It's a popular practice outside of the U.S., but there are some serious potential downsides that deserve consideration
U.S. boards typically combine the roles of chairman and chief executive officer, a majority practice among the Standard & Poor's 1500 composite index even today. Among the companies that do so, it is also common to appoint an outside independent director to serve as lead director. In Britain, where boards historically have had fewer independent directors than their American counterparts, a different practice arose: that of appointing an outside, independent director as nonexecutive chair. The question of whether U.S. companies should adopt the British model of separating chairman and CEO roles surfaces every time a corporate crisis erupts in America, most recently in the controversy over Countrywide Financial (CFC), where institutional investors called for splitting the combined roles held by Angelo Mozilo.
Institutional Shareholder Services' latest survey, released in September, 2007, noted that 36% of U.S. institutional investors favored the separation, although 50% found appointment of a lead director entirely satisfactory when the chairman and CEO roles are combined. Does separating the roles really provide better governance, or is it simply window-dressing for shareholders with little impact on board effectiveness? Before deciding what's best for your board, here are some practical implications to consider:
In 2004, the National Association of Corporate Directors (NACD) convened a blue ribbon commission comprised of 50 experienced board members, CEOs, and institutional investors to study the issue. Among the commission's findings:
One-third had a strong preference for separating the chairman and CEO roles, expressing concerns about the leader of the board (as chairman) also being the employee of the board (as CEO), and advocated the model of a nonexecutive chair as a best practice;
One-third had strong reservations about separating the roles and advocated maintaining the current practice of combining them but appointing an outside, independent director as lead director;
One-third felt it made little difference if independent board leadership was provided by a lead director or a nonexecutive chair. In this group's view, it was the effectiveness of the individual who provided leadership that mattered, and whether that person carried the title of nonexecutive chair or lead director didn't matter in the least.
The NACD endorsed the last view above as "best practice."
Recent surveys show that more than 70% of the Fortune 1000 now have lead directors. While some U.S. boards have appointed nonexecutive chairs, this practice has been adopted almost routinely at companies that have been through crises such as Tyco (TYC), Marsh & McLennan (MMC), AIG (AIG), Fannie Mae (FNM), and Walt Disney (DIS), which tout the separation of the roles as proof of a renewed commitment to good corporate governance. But is it? Or is the U.S. model—that is, appointing a lead director and leaving the chairman/CEO roles combined—actually a more effective system of board leadership?
I began my career working with boards in Canada 12 years ago, a country where chairman and CEO roles are nearly always separated. Over the past dozen years, I've worked with nearly 80 boards in both the U.S. and Canada, gaining perspective on the practical implications of each model, in particular some of the downsides inherent in splitting the chairman and CEO roles.
While I've had the privilege of working with some truly outstanding nonexecutive chairs, I have found that one of the biggest headaches in Canadian corporate governance is this: It's very hard to get rid of a bad nonexecutive chair. Who takes him or her out? It can't be the CEO. While there have been instances of a palace coup launched by other directors in circumstances where the nonexecutive chair was a true disaster (such departures are almost always couched in the context of "other commitments") they are few and far between.
Underperforming or problematic nonexecutive chairs are most typically allowed to continue underperforming until they reach mandatory retirement age simply because no one else on the board is in a position to put the bell on the cat.
Problems of managing the performance of nonexecutive chairs seem equally prevalent in Britain. In 1998, the Hampel Report alluded to this situation by recommending that British boards name a senior independent director who could ride herd on the nonexecutive chair. Hampel's recommendation would hardly have been necessary unless there were performance issues in that country, too.
Whether a nonexecutive chair or a lead director is your model of choice, to help better manage performance be sure to incorporate questions on board leadership into your annual board assessment and ensure that another committee chair (of the audit or compensation committee, perhaps) is given responsibility for collecting and delivering this feedback so that you don't create a situation where the board leader is conducting his or her own performance evaluation.
Performance issues among nonexecutive chairs in Canada and Britain are sometimes compounded by another practice common in both countries, namely recruiting a chairman who has not previously served as a member of the board. Lead directors, on the other hand, are typically chosen by their peers from among the current board members; the advantage being that it's known how this individual interfaces with fellow directors and the CEO. The position of lead director tends to be a rotational one. While U.S. practice on terms for lead directors is still evolving, a term of three to five years seems prevalent, and most continue to serve on the board after stepping down. Those recruited to be chairman typically serve in this role until they reach mandatory retirement age—often after a tenure of 10 years or more—and then leave the board.
Nonexecutive Chairs John Pepper and Stephen Ashley each receive $500,000 a year in chairman's fees (compared with annual board retainers for other directors of $65,000 at Disney and $100,000 at Fannie Mae). Lead directors Ralph Larsen and James McNerney are paid no more than any board members. The only material difference between the job of a nonexecutive chair and lead director is presiding at board meetings. Is this worth a half-million dollars a year to shareholders? Might this level of compensation not actually counter the very rationale behind splitting the roles in the first place, that of providing independent leadership to the board? How truly independent is a nonexecutive chairman who is pulling down $500,000 a year?
There are many highly effective nonexecutive chairs providing outstanding leadership to boards in Britain, Canada, and the U.S. There are lead directors doing so as well. It comes down to the effectiveness of the individual. Separating chairman and CEO roles not only provides no guarantee of better leadership, it can result in some downsides that U.S. boards and institutional investors should consider carefully before making this decision.