The relationships between directors and CEOs certainly appear to be much closer than those between directors and shareholders. Directors, in fact, are often close friends with members of the management team and especially with CEOs. Such friendships are not inherently wrong as long as they are founded on respect for the distinct duties of each party and as long as they do not interfere with fiduciary responsibility. When friendships result in directors not adequately fulfilling their checks and balances role, however, problems can arise.
Candidates for the board know who votes for or against them. This discourages institutional investors from voting their consciences because they get business from management and directors.
Although notable exceptions exist, most directors are nominated with the expectation that they will agree with the CEO unfailingly. In his book, Take on the Street, Arthur Levitt, former chairman of the SEC, describes how he was invited by Steve Jobs, Apple CEO, to join the company’s board of directors. Prior to becoming a director, he made a visit to the company’s San Jose, California, headquarters during which he gave the CFO a copy of a speech Levitt had given on corporate governance. When he departed he says, “I considered myself a part of the Apple family and looked forward to my first director’s meeting with enthusiasm.” The next day, however, Jobs told Levitt in a phone call that he had read the speech and, “Frankly, I think some of the issues you raised, while appropriate for some companies, really don’t apply to Apple’s culture.” Levitt was uninvited to join the board.
Unlike elected government officials, corporate directors are beholden for their jobs to the CEO and not to the shareholders/ electorate, who in reality neither nominate nor elect the board. Not only do CEOs nominate directors, they also have a great deal of say about how directors are compensated. Then there’s empathy. Many directors, having been CEOs themselves, understandably will sympathize with another CEO on management issues and challenges, despite their duty to represent the shareholders’ interest. After all, directors who are CEOs themselves often have other CEOs on their own boards and would prefer not to set a precedent of interference with management.
Ultimately, although they don’t actually have the power to fire a director, CEOs often have the ability to engineer the removal of a member of the board if that director fails to toe management’s line Very few directors resist. In the few instances where individual directors have put up a fight, CEOs have generally prevailed, pointing out that such discord is not in the best interest of the company. These issues can be even more complex. If directors do not perform well, someone should remove them. But challenging or disagreeing with management does not in itself indicate poor performance. It can, in fact, indicate precisely the opposite. Situations may arise, however, when a director should be removed from the board for legitimate reasons. In such cases, CEOs may feel compelled to exercise their extraordinary power to do so because no other mechanism exists. Certainly shareholders can’t do it. They lack any reliable way to assess board members’ performance, and even if they did, they have virtually no power to remove directors when they perform poorly.
Should a CEO have the power to fire directors? When Jamie Dimon became CEO of troubled Bank One, he determined that in order to move ahead with the bank’s turnaround, he would need a different kind of board. His solution? He exerted his authority by insisting on the resignation of most of the directors. In hindsight, in this instance he was justified in his actions. The bigger question remains: Are shareholders truly served well when CEOs can exercise such power over the shareholders’ fiduciaries? Probably not.
The relationship between directors and CEOs, as it has evolved, seems convoluted. Directors serve to provide management oversight, but when the CEO holds the power to hire, pay, and fire directors, the director’s ability to act independently is certainly compromised. Because independence is a hallmark of fiduciary responsibility, as discussed more fully in The Measure of a Board, anything that diminishes independence is a major governance problem.
Who Takes the Blame?
In deciding who should take the blame for specific instances of management or governance failures, the courts, regulatory agencies, the plaintiffs’ bar, and the media will expend lots of effort, time, and money. Answering the broader question is easy: Everyone shares the blame.
Management has acted in its own self-interest, set policy, and changed governance. Directors have failed to protect investors but have not had the time, the resources, and apparently the will to fulfill their duty. Institutional investors have encouraged earnings management and seemingly ignored earnings manufacture. Conflicted research analysts and the investment banks that pay them have contributed to the ease of stock price manipulation. Auditors have relied on compliance with GAAP instead of a truly accurate accounting of performance and risk. Shareholders across the board have sat by while executives have taken free rein and directors have done little or nothing to prevent it. Until very recently, the SEC has been less than effective in putting its resources toward reviewing the financial statements of large cap companies to uncover financial irregularities.
There is no single, simple explanation for how and why executives have been able to shift the balance of power so decidedly in their favor. Rather, the answers lie in a complex set of interrelated factors, conditions, and behaviors that has given executives the opportunity, the incentives, and the ability to take control. These factors generally fall into three categories:
- Situations that enable executives to execute a dramatic power grab, thereby rendering directors virtually powerless
- Increased corporate complexity that allows executives to control, manipulate, and obfuscate financial and other performance information
- Shareholders’ feelings of disenfranchisement that isolate them from their fiduciaries and prevent them from exerting their collective will