Cowardly Corporate Lions
By Sydney Finkelstein
In a room full of smart and accomplished corporate board directors and CEOs from leading companies around the world, one topic resonated above all the usual items on the table. It wasn’t strategy, risk management, or compensation that stood out among the group I spent a couple of days with last week.
It was courage.
Of course, that wasn’t the word they used to describe their dilemma. It only became apparent that courage was an issue when I asked the executives what they do when there’s something that comes up in a board meeting they don’t quite understand. It could be about technology, a competitor, a proposed acquisition, anything.
So what do these smart, accomplished corporate directors do when something doesn’t make sense to them? Nothing.
There are exceptions, of course, but most directors tend to assume that if they don’t understand the logic of a CEO’s argument or strategy, they’re probably the only one. Rather than be singled out, these people—who are the last line of defense for shareholders intent on reining in out-of-control management teams—shy away from asking the question they really want to ask.
For super-successful big-ego types who populate many public boards, acknowledging to your peers that you don’t understand something can be profoundly embarrassing. Better to play along, maybe hope someone else will give voice to your concern, and not call attention to what you don’t know.
It is the opposite of how a child behaves, isn’t it? When young people don’t understand, they usually ask why. They feel no shame in not knowing; instead, they just want to understand better.
Somewhere along the way, all of us lose some of that natural inquisitiveness. We become more guarded, self-protecting, even calculating. It’s a natural process, to be sure, but what happens when that innocent curiosity is lost—and your job is protecting shareholder interests as a director?
Answer: You get the dismal state of affairs that exists in many companies around the world, where effective oversight often takes a back seat to keeping your mouth shut and getting along. For example, how did the board of Hewlett-Packard stumble through multiple CEOs before finally settling on Meg Whitman—losing billions of dollars in bad acquisitions and lost market share along the way?
When most acquisitions fail to create shareholder value, why do boards continue to approve deals their CEOs want (Boston Scientific buying Guidant at an exorbitant price, leading to $4.5 billion in losses in the subsequent three-year time period; Microsoft’s deal for the weakest part of Nokia in the face of the collapse of Nokia’s mobile phone business under the onslaught of Apple and Samsung)?
The Canadian telecommunications giant Nortel is a classic case study in board failure. Once a leading company mentioned in the same sentence as Cisco, Intel, and IBM (Nortel built the world’s fastest optical networks), its board approved a disastrous series of acquisitions, headlined by Bay Networks, in the late 1990s that almost bankrupted the firm.
When the board finally did flex its muscles, it gave blanket acceptance to the faulty recommendations of board-sanctioned investigators. That led to an executive house cleaning at the very moment Nortel most needed that talent to lead the turnaround. If we were to write a job description for board director, would we include “uncritical acceptance of others’ views” in the short list of capabilities?
The Price of Cowardice
I’ve seen firsthand the price that shareholders, employees, and communities pay when boards lack curiosity and courage. For instance, as an expert witness in one of the Enron trials, I got access to confidential documents that had been presented by management at board meetings. The Houston-based energy giant’s top executives ended up in prison, the company collapsed, the stock tanked, and employees were out of jobs and often had their retirement savings largely wiped out.
Out of that morass of documents, there is one sequence of events that stood out.
Each quarter, the board would be given a pie chart that summarized the percentage of Enron’s assets that were performing above expectations, meeting expectations, below expectations, or were troubled. Quarter-by-quarter the board would see, as I did, how the percentage of assets performing at or above expectations declined, while assets in the “troubled” category increased. Then, after five quarters, the report stopped.
I searched far and wide for any document indicating that the board received this information in successive quarters, but it wasn’t to be found. The reports had just stopped.
Now, it doesn’t take an expert in corporate governance to wonder why the report was no more—arguably a small child might have been curious about that—and in consequence, what was happening to those assets. After all, the corporate directors had fiduciary responsibility over them.
There was no evidence in the board minutes, or anywhere else, that directors became alarmed at this deterioration. We all know how the story ended: the largest bankruptcy in American history at that time.
A quick look at the largest post-Enron bankruptcies reveals a similar story. Boards of directors at Lehman Brothers (the largest), Washington Mutual (second largest), WorldCom (third), and GM (fourth) all had opportunities to challenge what could have been deemed corrupt and certainly high-risk practices at each of these companies, ranging from excessive bets on subprime mortgages to continually misreading market trends.
In light of recent revelations on how General Motors allegedly disregarded ignition-switch problems that led to at least thirteen deaths in car accidents, it is clear that deficits in courage and curiosity did not disappear after that company’s bankruptcy reorganization.
The system of corporate governance that exists in most countries in the world—and especially in Western economies—is the backbone of capitalism. Without appropriate oversight by an independent group of experts with fiduciary responsibility to protect shareholder interests, the entire system breaks down. Small investors begin to feel like the system is rigged against them.
Unfortunately, despite the theory on how boards are supposed to work, the reality is considerably messier. Reinvigorating boards with curiosity and courage would be a very good place to start fixing what is broken.