Prepared by Terry L. Stroud – April 2016
The relationship between a company’s board of directors and executive management continues to be an important topic for shareholders, investor groups/activists, and regulatory agencies. As a former banking regulator, I have first-hand knowledge of a regulator’s impact on the commercial banking sector. As most investors and business people are aware, corporations and smaller businesses have a board of directors, which is responsible for overseeing the business activities and protecting the interests of the owners and, in the case of public companies, the shareholders. The board is almost always headed by a single chairman, who has significant influence over the activities of the board members both in their individual capacities and collectively.
In many of these companies, the chief executive officer (CEO) holds the most senior management position in the company, is responsible for day-to-day activities, and also serves as the chairman. This is especially true with start-up companies in which the founder is still involved with the company. So this leads us to the debate of whether corporations should separate the roles of the chairman and the CEO.
As an example, Norway’s oil fund, the largest sovereign fund in the world, has recently been at the forefront of a chorus of many institutional investors and advisory firms advocating that the large U.S. banks split the roles of the chairman and the CEO. The oil fund’s CEO was quoted as saying, “There is a special consideration that must be undertaken by the U.S. banks given their involvement and history in the 2007/08 financial crisis, which makes it untenable for these companies not to separate these roles”. Many of the large European Banks do not have these problems due to the fact they follow the “Dual Board” system that is prescribed by law in these countries (e.g., Germany). Hence, the “German Corporate Governance Code” prescribes that public companies must utilize the Dual Board system.
As an American living and working in several Eastern European countries, it was a bit strange in the beginning to observe and learn to understand these types of governance structures. However, after working on the development of the financial sector in numerous countries, I began to see the merits of the dual structure. I started to realize that using a dual structure resulted in more monitoring and dissemination of power by not allowing the CEO to be the chairman. In my opinion, the dual system made sense, since there was an acute shortage of seasoned financial professionals in these developing markets. I quickly subscribed to the concept of “the more oversight, the better.”
The issue of whether one person holding both roles reduces the effectiveness of a company’s performance is a hot topic. This topic becomes especially pertinent at annual shareholders meetings. It is my firm belief that there are several good reasons to separate the two positions, with the primary reason being the improvement of the overall integrity of the company and its responsiveness to its shareholders and the community and clients it serves.
To be sure, there are sound legal and financial arguments on both sides of this discussion and many, many examples of successes and failures for both forms of the governance structure. A 41512012 academic study that I reviewed for this article found that the cost of paying one person as the chairman/CEO was significantly higher than paying one person as the non-executive chairman and another as CEO. The study also found that long-term shareholder returns were significantly better at companies that had separated the two roles. As has been alluded to, the dual system has been adopted in most other developed economies in Europe; therefore, this leads to the question of why the United States is being so resistant?
In 2004, according to Fortune Magazine, almost three-quarters of the publicly traded companies in the Fortune 500 had combined the chairman and CEO roles. Some 60 companies that had separated the positions had reinstalled the former CEO as the chairman. It was reported that only 34 companies had a fully independent chairman. However, that situation has changed dramatically over the past 10 years. In the year 2014, it was revealed that barely half of the Fortune 500 companies had combined the roles and that a quarter of the companies (118) now have an independent director as chairman. This clearly illustrates that change has taken place and most likely will continue to accelerate. However, the back and forth on this issue still shows there are many questions concerning which governance system is the most effective.
I would also be remiss if I did not discuss, or at least touch on, the requirements of certain sections of the Sarbanes-Oxley Act (SOX). In my opinion, this single piece of legislation created more jobs for auditors and accountants than any other legislation that I have seen adopted in my career. SOX was created as a response to several high-profile corporate failures in the United States and, among other things, it set out more stringent requirements for corporate oversight, including a requirement that the audit committee for public companies consists of only external board members. In simple terms, this means that no member of active management can sit on the audit committee; however, SOX does have its shortcomings. In most cases, the committee is generally a sub-group of a larger board of directors, and if the full board of directors is headed up by the CEO, does this not then limit the effectiveness and independence of the audit committee? In my view, this is another reason to separate the two roles.
This issue is also relevant to me in my current work, as I am or have been involved as an expert witness in several lawsuits involving fiduciary responsibilities and possible conflicts of interest between the board of directors and management. In reviewing the facts of these cases, I can say with a great degree of certainty that had these entities had a strong and independent chairman who was better able to monitor and oversee the operations of these businesses, then many of the problems detailed in these lawsuits most likely would have never happened. When one person is able to set and control the agenda and activities of a company, potential, and real conflicts are bound to happen. Absolute power and control generally lead to some type of corruption or conflict that benefits one group at the expense of another.
In closing, recent shareholder activists have been advocating that the two roles should remain separate. The most critical aspect for their perspective seems to involve checks and balances on the span of control. My own view has changed over the past several years to reflect the fact that if a firm relies on one individual for virtually all its decision making, then there is a danger that all of the company’s eggs will put in one basket. In other words, one person acting in both roles is like leaving a student to grade his own homework or having an accountant audit her own work.
This does not seem right in my view. I am an advocate of having the chairman serve as a truly dispassionate outsider and advocate. Whether a business decides to maintain or separate the roles of the chairman and CEO positions, it is my advice at least to consider the appointment of a lead director who has the authority to take a prominent role including the authority to set the agenda for the full board and to also lead the executive committee sessions.
