Doing Something Right: Focusing on Exceptional Boards

by FEI Daily Staff

The best boards rely on a combination of best practices that includes diversity, an independent non-executive chair, superior compensation practices and high-quality skillsets.

According to several ratings and standards, Campbell Soup Co. has one of the best boards of directors in corporate America. Not only is it one of just 16 companies on the Standard & Poor’s’ 500 Index to be led by a woman — Denise Morrison, a highly-regarded food industry veteran who assumed the role of chief executive and president in August 2011 — but one-third of its 15-member board is also women.

That’s more than double the average of 16 percent of women serving in S&P 500 company boardrooms, according to a 2011 board survey by Spencer Stuart, a New York-based consulting and board-recruitment firm. Also from a diversity perspective, two members of Campbell’s board are African-American.

In addition, the global manufacturer and marketer also gets high marks for both splitting up the roles of CEO and board chairman, as 41 percent of the S&P 500 companies do, as well as for having an independent non-executive chair­­man.

Paul R. Charron, who became Campbell’s chairman in 2009, previously served 10 years as senior vice president, chairman and CEO of fashion clothier Liz Claiborne Inc. (which became Fifth & Pacific Cos. Inc. in May). He has never worked for Campbell.

Clearly, the performance of corporate boards has been facing serious scrutiny in the tumultuous business climate of recent years. By employing best practices that include diversity and having a truly independent non-executive chairman like Charron, however, companies like Campbell’s are serving as models for reform, particularly in the wake of the nation’s bruising financial crisis.

‘Where Were the Boards?’ “Where were the boards?” asked the U.S. Financial Crisis Inquiry Commission last year. And in their scathing book on boards of directors, Money for Nothing (2010, Free Press), authors John Gillespie and David Zweig report that too many board members have simply forfeited their duty to represent shareholders, the actual owners of companies.

“Despite many directors being intelligent, experienced, well-qualified and decent people who are tough in other aspects of their profe­ssional lives,” the authors write, “too many of them become meek, collegial cheerleaders when they enter the boardroom.”

Boards of directors, Gillespie and Zweig add, “are elected to monitor, advise and direct the managers hired to run the company. They have a fiduciary duty to protect the interests of shareholders. Yet, too often, boards have become enabling lapdogs rather than trustworthy watchdogs and guides.”

Lost in the shuffle, however, is the fact that the boards at many unsung companies have been employing best practices all along. And in the wake of governmental inquiries and legislation, increased shareholder activism and soul-searching by industry itself — and often in the form of weighty studies by blue-ribbon commissions — more companies are following their lead and incorporating best practices.

Companies are adding directors who provide their boards with both gender and ethnic diversity as well as independence and additional, specialized expertise or skillsets. Says Ralph Ward, editor of Boardroom Insider and an expert on governance issues: “Tech companies like Amazon and Google have done a really good job recruiting boards with outside directors who have strong resumes. They’re respected in the industry and they’re not the sort of people to be distracted by vaporous talk from management.”

Ward adds: “These are people who know how to run and grow a business and they know what trends are coming down the road.”

Boards are becoming more responsive to shareholders’ concerns on executive compensation, especially on “say-on-pay” votes that are now required by law under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Boards are moving to annual elections for directors as fewer “classified” boards have staggered terms — so much so that more than three-quarters of S&P 500 company boards were “declassified” by 2011, according to the Spencer Stuart survey, up sharply from 41 percent a decade earlier.

More boards are recognizing the importance of succession plans for CEOs, and they’re getting tougher with chief executives and management. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, says: “The number of CEO terminations at Hewlett-Packard, Yahoo! and Best Buy are examples of more effective monitoring.” And, in addition to taking their legal responsibilities to oversee management more seriously, top-ranked board members are energetically devoting their efforts to providing longer-term strategic advice. “Ultimately, a highly effective board should steer a company financially, operationally and strategically toward strong performance and shareholder value,” says New York-based board consultant Beverly Behan, author of Great Companies Deserve Great Boards (Palgrave Macmillan, 2011).

By all accounts, it is in a company’s self-interest to embrace best practices. “We understand that there are economic conditions and external factors,” says Anne Sheehan, director of corporate governance at California State Teachers’ Retirement System, “but we believe that well-governed companies with good boards that are plugged in to share­holder concerns can lead to better performance in the marketplace.”

Consider, for example, the ample evidence against combining the positions of board chairman and CEO. GMI Ratings, a corporate governance consulting firm, notes in a June 2012 report: “When these roles are combined, all the authority is vested in one individual; there are no checks and balances, and no balance of power. The CEO is charged with monitoring him or herself, presenting an obvious conflict of interest.”

Significantly, GMI found that companies separating out the two positions do better over the long haul. GMI analyzed 180 North American mega-cap companies worth at least $20 billion. It revealed that companies with the combined CEO-chairman structure had a short-term advantage over companies that separated the positions, beating them handily 11.65 percent to 2.27 percent for one year of average shareholder returns. But for the long term, companies that separated out the two jobs turned the tables.

GMI found that their shareholder returns over a five-year period averaged 39.96 percent, compared with 31.30 percent for companies that combined the two positions, a 28 percent premium.

A 2011 Rockefeller Foundation report, Bridging Board Gaps, promotes an independent chair as “the default for board structure” and suggests an additional reason why this arrangement can be so beneficial.

“The presence of managers other than the CEO on some boards presents another opportunity for positive change,” the report observes. “If management will be providing their views to the board anyway in their management roles, why should they occupy a voting board seat? The board can expand its pool of expertise by increasing the percentage of non-management directors.”

Executive Compensation: Key Measure Best practices at Campbell’s board actually go beyond a few items. For example, 14 of its 15 members are independent, its audit committee touts a robust risk management effort and board members regularly meet in executive session without any representatives of management present.

“Having an executive session without the CEO, even for a few minutes, is emerging as a best practice,” says governance expert Ward. “It’s helpful as a reality check, especially at the end of a full board meeting if someone has a question about something management was asserting that didn’t jibe [with] what they’d been reading about” in the business press or elsewhere.

By employing so many exceptional practices, Campbell’s is one of only a small fraction of the 5,500 global co­mpanies — including roughly 3,000 U.S. corporations — to earn an A rating from GMI, which bases its scores on a plethora of environmental, social and governance metrics.

Paul Hodgson, senior research associate at GMI, reports that only about 5 percent of companies in his firm’s universe achieve an A. (While about 20 percent earned a B, another 50 percent were judged “adequate,” with C’s, and about 20 percent received D’s. The remaining 5 percent or so flunked.)

Among S&P 500 companies, the percentage of A-rated companies is even scarcer: only six other companies earned a superior grade, or 1.4 percent.

Joining Campbell’s on the list of seven are FS Networks Inc. (information technology); McCormick & Co. Inc. (food processing); Paychex Inc. (business support/supplies); Pinnacle West Capital Corp. (electrical utility); SYSCO Corp. (food distribution/ convenience stores); and Xilinx Inc. (semiconductors).

Among smaller-cap companies, GMI reports, companies rated A are more common. One reason for the paucity of top-notch boards among the S&P 500, says Hodgson, is that the bigger an organization gets “the harder it gets to control what’s going on at its outermost reaches.”

And  an increasing number of corporate governance experts, institutional investors and board members themselves view executive compensation as a key metric in assessing board quality and effectiveness. Hodgson calls executive pay “a window into a company’s soul.”

He adds: “It’s a significant metric. Within the governance piece, it’s about 40 percent of the score. There is a great deal of disclosure surrounding compensation. If the board is making sensible, well-calculated decisions about compensation, it’s likely to be making good decisions in other areas.”

Robert McCormick, chief policy officer at San Francisco proxy advisory firm Glass Lewis, agrees. “Compensation is one of the more revealing aspects of a board. It’s the canary in the coal mine.”

In its study of S&P 500 board members, Spencer Stuart reports that executive compensation has risen markedly in importance among S&P 500 board members over the four years since its annual surveys began. In 2011, it reported, “Once again this year executive compensation came up as the No. 1 issue, ranked first by 79 percent of our survey respondents, up considerably from 52 percent in 2008.”

Based on information disclosed in proxy statements of S&P 500 companies, Glass Lewis publishes an annual overview on executive compensation. For example, its Pay Dirt 2011 lists both the “Overpaid 25” and the “Underpaid 25” named executive officers.

Those companies wishing to be recognized as employing best practices might aspire to the “underpaid” roster, which hails companies that successfully link the pay of top executives to earnings per share and stock performance. Companies on the Underpaid 25 list, notes Glass Lewis, “have driven corporate performance and delivered returns to shareholders that met or exceeded those of their peers.”

Topping the underpaid list for the third year in a row was Amazon.com, where in 2010 CEO Jeff Bezos received “$81,840 in base salary and $1.6 million in security arrangements.” Other top officers at the company also received only a “minimal level of cash compensation with restricted stock units serving as the primary mode of compensation,” Glass Lewis reports. At the same time, Amazon.com’s stock price advanced 33.8 percent.

On average, Glass Lewis found that the chief executives at Underpaid 25 companies were paid $5.5 million in total compensation for fiscal 2010. By comparison, the Overpaid 25 CEOs took home on average nearly $41 million. Among the best practices that all the companies on this list employed included the “use of several performance metrics” in calculating compensation that “minimized the risk of overpaying for mediocre results.”

Not all agree with this measure, however. Board consultant Behan believes that executive compensation is too highly rated as a corporate governance metric. Having been involved in several board “makeovers,” she believes that the keys to effectiveness comprise board culture, CEO succession plans and engagement in long-term strategy.

Paul Sweeney is a freelance writer in Austin, Texas, who specializes in business and governance subjects.
This article first appeared in the September 2012 issue of Financial Executive magazine.