Bill George One of 25 best
Leadership Books
Of All-Time

Go To
discoveryour
truenorth.org

Bill George

Harvard Business School Professor, former Medtronic CEO

Category: Politics

Nonperforming CEOs

Boards are irresponsible if they guarantee pay regardless of performance and such boards put themselves and employees at risk.

The public is outraged these days over CEO compensation, with good reason. Far too many chief executive officers get paid large sums even when they don’t perform. I believe that CEOs should be well-paid when they do perform, but there is no justification for paying for nonperformance.

As a result, shareholders are demanding the right to approve CEO pay packages. Following the tradition of British companies, “say on pay” proposals on proxy statements are gaining momentum in the U.S. But under U.S. corporate law, determining the compensation of CEOs is a fundamental responsibility of the board of directors. Directors are charged with the fiduciary duty to use their “business judgment” in these matters, and the courts have consistently backed them up.

However, by not paying CEOs based on company performance boards are failing to execute their responsibilities. Unless they step up to this issue they risk ceding their responsibilities if unhappy shareholders push through say on pay resolutions.

Home Depot, Hewlett-Packard Handouts

If this were to happen, who would determine these complex compensation packages? The courts? The Securities & Exchange Commission? External governance gurus, who have no responsibility for the corporation’s performance? None of these alternatives makes sense. In fact, they threaten the very foundation of our system of governance.

I must emphasize that the real problem here is not that CEOs are paid too much money. You don’t hear criticism of the compensation of top performers like A.G. Lafley of Procter & Gamble (PG) and Bob Ulrich of Target (TGT). The real problem is paying enormous sums to CEOs who fail to perform. Our system of capitalism is based on taking risks and being rewarded for success, not on guaranteeing huge payouts to CEOs who destroy shareholder value.

How can anyone justify Home Depot’s (HD) former CEO Bob Nardelli receiving a $200 million termination settlement after declines in market share and shareholder value? Or the former CEOs of Morgan Stanley (MS) and Hewlett-Packard (HPQ) losing their jobs and walking away with tens of millions? Shareholders ought to be outraged by these inequities.

Taking a Toll on Employee Motivation

It is ironic that by guaranteeing CEO compensation, boards put their CEOs at minimal risk while putting employees at far greater risk. When CEOs in these firms fail, it is the employees who lose their jobs and their income, while CEOs pocket their guaranteed pay.

Is it surprising that outsized CEO pay packages destroy employees’ trust? With loss of trust, employee motivation gives way to to cynicism and superior performance becomes mediocre.

The underlying cause of this problem is the failure of boards to develop their future CEOs internally. The board’s most important job is to ensure long-term succession plans for the top leadership. But many boards don’t take the time and expend the effort to develop seamless internal succession, and consequently they are forced to search outside the company, often yielding to investor pressures to hire a corporate savior.

No CEO Contracts at General Electric

In turn, these high-profile CEOs from outside the company who know little about the business, the company’s culture, or its people, hire high-powered attorneys to negotiate multiyear contracts that guarantee their compensation, regardless of performance.

Why do CEOs need contracts in the first place? The CEOs of General Electric (GE), Goldman Sachs (GS), and Exxon (XOM) don’t have them. They get paid to perform.

Executive compensation should be tied directly to the company’s long-term objectives and based on building the firm’s economic value, not its stock price. The best compensation programs tie up half of the executives’ compensation for the duration of their tenure, so they cannot cash out when the company’s stock peaks. These programs are based on a mix of short-term and long-term incentives so that no one objective can be pursued to the detriment of the firm’s interests.

To ensure the CEOs’ separation from the compensation process, boards should hire their own compensation consultants who do no work for management.

Finally, CEO compensation should not be based solely on a comparator group, which can be easily manipulated. Rather, internal equity should be given equal weighting so that gaps between CEOs and their subordinates are narrowed, and it is the team that is rewarded for the company’s success.

To rebuild the confidence of shareholders and the public and to retain control over CEO compensation, boards of directors should put their CEOs wholly at risk, with no contracts, and pay them only for long-term performance.

That’s the only way to restore trust in corporate leaders and in our system of corporate governance.

Who is Governing Corporations: The Board or Governance Gurus?

The never-ending barrage of proxy proposals from governance experts raises an uneasy question: Who is governing corporations these days – elected boards of directors or self-appointed governance firms?

The 2002 enactment of Sarbanes-Oxley and NYSE listing requirements has led to significant improvements in corporate governance. Boards operate more independently and the relative power of CEOs and their boards has been rebalanced. Even relationships between corporations and the SEC – the official federal regulator of corporate governance – have settled into appropriate equilibrium.

Just as corporate governance gets on track, self-anointed governance gurus – for-profit firms like Institutional Shareholder Services (ISS), the Corporate Library, GovernanceMetrics International (GMI), and Glass, Lewis – are challenging these legally elected bodies for control of corporations. Not satisfied with the improvements, these firms – which are not shareholders at all – agitate to wrest control for themselves and for shareholder activists. They purport to represent shareholders by rating company governance, submitting proxy proposals for consideration at shareholder meetings, and consulting with companies desirous of improving their governance ratings.

The governance gurus wrap themselves in the banner of “shareholder democracy,” although governance of American corporations was never intended to be democratic. The legislators who created governance laws recognized most corporate governance decisions are too complex to be made independently by thousands of shareholders. Only the most important decisions, such as the election of directors and major mergers and acquisitions, require a special shareholder vote.

Like elected representatives in the federal government, corporate directors are elected by shareholders and legally charged with the fiduciary responsibility to govern the corporation. The courts have consistently backed the responsibility of directors to use their “business judgment” in making decisions regarding the corporation´s best interests.

What these governance firms are proposing is not democracy at all, but rather taking control of corporate governance in order to promote an active market of takeovers and force changes in management and boards of directors. Their power is growing because institutional shareholders are unwilling to do the analysis and invest time into voting proxies for their vast array of shares. So they follow these firms´ recommendations – all for a fee.

ISS is the most powerful – and most conflicted – of the firms. It derives its power from its proxy advisory service for institutional shareholders, who currently hold over sixty percent of the shares of U.S.-based companies. Through its recommendations, ISS can influence – if not control – thirty percent or more of the shares voted. The “Corporate Governance Quotient,” ISS´ ratings model, attempts to quantify the quality of firms´ governance. ISS also sells its advisory services to companies anxious to improve their governance ratings, creating conflicts of interest for ISS´ supposedly independent advice. Nevertheless, many companies cater to ISS to improve their ratings and ensure favorable votes on proxy items.

In recent years governance firms have focused on the annual election of all directors, eliminating multi-year terms and staggered boards in order to enable hostile raiders to replace the entire board at a single meeting. They have also insisted on majority votes for directors. Recognizing the importance of director elections, many boards have agreed to reconsider directors´ standing in the absence of majority votes.

But these changes have not satisfied the governance specialists, who are now asking for “cumulative voting” for directors. Cumulative voting means that a shareholder representing one million shares in an election of twelve directors could cast twelve million votes for a single director, perhaps a write-in candidate. Shareholder democracy?

In actions like these governance firms have shown their hand, which is not democracy at all but support for takeovers and management changes. This enhances their relationships with the hedge funds, which usually care more about events that create volatility than they do about shareholder value.

Another focus is “say on pay” resolutions, following the British tradition of giving shareholders an up or down vote on the CEO´s compensation. At first glance, letting shareholders opine on compensation sounds logical, but the problems it creates are enormous. Legally, determining executive compensation is the responsibility of the board of directors, which in turn is delegated to its compensation committee. Determining CEO compensation is an extremely complex task, one that must be closely linked to the firm´s objectives and to employee compensation plans.

Granting shareholders such a privilege raises serious questions about the board´s responsibilities. What´s the remedy if the shareholders turn down the CEO´s compensation? Propose another plan and let the shareholders vote again? The governance firms would likely offer their own alternative to the CEO´s compensation. At this point, the power transfer from the board to the unelected governance firms would be complete and would lead to their next proposal to increase power. Boards that naively attempt to curry favor with ISS and others to win their approval will learn the hard way that these outside firms will never be fully satisfied until they have wrested control from the boards.

I am not suggesting that boards should stonewall these initiatives by dissident shareholders and governance firms. Rather, these unrelenting pressures suggest that board members must step up to their legally-elected leadership responsibilities and become more active in corporate governance. This requires more time and greater leadership. No longer can boards delegate their responsibilities to company management – but neither can they abdicate their duties to governance gurus.

The alternatives are clear: either boards step up to leadership, or our entire system of corporate governance is at risk. The time for leadership is now!

America’s Hidden Asset: Leadership of Global Capitalism

For the past seven years America´s political leaders have been trumpeting the spread of American-style democracy, with decidedly mixed results. Developing countries aren´t eager for America to impose its form of democracy on their fledgling – and often fragile – governments. In fact, many of them resent America´s attempt to tell them how to run their governments, especially when threats of “regime change” are not-so-subtlety mentioned.

It is American-style capitalism – not democracy – that is spreading like wildfire around the globe.

Every government leader and business executive I have met in developing countries is eager for one thing: American-style capitalism to build their economies, create jobs and wealth for their people, and bring their countries fully into the global trading network. From Kazakhstan to the United Arab Emirates to Vietnam, people are hungry for capitalism. They want to study it in the U.S., learn how to create local capital markets, acquire American technology and know-how, and build up companies that can export their goods around the world, especially to the U.S.

But most of all they want America´s hidden asset: global capitalism leadership.

Let me emphasize that this is not the old-style business leadership of the 20th century which thought U.S.-based companies had superior products and management processes and could simply export them to the less sophisticated markets around the world, eager for American goods and know-how. That day passed by twenty years ago.

In recent years America´s new competitive advantage has emerged: the ability to train and develop global leaders, capable of leading global organizations. These new leaders, who are mostly in their thirties and forties, have lived all over the world and are as comfortable doing business in the Ukraine or Indonesia as they are in Des Moines, perhaps more so. Many of them have attended America´s best graduate business schools, where they interact with a vast array of foreign nationals and newly immigrated Americans with similar leadership abilities and like ambitions.

Attending my class at Harvard Business School, my wife remarked, “I feel like I am in the United Nations.” In fact, more than one-third of Harvard´s MBAs at HBS and two-thirds of participants in its executive programs come from outside the U.S. to learn the latest leadership approaches in global business. These percentages do not include the substantial number of newly-immigrated Americans from all over the world attending these programs.

This new generation of American business leaders – as well as foreign nationals trained in America´s leading academic institutions – is very different than the previous generation: they are authentic leaders – collaborative, not imperial, in their relationships. They genuinely respect and appreciate the comparative advantages that people of other nations bring to their global companies, from manufacturing skills to ingenuity. Most importantly, they know how to bring together and motivate people of very different backgrounds to build high performing organizations.

America´s competitive advantage is seen most vividly in financial markets, where governments and business people around the world are eager to have America´s investment banks help them restructure their financial institutions and industrial companies to become competitive in global markets. Serving on the board of Goldman Sachs, I have had the opportunity to witness first-hand just how important this leadership is to countries like China, Saudi Arabia and the United Arab Emirates. In building financial institutions in these countries, America is developing the relationships with business leaders that will sustain this competitive advantage in global leadership for the next several decades.

For all the xenophobia about immigration and widespread panic over outsourcing, the reality is that America is the world´s melting pot. We are more accepting of people of diverse national origins and ethnic backgrounds than any country on earth. Progressive business leaders like IBM´s Sam Palmisano, Andrea Jung of Avon Products, GE´s Jeff Immelt, and PepsiCo´s Indra Nooyi recognize that diversity is not a challenge to be overcome, but a source of sustainable competitive advantage.

Whatever issues diversity may create – both real and perceived – America´s hidden competitive advantage is the ability of our leaders to operate effectively in integrated global organizations and to deploy the principles of capitalism throughout the world.

Our political leaders would be well advised to recognize this strength and use it to build America´s relationships with countries around the world, while helping them build their economies through capitalism, irrespective of their form of government.

Where Have All the Leaders Gone?

Paul Wolfowitz, Alberto Gonzales, Joseph Nacchio of Qwest, Heinrich von Pierer of Siemens, . . . What do they have in common?

A failure to accept the responsibilities of leadership.

No one seems to be willing to take responsibility for leading anymore. Either they “don´t know,” “can´t recall,” or “were just following their lawyer´s advice.” These leaders are either asleep, incompetent, not telling the truth about their actions, or simply unwilling to be responsible leaders.

What ever happened to leading with honor and accepting full responsibility for leadership? It brings to mind the title of the introduction to my first book, Authentic Leadership, “Where Have All the Leaders Gone?” – that is also the title of Lee Iacocca´s new book.

Let´s look at what these leaders have done or said and explore the common threads:

Paul Wolfowitz:
Wolfowitz directed the World Bank to pay after-tax compensation at the State Department for his “friend” Shaha Riza which exceeded the amount paid to Secretary of State Condoleezza Rice, and refused to own up to it. In so doing, he has besmirched the values of the office he is sworn to uphold, and completely undermined the credibility of his “anti-corruption” campaign. In working behind the scenes to hang onto his job, he risks cutting so many deals that he will render the power of his office useless.

Why doesn´t Wolfowitz resign with honor?

Alberto Gonzales:
Under oath before the Senate Committee, Gonzales testified time after time that he “could not recall” being involved with the decisions to eliminate the nine prosecuting attorneys and replace them with Bush loyalists. Couldn´t recall? Where was he on such an important decision? Either he failed to do his job, or he had a convenient memory lapse. In hanging onto his job, he damages the credibility of the Attorney General, and brings dishonor to the President.

Why doesn´t Gonzales resign with honor?

Joseph Nacchio of Qwest:
Last Thursday Joseph Nacchio, the former CEO of Qwest, was convicted on nineteen counts of insider trading for selling his Qwest stock just before it collapsed, at the same time he was giving shareholders rosy predictions about earnings growth. Nacchio led Qwest´s hostile takeover of U.S. West, a regional Bell operating company, drove its stock price to $60/share by initiating dramatic cuts in its service levels, and then sold his stock while the stock price declined all the way to $1.07 per share when the telecommunications bubble burst.

Shortly thereafter, he was replaced as CEO by the Qwest board of directors. Now it seems our legal system has judged him accordingly.

Heinrich von Pierer of Siemens:
As CEO and now chairman of Siemens during the 1990s, Heinrich von Pierer was one of Germany´s most respected business executives. He resigned last week to remove himself as a focal point of criticism of the firm for its alleged $500 millions in illegal payments by its communications division. While von Pierer claimed no knowledge of the payments, one has to wonder how engaged he was in the business if he did not know, or why he had not put in an effective audit system that would reveal the payments.

To his credit, von Pierer did the honorable thing and resigned.

 

All of these cases lead the general public to the conclusion that leaders can no longer be trusted. This is a very dangerous conclusion because the very nature of leadership requires that leaders maintain the trust and confidence of their constituencies.

 

The problem is not that leaders cannot be trusted. Rather, we are choosing the wrong people to lead. We should choose responsible leaders who are well grounded in their values and place the interests of their institutions and their constituencies ahead of their own. We don´t need leaders of public or private institutions that are known for their charisma, their style or their image. We need leaders known for their character, their substance, and their integrity. We need leaders who have demonstrated throughout their lives the capacity to lead in a responsible manner, especially under pressure – and when they fail in their responsibilities, to resign with honor.

‘The Takers’ Part II – The Executive Compensation Uproar

Two weeks ago President Bush had the audacity to say that executive compensation should be based on “pay for performance” and long-term incentives. As reported by the media present at this event, the business executives in his largely Republican audience sat in stunned silence. No one spoke in support of his proposal.

As often as I disagree with the President in matters of foreign affairs and government budgets, I think he is right on the money here. Who can argue with “pay for performance”? Only the “takers,” I guess. Why didn´t the business community rise up in support of the President on this point? Were we too focused on getting whatever we could take from the system?

The President was simply stating a basic principle of capitalism: those of us engaging in capitalistic businesses get rewarded for creating value. In my experience, those capitalists that create long-term value for their organizations and their shareholders claim the greatest gains. Think of Bill Gates, Warren Buffett, the late David Packard, Michael Dell, and Oprah Winfrey.

Are we so enamored with people like Bob Nardelli, Bill McGuire, Donald Trump, Marc Rich, and Michael Milken and their enormous wealth that we are prepared to abandon even the most basic principles of capitalism? If we are, I predict that capitalism is doomed. We will have regressed to Russian-style capitalism: take all you get for yourself legally, and then take whatever else you can get illegally, and ship your spoils out of the country. Be sure to keep your passport with you and your private jet available at all times so you can get out of the country before the law catches up with you, as it did with Jeff Skilling, Bernie Ebbers, Dennis Koslowski, Richard Shrushy and their compatriots.

It´s about time the rest of us who care about the future of capitalism speak out on behalf of “pay for performance” and not leave the President standing alone.

Let me know your views on these thoughts.

P.S. If I have offended any of you who are “takers,” please look in the mirror before responding.