuming and difficult, especially in light of greater compliance and reporting requirements. "It is a full-time job in itself to ensure you have best practices and to manage the board, which is a substantial responsibility in today's business world," says Pearce.

Another benefit is the dynamic change in the way the board interacts. "To get the benefit of all the knowledge and skills that outside directors possess you have to have leadership of the board that draws people out," says Pearce. "The only way you get that from a board is to have an independent chairman who wants to draw out each and every director, even when some of those points of view are going to be critical of management."

Wilson says the change can be immediate. "I have been in situations where an independent chairman is appointed and it is instantaneous how the dynamic in the boardroom changes," he says.The Lead Director

Perhaps the main argument against separating the jobs is that in many cases where there is a CEO/chairman, there is also a lead director, who presides over executive sessions, provides leadership to independent directors and a check on management, and upholds high corporate governance standards. However, participants in the Chairmen's Forum say that while appointing a lead director has it merits, it is a half measure that often does not go far enough to solve the conflict-of-interest problem.

"The difference is quite significant. I have served as a lead director and I have served as a non-executive chairman and there is a big difference. The person at the head of the table leads the meeting. Other directors do not look to the lead director in the same way they look to the chairman."

Other members of the Forum agreed. "The lead director is better than nothing," said one of the participants at a recent Chairmen's Forum gathering. "But on a scale of 1 to 10, having a [non-executive] chairman is a 10, and having a lead director is about a 4."

Wilson, who also is a director at Yahoo, is less sanguine about the benefits of a lead director. "I think it's almost worse than not having one, because it tends to lull people to sleep with the appearance that the board has independent leadership."

Pearce also dispels the argument that executive sessions without management can provide the type of oversight required of the board. "You need someone who the board looks to as their leader to initiate the kind of frank, candid discussions that are needed. Otherwise, you end up with an executive session where no one quite knows what to say, and they end up being brief and unproductive."

Another common argument is that companies who are recruiting a new CEO will not be able to attract the best candidates if the job does not also include the chairman's position. "It's not necessarily true," says Wilson. "We just did it at Yahoo. It is not a barrier to getting top candidates interested in the position," he adds, referring to the appointment of Carol Bartz to the CEO job in January, widely hailed as a strong selection. Roy Bostock is the non-executive chairman at Yahoo. "When we get separation of both positions, it will not be a problem because it takes it out as a competitive issue."Adding Some Teeth

The current proposal from the Chairmen's Forum calls for a voluntary adoption of the split structure, but the Forum may consider advocating for a rule of some kind, and is currently weighing options on just how that would work. One of the options is for the New York Stock Exchange and Nasdaq OMX to adopt the Forum's recommendations as part of their corporate governance principles in their listing requirements.

A second possibility is a rule from the Securities and Exchange Commission (SEC) that would require companies with a combined CEO and chairman to explain in the proxy statement the steps they are taking to handle the inherent conflicts of interest that arise. "It's unlikely they would want to address that, and it would probably push more companies to adopt the separate structure," says Wilson.

Meanwhile, some shareholders are not waiting for companies to voluntarily split the post or for the SEC or exchanges to adopt new rules. Proxy proposals to force companies to appoint an independent chairman are on the rise. As of May 1, there were 48 proposals to require a non-executive chairman, up from 31 at the same point last year. At Bank of America, a proposal to require an independent chairman passed by a slim margin, forcing CEO Ken Lewis to give up the chairman's title.

The Chairmen's Forum has won the support of some large investors, including Norges Bank Investment Management, Europe's largest pension fund. "One of the most important roles the board has is to fire and supervise management. Therefore, the board cannot be led by management itself," says Anne Kvam, global head of corporate governance at NBIM.

Wilson says some institutional investor groups have been hesitant to fully back the proposal, but he says the tide may be turning. "They have not wanted to rock the boat in the past, but they are now in a mood that they are more willing to rock the boat," he notes. "Separating the roles of chairman and CEO is the critical missing piece in the evolutionary path of boards representing owners better."

Says Pearce: "When you have been there in the boardroom and you have experienced both models, it is just so obvious that the split roles make sense."

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