Giving the boot
Boards with new backbone are dumping imperial CEOs
Last week's conviction of former WorldCom CEO Bernard Ebbers--and the very real possibility that the rags-to-riches entrepreneur will spend considerable time behind bars--are expected to have a chilling effect in executive suites across corporate America.
But to members of corporate boards, a perhaps scarier event happened earlier this year. In January, a massive shareholder lawsuit arising out of Enron's bankruptcy was settled with an unprecedented twist: Ten former directors were held personally liable for the company's apocalyptic 2001 collapse, requiring them to fork over a total of $13 million out of their own pockets. A similar settlement was announced in a WorldCom shareholder lawsuit, though it was subsequently voided, and a new agreement is expected this week.
Money talks. Corporate governance experts say the prospect that once cushy directorships could now become a liability, in the true sense of the word, is one reason for the recent spate of hasty ousters from the executive suite. "For directors, it certainly focuses the mind," says Harvard Business School Prof. Rakesh Khurana.
So perhaps it is no surprise that the list of ousted executives includes both those whose sin was failing to deliver on their promises to shareholders--like Hewlett-Packard's Carly Fiorina and Disney's Michael Eisner--as well as those whose sin was, well, real, such as Boeing's Harry Stonecipher, who lost his job after acknowledging an affair with a subordinate. Such entrenched imperial leaders as AIG's Maurice "Hank" Greenberg are not above boardroom discipline as soon as a whiff of scandal arises. Even the Japanese, whose love of ritual and respect for hierarchy are legendary, are getting into the act: Sony directors replaced CEO Nobuyuki Idei with Welsh-born American Howard Stringer in an attempt to shake up the company and boost its sagging stock price.
Power is shifting from the executive suite to the boardroom, and directors are taking their responsibilities as shareholder representatives more seriously. John Challenger, of the outplacement firm that bears his name, equates the shift with what took place in Washington following Watergate, when the power of the presidency shrank while Congress took on a more prominent role.
Shareholders, especially institutional ones, are playing a large role, prodding once lackadaisical directors to sit up and take notice. From mutual fund companies to state pension plans, these investors are flexing their muscles for a couple of reasons: First, academic research indicates that shares of companies with what are perceived to be good corporate governance provisions tend to outperform other stocks. Second, "investors view governance as a risk factor," says Patrick McGurn, executive vice president of Institutional Shareholder Services, which tracks corporate governance issues. "And right now, they are trying to mitigate risk in their portfolios."
Boardroom beheadings are by no means new. In the early 1990s, several high-profile CEO s at companies ranging from General Motors to IBM to American Express were also forced to walk the plank. But the pace of ousters is clearly on the rise. And it's not just the celebrity CEO s whose mugs grace the covers of the business books. Last year, 97 chief executives at Fortune 1,000 companies had to be replaced for one reason or another. That was up from 85 CEO s in 2003 and 44 in 2002, according to the public relations firm Burson-Marsteller. "Boards are being much more aggressive," says McGurn. "Whether it's a fear of personal liability or a desire to do better, boards are being prodded by investors to do a better job."
They're certainly working harder. A study released two weeks ago by Mercer Delta Consulting found that corporate directors spent 188 hours on average last year dealing with board-related matters, compared with 156 hours in 1999.
But most important, they're assuming a more critical stance with regard to chief executives, even imperious ones who ruled over their companies as virtual monarchs and treated directors as vassals. Case in point: AIG's Greenberg. Last week, the man who took American International Group public in the late 1960s and who has run the insurance giant for nearly 40 years agreed to step down under board pressure following an investigation into the company's financial practices.
Assertive. "Inside the boardroom, directors are asserting themselves in ways they didn't 10 years ago, and that includes standing up to the CEO," says Charles Elson, a director of the John L. Weinberg Center for Corporate Governance at the University of Delaware and a member of three corporate boards.
Greenberg's defiant attitude toward New York Attorney General Eliot Spitzer didn't help his cause. In the wake of the corporate scandals and the legislative and prosecutorial reactions to them, corporate boards are more wary than ever of ambitious dirt-diggers such as Spitzer, who seems eager to add another Wall Street scalp to his growing collection.
Ironically, it is the huge compensation that some corporate titans have secured--tied to the hope that the company's stock will rise along with their own--that has become a sword of Damocles hanging over their heads. Pay-for-performance has become unemployment-for-underperformance. "The reason we pay CEO s so much is that it is such a high-risk job," says Nell Minow, cofounder of the Corporate Library, an investment research firm.
Not that anyone should feel sorry for the ousted CEO s. Most will surface again at another company or on some friendly CEO's board. Fiorina takes a severance package valued at more than $21 million with her as a consolation, and Stonecipher has last year's $2.1 million bonus to live on as he figures out how to answer the divorce pleading from his wife, Joan.
For CEO s who dodge the bullet or are doing a fine job, the trappings remain handsome: Paychecks for American CEO s grew 7.2 percent in 2003 and 10 percent in 2002, according to a survey of 350 companies conducted by Mercer Human Resource Consulting. The median CEO compensation in 2003 was $2.1 million. Mercer's latest survey, with 100 companies reporting so far, shows their CEO pay was up 25.3 percent in 2004.
No tears. That such largess comes with strings attached--you might get fired if you underperform--would hardly seem unfair to the average salaried worker. "If you want job tenure, there's a great position in the mailroom," says Minow.
But not in Disney's mailroom, at least not for Magic Kingdom kingpin Eisner. Last week he announced that his 21-year reign over the House of Disney will end in September, a year earlier than planned. Eisner has long been a poster boy for outlandish executive compensation, having taken home over $1 billion during his tenure at Disney. And though he transformed the company from a sleepy but well-known brand into a media and entertainment powerhouse, the board seemed to want to know what he had done for shareholders lately. "Eisner overstayed his welcome," says securities analyst Dennis McAlpine. "He did very well when he had things he could do, but after he got those cleared up, what was he going to do for an encore, go after the window washers?"
The same goes for Fiorina. HP shares are down 30 percent since she took over in July 1999, and the $19 billion merger with Compaq Computer that she engineered in 2002 hasn't yielded the proverbial "synergy" she promised. Last month, HP directors asked for and got her resignation. "Carly's the greatest saleswoman on Earth, but she failed to execute," says Minow.
Not so with Franklin Raines of Fannie Mae. Revenue and earnings were up the past few years at the home mortgage giant, but regulators say accounting sleight of hand was used to smooth earnings to trigger executive bonuses. Raines, who had come under repeated criticism from lawmakers in Washington, was pushed aside in December after the company announced that it would restate earnings for the past four years.
Fannie Mae clearly has major problems with regulators. But in this cautionary new era, even a hint of impropriety can mean curtains for an executive, where once a slap on the wrist and a bit of clever public relations might have sufficed. Boeing's Stonecipher was pushed out although his acknowledged affair was consensual. The fact that he violated the very ethics code of conduct he required all of the company's employees to sign only underscored his precarious position. "Right now, there's no forgiveness and no burying mistakes," says Challenger.
And though boards are moving aggressively in some instances to force out CEO s, they still tend to be pragmatic when it comes to finding a successor. Last year, 66 percent of all CEO successors at Fortune 1,000 companies were insiders, much like Robert Iger, who has been selected to succeed his longtime boss at Disney. That's up from 2002, when 61 percent of newly named CEO s emerged from inside the firm.
That said, the question is, Which CEO is next? Among those on the short list of Wall Street insiders are people like Raymond Gilmartin of Merck, who is now contending with a painful recall of pain reliever Vioxx, as well as the class action lawsuits and falling profits that it has spawned.
Predicting the next CEO to fall is an uncertain science at best. What's certain is that there will be a next one, and more after that.
FIORINA
A great saleswoman, she drove the controversial merger of HP and Compaq but never delivered on the expected synergy. Meanwhile, Dell ate HP's lunch in PCs.
STONECIPHER
Brought back to clean up after an Air Force scandal, he instituted a companywide ethics code. His own ethics came into question after he admitted an affair with a colleague.
IDEI
The Japanese head of Sony lost his job to a westerner after the company fell behind Microsoft and Apple in the rapidly changing music and video game business.
GREENBERG
He personified insurance giant AIG with four decades at the helm, but a growing investigation of the insurance industry by New York Attorney General Eliot Spitzer did him in.
RAINES
The former White House budget director found political connections couldn't save him when the mortgage company was forced to restate billions of dollars in past earnings.
EISNER
After a strong start, the longtime head of the Magic Kingdom lost his mouse ears when shareholders and Disney heirs seized on a series of business blunders and PR fiascoes.
With Betsy Streisand
This story appears in the March 28, 2005 print edition of U.S. News & World Report.