By John A. Byrne
Nearly 50 years ago, a Harvard Business School professor observed that too many boards of directors were mere "ornaments on a corporate Christmas tree"--largely decorative, in other words, and serving little real business purpose.
The recent spate of accounting scandals, ethical lapses, and outrageous CEO payouts is proof that not much has changed. Now, in the post-Enron Corp. world, there is no shortage of new ideas for making boards more responsible to shareholders and less beholden to management. But the most reasoned and intelligent response to the governance crisis is coming from, of all places, the New York Stock Exchange, that bedrock of free-market power. On June 6, the NYSE unveiled proposals that, if accepted, would force some of the most dramatic changes ever in corporate governance.
NYSE Chairman Richard A. Grasso got into the reform-making act at the request of Securities & Exchange Commission head Harvey L. Pitt, who on Feb. 13 asked for a review of the exchange's listing standards. Grasso acted swiftly, recruiting former AOL Time Warner Inc. CEO Gerald M. Levin, New York State Comptroller H. Carl McCall, and Leon Panetta, ex-White House chief of staff, to head up the efforts.
Their recommendations pose a clear challenge to boards: Start thinking for yourselves. Among other things, the new rules would force the independent directors of every company listed on the exchange to meet regularly without management present. That group would have to name a lead director to preside at these sessions, and the panel could communicate directly with employees and shareholders.
Best of all, the proposals put the CEO on the moral--if not legal--hook for the company's results. Each year, the boss would have to certify that information provided to shareholders is accurate and complete and that the company is complying with the new standards. The NYSE would publicly reprimand first-time violators and could delist a company that repeatedly or flagrantly defies the rules. "That is tough stuff," says Ira M. Millstein, a longtime governance guru.
With Congress gridlocked and the SEC playing catch-up, the NYSE's proposed new rules could go a long way toward correcting more than a decade of excess and abuse by calling for stronger checks and balances--especially since the regulations would go far beyond the anemic reforms adopted by Nasdaq last month. That has shareholder activists and governance experts heaping on the praise: "My basic reaction is surprise and delight," says shareholder activist Nell Minow.
Perhaps the single greatest surprise is how deeply the NYSE dug into the inner workings of key board committees. The new standards would require audit committees to be chaired by directors with financial expertise. And the panels would have to meet--separately and at least every quarter--with management, internal auditors, and independent auditors. That's a minimum of 12 meetings a year. The audit panel of Johnson & Johnson's board, one of the best in Corporate America, met only four times last year.
Many of the proposed changes are long overdue. After years of complaints about management-heavy boards, the exchange now wants outsiders to make up a majority of directors. Its current standard requires only three independent directors--even though "best practice" guidelines have long urged otherwise.
None of these reforms can guarantee that directors will always put shareholders' interests first. The exchange also must resist efforts to water down the rules during a two-month comment period before they're passed on to the SEC for approval. If enacted, virtually all these standards would take effect immediately. But just proposing them puts Corporate America on the road to restoring trust; implementation would help to rebuild confidence in U.S. financial markets. The new rules might even make real directors out of those decorative ornaments. Senior Writer Byrne writes on management and governance issues.