A Board's Top Job: Watching the CEO


Scandals involving corporate governance have shaken investors' confidence, taken an enormous financial toll on employees at tarnished companies, and sunk perceptions of corporate America's integrity. In the wake of these debacles, few issues are as important as those relating to corporate governance. With this article, BusinessWeek Online offers a new forum called "Ask the CEO." The idea is to pose questions to CEOs, and then let them show you in more detail their thinking about decisions that have an impact on their companies, workers, and shareholders. What would you like to Ask the CEO? Please submit your questions to Ask_the_CEO@businessweek.com

On May 1, federal prosecutors unsealed indictments against more Enron execs, including Lea Fastow, the wife of former Chief Financial Officer Andrew S. Fastow. We asked Steve Baum, chairman, president, and CEO of Sempra Energy (SRE), a San Diego-based natural gas and energy supplier with 2002 revenues of $6 billion, what his company has done to improve corporate governance post-Enron. Sempra Energy is in the energy-trading business, like Enron. Here are edited excerpts from his detailed replies to five questions:

Q: How do you define what successful corporate governance is?

A: Success in corporate governance comes from the board and management having a clear understanding of their roles in creating and sustaining shareholder value. The major issue that corporations must address is that there [should be] enough expertise on the board to address complex financial issues with a high degree of financial sophistication and experience. As a corporation, Sempra Energy looks for active and former CEOs [to serve on the board], who generally have a higher level of business and financial acumen.

The real measure of corporate-governance programs' success is how well the board discharges its responsibilities supervising the CEO. There are processes in place to determine and monitor the CEO's pay. There are criteria to consistently determine the CEO's performance. The audit committee has independent access, plus the financial literacy required, to objectively determine the integrity of financial statements.

Q: What are the top five most important elements for strong and effective corporate governance?

A: a. Successful boards of directors [should be] independent from the executive management team and composed of highly qualified directors with diverse backgrounds.

b. The CEO must encourage board involvement for the review of major management and financial decisions.

c. Transparency -- easily understandable, simple, and straightforward presentation of financial information for shareholders.

d. Incentive-based compensation plans that offer rewards to management for performance that creates increased shareholder value.

e. A strong and independent audit function.

Q: How do you know you have successfully addressed governance issues?

A: Corporate governance is a dynamic process that evolves and responds to ever-changing business challenges. Corporate leaders shouldn't look at governance strictly in terms of solving a problem. A strong corporate-governance framework will help companies to successfully adjust continually to a changing competitive landscape. On this basis there are several examples of what we believe constitutes a strong corporate-governance framework:

Financial disclosure and reporting.

Because of the emphasis on CEO certification, we have developed a procedure resulting in what we call a "cascade of disclosure." Each business-group head does their own certification with respect to quarterly and annual financial statements for their respective group. This certification process by business group percolates up to the CEO and CFO for final certification. Any issues uncovered as part of this certification process are discussed with our external auditors, Deloitte & Touche.

Their findings are then reviewed with the board of directors' Audit Committee. The certification process is separate from the audit process. But the structure must allow for the Audit Committee to be the final arbiter of any surprises that come up in either case as auditing covers a variety of issues not considered during the certification process. As an energy company in a heavily regulated environment, we live in more of a fishbowl than other corporations in other industries do, especially in regard to our financial disclosures.

Executive compensation.

To properly scope executive pay, Sempra Energy has hired an outside consultant, Hewitt & Associates. The consultant is responsible for conducting market studies to determine the appropriate compensation levels for the CEO and other executive-level staff. This consultant works directly for the Board of Directors' Compensation Committee. All reports are given directly to the committee and not to the CEO. The consultant meets with the Compensation Committee without the presence of the CEO or other senior management of the company.

This committee sets the compensation for the CEO and for all of the top officers of the corporation and performs an annual review of the penumbra of benefits offered to executive staff. An internal auditor reviews expense reports and other non-expense-related cost centers for the CEO and top executives and reports these findings to the Compensation Committee.

Board of directors.

Ethics guidelines for all members.

Any committee of the board of directors can meet without the CEO being present.

The CEO is the only member of the senior-management team serving on the board of directors.

We have two executive sessions -- one session with the CEO and the board together and a second held exclusively by independent members of the board of directors without the CEO being present. The head of the board's Compensation Committee manages this second meeting.

Six meetings of the board of directors are held each year. In addition, there are four separate meetings of the Audit Committee. Members of the board are expected to attend at least 75% of all board meetings.

No loans are allowed of any kind to corporate officers or members of the board of directors.

Evaluations are made for each member of the board standing for election at the next annual meeting of shareholders, which occurs every spring. Separately there's an annual review of the board's overall effectiveness performed by the chairman of the Corporate Governance Committee.

We've developed a set of principles for effective board service.

A mandatory course in finance and accounting for all board members.

A hotline has been established for anonymous reporting of all complaints and allegations related to potential violations of company ethics and policies. All reports or complaints are subject to an internal audit where findings, made by the internal auditor, are reported directly to the Audit Committee of the board of directors.

Q: What failings have you seen in ways that other CEOs or companies have addressed corporate-governance issues?

A: I don't feel qualified to comment on others' governance issues, although I have to say that it does make me very angry that a few CEOs and corporate officers engaged in criminal wrongdoing have given a black eye to honorable managers. The few have, if nothing else, caused people to make jokes and be suspicious.

In the merchant-energy sector, the faults of Enron and other companies have spilled over onto good companies like Sempra Energy and depressed stock prices. The actions of the few make for a more difficult and time-consuming effort with analysts to defend why we're different from Enron and their like. Better corporate governance benefits all companies.

Q: What's the most important consideration for another CEO who has to address this problem?

A: The first place to start is to look at the system of internal controls right away. How robust is it? How well can you monitor and test the functionality of internal control structures?

Then, you have to determine the competency and training of your internal auditors. Do they follow up on issues raised? Does the corporation have a structured response process for issues raised by audit staff? Is there an accountability structure to ensure certification under Section 404 and other requirements of the Sarbanes-Oxley Act?

You must assess if the board has the structural independence to govern properly and to act on all information obtained from internal control structures. After an analysis process, you must give a letter from management to the outside auditors to certify whether material weaknesses have been found in the system of internal controls and recommendations for corrections.

More information on Sempra Energy's corporate-governance policies is available at the following Web pages:

Corporate values,

Corporate governance guidelines,

Business conduct guidelines, and Corporate diversity practices By David Liss in Washington


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