For nearly a decade, Hewlett-Packard (HPQ) has served as the poster child for boardroom dysfunction. From director wiretaps to chief executive dismissals, this board's had it all. Can anyone disagree with the statement that HP should remake its board of directors?
Institutional Shareholder Services has condemned the computer maker's chairman Ray Lane and CEO Leo Apotheker for their roles in identifying new directors, but in fact both ISS and HP's shareholders should embrace Lane and Apotheker for having the courage to tackle this nasty issue and for coming up with a terrific roster of new board talent that includes Meg Whitman, former CEO of eBay (EBAY), Pat Russo, former CEO of Alcatel-Lucent (ALU), and Shumeet Banerji, CEO of Booz & Co.
Instead ISS, the country's foremost governance watchdog, has recommended that shareholders withhold their votes for HP directors to protest the "direct involvement of the company's CEO in the selection process for new board nominees." ISS's stance on HP is the classic "forest for the trees" scenario. Apotheker's hefty compensation package and the past dramas of the HP boardroom led ISS to sound alarm bells over procedural irregularities that appear to amount to little. Meanwhile, ISS lost sight of the bigger picture of what HP's board has just accomplished.
The Red Flags
Let's take a look at what all the fuss is about. ISS implies that Apotheker employed the old imperial CEO tactic of populating the boardroom with buddies. But did he? Certainly, the director recruitment process at HP involved two red flags.
First, the board created an ad hoc committee to identify director candidates rather than using the nominating/governance committee—to whom this job is assigned by the company's charter and stock exchange rules—and gave Apotheker a seat on the ad hoc committee. This is, indeed, very unusual. The ISS report indicates, however, that HP's nominating/governance committee vetted any prospective directors recommended by the ad hoc committee and director appointments required approval of the full board. As such, there appear to have been several checks and balances in place on the CEO's involvement in the process and plenty of opportunities for independent HP directors to vote down Apotheker's candidates.
Second, one of the new HP directors sits on a board in Europe with Apotheker, and some of the other candidates had been customers of SAP (SAP), where Apotheker worked from 1988 to 2010. Such associations always raise independence concerns. ISS actually recommends, however, that shareholders all should vote in favor of the new director nominees—likely viewing them as not only strong board candidates but also sufficiently independent to warrant an endorsement. ISS recommends that shareholders vote only against members of the board's nominating and governance committee.
Overlooking the Real Issue
ISS suggests there is something sinister about the fact that "the new CEO was involved from the earliest stages of the process." But in fact, at the outset of director recruitment activities, it would be bad practice for a nominating/governance committee not to gather the CEO's views about the skills and experience the board needs. Moreover, if a CEO has recommendations on well-qualified board candidates who seem to fit the criteria for new directors, why shouldn't he put their names forward for consideration? ISS, however, takes the extreme position that "permitting the CEO to influence the identification and appointment of outside directors runs contrary to best practices."
As for the director recruitment process itself, any CEO constitutes a vital part of that process despite the stock exchange safeguards—in place since the fall of Enron—that transfer power for director recruitment to independent members of the board. Most directors will tell you that the CEO's character and capabilities are pivotal to their decisions to accept board invitations: Do prospective board members genuinely believe this CEO has what it takes to make the company successful? Is this CEO someone they can work with as a board member? Or do they doubt this CEO's abilities? Or believe he or she will be less than forthright or is otherwise lacking in integrity? ISS suggests that "a CEO's participation in the appointment of directors" is problematic. In fact, it is fundamental.
Perhaps the most troubling aspect of ISS's position on HP, however, is that it overlooks a larger shareholder issue: the fact that so many boards fail to revitalize themselves. Some become entrenched, passively renominating directors year after year regardless whether they say anything relevant in board meetings. HP, on the other hand, has stepped up to this thorniest of issues by saying farewell to four long-serving board members and fielding an impressive team of new directors that should delight shareholders. The company is essentially giving this board and its new CEO a fresh start, aimed at overcoming this company's past boardroom problems. For that, the HP board deserves a great deal of credit.