Independent Chairman (Separate Chairman/CEO)

Discussion

The positions of chairman and CEO are two distinct jobs with different job responsibilities. The chairman is the leader of the board, which is responsible for selecting and replacing the CEO, setting executive pay, providing advice and counsel to top management, monitoring and evaluating managerial and company performance, and representing shareholder interests. By contrast, the CEO is responsible for managing the day-to-day operations of the company, acting as the company's spokesperson, and formulating strategy for the company, subject to the board's approval.

Some believe that having the same person hold the positions of chairman and CEO calls into question whether the board can adequately oversee and evaluate the performance of senior officers (including the CEO) and the company. This has been driven home by the rash of accounting scandals at firms such as Enron Corp., Tyco International Ltd., and Worldcom Inc. As observed by Harvard Business School Professor D. Quinn Mills, “CEOs in large American publicly held corporations have too much power; that's the core of the abuses that have been going on. You have to reduce the power of the CEO, and one of the very few ways to do that is to separate the chairman of the board position from the CEO position.”[1]

Combined Role Is Common in the U.S.

Despite the apparent conflicts of interest involved in having a unified post of chairman and CEO, the practice continues to be common. As of Jan. 1, 2007, ISS data on more than 5,500 companies showed that 48.5 percent of firms still combine the chairman and CEO jobs, while 44.4 percent separated the two positions.

In cases where the CEO also serves as chairman, some governance experts advocate the establishment, formally or informally, of a "lead director" position. While the duties may vary company to company, the lead director typically is responsible for scheduling and setting the agenda for board meetings, leading executive sessions of the outside directors, ensuring that directors have the information necessary to perform their duties, organizing performance evaluations of the CEO and the board as a whole, and leading the board in crisis situations.[2]

Opponents of separating the positions of chairman and CEO argue that such a leadership structure can create two power centers, compromising the CEO's ability to lead the company. However, directors tend to favor the split roles, according to a 2006 Russell Reynolds' Board Member Survey. The survey found that 59 percent of directors polled advocated separating the positions of CEO and chairman.[3] An October 2003 survey by Pearl Meyer & Partners of 84 directors at the 200 largest U.S. companies showed that 69 percent favored the appointment of a lead director and 40 percent supported the idea of having a non-CEO chairman. [4] A 2007 survey of 200 U.S. firms by Grant Thornton indicated that 78 percent of chief financial officers at those firms support independent board chairs.

Many institutional investors support an independent chair as the preferable leadership structure. However, in the absence of an independent chair, institutional investors generally favor an independent lead director with clearly defined duties as an effective counterbalance to a combined chair/CEO. According to ISS’ 2007 policy survey, 36 percent of investors find a combined CEO/chair to be generally unacceptable.

Although a combined chairman/CEO is commonplace in the United States, the positions are separated in other countries. Across Europe, combined chairman/CEOs are disappearing rapidly. Separation of the positions is considered best practice in Canada, France, the U.K., and Switzerland. For example, in Switzerland--which is home to some of the world’s largest financial and pharmaceutical companies--only 7 of the largest 100 companies by market capitalization now combine the positions. In Germany, due to a dual board structure mandated by law, the combination of CEO and chairman positions is excluded completely. In France, where companies have the option to choose between a united or dual board structure, companies that choose a unitary board with a combined chairman and CEO have all but disappeared.

In the United Kingdom, it is common practice to separate the board chair and CEO positions. In fact, after a series of business scandals in the 1990s, the Cadbury Committee on the Financial Aspects of Corporate Governance drew all of Britain’s mainstream economic institutions behind a new “Code of Best Practice” that recommended that companies split the positions to enhance board oversight and guard against the possibility of an “all-powerful” chairman. If one person holds both positions, Cadbury held that there should be a strong group of outside directors, led by a single individual, on the board.

Lead Directors

In a 1996 article, Constance Bagley and Richard Koppes suggested that boards need to be encouraged either to separate the roles of chairman and CEO or to select a senior independent director to lead the independent directors (a lead director; at some companies a vice chairman may fulfill the same role).[5] The authors propose that the stock exchanges amend their listing policies to require companies to disclose in their proxy statement whether the roles of chairman and CEO are separated and, if not, whether a lead director has been selected. If the board leadership structure permits a combined post for the chairman/CEO or fails to designate a lead director, companies would be required to provide an explanation in the proxy statement as to why such a structure is in the best interests of the company and its shareholders.

The Conference Board's Commission on Public Trust and Private Enterprise similarly recommended three approaches to achieving an appropriate balance between the board and CEO:

1. Separate the offices of chairman and CEO, with an independent director serving as chairman.
2. Separate the two roles and allow a non-independent director to serve as chairman, provided that he is not a member of management and does not report to the CEO. In this circumstance, a lead independent director or equivalent position should be established.
3. Where boards do not choose either of the above, a presiding director position should be established.

In the last two scenarios, the Commission advises that the lead or presiding director should work closely with the chairman on approving the information flow to the board, meeting agendas, and meeting schedules; chair board meetings in the absence of the chairman; oversee meetings of the non-management directors; serve as the principal liaison between the independent directors and the chairman; and take a leading role in the board evaluation process.

In the wake of Enron's bankruptcy in 2001, the New York Stock Exchange (NYSE) reached an alternative solution. To better empower the board to serve as a check on management, the NYSE required listed companies to appoint a "presiding" director from among the non-management board members to oversee executive sessions of the outside directors. The name of the presiding director would also be disclosed in the annual proxy statement to facilitate communications between shareholders and outside board members. While this position provides some counterweight to a combined chairman/CEO, it is not as strong a leadership structure as a non-executive chairman or lead director with a more expansive set of duties. By 2007, 53 percent of S&P 1,500 companies had appointed lead or presiding directors, up from 17 percent in 2003, according to ISS' Governance Research Service data.

Martin Lipton and Jay Lorsch, two of the main proponents of the lead director position, argue that the concept of a lead director is a critical factor in making boards more effective. A lead director can serve as a communication conduit for outside board members to air their concerns and ensure that their issues are included on the chairman's agenda. In fact, in many boardrooms such a leader is already recognized by management and the outside directors.[6]

This is a natural concomitant of responsibility for audits, compensation, and nominations being placed in the hands of committees of outside directors. The chair of one of these committees usually emerges as the leader of the outside directors. Some companies, such as Pfizer Inc., have taken this a step further with a "jurisdictional" lead director. In this instance, the chairs of the audit, compensation, and governance committees each act as the chair at meetings or executive sessions of the outside directors at which the principal items under discussion are within the scope of his or her committee's authority. In other cases, the director with the most seniority or the one most respected by the other board members develops the lead role.

Separate Roles and Firm Performance

Attempts to correlate the separation of position with market performance have been inconclusive. A study by three university professors shows that the stock price is unaffected by a company's announcement that it will adopt a unitary leadership structure or, alternatively, that it will separate the positions of chairman and CEO.[7]

According to the authors, (1) the market is indifferent to changes in a firm's duality status; (2) there is little evidence of operating performance changes around changes in duality status; and (3) there is only weak evidence that duality status affects long-term performance, after controlling for other factors that might impact that performance. Similarly, another trio of academics found that the costs of splitting the positions of chairman and CEO outweighed the benefits for most firms. [8]

Other studies, however, have shown that firms with a dual leadership outperform firms with a unitary leadership. For example, banks and large industrial companies with non-executive chairmen exhibit higher price-to-book multiples, returns on assets, and cost efficiency ratios than peers where the chairman also serves as CEO.[9] And conferring both jobs on one individual makes it harder for a board to replace a poor performing CEO. [10]

Splitting the chairman and CEO offices is not without drawbacks. It can be difficult to recruit a CEO without offering the chairman's title as well. And taking away a CEO's board chairmanship, or even appointing a lead director, could trigger termination provisions in the CEO's employment and severance agreements since it constitutes a reduction of duties. More important, simply dividing the jobs is not enough: the non-executive chairman should be an independent director for the structure to be meaningful. Having a “lingering” former CEO serve as chairman, other than for a transitional period, may represent a worse scenario because it could undermine the new chief executive's ability to pursue his own strategy and direction. (See “Voting on Director Nominees in Uncontested Elections: Retired CEOs.” )

The same holds true of a lead director. If the person is not independent or lacks substantive duties, the position is simply cosmetic. This was aptly demonstrated at Tyco where former lead director Frank Walsh chaired CEO Dennis Kozlowski's compensation committee, controlled two companies that did business with Tyco, and received $20 million in payments for orchestrating the firm's failed merger with CIT Group Inc. [11]

A 2007 study on options backdating and board interlocks found that “the likelihood of a firm initiating backdating is also positively correlated with the stock and option ownership of the CEO, and when the CEO is also chairman of the board.[12]

Reaching a Voting Decision

While generally in favor of separating the positions, ISS looks at this issue on a case-by-case basis. Small companies with a limited roster of executive officers and recently reorganized companies may find it necessary to combine these positions, at least in the short term. Other companies may have a governance structure in place that counterbalances a combined chairman/CEO position. (See the bulleted list at the beginning of this section for factors that such a structure should encompass.) As noted above with Tyco, shareholders should be vigilant of performance issues and alternate structures that are not effectively serving shareholders’ interests.

Given the growing importance of the functions of an independent lead director versus the best governance practice of appointing an independent chair, the policy adds two additional factors for consideration in its evaluation of shareholder proposals calling for an independent chair: (1) a comparison between the duties of its independent lead director and non-independent chairman; and (2) a sufficient explanation for not appointing an independent chair and instead maintaining both a non-independent chair and an independent lead director. The purpose of adding these two factors in our evaluation is to gain more insight from companies on the duties of the lead director, a rationale for maintaining a combined chair/CEO structure, and any associated benefits to shareholders of not appointing an independent chair.

However, consistent underperformance by a company in comparison to its peer group (which consists of 12 companies closest to the company in revenue at fiscal year end within the company’s 6-digit GICS group) and index (both measured on 1-year and 3-year time frames) would indicate a need for the separation of these roles, even if the company has an appropriate alternative governance structure in place.

Notes

[1]	Randy Myers, “Chairman + CEO: Two Jobs, Two People.” Corporate Board Member, March/April 2003.
[2]	The Conference Board, "Directors Compensation and Board Practices 2002." The American Society of Corporate Secretaries, "Current Board Practices 2002."
[3]	Russell Reynolds Associates, " Board Member Survey—Changing Leadership Roles: Splitting Chairs," Feb. 1, 2006
[4]	Pearl Meyer & Partners 2003 Survey: “What Directors Want.”
[5]	Bagley, Constance and Richard Koppes, "Mandated Disclosure of Board Leadership Structure," The Corporate Governance Advisor, November/December 1996. Vol. 4, No. 6, pp. 10-13.
[6]	Lipton, Martin and Jay Lorsch, "The Lead Director Proposal." The Corporate Governance Advisor, April/May 1993, p. 20. Hilary Rosenberg, “Should You Have a Lead Director?” Corporate Board Member, Autumn 1999.
[7]	Baliga, B. Ram, R. Charles Moyer, and Ramesh P. Rao, "CEO Duality and Firm Performance: What's the Fuss?" Strategic Management Journal, Vol. 17, No. 1, January 1996, pp. 41-53.
[8]	Brickley, James A., Jeffrey L. Coles and Gregg A. Jarrell, "Corporate Leadership Structure: On the Separation of the Positions of CEO and Chairman of the Board." Journal of Corporate Finance Vol. 3, Issues 3, June 1997, pp. 189-220.
[9]	Anil Shivdasani and Marc Zenner, "Best Practices in Corporate Governance: What Two Decades of Research Reveals," Salomon Smith Barney, August 2002. L. Pi and S. Timme, "Corporate Control and Bank Efficiency," Journal of Banking and Finance , Vol. 17: 515-30 (1993). David Yermack, "Higher Valuation at Companies with a Small Board of Directors ," Journal of Financial Economics , Vol. 40: 185-212 (1996).
[10]	Anil Shivdasani and Marc Zenner, "Best Practices in Corporate Governance: What Two Decades of Research Reveals," Salomon Smith Barney, August 2002. Vidhan K. Goyal and Chul W. Park, "Board Leadership Structure and CEO Turnover," Journal of Corporate Finance , Vol. 8: 49-66 (2002).
[11]	Louis Lavelle, “Just How Independent Are These ‘Lead Directors?' Business Week , May 12, 2003.
[12]	John Bizjak, Michael Lemmon, and Ryan Whitby, “Option Backdating and Board Interlocks,” February 2007.