Why good governance can come from smaller boards

Boards should be smaller, meet more often, and be populated by those with greater industry expertise, says a Harvard Business School lecturer and former general counsel for Fidelity Mutual Funds.
Robert Pozen provided his recipe for board reform at the Canadian Coalition for Good Governance annual general meeting in Toronto May 29. He said it’s high-functioning boards, not legislation, that leads to better governance. He went on to note there are too many “social loafers” on boards who are investing too little time understanding the issues of the company they are supposed to be serving.

“The problem with 14 or 18 directors is social loafing. If you’re part of that big of a board the thinking of many is, ‘well, someone else will take care of it.’ If you don’t feel that responsibility it is a very bad dynamic,” says Pozen.

Pozen was formerly chairman of Boston-based mutual fund company MFS Investment Management, and is currently a senior lecturer at the Harvard Business School. He sat on the board of BCE Inc. until 2009 and is the author of Too Big to Save? How to fix the U.S. Financial System. From 1987 to 1996 he was managing director and general counsel of Fidelity Investments.

During his talk, Pozen put forward his alternative model for boards. He thinks there should be no more than six directors on a board, along with the CEO, and that they should meet more than six times a year spending two to three days a month on board business. They should also be paid more for the extra work.

There should also be no mandatory retirement age for board directors as many are retired executives who still have a lot to contribute after they leave their companies.

Pozen outlined why regulatory legislation in the U.S. failed to protect against the actions that led to the financial crisis. For example, in 2002 after the WorldCom and Enron scandals, the United States Congress passed the Sarbanes-Oxley Act requiring a majority of independent directors, independent audit committees to oversee financial statements, and assessment of internal controls.

But the list of companies that were SOX-compliant includes Lehman Brothers Holdings Inc., Citigroup Inc., Wachovia (now Wells Fargo), Bear Stearns, Merrill Lynch, and Bank of America Corp.

“All of these companies had lots of independent directors and wonderful internal audit committees, so how is it possible that in a litigious society like the U.S. no one has sued any of those companies for violation of SOX? These requirements were supposed to bring about good corporate governance. The evidence was in the cooking — it didn’t seem to work,” said Pozen.

The most important change that came out of SOX, he noted, was a New York Stock Exchange rule requiring boards to hold “executive sessions,” which meant independent directors meeting without management present.

“When you have executive sessions people actually talk about what the problems of the company are. I think it’s a good idea to have executive sessions before every meeting. On a larger scale it suggests what is really important in governance is not so much all of these rules, but what you have as the culture of the board and how the peers view themselves,” says Pozen.

Citigroup’s board in 2007 was the poster child for a terrible board, according to Pozen. It was too big with 18 directors, 16 of whom were independent. Of the 16, only one had ever worked for a financial services company.

The average for financial services boards around the world is 14 members of which only three have financial experience.

“I’m all for being a dilettante but even I believe it’s a good idea with a financial services company to have the majority of directors who know something about finance,” he says.

On the issue of executive compensation Pozen says he doesn’t think it can be legislated — a more constructive way is to have better boards.

For example, as of February 2009 any senior executive of U.S. institutions that received any government assistance — some 600 companies — could not receive a bonus that exceeded one third of their base salary.

“So guess what happened? The base salaries all went up. At Morgan Stanley I saw the bases quadruple,” he says. “We have taken contingent performance bonuses based on whether you did a good job turned into guaranteed salaries.”

He is also against giving bonuses based on one year of performance. “Any young person can get lucky, I like to base it on three-year performance — it’s hard to get lucky three years in a row.”

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