Directors and Blame. Where does the fault lie?

Gretchen Morgenson wrote on Sunday in What iceberg? Just glide to the next boardroom in the NY Times that you would think that directors who oversaw companies that collapsed in the credit crisis would be disqualified from serving as directors at other public companies. “You would, however, be wrong.” She comments.

She then goes on to list three companies with a brace of directors each who served in some capacity on a failed financial company board. Failed boards like Countrywide Financial, Washington Mutual, and Fannie Mae. Directors from those companies serve on the boards of successful companies like Sunoco and PACCAR. PACCAR is, incidentally, one of our Pay for Success companies; a company that is being run so well that not only does it reward its CEO, it rewards its shareholders too. A company that, by our definition, has a well-functioning board. You can purchase the corporate governance risk profiles of any of the companies in the Pay for Success report here to read more about their policies.

So what do we make of this? Fair enough, the two PACCAR directors who served on the Washington Mutual board (for 38 years) and the Countrywide board (for four years) are two among a total of 12 directors, but they must still be having some kind of effect. Is it a good one and was the 38 years at WaMu just a bad dream? Or is their service on a failed company board irrelevant. Or is it an advantage?

I can see some situations where having a director with experience on the board of a company that has collapsed is valuable. They’ve been through it, so they’re going to make sure it doesn’t happen again. They’ll be more vigilant. They’ll ask the right questions. Insist on getting the right answers.

Sounds good in theory, but what if they were incriminated in the failure? What if their inability to do the job properly led, in part, to the company’s decline?

We’ve had our eye on this problem for a while. For example, our particular bête noir in this area, the poster boy of “boy, they shouldn’t be serving as a director anywhere” if you will, is Frank Savage, who served as a director of the Enron Corporation from 1999 to 2002.

Yes, that’s right, Enron. And those were the key years, too.

Mr. Savage currently serves on the ethics and corporate responsibility committee, ironically enough, of the Lockheed Martin board.

What’s more, Lockheed Martin is so unconcerned about Mr. Savage’s service on the Enron board that it is included in his biography in the proxy statement, where they are asking shareholders to vote for his election to the board. Even PACCAR coyly omits the WaMu and Countrywide service in its directors’ bios. What’s more, only 7.64 percent of Lockheed’s shareholders cared enough to withhold their votes from Mr. Savage.

So what does this mean? Directors were clearly culpable at Enron, if nothing else from sins of omission if not commission. The same must be said of directors at Countrywide, Lehman, Bear Stearns, etc, etc. Are they to be forever tarnished because of their association with those boards?

Gretchen’s article has already inspired a blog post by Peter Cohan called Why American Corporate Governance is a Bust, in which he discusses Thomas Gerrity who – says Gretchen – sat on Fannie Mae’s board during the whole accounting restatements cock-up and through the sub-prime collapse. Mr. Cohan worked for Professor Gerrity at one time, noting that he was a Rhodes scholar with a doctorate from MIT, and is, in his opinion, a brilliant thinker.

So what happened? Checked the brain at the door along with the coat? It doesn’t seem very likely.

Both Mr. Cohan and Gretchen come to the conclusion that it is simply a problem with the way that boards function. Directors are more keen to work for the CEO (who effectively chooses them and pays them and takes them on elaborate trips) than for shareholders, whom they are supposed to represent. This conclusion would seem to suggest that if directors simply cannot act independently then there is something seriously wrong with current corporate governance – not just here in the U.S. but almost everywhere. If we are to retain boards as a governance structure then a great deal more needs to be done to make them accountable to shareholders than is currently being considered by any of the governance-related bills before Congress.

Mr. Cohan suggests that they buy significant stakeholdings, and only directors who have these should be allowed to serve on boards. This would narrow the field for recruitment somewhat (it costs a lot of money), and would make public companies resemble private equity companies (is that such a bad thing?) or the family-owned companies that we are often told are outperforming the indices anyway.

An invested director is a caring director?

But there is an alternative theory to this suggestion. If directors are so invested in a company, so tied up in it, might they not be driven by the kind of impetus that drives executives with millions of stock options to book revenue that hasn’t been earned yet, to manipulate earnings, to artificially boost stock prices?

An invested director is a crooked director?

Clearly there is no single answer to this problem. But there are significant improvements to be made and the first step is to apologize.

Since we have strayed a long way from the initial premise of this blog posting – how come directors from failed companies get to keep their jobs elsewhere – it is time we got back to it. Now it might not be each director’s fault that, for example, Lehman went bankrupt, or that Countrywide was sold at a yard sale. But whether it was each directors’ fault or not, they were responsible. And one thing that has been conspicuous by its absence, as I told Gretchen when she called me up on Christmas Eve, is acknowledgement by these directors that they did not do their job properly or even very well. I have yet to see or hear or read a single apology to shareholders. Even a couple of CEOs have apologized, though only the ones that still have a job.

One of the things my Mum and Dad always taught me was that it is a sign of maturity to recognize when you have done something wrong and to apologize for it. It goes a long way when you are asking for forgiveness, and re-election is a form of forgiveness.

So.

Shareholders are waiting.

Paul Hodgson - Senior Research Associate

Comments

[James McRitchie]

Paul: I like your very thoughtful piece. I agree, apologies would be nice but what if these directors did everything they could to avoid trouble at Washington Mutual and Countrywide? Would they need to apologize for not convincing the rest of the board or for remaining on the board, instead of making a noisy exit?

One of the fundamental problems that shareowners have in monitoring boards is that they are such a black box. We don't know who is responsible for what, other than by what committees they sit on.

Instead of an apology, or perhaps accompanied by one, directors should offer up an explanation of what went wrong, their role in it, and what lessons they learned.

As I recall, the SEC's new disclosure requirements will mandate a list of boards served on. I'd love to see proxies also include statements from the candidates about why we should elect them... which could include apologies, lessons learned, etc.

[Paul Hodgson]

You are absolutely right, James, it's not just apologies that are needed but explanations if there is no fault.

Silence is simply unacceptable.

I did give the directors the benefit of the doubt on several occasions through the blog, but I did, on the other hand, get a bit dogmatic at the end.