The Wall Street Journal-20080114-Corporate Governance -A Special Report-- Why CEOs Need To Be Honest With Their Boards- Too often- chief executives sugarcoat the truth- That-s more dangerous than ever
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Corporate Governance (A Special Report); Why CEOs Need To Be Honest With Their Boards: Too often, chief executives sugarcoat the truth; That's more dangerous than ever
As a former chief executive officer of Gillette Co. and Nabisco Inc., James M. Kilts knows a thing or two about dealing with corporate boards. So when Mr. Kilts gave a keynote speech at a corporate- governance conference last April, he decided to share some of what he has learned over the years.
The advice was surprisingly simple. "Tell the truth," Mr. Kilts told the crowd of executives, directors, corporate-governance gurus and others. CEOs, he said, must be open with their board about a range of issues, from the failure of strategic plans to unsavory business practices within the organization.
Such a recommendation may seem obvious, but people who have spent time in corporate boardrooms say honest communication is often lacking between CEOs and their fellow directors. "Communication and transparency being a problem is more the rule rather than the exception," says Steve Wheeler, a vice president with consulting firm Booz Allen Hamilton.
In some cases, this lack of honesty makes the headlines -- when CEOs backdate stock options without informing their directors, for instance, or hold merger talks without permission from the board. But there are less dramatic, and much more frequent, communication problems that are just as damaging. We're talking here about the CEOs who try to solve problems themselves without keeping the rest of the board informed of new developments. Or the CEOs who are reluctant to admit mistakes -- and may massage the truth to make things appear better than they are.
"Many times it's the thing not said, or overly optimistic positioning, that gets CEOs in trouble," says Mr. Kilts, now a partner at Centerview Partners, an investment-banking and financial-advisory firm he joined in 2006.
In many cases, the CEOs have the best of intentions. As leaders, they want to take charge and inspire confidence, even when things are turning sour. But that instinct can lead them to be less than forthcoming about problems -- which can snowball into severe tensions with directors. That's especially true these days, as calls for good governance grow louder and directors seek to shed their image as fiduciary figureheads, insulated from a real understanding of the companies they serve.
In order to properly oversee these companies, boards need to believe that the CEO -- who's often their main source of information -- is giving them an accurate picture. "In the past, CEOs had carte blanche to do what they needed to do to run the company," says Dirk Hobgood, a governance and risk-management consultant, and chief financial officer, at consulting and executive-search firm Accretive Solutions, based in Hauppauge, N.Y. "Today's CEO really has to work effectively as a team member with the board and keep them up-to-date, and keep the players involved."
CEOs who fail to make that leap increasingly risk being fired. In 2006, 31.9% of CEOs who stepped down world-wide did so due to conflicts with the board, up from 12.4% in 1995, according to a recent Booz Allen study. The forced departures were "nearly always because of transparency issues," says Mr. Wheeler, who co-wrote the study.
For the most part, the nature of CEO ousters escape public notice because they're far from cut-and-dried cases of deception or dishonesty. Rather, they represent a slow deterioration of trust. So the termination is generally packaged as a "loss of confidence" or some other tenuous phrase.
"Typically, there are multiple events where the board felt left out or felt the CEO was leading them down a path, giving them just enough information to be able say, 'I kept you informed,'" says Mr. Hobgood of Accretive Solutions. "I've seen CEOs fired for this, and the situations become 'a lack of confidence.' The board is saying, 'I no longer believe that this person is credible or is going to involve me in situations. I feel I am being led down a path.'"
In addition to getting the CEO fired, failure to keep directors in the loop can also increase liability for the company. In a handful of recent lawsuits, judges have sharply rebuked CEOs who made big plans without informing their board.
Consider the case of Kinder Morgan Inc., a large transportation and energy company in Houston. In 2006, groups of shareholders who had filed suits in state courts in Kansas and Texas were seeking to prevent a special meeting of shareholders to vote on a sale of the company. The investors alleged that the management-led buyout was undervalued. They further argued that Rich Kinder, the company's founder and chief executive, and Kinder Morgan's other directors and officers breached their fiduciary duties in crafting and approving the buyout.
A retired judge, appointed by the court to look into the matter, ultimately recommended in favor of the company, saying the board did its due diligence. But he also made pointed remarks about the CEO's approach to the acquisition, saying it was done in a "somewhat stealthy fashion."
According to the retired judge, Joseph T. Walsh, Mr. Kinder went about formulating a sale with a group of private-equity buyers without informing the full board of the extent of his negotiations. When the details of the plan were announced to the board, "it is fair to say that the independent directors were taken by surprise," wrote Mr. Walsh.
However, Mr. Walsh decided that the board took the appropriate steps to evaluate the proposal once it was presented. Among other actions, the board created a special committee to weigh the offer and, with the help of their own independent advisers, they canceled agreements made between Mr. Kinder and the buyers in order to open the door for other potential offers. In the end, the company accepted a higher offer from the private-equity group.
The directors involved either declined to comment or couldn't be reached for comment. When asked about Mr. Walsh's comments, Mr. Kinder said in a statement, "Justice Walsh ruled in our favor. While it is certainly possible to search through his order and pull out the few statements in which he criticized us, the vast majority of his order and certainly his conclusions were favorable to us."
Of course, it can be tough for even well-intentioned CEOs to know when to inform a board, and missteps are inevitable. One difficulty is that the line that used to separate management's role from that of the board has blurred, making it harder for executives to know when to say something, says Chuck Lucier, senior vice president emeritus at Booz Allen and co-author of the CEO study.
In the past, boards were content to act as overseers, approving management's plans and rarely taking an active role in developing those plans. Today, boards are more likely to want their input sought throughout the process, Mr. Lucier says.
"There used to be a bright, clear line: We, the management, made the decisions and they, the board, reviewed and approved those decisions," says Mr. Lucier. "That bright, clear line has gotten really fuzzy now."
This is forcing executives to start informing boards of major plans and problems sooner than in the past. For less urgent news, such as small bumps in a strategic plan, CEOs might simply add an item to the agenda of the next board meeting, suggests Jim Copeland, former CEO of accounting firm Deloitte & Touche and currently a director on several corporate boards. In more serious situations, such as an unsolicited acquisition bid, CEOs might schedule a conference call with the board, or alert the independent chairman or lead director, Mr. Copeland says.
In some cases, the transition may require some prodding by directors. Mr. Hobgood once worked with a company where the CEO, who was also the founder, perfunctorily informed the board of operating issues because this was the way things had always been done. The board was also generally content to operate this way -- until the company started performing worse than expected. On several occasions, the CEO and the CFO informed the board, just days before quarterly results were released to the public, that the company had missed its earnings projections. So the board demanded a change.
"The board essentially said, 'If you want to continue to work in this role, you guys need to communicate with us,'" recalls Mr. Hobgood. "Letting the board know a week before the rest of the markets know you've missed your quarterly earnings doesn't work anymore. They want to know throughout the quarter: 'If we're not going to meet our guidance, let's start talking early on about what our strategy is.'"
Why is it so tough for CEOs to keep the board informed in a timely manner? Simply enough, CEOs want to appear to be in control, experts say. It can be hard for them to concede defeat or to admit they don't have all the answers.
"I think sometimes CEOs struggle with the question of when to share bad news largely because they want to bring solutions, not problems, to the board," says Mr. Copeland, the former Deloitte & Touche CEO. "They want to be able to say, 'We have this problem, and here's what we're going to do about it.'"
CEOs can also be reluctant to admit that things are not progressing as expected, or that a change in plans may be warranted. This is especially true when it comes to the executive's vision for the company.
It's the CEO's job to "put a good face on things to mobilize and drive the changes that any company needs going forward," says Mr. Lucier. "This requires inspiring people and giving them the confidence that if you only make this last push you will get there."
Such qualities can breed success at the bargaining table, but they can be detrimental if used too heavily in the boardroom. Today's directors want to feel that they can rely on the CEO for an accurate and up-to-date picture of how things are progressing.
"If you try to put the best light on a bad situation and the best light is an overly optimistic light, you lose credibility with the board," says Mr. Kilts. "Many times what you will do is say, 'Maybe something will turn this around, or maybe the situation will get better.' Generally, it never gets better. It gets worse."
Of course, it can be hard to get up the courage to tell the board something it may not want to hear. For Mr. Kilts, his toughest boardroom interaction came shortly after he was appointed to run Nabisco in 1998. He wanted the board's approval to reorganize the company's sales force, a change that would cost $100 million. Mr. Kilts's plan would undo changes the board had just approved two years earlier, alterations that had already cost $50 million. To Mr. Kilts, the initial reorganization hadn't worked, but telling this to the board wasn't going to be easy.
"I can still remember some board members looking at me like I had three heads," Mr. Kilts recalls of the experience. In the end, the board approved his plan.
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Ms. Whitehouse is a reporter for Dow Jones Newswires in Jersey City, N.J. She can be reached at [email protected]. The Wall Street Journal's Joann S. Lublin contributed to this article.
