12/08/97 DIRECTORS IN THE HOT SEAT

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DIRECTORS IN THE HOT SEAT
Activists are singling out individual board members who don't measure up
It was hardly the time for the directors to miss a bunch of board meetings. The company's performance was lagging. A couple of disaffected family stockholders was prodding management to put more independent directors on the board. And two activist investors were about to buy stakes and press the company to dump its money-losing data-services unit.
Yet as those events unfolded, three directors of Dow Jones & Co. missed 40% or more of their board and committee meetings last year. Attorney Vernon E. Jordan Jr., who sits on 10 boards, and Martha S. Robes, a member of the Bancroft family, which controls Dow Jones, failed to show up at 40% of the sessions. David K.P. Li, chief executive of Bank of East Asia Ltd., missed 45% of the 11 meetings.
Much to Dow Jones's chagrin, Institutional Shareholder Services (ISS) then began urging its clients--many of them investors in Dow Jones--to withhold their votes for Li, the only one of the three up for reelection. The reason: He and his fellow directors flunked the CIAO test.
If you haven't heard the term, add it to your vocabulary fast. CIAO stands for commitment, independence, attendance, and ownership. And increasingly, institutional shareholders and activists are going to turn up the heat on individual directors who fail to pass the test.
''JUST VOTE NO.'' Until recently, activists mostly pressured boards of poorly performing companies. Rarely did they attack individuals. But that is quickly changing, as investors realize that the best way to improve overall performance may be to hold individual directors more accountable. Those who sit on too many boards, have potential conflicts of interest with management, miss too many board meetings, or own little or no stock are suddenly as out of fashion as the three-martini lunch. ''Some institutions are beginning to use just-vote-no campaigns against individual directors instead of whole boards,'' says Patrick S. McGurn, director of corporate programs at ISS, who coined the term CIAO.
Several public pension funds, including the Teachers Insurance & Annuity Assn.-College Retirement Equities Fund (TIAA-CREF), now scrutinize the composition of boards. The $205 billion fund, the world's largest, has begun using the data to lobby CEOs to nudge aside undesirable directors. The AFL-CIO pension funds plan to target directors with potential conflicts of interest in next year's proxy contests, urging ''no'' votes against their re-election. ''The board is a collection of individuals accountable to shareholders,'' says Bill Patterson, director of the AFL-CIO's office of investment. ''Shareholders have the right to engage individual directors about how they execute their duties.''
Directors and companies say that such campaigns are unfair. They argue that you can't always measure the quality of a director's contribution by ''quantitative information'' lifted out of a company's proxy statement. Dow Jones's Li, who also missed 40% of his meetings as a director of Westinghouse Electric Corp. last year, says there were extenuating reasons for his poor attendance. He was a member of a 150-person group selected by the Chinese government to pave the way for a smooth handover of Hong Kong. The meetings in Beijing ''suddenly clashed with the board meetings,'' says Li, who says he has a perfect record at Dow Jones this year.
The publishing concern's directors, however, have consistently had among the worst attendance record for boards in America. In 1995, four directors--including Li--were no-shows for 27% to 44% of board sessions. In 1993, Li missed 29% of the meetings. Jordan, meantime, failed to show up more than 30% of the time in both 1994 and 1993. ''A hard-and-fast attendance rule that does not take other things into account is a mistake,'' insists a Dow Jones spokesman. ''These are extraordinarily busy people.''
ON THE RUN. Indeed, for virtually all directors, a board seat is a tiny, part-time post. Most are fully employed elsewhere in highly demanding jobs. William B. Harrison Jr., vice-chairman of Chase Manhattan Corp., missed 29% of the board and committee meetings at Dillard's Inc. last year because he was heavily occupied by Chase's merger with Chemical Banking Corp. Gareth C. Chang missed 49% of director meetings at Mallinckrodt Group Inc. last year because of ''unanticipated scheduling conflicts'' at Hughes Electronics, where he is senior vice-president. ''The time pressures are extraordinary,'' says Dennis C. Carey, a managing director at search consultant SpencerStuart, which says CEOs are turning down board jobs at a rate of 8 to 1.
Still, no one ever said that looking out for shareholders was supposed to be easy--and if directors can't make time for the meetings, many governance mavens are asking how the job will get done. There has been a flood of governance guidelines from shareholder activists, business groups, and trade associations. All of them outline new expectations for directors that virtually invite stockholders to measure directors by such factors as attendance and share ownership. ''Investors don't have enough information to judge the qualitative participation of each director on a board,'' says McGurn of ISS. ''Most boards don't have meaningful peer or board evaluations. In their absence, shareholders are left to judge a director by the CIAO test.''
Already, the Teamsters union funds publish an annual list of the worst directors in America based on such data. Frank C. Carlucci, a Washington investment banker who is on a dozen boards, topped this year's Teamsters list. The Council of Institutional Investors (CII) has cobbled together a list of ''director turkeys'' that's available on the Web. The Web site lists board members who serve on more than one underperforming company.
Who's likely to feel the glare of this harsh new spotlight? Activists will have little trouble naming names. The boards of many of the largest and most visible corporations boast directors who don't live up to the ''best practice'' principles being pushed by the good-governance crowd. Among other things, those guidelines say that fully employed directors should sit on no more than three boards and that they shouldn't do business--either directly or indirectly--with the companies on whose boards they sit.
The most obvious targets are directors who serve on too many boards. Jordan, whose 10 board memberships include American Express, Bankers Trust, J.C. Penney, and Xerox, is hardly alone. Carlucci, chairman of merchant banking's Carlyle Group, sits on 12 corporate boards, including Ashland Oil, Quaker Oats, and Westinghouse. That total does not include the boards of Bell Atlantic Corp. or General Dynamics Corp., which he left this year. John L. Clendenin, who just earlier this year stepped down as chief executive of BellSouth Corp., finds the time to fill 10 board seats.
Multiple board sitters like Carlucci and Clendenin are likely to face increasing pressure, much of it from their own colleagues, to cut their commitments. ''This is going to be the biggest issue for directors since the elimination of pensions,'' says McGurn. Only three years ago, roughly 60% of companies handed out pensions to directors. Today, because of activists and investors who believe pensions discourage directors from challenging management, that number has dropped to about 15%.
Stock ownership by directors also is attracting greater scrutiny. ''Self-interest is a great motivator,'' says William D. Crist, board president of the California Public Employees' Retirement System (CalPERS). ''Historically, one of the problems in governance is the separation of ownership and control. There is an inevitable link between motivation and performance.'' Many boards seem to agree with him. More companies than ever now pay directors partly or completely in stock to ensure a link with shareholder interests.
HOLDOUTS. At some companies, stock ownership rules have prompted directors to reach into their pockets to buy shares. In 1993, Ashland Inc. set a target that each director should own stock worth $150,000 within five years. In the first year, the median value of outside directors' holdings in Ashland grew from $140,000 to $370,000. All told, outsiders upped their holdings from $4.2 million to $7.3 million in one year.
Yet plenty of directors don't ante up. On Occidental Petroleum Corp.'s board--which recently approved a $95 million payout to the CEO to cancel his existing contract and replace it with a new one--at least two directors own little stock. George O. Nolley, a rancher who is chairman of the board's compensation committee, owns just 2,280 shares, while Aziz D. Syriani owns only 1,450 shares. Both have been directors for 14 years. Neither Nolley nor Syriani returned calls for comment.
Even directors who have helped create good-governance guidelines don't live up to them. Consider Thomas Wyman, who last year sat on a National Association of Corporate Directors' panel that, among other things, urged directors to own ''a substantial equity stake'' in companies whose boards they sit on. Wyman, former CEO of CBS Inc., has been on the AT&T board for 16 years, yet owns only 1,000 shares of stock outright and a further 1,570 in a deferred account given to him by AT&T. He didn't return phone calls for comment.
An even more nettlesome issue is potential conflicts of interest. Vernon Jordan not only sits on a multitude of boards but also is a senior partner in a law firm--Akin, Gump, Strauss, Hauer & Feld--that is employed by many of those same companies, including Dow Jones. These business affiliations are fully disclosed by the companies, but critics say the ties make Jordan a far less independent director. ''Why would he want to challenge the CEO if his firm could lose their business?'' asks Charles M. Elson, a professor at Stetson University's law school and a director at Sunbeam Corp. That's why the AFL-CIO is plotting a major assault on such conflicts next year. It wants to boot directors off of boards when their firms do business with the company or its CEO. ''The whole system where directors are held captives of CEOs needs to be exposed,'' says Patterson. ''If shareholders know about them, you are halfway there in terms of reining them in.''
Trouble is, current disclosure rules allow companies to hide such potential conflicts of interest. Take Walt Disney Co. Since 1987, attorney Irwin E. Russell has been a director on Disney's board while also serving as CEO Michael D. Eisner's personal lawyer for most of that time. Russell was even chairman of the board's compensation committee until only recently. Yet the company didn't disclose this relationship in its proxy statement to shareholders because it was not required to do so. ''It was never a secret,'' says Sanford M. Litvack, senior vice-president of Disney and a director. ''It is the most well-known public fact that I know of.'' Litvack adds that Russell did not participate as a director in any discussions involving Eisner's rich pay packages.
Make no mistake: Directors who fail the CIAO test are going to face more pressure from investors and activists than ever before. As for Li at Dow Jones, the company says he can now ''attend'' a board or committee meeting by conference call when he can't show up in person. That will help to keep him off the radar screens next time.
By John A. Byrne, with Leslie Brown in New York and Joyce Barnathan in Hong Kong

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