Traditionally, the CEO of a corporation decided whom to invite to board membership and merely asked the shareholders for approval in the annual proxy statement. All nominees were usually elected. There are some dangers, however, in allowing the CEO free rein in nominat- ing directors. The CEO might select only board members who, in the CEO’s opinion, will not disturb the company’s policies and functioning. Given that the average length of service of a U.S. board member is three 3-year terms (but can range up to 20 years for some boards), CEO-friendly, passive boards are likely to result. This is especially likely given that only 7% of surveyed directors indicated that their company had term limits for board members.
Nevertheless, 60% of U.S. boards and 58% of European boards have a mandatory retirement age—typically around 70.52 Research reveals that boards rated as least effective by the Corpo- rate Library, a corporate governance research firm, tend to have members serving longer (an average of 9.7 years) than boards rated as most effective (7.5 years).53 Directors selected by the CEO often feel that they should go along with any proposal the CEO makes. Thus board members find themselves accountable to the very management they are charged to oversee.
Because this is likely to happen, more boards are using a nominating committee to nominate new outside board members for the shareholders to elect. Ninety-seven percent of large U.S.
corporations now use nominating committees to identify potential directors. This practice is less common in Europe where 60% of boards use nominating committees.54
Many corporations whose directors serve terms of more than one year divide the board into classes and stagger elections so that only a portion of the board stands for election each year. This is called a staggered board. Sixty-three percent of U.S. boards currently have stag- gered boards.55 Arguments in favor of this practice are that it provides continuity by reduc- ing the chance of an abrupt turnover in its membership and that it reduces the likelihood of electing people unfriendly to management (who might be interested in a hostile takeover) through cumulative voting. An argument against staggered boards is that they make it more difficult for concerned shareholders to curb a CEO’s power—especially when that CEO is
also Chairman of the board. An increasing number of shareholder resolutions to replace stag- gered boards with annual elections of all board members are currently being passed at annual meetings.
When nominating people for election to a board of directors, it is important that nominees have previous experience dealing with corporate issues. For example, research reveals that a firm makes better acquisition decisions when the firm’s outside directors have had experience with such decisions.56
A survey of directors of U.S. corporations revealed the following criteria in a good director:
■ Willing to challenge management when necessary—95%
■ Special expertise important to the company—67%
■ Available outside meetings to advise management—57%
■ Expertise on global business issues—41%
■ Understands the firm’s key technologies and processes—39%
■ Brings external contacts that are potentially valuable to the firm—33%
■ Has detailed knowledge of the firm’s industry—31%
■ Has high visibility in his or her field—31%
■ Is accomplished at representing the firm to stakeholders—18%57
ORGANIzATION OF THE BOARD
The size of a board in the United States is determined by the corporation’s charter and its bylaws, in compliance with state laws. Although some states require a minimum number of board members, most corporations have quite a bit of discretion in determining board size.
The average large, publicly held U.S. firm has 10 directors on its board. The average small, privately held company has 4 to 5 members. The average size of boards elsewhere is Japan, 14;
Non-Japan Asia, 9; Germany, 16; UK, 10; and France, 11.58
Approximately 68% of the 100 largest U.S. company’s top executives hold the dual desig- nation of Chairman and CEO.59 The combined Chair/CEO position is being increasingly criti- cized because of the potential for conflict of interest. The CEO is supposed to concentrate on strategy, planning, external relations, and responsibility to the board. The Chairman’s respon- sibility is to ensure that the board and its committees perform their functions as stated in the board’s charter. Further, the Chairman schedules board meetings and presides over the annual shareholders’ meeting. Critics of having one person in the two offices ask how the board can properly oversee top management if the Chairman is also a part of top management. For this reason, the Chairman and CEO roles are separated by law in Germany, the Netherlands, South Africa, and Finland. A similar law has been considered in the United Kingdom and Australia.
Although research is mixed regarding the impact of the combined Chair/CEO position on over- all corporate financial performance, firm stock price and credit ratings both respond negatively to announcements of CEOs also assuming the Chairman position.60 Research also shows that corporations with a combined Chair/CEO have a greater likelihood of fraudulent financial reporting when CEO stock options are not present.61
Many of those who prefer that the Chairman and CEO positions be combined agree that the outside directors should elect a lead director. This person is consulted by the Chair/CEO regarding board affairs and coordinates the annual evaluation of the CEO.62 The lead director position is very popular in the United Kingdom, where it originated. Of those U.S. companies combining the Chairman and CEO positions, 96% had a lead director.63 Korn/Ferry found that in 2003 72% of respondents thought a lead director was the right thing to do, while 85%
thought so in 2007. A lead director creates a balance in power when the CEO is also the Chair of the Board. The same survey showed that board members are spending 16 hours a month on board business and that 86% were either very satisfied or extremely satisfied with their role in the business. The lead director becomes increasingly important because 94% of U.S. boards in 2007 (compared to only 41% in 2002) held regular executive sessions without the CEO being present.64 Nevertheless, there are many ways in which an unscrupulous Chair/CEO can guarantee a director’s loyalty. Research indicates that an increase in board independence often results in higher levels of CEO ingratiation behavior aimed at persuading directors to support CEO proposals. Long-tenured directors who support the CEO may use social pres- sure to persuade a new board member to conform to the group. Directors are more likely to be recommended for membership on other boards if they “don’t rock the boat” and engage in low levels of monitoring and control behavior.65 Even in those situations when the board has a nominating committee composed only of outsiders, the committee often obtains the CEO’s approval for each new board candidate.66
The most effective boards accomplish much of their work through committees. Although they do not usually have legal duties, most committees are granted full power to act with the authority of the board between board meetings. Typical standing committees (in order of prevalence) are the audit (100%), compensation (99%), nominating (97%), corporate gov- ernance (94%), stock options (84%), director compensation (52%), and executive (43%) committees.67 The executive committee is usually composed of two inside and two outside directors located nearby who can meet between board meetings to attend to matters that must be settled quickly. This committee acts as an extension of the board and, consequently, may have almost unrestricted authority in certain areas.68 Except for the executive, finance, and investment committees, board committees are now typically staffed only by outside directors.
Although each board committee typically meets four to five times annually, the average audit committee met nine times during 2007.69
IMPACT OF THE SARBANES–OxLEY ACT ON U.S. CORPORATE GOVERNANCE
In response to the many corporate scandals uncovered since 2000, the U.S. Congress passed the Sarbanes–Oxley Act in June 2002. This act was designed to protect shareholders from the excesses and failed oversight that characterized criminal activities at Enron, Tyco, WorldCom, Adelphia Communications, Qwest, and Global Crossing, among other prominent firms. Several key elements of Sarbanes–Oxley were designed to formalize greater board independence and oversight. For example, the act requires that all directors serving on the audit committee be inde- pendent of the firm and receive no fees other than for services of the director. In addition, boards may no longer grant loans to corporate officers. The act has also established formal procedures for individuals (known as “whistleblowers”) to report incidents of questionable accounting or auditing. Firms are prohibited from retaliating against anyone reporting wrongdoing. Both the CEO and CFO must certify the corporation’s financial information. The act bans auditors from providing both external and internal audit services to the same company. It also requires that a firm identify whether it has a “financial expert” serving on the audit committee who is indepen- dent from management.
Although the cost to a large corporation of implementing the provisions of the law was US$8.5 million in 2004, the first year of compliance, the costs to a large firm fell to US$1–$5 million annually during the following years as accounting and information processes were refined and made more efficient.70 Pitney Bowes, for example, saved more than US$500,000 in 2005 simply by consolidating four accounts receivable offices into one. Similar savings were realized at Cisco and Genentech.71 An additional benefit of the increased disclosure
requirements is more reliable corporate financial statements. Companies are now reporting numbers with fewer adjustments for unusual charges and write-offs, which in the past have been used to boost reported earnings.72 The new rules have also made it more difficult for firms to post-date executive stock options. “This is an unintended consequence of disclosure,”
remarked Gregory Taxin, CEO of Glass, Lewis & Company, a stock research firm.73 See the Global Issue feature to learn how board activism affects the managing of a global company.
Improving Governance
In implementing the Sarbanes–Oxley Act, the U.S. Securities and Exchange Commission (SEC) required in 2003 that a company disclose whether it has adopted a code of ethics that applies to the CEO and to the company’s principal financial officer. Among other things, the SEC requires that the audit, nominating, and compensation committees be staffed entirely by outside directors. The New York Stock Exchange reinforced the mandates of Sarbanes–Oxley by requiring that companies have a nominating/governance committee composed entirely of independent outside directors. Similarly, NASDAQ rules require that nominations for new directors be made by either a nominating committee of independent outsiders or by a majority of independent outside directors.74
Partially in response to Sarbanes–Oxley, a survey of directors of Fortune 1000 U.S. com- panies by Mercer Delta Consulting and the University of Southern California revealed that 60% of directors were spending more time on board matters than before Sarbanes–Oxley, with 85% spending more time on their company’s accounts, 83% more on governance practices, and 52% on monitoring financial performance.75 Newly elected outside directors with finan- cial management experience increased to 10% of all outside directors in 2003 from only 1% of outsiders in 1998.76 Seventy-eight percent of Fortune 1000 U.S. boards in 2006 required that directors own stock in the corporation, compared to just 36% in Europe, and 26% in Asia.77
Evaluating Governance
To help investors evaluate a firm’s corporate governance, a number of independent rating services, such as Standard & Poor’s (S&P), Moody’s, Morningstar, The Corporate Library, Institutional Shareholder Services (ISS), and Governance Metrics International (GMI), have established criteria for good governance. Bloomberg Businessweek annually publishes a list of the best and worst boards of U.S. corporations. Whereas rating service firms like S&P, Moody’s, and The Corporate Library use a wide mix of research data and criteria to evaluate companies, ISS and GMI have been criticized because they primarily use public records to score firms, using simple checklists.78 In contrast, the S&P Corporate Governance Scoring System researches four major issues:
■ Ownership Structure and Influence
■ Financial Stakeholder Rights and Relations
■ Financial Transparency and Information Disclosure
■ Board Structure and Processes
Although the S&P scoring system is proprietary and confidential, independent research using generally accepted measures of S&P’s four issues revealed that moving from the poorest to the best-governed categories nearly doubled a firm’s likelihood of receiving an investment- grade credit rating.79
Avoiding Governance Improvements
A number of corporations are concerned that various requirements to improve corporate governance will constrain top management’s ability to effectively manage the company. For
SOURCES: B. Stone. “Marissa Mayer Is Yahoo’s New CEO,”
Bloomberg Businessweek (July 16, 2012), (www.businessweek .com/articles/2012-07-16/marissa-mayer-is the-new-yahoo-ceo);
Yahoo! Website - http://pressroom.yahoo.net/pr/ycorp/overview.
aspx; Damouni, N. “Yahoo CEO Search down to Leninsohn, Hulu CEO’s Jason Kilar,” Accessed 5/30/13, www.huffingtonpost .com/2012/07/05/yahoo-ceo-search-down-to-levinsohn-kilar_n_
1652674.html; Temin, D. “Little Lies; Big Lies - Yahoo! CEO Scott Thompson’s Revisionist History“, Accessed 5/30/13; www.forbes .com/sites/daviatemin/2012/05/07/little-lies-big-lies-yahoo-ceo- scott-thomponson-revisionist-history.html; Pepitone, J. “Yahoo confirms CEO is out after resume scandal,” Accessed 5/30/13. www .money.cnn.com/2012/05/13/technology/yahoo-ceo-out/index .html; Kopytoff, V. and Miller, C. “Yahoo Board Fires Chief Executive,”
Accessed 5/30/13 www.nytimes.com/2011/09/07/technology/
carol-bartz-yahoos-chief-executive-is-fired.html; Carmody, T. “Co- Founder, Ex-CEO Jerry Yang Resigns From Yahoo’s Board,” Accessed 5/30/13, www.wired.com/business/2012/01/jerry-yang-resigns- yahoo/; Compensation - Terry S Semel, Accessed 5/30/13, www .forbes.com/static/pvp2005/LIRXC25.html; Vogelstein, F. “How Yahoo! Blew It,” Accessed 5/30/13, www.wired.com/wired/
archive/15.02/yahoo.html.
global issue
and market share continued to drop. The board became increasingly dissatisfied with her performance and acted suddenly in September 2011. Without a replacement in hand, she was notified via a phone call from the Chairman of the Board that she was fired.
After a lengthy search, Scott Thompson was hired as the CEO in January 2012. He had previously been the CEO of eBay’s PayPal unit and had done what most experts believed was a very good job. Unfortunately, he listed a computer science degree from Stonehill College that he had not earned. He did graduate, but with an accounting degree. Activist shareholder group Third Point (who has a chair on the board and owns 5.8% of the company) re- leased details about his resumé padding. The information was part of a proxy fight that led to a board shakeup in February of 2012. That shakeup saw most of the previous board members removed and a new group of members (approved of by Third Point) elected.
Thompson resigned and Ross Levinsohm, the former head of global media for the company, was named the interim CEO while the company did yet another search.
That search ended in July 2012 when the company named Marissa Mayer as the new CEO. Mayer was a longtime Google executive who ran their search group.
The continuous changes at Yahoo! have served to dam- age the company’s ability to perform. It is difficult to gain any momentum in an industry when the top management changes so often and with such dramatic flair. The board of directors has a responsibility to the shareholders. The question is: At what point have they failed to do their job?
In the digital age in general and with Internet-based companies in particular, the impact of board activism now cuts across geographic boundar- ies like nothing has in the past. Yahoo grew to become the largest Internet search engine company in the world used by individuals in their own language.
Yahoo! was founded in a Stanford University campus trailer in early 1994 by Ph.D. candidates David Filo and Jerry Yang as a means for people to keep track of their favorite interests on the Internet. Yahoo! is an acronym for
“Yet Another Hierarchical Officious Oracle.” Young com- panies often see dramatic moves by the board of directors who are unaccustomed to the growth phases in a busi- ness. An activist board will hold management responsible for their actions and may take on the role of a catalyst board in some circumstances.
Yahoo! grew quickly before the Internet bubble nearly bankrupted the company. Terry Semel, a legendary Hollywood dealmaker who didn’t even use e-mail, was hired to turn the company into a media giant. In the summer of 2002, Semel tried to buy Google for roughly US$3 billion (this was two years before Google went public). At the time, Google’s rev- enue stood at a paltry US$240 million, while Yahoo!’s was in excess of US$800 million. Despite failures to purchase Google, Facebook, and YouTube, Yahoo! became an Internet search giant serving more than 345 million individuals a month. By 2005, Yahoo! was the number one global Internet brand.
Forbes listed Semel’s total compensation as US$230.6 million.
His reign saw both the rise and fall of the company. The board grew increasingly dissatisfied. By 2007, the company was los- ing market share and repeated acquisitions had failed to pro- duce any real bump in the stock price. The board moved to act in June 2007. Semel assumed the role of non-executive chairman and Jerry Yang became the CEO once again.
Things did not improve. There were regular calls for Yang’s resignation as the company continued to floun- der. At a time when tech companies were growing dra- matically, Yahoo! continued its long, slow slide. Frustrated by his inability to strike deals with rivals Microsoft and Google, Yang and the board agreed that it was best for him to resign as CEO. His tenure lasted a scant 18 months.
Carol Bartz was hired in January 2009 to turn the com- pany around and help it regain its stature. She was the for- mer CEO of Autodesk and was viewed as a no-nonsense industry veteran. She instituted layoffs, reshuffled man- agement, and turned over search operations to Microsoft in a deal that brought US$900 million to Yahoo!. How- ever, shares remained effectively flat during her tenure
GLOBAL BUSINESS BOARD ACTIVISM AT YAHOO!
example, more U.S. public corporations have gone private in the years since the passage of Sarbanes–Oxley than before its passage. Other companies use multiple classes of stock to keep outsiders from having sufficient voting power to change the company. Insiders, usually the company’s founders, get stock with extra votes, while others get second-class stock with fewer votes. For example, in 2012 Mark Zuckerberg, the CEO of Facebook, owned approxi- mately 28% of the outstanding shares, but because of a two-class stock system, he controlled 57% of the voting shares.80 A comprehensive analysis of firms completed in 2006 reported that approximately 6% of the companies had multiple classes of stock.81
Another approach to sidestepping new governance requirements is being used by corpo- rations such as Google, Infrasource Services, Orbitz, and W&T Offshore. If a corporation in which an individual group or another company controls more than 50% of the voting shares decides to become a “controlled company,” the firm is then exempt from requirements by the New York Stock Exchange and NASDAQ that a majority of the board and all members of key board committees be independent outsiders. It is easy to see that the minority shareholders have virtually no power in these situations.