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Restoring Trust in Corporate Governance:

The Six Essential Tasks of Boards of Directorsand Business Leaders

Policy Brief

January 2010

Policy and Impact Committee of the Committee for Economic Development


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Restoring Trust in Corporate Governance:

The Six Essential Tasks of Boards of Directors

and Business Leaders

POLICY BRIEF

Policy and Impact Committee of the Committee for Economic Development


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Contents

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x

I. INTRODUCTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

II. RESTORING TRUST WITH SIX ESSENTIAL GOVERNANCE TASKS . . . . . . . . . . . . . . . . . . . . . . 3

1) Redefining the Mission of the Corporationand the Roles of the Board of Directors and the CEO. . . . . 3

2) Revamping the Leadership Development Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

3) Refocusing the Process for CEO Selectionand for Other Promotions intoHigh Corporate Positions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

4) Reformulating Operational Objectives for Performance, Risk and Integrity. . . . . . . . . . . . . . . . . . . . . . . . . 5 5) Revising Compensation for the CEO, Senior Executives and Other Key Employees . . . . . . . . . . . . . . . . . . 9

6) Re-aligning the Board s Oversight Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

III. OBSTACLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1) Labor Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

2) Differing International Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

3) Changing Board Compensation Advisors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

4) Short-Termism of Institutional Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5) Manipulating the Numbers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

6) e Reduction of Pressure for Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

IV. ACCOUNTABILITY AND LEADERSHIP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1) e Market. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

2) Shareholder Involvement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

3) Government Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

4) Back to the Future: e Duties of Boards of Directors and Top Business Leadership . . . . . . . . . . . . . . . . 18

ENDNOTES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19


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Policy and Impact Committee

Chairmen

PATRICK W. GROSSChairmane Lovell Group

WILLIAM W. LEWIS

Director Emeritus, McKinsey GlobalInstituteMcKinsey & Company, Inc.

Members

JOHN BRADEMASPresident EmeritusNew York University

BETH BROOKEGlobal Vice Chair - Public Policy,

Sustainability and StakeholderEngagement

Ernst & Young LLP

GERHARD CASPERPresident Emeritus and ProfessorStanford University

MICHAEL CHESSERChairman & CEOGreat Plains Energy Services

RANJANA B. CLARKExecutive Vice President, Global Payments

and Global Strategy

Western UnionROBERT COLSONPartner - Institutional AcceptanceGrant ornton

W. BOWMAN CUTTERManaging DirectorWarburg Pincus LLC

KENNETH W. DAMMax Pam Professor Emeritus of American

& Foreign Law & Senior Lecturer,University of Chicago Law School

e University of Chicago

MICHELLE DENNEDYChief Governance OfficerSun Microsystems, Inc.

HOWARD FLUHRChairmane Segal Company

PATRICK FORDPresident and Chief Executive Officer, U.S.Burson-Marsteller

CONO R. FUSCOManaging Partner (Retired)Grant ornton

BEN W. HEINEMAN, JR.Senior FellowHarvard Universitys Schools

of Law & GovernmentFormer GE Senior Vice Presidentfor Law and Public Affairs

RODERICK M. HILLS , ESQ.ChairmanHills Stern & Morley LLP

PAUL M. HORNSenior Vice President (Retired)

IBM Corporation

EDWARD A. KANGASChairman and Chief Executive Officer

(Retired)Deloitte Touche Tohmatsu

JOSEPH E. KASPUTYSChairman, President and Chief Executive

OfficerGlobal Insight, Inc.

DAVID H. LANGSTAFFFormer President & CEO, Veridian Corp.;

Chairman, Wildheart GroupVeridian Corporation

JOHN C. LOOMISVice President, Human ResourcesGE Infrastructure

BRUCE K. MACLAURYPresident Emerituse Brookings Institution

MARGERY W. MAYERPresident, Scholastic Education

Scholastic Inc.

WILLIAM MCDONOUGHVice Chairman and Special Advisor to the

ChairmanMerrill Lynch & Co., Inc.

ALFRED T. MOCKETTChairman & CEOCorinthian Capital LLC.

LAURENCE G. ONEILPresident and Chief Executive OfficerSociety for Human Resource

Management

STEFFEN E. PALKORetired President

XTO Energy Inc.

DONALD K. PETERSONChairman and Chief Executive Officer

(Retired)Avaya Inc.

LOIS E. QUAMPresident and Chief Executive OfficerTysvar

NED REGANProfessore City University of New York

DANIEL ROSEChairmanRose Associates, Inc.

LANDON H. ROWLANDChairmanEver Glades Financial

KENNETH P. RUSCIOPresidentWashington & Lee University

DONNA E. SHALALA

PresidentUniversity of Miami

CHRIS SHAYSFormer Member of Congress

JOHN C. SICILIANOSenior Managing Director and CEO,

Investment BoutiquesNew Your Life Investment Management

PETER P. SMITHSenior Vice President, Academic

Strategies and DevelopmentKaplan, Inc.

JON STELLMACHERExecutive Presidentrivent Financial for Lutherans

FREDERICK W. TELLINGVice President, Corporate Policy & Strategic

Management (Retired)Pfizer Inc.


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PATRICK TOOLEVice President & Chief Information OfficerIBM Corporation

VAUGHN O. VENNERBERGSenior Vice President and Chief of StaffXTO Energy Inc.

JOSH S. WESTONHonorary Chairman

Automatic Data Processing, Inc.

JOHN P. WHITERobert & Renee Belfer Lecturer, Kennedy

School of GovernmentHarvard University

JACOB J. WORENKLEINChairman and Chief Executive Officer,

(Retired)US Power Generating Co.


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Corporate Governance Subcommittee

Chairman

BEN W. HEINEMAN, JR.Senior FellowHarvard Universitys Schools

of Law & GovernmentFormer GE Senior Vice President

for Law and Public Affairs

Members

MORTEN ARNTZENPresident and Chief Executive OfficerOverseas Shipholding Group, Inc.

DEBORAH HICKS BAILEYChairman and CEOSolon Group, Inc.

LYDIA I BEEBECORPORATE SECRETARY

Chevron Corporation

CATHERINE BROMILOWPartnerPricewaterhouseCoopers LLP

BETH BROOKEGlobal Vice Chair - Public Policy,

Sustainability and StakeholderEngagement

Ernst & Young LLP

HYEWON CHOIVice President and Head of Corporate

GovernanceTIAA-CREF

MARTIN COHENManaging DirectorMorgan Stanley

ROBERT COLSONPartner - Institutional AcceptanceGrant ornton

EDWARD F. COXOf Counsel

Patterson Belknap Webb & Tyler

STEPHEN A. CRANEChairmanInsurance and Reinsurance Strategies

MICHELLE DENNEDYChief Governance OfficerSun Microsystems, Inc.

WILLIAM H. DONALDSONChairmanDonaldson Enterprises

MAUREEN ERRITYDirector Center For Corporate GovernanceDeloitte LLP

MARGARET FORANVice President, Chief Governance Officer

and SecretaryPrudential Financial

PATRICK FORDPresident and Chief Executive Officer, U.S.Burson-Marsteller

BARBARA HACKMAN FRANKLINPresident & CEO and Former US Secretaryof Commerce

Barbara Franklin Enterprises

CONO R. FUSCOManaging Partner (Retired)Grant ornton

PATRICK W. GROSSChairmane Lovell Group

ADAM J. GUTSTEIN

Chief Executive Officer and PresidentDiamond Management & Technology

Consultants, Inc.

HOLLIS W. HARTDirector of International OperationsCiti

RODERICK M. HILLSChairmanHills Stern & Morley LLP

PHILIP K. HOWARDPartner

Covington & Burling LLP

ROSEMARY M. KENNEYDirector, Corporate Governance &

CommunicationsPfizer Inc

JOHN LIFTINGeneral CounselD. E. Shaw & Co., L.P.

IRA M. MILLSTEINSenior PartnerWeil, Gotshal & Manges LLP

MICHAEL G. MORRISChairman, President and Chief Executive

OfficerAmerican Electric Power Company

NELS OLSONManaging Director, Eastern Region; Sr.

Client Partner, CEO & Board ServicesPractice

Korn/Ferry International, Inc.

LAURENCE G. ONEILPresident and Chief Executive Officer

Society for Human ResourceManagement

DEBRA PERRYManaging MemberPerry Consulting LLC

DONALD K. PETERSONChairman and Chief Executive Officer

(Retired)Avaya Inc.

MARK PREISINGERVice President, World Wide Public Affairs

& Communicationse Coca-Cola Company

NED REGANProfessore City University of New York

LANDON H. ROWLANDChairmanEver Glades Financial

JOHN C. SICILIANOSenior Managing Director and CEO,

Investment BoutiquesNew York Life Investment Management

SARAH B. TESLIKSr. Vice President, Policy and GovernanceApache Corporation


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Corporate Governance Subcommittee

VAUGHN O. VENNERBERGSenior Executive Vice President and Chief

of StaffXTO Energy Inc.

FRANK VOGLPresident

Vogl Communications

JOHN C. WILCOXChairmanSodali Ltd.

HAROLD M. WILLIAMSPresident EmeritusGetty Trust

Guests

MICHAEL CLAESManaging Director, Corporate PracticeBurson-Marsteller

JUDITH SAMUELSON

Executive Director, Business and SocietyProgram

e Aspen Institute

Staff

ELLIOT SCHWARTZVice President and Director of Economic

Studies

STUART KOTTLE

Research Associate


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PREFACE

In a series of Policy Statements since 2006 on corpo-rate governance issues, the Committee for EconomicDevelopment has analyzed: first, how corporationscould regain the publics trust in the wake of theEnron-WorldCom scandals; second, how corporatedirectors could promote the long-term enduring quali-ties of their enterprises rather than give in to financialmarket short-termism; and, third, how corporateleadership could be rebuilt by linking long-term

performance with societal goals.Since these reports, the nation (and the world) hasbeen hit by the worst economic crisis since the GreatDepression. One cause was poor business decision-making by boards of directors and senior executives inboth the financial and industrial sectors. Corporatecompensation, in particular, has been sharply criticizedas poorly structured, a cause of excessive risk-takingand out of proportion to good judgment and commonsense. ese developments, combined with a constant

media barrage of stories about business issues, havecombined to drive public confidence in business to avery low ebb. Cries for more regulation of business arecoming from many quarters.

In a period of economic turmoil and public policy fer-ment, this Policy Brief seeks to identify the six essentialand seamlesstasks which boards of directors and seniorexecutives together must discharge to create long-termvalue through strong economic performance, soundrisk management and high integrity. To help restore

deserved trust in corporate governance and account-ability, it seeks to provide an actionable frameworkon the fundamentals for private-sector leadership.Corporate leaders must balance risk-taking(innovationand creativity) with risk-management (financial andoperational discipline) and fuse high performance withhigh integrity to create durable, sustainable growingeconomic enterprises that benefit shareholders andother critical stakeholders.

Restoring Trust in Corporate Governance:The Six Essential Tasks of Boards of Directors

and Business Leaders

is Policy Brief is released when necessary, spiritedand extensive regulatory debates are taking place onthe safety and soundness of the financial system andon governance issues applicable to all publicly heldcompanies (e.g., disclosure on compensation andrisk; enhanced shareholder role). But, the Policy Briefpurposely focuses exclusively on private sector self-determi-nation, not public sector regulation. e reason for thisapproach is straightforward: a deep-seated belief that,whatever the outcome of the many public inquiriesand varied public policy debates, only the leadership of

corporationsboards of directors and senior execu-tivescan make the complex decisions that will yieldsustainable, durable creation of value with sound riskmanagement and high integrity. Because this role ofcorporate decision-making is enduring and criticalto our nations economic well-being, the Policy Briefencourages corporations to focus on these essentials,which are fundamental regardless of policy outcomes,as we move across the business landscape altered by theGreat Recession.

is Policy Brief seeks to build on, add to and tightlyfocus the work of CED and other leading governancegroups on todays problems. It also integrates insightsfrom Ben W. Heineman, Jr.s ongoing research andwriting on corporate integrity. It is intended to be anactionable, practical ideal. It is intended to stimulatediscussion on the essentials of corporate governance.It is, of course, hardly the final word on this topic. But,for those who must focus on making real-world deci-sions about the destiny of publicly held companies, itis an invitation to focused debate on corporate leadersmost fundamental tasks.

is Policy Brief is authored by Ben W. Heineman,Jr., former GE Senior Vice President for Law andPublic Affairs. He is a CED Trustee and chair ofthe CED Subcommittee on Corporate Governance,senior fellow at Harvard Universitys Law School andKennedy School and member of the advisory board ofthe Millstein Center for Corporate Governance and


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Performance at the Yale School of Management. Heis the author of High Performance with High Integrity(Harvard Business Press, 2008). e Policy Briefwas written with the active engagement and advice ofCEDs corporate governance subcommittee.

ACKNOWLEDGEMENTS

We are grateful for the time, effort, and care put intothis Policy Brief by Mr.Heineman, the CED Trusteesand other participants in the Subcommittee on Cor-porate Governance, and other experts and colleagueswho commented on earlier drafts of this report. Wethank Elliot Schwartz, CED Vice President andproject director for the Subcommittee on CorporateGovernance, and Stuart Kottle, CED ResearchAssociate, for their assistance. We are also gratefulto both Stephen M. Davis and Ira M. Millstein ofthe Millstein Center for Corporate Governance andPerformance at the Yale School of Management,Stephen B. Young of the Caux Round Table, andRoderick Hills of the Hills Program on Governance atthe Center for Strategic and International Studies fortheir endorsement and support of this Policy Brief.

Patrick W. Gross, Co-ChairPolicy and Impact CommitteeChairman, e Lovell GroupFounder, AMS, Inc.

William W. Lewis, Co-ChairPolicy and Impact CommitteeDirector Emeritus, McKinsey Global InstituteMcKinsey and Company, Inc.


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e business community faces a crisis in confidence.Many are asking: how can corporations govern them-selves more effectively?

is Policy Brief describes six fundamental, inter-related tasks which boards of directors and seniorexecutives should discharge in governing publiclyheld corporations in order to regain the vital trustupon which business is based. It hopes to make asingular contribution by defining the six essentialgovernance tasks, by emphasizing their interrelation-

ship and by showing that these seamless tasks are thetouchstone of corporate accountability.

Boards of directors in particular should focus on thesesix tasks in clarifying a right-sized role going forward.is will require focused intensity. But, the CEO andother senior company executives must make thesetasks the core of their leadership and managementefforts as they govern the company on a day-to-daybasis. is Policy Brief is not just about the role ofboards of directors but also about the importance of a

powerful board/business-leader partnership in direct-ing the destiny of publicly held corporations.

By showing how closely, indeed seamlessly, these sixtasks relate to each other, this Policy Brief hopes toprovide an affirmative, actionableframework whichboards and business leaders can apply, as appropriate,in their own corporations (to the extent they are notdoing so already, which some certainly are). Althoughwritten in a prescriptive form, this paper, preparedin the aftermath of the greatest economic down-turn

in 60 years, is intended to stimulate an importantdiscussion on the essentials of corporate governance,not to exhaust or end it. It encourages debate on thesubstance of what corporations should do, not just ontheprocessesfor how to do it.

e six seamless tasks are:

1) A redefinition of the mission of the companyandthe role of the board of directors and the CEO to create

durable value for shareholders and other stakeholdersthrough sustained economic performance, sound riskmanagement and high integrity. is requires thatleaders must find a sound balance between risk-taking(innovation and creativity) and risk-management(financial and operational discipline) and must fusethis high performance with high integrity (commit-ment to law, ethics and values to reduce legal, ethical,reputational, public policy and country risk). eemphasis on short-term maximization of shareholdervalue should be reduced significantly.

2) A revamped internal leadership training process builton these integrated essentials of performance, risk andintegrityand on a culture in which all are honoredand exemplified.

3) A refocused CEO selection process, flowing from arevised leadership development process, which seeks abroader set of skills appropriate to a redefined mission.

4) A restatement of fundamental but operational finan-cial and non-financial measurements for performance,

risk and integritythat expresses the near, mediumand long-term corporate goalswith primary focuson creation of sustainable value for shareholders andother stakeholders, such as employees and customers,essential to the companys well-being.

5) A revision of compensationfor the CEO and topbusiness leadersand for other employees withsignificant impact on the corporationwhich is basedon real performance against those restated operationalobjectives in the performance, risk and integrity

dimensions. Although top business leadership willreceive substantial annual cash compensation, asignificant proportion of compensation in a particularyear will be variable cash and variable equity whichwill be paid out or held back over time as objectives aremet, exceeded or missed.

6) A re-alignment of the boards fundamental oversightfunctionwith the highest priority performance, risk

Executive Summary


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and integrity issuesthose operational objectiveswhich are central to attainment of corporate missionand to compensation based on the impact of actionsover both nearer and longer terms.

Corporations current statements of purpose may makereference to these six fundamental tasks. But, thetasks may either be lost amidst many other corporate

goals or may not be matched by robust practice. eharsh reality is that business organizations must bedesignedby boards at a conceptual level and businessleaders at both a conceptual and operational leveltocheck short-termism, greed and corruption and tochannel capitalisms innovation and animal spiritsinto sustained, durable creation of real economic valuewithin a framework of financial discipline, law, ethicsand values.

A relentless focus on the six fundamental tasks is an

important guide to creation of sustainable shareholderand stakeholder value. Moreover, developing appropri-ate executive compensationthe governance topicgenerating the most public heat todaycan only flowfrom definition of corporate mission and articulationof related operational goals and measurements.

is Policy Brief also identifies difficult, real-world problems which boards of directors and busi-ness leaders must candidly confront because theseissues can undermine a corporations will and ability

to discharge the six, seamless tasks in a meaningfulway. ese problems include: competition in the labormarket for top executive and other business talent; dif-fering regulatory standards and the risk of regulatoryarbitrage; the limitations of many current compensa-tion consultants; the increasing short-termism of manyinstitutional investors; and the dangers of gaming anysystem of measurements. Each company will need todevise its own response to these issues. is reportbriefly notes some possible solutions to these problemsin the interest of stimulating debate and highlighting

governance agenda items for further research andanalysis.

Finally, the Policy Brief discusses the ultimategovernance question: how can corporate account-ability be assured? e pricing signals from the stockmarket, an enhanced shareholder role in governanceand increased government regulation all may have a

role. But all have important imperfections in assuringaccountability. All are the subject of strenuous debate.

e most direct accountability mechanism is soundstewardship by the CEO and senior executivesunder the direction and oversight of hard-working,independent-minded boards of directors who are bestpositioned to balance the many competing interests at

play in all significant corporate decisions. Critics arguethat this accountability mechanism is weak becauseboards can be self-perpetuating and inward looking,incapable of asking CEOs hard questions and ignoringimportant shareholder or other stakeholder concerns.

But the other methods of accountability are, in manyrespects, all aimed at the fundamental goal of thisPolicy Brief: strong, energized boards and businessleadership dedicated to the discharge, in good faith, ofthe six essential functions, in part through meaningful

consultation with shareholders and other importantstakeholders.

* * * * *

Many reports, like this one, address hard problems,with deep structural roots, by calling for leadership.Too often that plea goes unansweredor the struc-tural problems are too intractable. But today, witha governance crisis in confidence, it is in the interestof corporations and of capitalism itself for people inleadership positions truly to address the governanceproblems of the era and provide a clear, credible andpowerful private sector response.


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e business community faces a crisis in confidence.Many are asking: how can corporations govern them-selves more effectively?

is Policy Brief describes six fundamental, inter-related tasks which boards of directors and businessleaders should discharge in governing publicly heldcorporations in order to regain the vital trust uponwhich business is based.

As discussed in more detail below, thefirst taskis toredefine the corporate mission away from short-term

maximization of shareholder value towards threereinforcing objectives: creation of durable value forshareholders and stakeholders through

a. sustained economic performance b. sound risk management and

c. high integrity.

From this general restatement of mission flow thefive other tasks:

2. revamped leadership development;

3. refocused CEO selection;4. reformulation of operational goals to reflect

the broader mission; 5. revision of compensation to reward attain-

ment of those operational goals; and6. re-alignment of board oversight to track the

highest priority performance, risk and integ-rity issues.

Boards of directors in particular should focus onthese six tasks in clarifying a right-sized role going

forward. is will require energy and intensity withinthe normal time parameters of board service. But, thislaser-like board focus will only be possible if the CEOand other senior company executives also make thesetasks the core of their leadership and managementefforts as they govern the company on a day-to-daybasis. is Policy Brief is not just about the role ofboards of directors but also about the importance of a

powerful board/business-leader partnership in direct-ing the destiny of publicly held corporations.

By showing how closely, indeed seamlessly, these sixtasks relate to each other, this Policy Brief hopes toprovide an affirmative, actionableframework whichboards and business leaders can apply, as appropriate,in their own corporations. Such a framework is ofspecial importance in orienting the company towardsthe essential in an era when any commonality amongshareholders has broken downindeed shareholders

have many conflicting objectives and agendasandwhen stakeholders, too, make many competingdemands on the corporation. e forward trajectoryof corporations involves a balance between manycompeting objectives and claimsnot pursuit of onesimple goaland, at the end of the day, only boardsand senior executives can make the complex decisionsto find the right balance.

Although written in a prescriptive form, this paper,prepared in the aftermath of the greatest economic

down-turn in 60 years, seeks to stimulate an importantdiscussion on the essentials of corporate governance,not to exhaust or end it, by arguing for the primacy ofthe six fundamental tasks. It encourages debate on thesubstanceof what a corporation should do, not just ontheprocessesfor how to do it. It discusses illustrativeconcepts to provide context but hopes to avoid mind-numbing or rote box-checking detail.

is crisis of confidence in corporate governance hasmany origins. Major financial institutions (banks

and investment banks) and industrial companies(automobiles) have gone bankrupt with significantinjury to all stakeholders. Important financial servicecompanies contributed to the credit melt-down andsevere recession (through, among other things, poorrisk management, high leverage, inadequate liquidity,creation of ill-understood products). High, poorlystructured corporate compensation has drawn sharpcriticism as a cause in excessive risk taking and as

I. Introduction


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out of proportion to good judgment and commonsense. And other corporations in both the financialand industrial sectors, even those which are well-run,are not immune from general reputational harm tobusiness caused by almost two years of headlines aboutcorporate problems, excesses and failures.

To address these real and perceived issues about

corporate leadership, about corporations ability togovern themselves effectively and about corporateaccountability, there are two broad options:

more public-sector regulation to limit private-sector self-determination either in the financialsector or across all publicly held corporations;and

more broad-gauged, transparent and effectiveprivate-sector leadership to articulate the corepurposes of public corporations and to carry

them out with rigor.

is Policy Brief focuses on the second option:enhanced corporate self-governance at all publiclyheld companies.1It builds on prior policy statementsfrom leading governance groups2and on recent reportsabout the causes and cures of the financial and auto-mobile company melt-downs.3

It hopes to make a singular contribution by defining the six

essential governance tasks, by emphasizing their interrela-tionship, and by showing that these seamless tasks are thetouchstone of corporate accountability.

A company culture that truly makes the six intercon-nected tasks a reality is necessary whether or not thereis additional public-sector regulation. Some companiesdischarge some of these tasks; some may discharge all.But, to meet the demands of the times, all companiesmay find it helpful to re-assess their current approachagainst these six priority actions. At the end of the

day, whatever the result of the public-policy debatesabout governance structure and process, only out-standing boards of directors and outstanding businessleadership can together make corporations work.


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II. RESTORING TRUST WITH SIX ESSENTIALGOVERNANCE TASKS

In this period of economic upheaval and change,boards of directors and CEOs are buffeted from manysides with conflicting demands about what they shoulddo. A common board lament is being overwhelmedwith too little time and too much complexity.

In arguing that boards of directors and businessleadership must discharge six core tasks in order toregain public trust, this Policy Brief underscores thatthese are seamless, building upon and reinforcing eachother. While the details of discharging these tasks will

necessarily vary with company, industry, geographyand competition, focusing on them together as action-able, core functions will help answer the pressingquestion asked by boards and business leaders: whatshould be our priority tasks?

Attempting to draw the line between board-of-directorand business-leader responsibility is not the purpose ofthis Policy Brief. e long-standing proposition thatthe board of directors sets the corporations directionand oversees implementationand the CEO and

senior executives lead and manage the corporation it-selfcontinues to apply. Too much of the governancewriting, especially since Enron, has emphasized theboards role in being a check and balance on manage-ment, as if they are necessarily in perpetual opposition.

Butand this must be emphasizedif the boardcorrectly defines the jobs of the CEO and top businessleaders and chooses the right people, the primaryrelationship should be a questioning but affirmativepartnership. at partnership critically but construc-

tively tests the reasonableness of both the fundamentalsystems and processes instituted by management andthe high priority decisions and results flowing fromthose systems and processes.

1) Redefining the Mission of the Corporationandthe Roles of the Board of Directors and the CEO.

Far too much emphasis has been placed in recent yearson the single corporate goal of maximizing short-term

earnings per share, stock price and shareholder value.As discussed below, this is due, in important part, topressures exerted by the change in institutional inves-tors who are increasingly preoccupied with short-termresults, with beating composite industry benchmarksand with their own absolute profitability, rather thancompany fundamentals.

A statement of the mission of publicly held companies,appropriate to these times, is creation of durableshareholder and stakeholder value by:

Attaining high performancewhich means:strong, sustained economic growth; throughthe continuous provision of high quality goodsand services; which in turn provide durablebenefits for shareholders and other stakehold-ers (creditors, employees, customers, suppliers,communities, regulators) upon whom thecompanys health depends.

High performance entails an essential balancebetween risk-taking (the creativity and innova-

tion so essential to the growth of our economy)and economic risk-management (the financial,commercial and operational disciplines soessential to the soundness and durability ofbusiness institutions).

Creating a culture of high integritywhich means:robust adherence to the spirit and letter ofthe formal rules, legal and financial; adoptionof global ethical standards which are in thecompanys enlightened self-interest and which

bind it and its employees as if they were formalrules; and securing employee commitment tothe core values of honesty, candor, fairness,reliability and trust-worthiness in all internaland external relationships.

High integrity has positive benefits inside thecompany, in the marketplace and in a globalsociety but it also addresses serious legal,


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regulatory, reputational, communications andpublic-policy risks which are also importantfacets of contemporary business.

Fusing high performance with high integrity. isfusion of sustained economic performancewith a strong commitment to law, ethics andvalues is the foundation of the contemporary

corporation. Properly addressing business-in-society issues. In

balancing risk-taking with risk managementand in fusing high performance with highintegrity, contemporary CEOs, and their topbusiness associates, need to pay systematicattention to business-in-society issues: howsociety can and will affect the conduct ofbusiness; how business has an impact onsociety; and how business leaders should shape

and communicate the alignment of businesswith societal interests through the concept ofcorporate citizenship.4

As emphasized, each company will give detailedmeaning to these concepts of performance, risk andintegrity, but together they constitute the core mis-sion of the contemporary corporation and define thefundamental role of the board of directors, the CEOand other senior executives.

2) Revamping the Leadership Development Process.

Corporations often provide highly specialized trainingin such business skills as sales, marketing, finance, IT,business development, manufacturing, engineeringand product or technology development. ey alsomay provide less specialized, more general training forP&L (profit-and-loss) managers, who are promotedfrom positions of narrow expertise to assume broaderoperational responsibilities. Such general managertraining customarily focuses on achieving commercialgoals in different environments.

But, with careful board oversight, the CEOand other top business leaders must institutemanagement development processesfor corpo-rate P&L and functional leaders that, at earlystages in their careers, put strong emphasis notjust on developing specialized expertise or onachieving commercial goals but on developingthe experience and skills to do this through

balanced risk-management and performancewith integrity. is emphasis on risk manage-ment and an integrity culture should be atalent-management imperative as individualsrise within the corporation and face increas-ingly broader challenges requiring integrationof all three dimensions of corporate mission.

Such development will involve broader anddifferent educational courses offered by thecorporation during an individuals career onthe interrelationship between performance,risk and integrity in the context of a globalsociety. Such courses may be offered insidethe company or in executive MBA or executiveeducation programsbut a rethinking of suchcourses, both in the company and in academia,may be necessary, given a broader definitionof the CEO and business-leader role and the

robust debate about necessary changes in busi-ness education as a result of recent businessfailures.5

Such leadership development will also entailgiving high-potential individuals a broader rangeof assignments earlier in their careerse.g.,working on a team scrubbing a new productline for its risks; being integral to a majorinternal investigation of potential wrong-doing; helping to ascertain the geopolitical

issues, as well as the business issues, in locatinga new manufacturing facility in one of threeor four Southeast Asian nations; assessingsupply-chain risks and opportunitiesandthird-party suppliersin emerging markets.Establishing the theory and practice ofsystematically implementing cross-functionalassignments for up-and-coming leaders is avital role for the CEO and senior HR leaderworking with the management development

and compensation committee of the board ofdirectors.

3) Refocusing the Process for CEO Selectionandfor Other Promotions into High CorporatePositions.

e ultimate result of the initial tasksredefining themission of the company and the CEO and revampingleadership developmentshould be a CEO-succession


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process which expressly searches for and then selectsa new leader for the company whose personality andcareer reflect the combination and integration of thenecessary performance, risk and integrity dimensions.

As it begins this succession process, theboard of directors should restate and reiter-ate the mission of the company and the key

characteristics of balancing risk taking withrisk management and fusing high performancewith high integrity in a company-specificarticulation of purpose aimed at both insideand outside audiences.

In exercising this functionwhich has histori-cally (and properly) been viewed as its mostimportant taskthe board should hopefully(ideally) be able to choose from a strong talentpool inside the company.

Similarly, promotions to senior corporateleadership jobs which the CEO recommendsand the board of directors approves should beawarded to individuals who have the broadconstellation of talents and skills required bythe contemporary corporation with a redefinedmission.

e need for core economic performance skillsfi-nancial, commercial, operational, strategicare asimportant as ever in the CEO and top business leaders.

Nothing said here is intended in any way to diminishthe primacy of high economic performance in a busi-ness organization. But failures of business leadershipin the recent past have frequently been due to seriousweaknesses in risk assessment and management, or toserious lapses in adhering to legal, financial or ethicalstandards.

ese failures have had significant, even catastrophic,impacts on shareholders, creditors, employees, custom-ers, suppliers and communities. ey have, over time,

eroded the trust upon which successful conduct ofbusiness depends. A contemporary CEO must haveproven skills in risk management, in creating a cultureof integrity and in understanding business-in-societyissues which pose both threats to, and opportunitiesfor, the corporation. Strength in commercial opera-tions and strategy is absolutely necessary, but notsufficient, in todays business environment.

4) Reformulating Operational Objectives for Perfor-mance, Risk and Integrity.

How the company measures commitment to its funda-mental mission over the short, middle and long termis, of course, a critical task in driving desired behaviorand setting the terms for corporate accountability.6Boards of directors and business leadership must

together define a concise, comprehensive and robustset of operational objectives across the dimensions ofeconomic performance, risk management and highintegrity which can be clearly communicated insideand outside the company. Some will be enduring, likefundamental systems and processes. Others will needmodification as the competitive, regulatory and geopo-litical landscape changes.

is annual process of translating the broad articula-tion of mission into operational objectives requires

great care and sustained attention. It should measureboth financial and non-financial factors. It mustbecome a core feature of the board/business-leadershiprelationshipa joint deliverable at the end of oneyear to provide an accountability test in the next.

Some important, illustrative measures follow. Eachcompany will, of course, explicitly articulate and clearlyexplain the ones which it chooses to use because each,by itself, can create or hide problems.7

a. Sustained Economic Performance. ese measure-

ments should be insulated as much as possiblefrom book-keeping manipulation and short-termstock price fluctuations.

e efficient use of capital through suchmeasurements as return on assets and returnon invested capital.

Operational excellence as reflected in cash flowor operating margins or productivity increases.

Strong connections to customers, throughsuch measures as: market share, increases inrevenues, repeat customer percentages, assess-ments of customer satisfaction, new productsas percentage of offerings, brand strength.For all the past focus on shareholders, thecore activity of the corporation is sellingquality goods and services to customers,the


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stakeholders upon whom the company trulydepends.

Employee motivation, satisfaction and indi-vidual productivity.

e more traditional performance measuresof net profits, earnings per share, stock priceincreases, total shareholder return and returnon equity. While these metrics of economicperformance should not overwhelm all others,they will continue to be important. One ofthe challenges is how to give them their due,not make them dominant and thus put themin context with the many other measures ofperformance which make for a strong, growingcompany.

How, and to what degree, changes in newtechnologies, new products, new acquisitions

(or dispositions) and new geographies posi-tively impact economic performance.

Performance against peer companies in allthe measurements mentioned above wheneverpossible.

b. Systematic Risk Management for EconomicPerformance. Risk disciplines must be matchedwith decisions about setting and implementingeconomic performance objectives. is Policy Brief

discusses, in this section, direct economic risksrelat-ing to capital adequacy, leverage, liquidity, interestrates, currency, credit-worthiness of counterpar-ties, products and operations. Other critical riskswhich can indirectly affect economic performancesuch as legal, reputational, ethical, IT, supplychain, country and geopolitical issues are discussedin the next section (on integrity measurements andprocesses).

e goal, of course, is not to eliminate economic

risk takingrisk is the very nature of business.Indeed, the drumbeat of risk discussions in therecent past, while understandable, should not ob-scure the essential role of business in creativity andinnovation. Rather the purpose is to understandrisks to the extent possible, mitigate to the extentpracticable and to ensure that there is adequatespread of risk so if large known or unknown

adverse events occur the company is protected, notfrom decline but from destruction.

A prefatory note on risk organization: there aremany different ways to organize risk functionsboth inside the company and at the board level.is Policy Brief does not attempt to say what isthe best organizational form. at will depend on

company mission and culture. As indicated below,it does say that, inside the company, there needto be independent experts on various direct andindirect economic risks. At the board level, eachof these independent company experts should bedirectly connected to a committee (be it Audit, anew Risk Committee or a Public Affairs or PublicResponsibility Committee). Ultimately pullingall the threads of risks together for the enterpriseis, however, the responsibility of the CEO (thechief risk officer in a very real sense) and of the

board of directors as a whole.

i. Within the company

Inside the company, the economic risk func-tion must be independent of operationalbusiness leadership. It must have direct accessto the CEOand, on highest priority mat-ters, to the board. Assessing whether such anindependent risk function exists, the quality ofits people, and where it reports are all part of a

risk measurement process. e fundamental job of financial risk manage-

ment directed at economic performance is toassess major, direct and discrete economic riskdimensions of the firme.g., capital, leverage,liquidity, credit, currency, market, opera-tionsthrough process-mapping, identifica-tion of important risk areas, and developmentof risk-mitigation measures and controls.Activities covered range from new products,

to new geographies, to new customers, tomajor areas of existing operational exposure.Companies must also rigorously assess off-balance-sheet risks as part of this activity.8ese fundamental risk systems and processescan be assessed and measured.

As a matter of business decision-making, therisk function should have an opportunity in


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front of top leadership (separate from thebusiness leaders proposing a course of action)to present important issues. e risk functiondoesnt make the decision: top business leadersand (on high priority matters) the board ofdirectors must expressly balance well-artic-ulated reward and risk. But boards and topbusiness leaders must understand as clearly as

possible not just the rewards, but also the risksthrough candid, systematic presentations bythose expert in risk. A healthy, candid debate iscritical.Again, it is possible to assess whethersuch interaction took place during the courseof the year on the right set of priority issues.

Risk management must also ascertain thesystemic risk to the corporation from thecombination of financial, commercial andoperational risks. Without entering the

voluminous and spirited debate about math-ematical risk models, it is fair to say that, whilethey have utility in measuring some types ofsystemic risk, they are not better than theirassumptions and the past data from whichthey are constructedwhich can well beinadequate in times of future stress or disloca-tion. Systemic risk assessment involves somescenario-planning around worst-case criticalissuessuch as leverage, liquidity, currency,

credit and operational risksincludingthose occasioned by major global economicdislocations.

e company must decide how to spread riskprudently so that even an unknown, low-probability event in a particular area or activitycannot sink the company. Articulation of thisspread-of-risk philosophy and adherence to itis also an important risk objective.

Similarly, the company should institute early

warning systems on economic riskswhetherin regular valuation of assets, or changes inmarkets, or unforeseen moves from competi-torswhich trigger a high-level discussion ofrisk-taking/risk-management issues that couldlead to changes in course.

ii. At the board committee and full board level

ere should be a board entitywhether theAudit Committee or a new Risk Commit-teewhich has the task of assessing the directeconomic risksnoted above (capital, leverage,liquidity, credit, market, operational) confront-ing the company. Working with management,it should review and agree upon the funda-mental systems, processes and measures for

assessing, mitigating and monitoring risk, asdescribed immediately above. It should receivetimely updates on the status of high risks fac-ing the company. It should also receive reportsfrom relevant risk officials in a company onwhether those receiving compensation above acertain level have identified relevant risks andtaken appropriate risk-mitigation steps. (isactivity is relevant both to accountability andto compensation.)

Ultimately it is the job of the full board to un-derstand the work of the business leadership andthe risk/audit committee on the assessment andmanagement of the high-priority risks associatedwith economic performance which can seriouslyinjure the corporation. Significant allocationof its limited time should be devoted to thissubject of priority risk issues.9

c. Promoting High Integrity and Assessing Legal, Coun-try and Geopolitical Risk. A major change for many

corporations would to be explicit about measuringbusiness leaders on creating a culture of integrity,as defined above (law, ethics, values), and assessingintegrity risks as systematically as the corporationreviews economic risks.10

i. Inside the company

A company can measure the integrity promo-tion efforts of its CEO and other seniorexecutives across at least five dimensions. Have

leaders:adopted key principlessuch as consistencyand commitment in both words and actions;embedding integrity disciplines in businessoperations; having systematic processes forsurfacing, analyzing and deciding ethicalissues; giving employees voice to expressconcerns; protecting company security?


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adopted key implementing practicesto makethose foundational principles a reality (riskassess/risk manage fundamental businessprocesses intersected by variety of legal re-quirements; insure that systems for preventing,detecting and responding to integrity issuesare robust across businesses and geographies)?

created an affirmative culture of integritywhere employees are not just afraid of violatingrules but affirmatively want to do the rightthing? Culture can be assessed by a numberof techniques, including anonymous internalsurveys, external reputational surveys and 360evaluations of key leaders.

performed well against peers(comparisons toother divisions inside companies or to externalpeer companies, in, for example, environmen-

tal compliance)?established and met annual goals and objectives(how are hard problems handled, key peoplehired, identified weaknesses remedied)?

As with financial, commercial and operationalrisks, companies should establish integrityearly-warning systems to identify important,emerging risks which can have indirect eco-nomic impact (as well as other adverse effects):

Changes in broad public-policy architecture(e.g., tax, trade, environment, health care etc.).

Changes in important but more fine-grainedlegal or financial rules that can have a signifi-cant impact on the company.

Changing ethical expectations anddemands.

Security threats to people, facilities, infor-mation and supply chain.

Changing geopolitical or country risk. Inparticular, an understanding of geopoliticalcontext is critical because low-probability buthigh-impact events (military action, currencydevaluations, political upheaval) can, of course,have dramatic impact on business operations.

Properly designed, such early warning systemsgather information systematically and presentissues on periodic basis to business leadersfor decision. Is detailed analysis beyondissue identification needed? Business leadersmust decide. If so, should the business takeanticipatory action to get ahead of the curve(e.g., adopt consumer protections in financial

services to anticipate regulatory change andavoid enforcement actions and consumer lawsuits)? Both the process (does every appropri-ate business unit have such processes relevantto their product mix?) and the results (werechallenges anticipated, if not why not?) can beassessed.

ii. At the board committee and full board level

As with financial risk, a committee of the

board of directors should be responsible forreviewing and agreeing upon the fundamentalmeasures for promoting integrity and thesystems, processes and measures for assessing,mitigating and monitoring integrity, countryand geopolitical risk. As noted at the outset ofthis section, whether this is the Audit Com-mittee, a special Risk Committee or a PublicResponsibilities or Public Affairs Committeewill turn on each companys culture. (Jointcommittee meetings may be appropriate on

such topics as country or geopolitical riskwhich have multiple causes and impacts.)

Finally, as with economic performance, it isultimately the responsibility of the full board tooversee basic integrity risk-mitigation systems,processes and priority results and assess whetheran integrity culture exists.

In sum, these basic operational goals and measure-ments across performance, risk and integrity dimen-

sions are essential for allocating responsibility andensuring accountability insidethe corporation. Butthey also should provide a public template for account-ability that is a meaningful alternative to the reduc-tionist, at times misleading, metric of short-term shareprice as indicator of company value and performance.11(See page 11 for discussion of a need for corporationsto articulate these operational goals publicly in orderto fix their responsibility and accountability.)


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5) Revising Compensation for CEO, Senior Execu-tives and Other Key Employees.

A revised approach to compensation flows from aredefinition of the CEO role, revamped leadershipdevelopment, a new process for CEO selection, anddevelopment of broader operational objectives to holdexecutives accountable. It should reinforce and be

reinforced by those other tasks. e broader purposeis to change compensation based on short-term resultsthat ignore long-term risks and to use compensation toincentivize short, medium and long-term value creationattained with sound risk management and with highintegrity. e purpose of compensation is, of course,to attract and retain talent, butwithin that balancedframework. Select companies are moving explicitly inthis direction.12

e setting of compensation for the CEO and top

business leadership is a fundamental role of the com-pensation committee and then the full board. But,development of the overall compensation philosophyand its application to top company talent should be ajoint board and senior executive function.

is Policy Brief advances the following concepts for arevised approach to compensation. ese concepts areconsistent with those advanced in other recent analysesand reports as a consensus is beginning to form onnew pay principles (if not yet on critical details and

methodologies).13

Compensation for the CEO and top business lead-ers should turn on actions and results in the threeseparate operational areas comprising corporatemission: sustainable, durable economic perfor-mance; effective risk assessment and mitigation;and promotion of an integrity culture throughsystems and processes embedded in businessoperations. Each should be a discrete element ina comprehensive pay regime which then uses them

in combination to determine total awards. Although top business leadership will receive

substantial annual cash compensation, significantcompensation in a particular yearwill be variablecash and variable equity which will be paid out orheld back over time as performance, risk and integ-rity objectives are met, exceeded or missed. eseobjectives should generally reflect relative effort

of leaderscompared to past results within thecompany (positive or negative trends) or againstpeers or both. Deferred cash has the advantage ofavoiding stock price manipulation and providingnecessary liquidity to individuals. Deferred equityhas the advantage of tying employees to the long-term creation of shareholder value.14

Variable cash granted in a single year will be somemultiple of annual cash and should be paid out inincrements on a multi-year schedule. Some missesdue to negligent or intentional actsa significantmisstatement of financials upon which companyresults were based or a serious failure to weigh riskor a major integrity lapsecan lead to completecancellation of the variable out-year compensation.Others misses due to serious, avoidable mistakesmay lead to a diminution but not cancellation ofvariable compensation.

Variable equity should also be granted in one yearbut only vest in out-years depending on attainmentof performance, risk and integrity measurements,although the mix might be tilted more to balancedeconomic performance (in the different categoriessummarized above, efficient use of capital, opera-tional efficiencies, relationships with customersetc). Stock price increases and total shareholderreturn should be a factor but not the factor.15Again, these performance options or RSUs should

be withheld or clawed back for serious negligentor intentional acts similar to the cancellationof variable cash grants. So, too, lesser mistakesmay lead to diminution, not cancellation. Tominimize manipulation of business for short-termstock gains even in the out-years a holding period,beyond the vesting period, may be appropriate.

Variable cash and variable equity awards mayalso be designed in the year they are granted withincentives for sustained performance in the out-

years. For example, if future operational objectivesset in year one are exceeded in subsequent years,then cash and equity awards from year one whichare vesting in those subsequent years could beincreased.

In cancelling variable cash or variable equityawards for performance, risk or integrity missesdue to negligent or intentional acts, boards should


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utilize hold-backs and claw-backs. A hold-back occurs during the vesting period of theaward: the cash or equity never goes to the recipi-ent. A hold-back occurs at the discretion of thecompany, and employees have to bring an actionif they believe the corporate action was improperor unfair. A claw-back occurs after the vestingperiod and requires some type of formal company

action to demonstrate that clearly articulatedstandards triggering a claw-back were breached.16

Similarly, compensation plans must risk assessjobs below the top business leaders and apply newcompensation design for individuals, not just topofficers, with the ability to commit resources withsignificant long-term opportunities and risks forthe corporation (e.g., those who sell instrumentscreating long-term obligations for the company).Compensation design will turn on specific perfor-

mance, risk and integrity parameters applicableto those individuals. But, the variable cash andequity compensation will outweigh annual cashcompensation. Here too, the board should havethe power to hold-back or claw-back variablecash or equity for negligent or intentional misseswithin a defined sphere of responsibility, as wellas providing for diminution or augmentation oftarget compensation in the outyears depending onenhanced or poor results.

But, even for those individuals important tocompany performance, compensation shouldhave an important element built on company anddivision results, not on solo contributions alone, tohelp create a strong and loyal culture.

Application of these principles would sharplyreduce two problematic compensation mechanismswhich, in the view of a number of commentators,drove short-termism and excessive risk-taking:

the naked stock option which rewards a simpleincrease in share price disconnected from attain-ment of priority operational goals; and

the huge annual cash bonus awarded withoutregard to risk consequences in the out-years.

Such a compensation redesignlike establishingmeasurements for risk, performance and integrity

accountabilityrequires new thinking and hardwork.

One problem is devising multi-factor mea-surements (performance, risk, integrity) in theright proportions that reflect the mission of thecompany but are not so complex as to be confusingor opaque nor so simplistic as to be a distortion of

reality.A second difficulty is ascertaining whencompany leaders or individual performers havemade a difference by their effortsthe kind ofdifferentiation which should be at the core of allcompensationor whether exogenous conditionshave affected results, either on the positive or thenegative side. Leaders and key employees shouldnot be penalized for events beyond their control,but neither should they be rewarded excessively for

such occurrences.A third criticalissue is pay equity (which hasdrawn tremendous fire in the financial sector):both the absolute amount and the amount relativeto other key personnel inside the corporation.Companies need to face into the question: howmuch is too much?

All these issues should be addressed in a revisedcompensation regime.

e revised approach to compensations should becommunicated in clear, understandable terms toshareholders and others. Meaningful, nuanceddiscussion with appropriate groups about the ap-proach to compensation, including but not limitedto shareholders, is more important than a bluntadvisory vote of compensation philosophy, mea-surements and results at shareholders meetings.

6) Re-aligning the Boards Oversight Function.

e critical oversight function of the board of direc-tors should be aligned with the performance, risk andintegrity measurements which indicate whether thecompany is attaining high performance, sound riskmanagement and high integrity and which will beused in delivering compensation to the CEO and topbusiness leadership over a multi-year period.

is alignment should help directors focus, in theirlimited time, on what is essential.


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Properly seen, strategy from the board perspec-tive is not just commercial strategy, but the mostimportant performance, risk and integrity issuesfacing the corporation both in the coming year andover a longer-term planning horizon (3-5 years?).

At the end of each calendar year, the CEO andtop business leaders should present to the board

of directors a list of key performance, risk andintegrity issues. From this list andfrom their ownassessment of corporate challenges, the board willchoose the priority board meeting issues for thecoming year. is choice will set the core boardagenda, subject, of course, to the emergence of newhigh-priority issues. A robust director discussionof these possible priority issues, not just a quickrubber stamp, should occur at this critical end-of-year event.

e independent board chair or presiding directorwill ensure that these issues are, in fact, coveredin depth during the course of the year and thatthe core trade-offs and considerations are fairlyand candidly discussed with the board (whetherin written materials, oral presentations or somecombination). Requiring boards to give approvalsor considered views on hard issues after just onemeeting should be resisted. Structuring sequentialdiscussions of complex and important issues overseveral meetings may help the board more fully

come to grips with priority matters. e boardstask is to review, appraise, critique and enrich theanalysis and decision relating to these issues.17e business leaders should strive to present theboard with high-quality information focused onthe priority issues and the real choices or options.Quality, not quantity, and absolute candor on thehard issues, not vague descriptions of the decision,should be the touchstones.

At the end of each year, the CEO and business

leaders should prepare a report for board of direc-tors review on how the company has performedon the various measurementsand whether, inlight of experience and emerging developments,the measurements for the following year should bemodified. Such a systematic review, coupled withthe agenda-setting exercise for subsequent boardmeetings, can require significant board attention inthe fourth quarter both to assess the current year

and to plan for the subsequent one. It is hard toimagine a better use of board/management time.Such a review may also require intense discussionsbetween the board leader and the CEO in advanceof the board meeting to improve the candor andcompleteness of the presentation.

To increase accountability, the board of directors

and business leaders could consider how to makea report available to the public which in clear,concise form discusses the record of the yearagainst operational goalsand the operationalgoals and issues for the following year. At present,discussions at end-of-year analysts meetings, inProxy Statements (e.g., on executive compensation)and in Annual Reports (CEO letter/ManagementDiscussion and Analysis) may not present a clear,comprehensible accountin plain, understandablelanguageof past goals, present record, future

goals. A new joint Board-CEO statement orrecasting of the CEOs letter to the shareholders inthe Annual Report could constitute such a plainEnglish report.18

* * * * *

Carrying out these six foundational, interrelatedgovernance tasks is the core of a right-sized, critical butconstructive relationship between a corporations boardof directors and its CEO/senior business leadership.

Carrying them out well should help create a strong,durable growing corporationand could addressthe current crisis of confidence in the governance ofcorporations.


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Boards of directors and business leadership musthonestly confront key obstacles to this basic reorienta-tion of corporate governance. A brief enumeration ofsalient problems follows, which is intended to raiseissues for further discussion, action, research andanalysis.

1) Labor Markets. Can individual corporations whichdefine short, medium and long-term performance,risk and integrity operational objectivesand basesignificant deferred compensation on their attain-

ment compete in the labor market for businesstalent? Other business entities willing to use largeamounts of cash and options, with fewer pay-outrequirements, may seek to attract top leaders andperformers in a very competitive labor market.

One approach, beyond individual firm initiativesand well short of comprehensive public regulation,is for corporations in a particular industry group(or in a more general business association) todevelop a code of compensation principles (in a

manner that must avoid antitrust concerns). Acorporations commitment to such a code andsubsequent implementation could be reported insequential Proxy Statements. Such codes musthave principles which are specific enough to guideaction. ey must also avoid leakage eitherthrough an inability to ascertain clearly whethersignatories are keeping their commitments orthrough the refusal of peer entities to sign up inthe first place.

A less difficult, more traditional approach isto rely on institutional loyalty spawned by strongleadership. Such leadership can create exciting,empowered, growing corporations serving custom-ers with great products and services and meetingfascinating challenges in the global marketplace.Many people have important values, other thanmoney, that need to be served in an institutionand great leadership can make those values come

alive, can create loyalty and can, thus, attract,retain, promote and challenge outstanding indi-viduals from all over the globe. For those employ-ees motivated solely by greed, little can be doneby an individual firm dedicated to the changes inmeasurements and compensation described above.

2) Differing International Standards. Because of itscentrality to the effective functioning of the globaleconomy, the financial sector is the subject ofprocedural or substantive regulatory debates ad-

dressing some or all of the governance issues raisedaboveas well as important questions relating tobroader issues of safety and soundness. (See note1.) For example, the G-20 recently announced aset of broad principles covering risk and compensa-tion practices which should be subject to nationalregulation.19 But, the prospects for genuine har-monization of national lawsor even significantconvergenceare mixed, at best.20Until thathappens across major capital markets, there is agenuine risk that companies or talented individu-

als in the financial sector will take advantage ofregulatory arbitrage to avoid governmentalpressures for the types of changes outlined above,even if those changes are undertaken voluntarily byfinancial institutions. Similar regulatory arbitragemay occur with non-financial public companies asa result of different regulatory regimes across theglobe relating to governance (and other impactful)regulatory issues.

Companies concerned about the issues in this

Policy Brief need to consider political action intheir major markets to urge as much uniformity aspossible. Such political action could be directed atregulation which they believe is a necessary floorunder private action. But it could also be aimedat regulations with which they may differ butwhich will have greater adverse impact if lacking inuniformity (e.g., capital requirements or liquidityprotections).

III. Obstacles


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3 Change in Board Compensation Advisors. Manycompensation advisors to boards are expert incomparing executive compensation delivered atone company to compensation delivered at peercompanies. ey are expert in designing variousmechanisms for delivering that compensationsalary, bonus, deferred salary, deferred bonus,stock options or restricted stock units. But, for

boards of directors to revise compensation ofsenior executives and to oversee broader companycompensation regimes, they need their own advi-sors with additionalexpertise. Many reports focuson the advisers independence. at is important.But a revised skill set is of equal importance.

Compensation advisors to boards need to havea detailed understanding about how the companyworks in the context of global markets and globalsociety so that they can help the board have its

own perspective, when working with management,to define the operational performance, risk andintegrity objectives which are appropriate to thecompany and upon which a revised compensationregime must be built. Finding such an advisorwith business as well as compensation expertisemay require boards to go beyond the traditionalcompensation consulting firms. Eventually, a newcadre of independent consultants can emerge, butonly if boards of directors make clear that they

want advisors who can help analyze the businessgoals which must necessarily precede compensa-tion sound design.

4) Short-Termism of Institutional Investors. Perhapsthe most difficult of these difficult issues is how docorporations resist the short-termism of certain,important institutional investors? Such investorstoday own more than 60 percent of U.S. equitiesand drive the direction of the stock markets.Institutional investorswhether traditional ones

like pension, insurance and mutual funds or newermore ones like hedge funds or micro-second trad-ersmaybe primarily, even exclusively, interestedin short-term profits to beat composite bench-marks or to attain highly remunerative 2-and-20absolute returns. Individual investors place theirfunds with institutional investors and are likely tocare more about how the institution manages theirmoney, than about the underlying performanceof the companies owned by various funds. ere

is now substantial debate about whether (or overwhat period) the stock market accurately reflectsthe value and performance of a company,especially as the average holding period for equitiesis now less than a year.21

ese financial intermediaries can create pres-sures for behaviors that are not in the interest of

sustained value creation. Indeed they can injurethe company by forcing bad business decisions (ill-considered risk-taking, improper leverage to boostearnings temporarily, deferred investments ormaintenance costs, delay of R&D) or by creatingpressures for illicit ones (fraudulent accounting,improper payments). ese intermediaries maycare little for a corporations other stakeholderswho have a long-term financial interest in thecompany (e.g., long-term shareholders, creditors,employees, customers). Although empirical

research is needed to understand their impact onthe market in near, middle and long-term timeperiods, there is little question that institutionalinvestors with a short-term orientation are anincreasingly powerful force in the equity markets.

Two seasoned observers describe the problem.In a new book, economist Henry Kaufman says:Most investment relationships today are veryfickle. Portfolio performance is measured oververy short-term horizons.Day trades and port-

folio shifts based on the price momentum of thestockrather than anything having to do with theunderlying fundamentalsare commonplace.22Ira Millstein, a pioneer in the governance move-ment and proponent of shareholder voice, hasrecently expressed similar views.23So have theFederal Reserve and regulatory bodies in Europe.24

One answer is to begin a much closer examina-tion of the governance of these various types ofinstitutions, the compensation of fund managers

and the need for greater transparency.25But, giventhe variety of institutional investors, it may be along process to evaluate governance, fund managerincentives, the different market impact of differenttypes of institutional investors and, ultimately,whether any private or public, substantive orprocedural, governance reforms are necessary orappropriate.


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A second response is to consider adjustmentsto current tax and other public policy provisionswhich may promote short-termism.26

A third approach is for boards and corporateleaders to resist strongly the claims of short-term-ers where, in the best exercise of their judgment,actions to pump up short-term earnings and stock

price would be harmful to creation of long-termvalue. In standing up in such circumstances,business leadership needs to establish meaning-ful engagement with other investors who have alonger time-frame, either to secure support forthe corporations mission, objectives and methodof compensation or to make appropriate changessuch long-term investors suggest. Obviously,companies talk with major shareholders and holdanalysts meetings. But it is worth examiningwhether this process can be enhanced by more

complete, transparent discussion of the six seam-less tasks with advisory councils of shareholders,consistent with the strictures of fair disclosureto all investors. A question of great moment iswhether those longer-term investors concernedabout durable growth of corporations can counterthe influence of other financial intermediariesfocused only on market movements and their ownshort-term profits.

e United Kingdom is considering transfor-

mation of the third approach into a more formalstewardship codefor fund managerswhich,among other things, establishes best practicesfor institutional investors that choose to engagein discussions about long-term strategy (at timescollectively) with companies in which they invest(while not precluding a sell decision if that isdeemed the most effective response). Under thisproposed regime, institutional investors choosingnot to comply with the stewardship code would

need to explain their alternative business modeland reasons for not subscribing to the steward-ship code.27

5) Manipulating the Numbers. While it is importantto translate a redefinition of mission into opera-tional financial and non-financial objectives acrossperformance, risk and integrity dimensions, thesemeasurements must be meaningful and carefullyimplemented. While it is true, as a general matter,

that measurements drive behavior, it is also true,that, when consequential, there is always pres-sure to manipulate the measurements to hidenon-performance.

Boards of directors and business leaders mustuse audits and other checks and balances toensure that measures are milestones on the path to

corporate virtue not numbers to be gamed on theroad to corporate hell.

6) e Reduction of Pressure for Change. Althougheffects of the credit crisis, the deep recession andhigh unemployment are likely to remain for sometime, signs of bottoming out or of nascent recoverymay remove pressure for regulation which is alwaysat its height when circumstances are at their worst.And the threat of new regulation is one of thedrivers for private-sector change. Will companies

still face into the need for re-evaluating and pos-sibly revamping the essentials of governance as therecovery grows in strength?

All companies, even (or especially) well-man-aged ones, should view this period of economicdiscontinuity as an appropriate time to review thefundamentals of what the corporation stands forand what are its core governance tasks. In fact,improvement in the economy, however slight, maylessen the need for full-time crisis management

and free up time to address these foundationalissues.


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e crisis of confidence in corporate governance leadsto the ultimate governance question of how boards ofdirectors and business leaders are held accountable.Although a number of mechanisms exist, they all leadback to finding boards of directors and business leaderswho can create sustained economic value for share-holders and other stakeholders with high performance,sound risk management and high integrity.

is is so because, while the main accountabilitymechanisms have strengths, they have also have

limitations.28

1) e Market. One answer to the accountabilityquestion is stock price. Maximization of shareholdervalue has been seen as the ultimate goal of the cor-poration and thus the measurement by which boardsand senior business leaders are held to account. Asdiscussed, the events of the past two years have raisedimportant questions about efficient-market andrational-choice theories which posit the market accu-rately assesses the value of the company. An important

question is when is the market yielding the rightvaluation answer, given, among other things, the riseof short-term institutional investors, the asymmetry ininformation as companies and products become morecomplex, the possibility of non-rational or irrationalbehavior at any point in time and the periodic creationof bubbles?29

So, even to say that the long-term value of a com-panys stock is an important way to measure account-ability is to raise questions. What is long-term? Is

a changed valuation in out-years a steady trend overtime or simply a short-term valuation at some futurepoint? In light of the widely divergent institutional in-vestor time frames, objectives, products, risk appetites,incentives, governance structuresand the irrationali-ties and inefficiencies of the marketthere are seriousand intense debates in the business, economics andfinance communities over whether, when and to whatdegree stock price is the proper measure for holdingcompanies accountable.

IV. Accountability and Leadership

2) Shareholder Involvement. A second answer to theaccountability question is more shareholder involve-ment in the governance of the company. Such involve-ment can be imposed by regulatory entities (federalgovernment, states, stock exchanges) or adopted bythe company itself (through voluntary changes orthrough responses to shareholder votes). One type ofchange is aimed at enhancing shareholder advisoryvoice. Recent examples are, of course, say-on-payshareholder advisory votes and attempts to make iteasier for shareholders to call a meeting. A second is

directly to affect the election of directors. One recentexample is the requirement that directors who receiveless than 50 percent of votes cast should resign (or beremoved from) the board. Another long-standing andcontroversial issue involves ballot-access proposalswhich would make it easier for dissident shareholdersto put a director nominee up against the boards ownslate in the election of directors.

Of course, as noted, there is no such animal as ashareholder. Instead, equity owners are a menagerie

of the individual and institutional; the short, long orboth; the technical or not. Whether shareholders arepart of the solution (because boards can be complacentand self-perpetuating) or part of the problem (becauseof the short-termism of important institutional inves-tors disconnected from any concern about the funda-mentals of the underlying company) is also a subject ofspirited debate regarding shareholder voice, access,and, of course, the rules governing takeover andcontrol, the ultimate exercise of shareholder power.

3) Government Regulation. A third accountabilitymechanism is government regulation, where publicdecisions limit the discretion and self-governance ofprivate corporations. Such limitations in our mixedeconomy have, of course, existed since the 19th centuryand have covered a wide array of issues from taxes todisclosure to listing requirements to environmentalhealth and safety.


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Today, in the case of financial institutions, global regu-lators are considering a number of substantive require-ments, which would limit business decision-making:e.g., counter-cyclical capital requirements, liquidityprotections, accounting standard revisions, creditagency reform, regulation of complex products, author-ity to address systemic risk, and special oversight forlarge complex organizations. Similarly, with respect to

all publicly held companies, various procedural/disclo-sure requirements are also under consideration, such asincreased transparency about how risk is managed andhow compensation is designed in order to discourageexcessive risk-taking. Organizational mandatessuch as a risk-committee requirementare alsobeing considered.

Here, too, there are sharp debates about: the shapeof regulation, its effectiveness, its possible unintendedconsequences and its impact on the necessary innova-

tion and creativity which drive companies and theeconomy.

* * * * *

4) Back to the Future: e Duties of Boards ofDirectors and Top Business Leadership. At the endof the day, this Policy Brief notes these importantaccountability mechanisms, and some of the key issuesthey raise. But, because of its focus on self-governance,it does not address the debates swirling around them.

Instead, it stresses that the goal of accountabilitymechanisms briefly described above (with a caveatabout short-term investors disinterested in companyfundamentals) is, or should be, a board of directors andtop business leadership that discharges the six seamlesstasks with vision, energy and effectiveness to createlong-term value for shareholders and stakeholders.

e stock market, the shareholders, and the govern-ment cannot lead and manage the corporation. eultimate accountabilityand responsibilitystill lies

with the senior executives and an engaged board of di-rectors. is is so for traditional but still fundamental

reasons. Corporate decisions require judgment inmaking the inevitable trade-offs. Only management,under board oversight, can effectively implement thecorporate mission. Indeed, outstanding leadershipfrom boards and business leaders answers the prob-lems which the other accountability mechanisms seekto solveoutstanding leadership, not complacent,self-protecting boards.

But, as this Policy Brief has argued, boards of direc-tors and senior executives must explicitly address thisfundamental issue of accountability. Accountabilitycan be improved if corporate leadership focuses on thesix seamless tasks and if it articulates, both inside andoutside the company, a set of performance, risk andintegrity operational objectives which are clear andunderstandable and against which boards and seniorexecutives can be measured and held responsible. Suchmeasures flow from a redefined mission which shapes

leadership development, CEO selection, and definitionof operational objectives. ese tasks, in turn, focusexecutive compensation on the right issues and re-alignboard oversight on the right priorities. Candor inassessing how the company is doing in relation to itskey operational objectives is essential to accountabil-ityand to creation of trust.

In this turbulent era, when debates about the role ofmarket prices, shareholder actions and governmentregulation are on the front burner, it is vital that

boards and business leaders step up to the questionsabout the capacity of corporations to govern them-selves effectively.

Many reports, like this one, address hard problems,with deep structural roots, by calling for leadership.Too often that plea goes unansweredor the struc-tural problems are too intractable. But today, witha governance crisis in confidence, it is in the interestof corporations and of capitalism itself for people inleadership positions truly to address the governance

problems of the era and to provide a clear, credible andpowerful private sector response.


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Endnotes

1 In focusing on self-governance issues, the Policy Brief doesnot intend to minimize the importance of the public policydebate on how to assure the safety and soundness of finan-cial institutions in the f uture through regulation of such is-sues as capital requirements, liquidity protections, systemicrisk, special regulation of large financial institutions, rating

agency reform and reform of accounting standards.Similarly, the Policy Brief does not argue the pros and consof, nor minimize the potential importance of, more generalgovernance public policy issues which are currently thesubject of legislative or regulatory debates: e.g. compensation (say on pay, clawbacks, no severance for poor performance,independence of compensation committee, independenceand disclosure relating to compensation consultants;disclosure of relation between pay and risk); directorelections (proxy access, ban on broker voting, abolition ofstaggered boards, majority vote in uncontested elections);risk (creation of special r isk committee; increased disclosure

on risk); other (independent board chair; disclosure ofreasons for board chair/CEO structure). e Policy Briefdoes address a number of these issues, but in the context ofdesirable corporate self-governance and self-determination.

2 See, Committee for Economic Development,Built toLast: Focusing Corporations on Long-Term Performance,(Washington, D.C.: CED, 2007); Committee for EconomicDevelopment, Private Enterprise, Public Trust: e Stateof Corporate America After Sarbanes-Oxley,(Washington,D.C.: CED, 2006); Task Force of the ABA Committee onCorporate Governance Issues, Report on the Delineation ofGovernance Rules and Responsibilities(Washington, D.C.:ABA, 2009); Aspen Institute, Overcoming Short-Termism:A Call for a More Respons

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