Tuesday, April 10, 2018

Preventing CEO Distraction by Restricting Outside Board Service

Last week, the Neel Corporate Governance Center at UT Knoxville hosted one of UT Knoxville's alums, Ron Ford, as a featured speaker.  He gave a great talk on boards of directors, from his unique vantage point--that of a CFO.  In the course of his remarks, he mentioned a public company corporate gpvernance policy that I had not earlier heard of: a CEO limit or prohibition on outside board service (other than local, small nonprofit board service).  A 2017 study found that:

Only 22% of S&P 500 boards set a specific limit in their corporate governance guidelines on the CEO’s outside board service; 65% of those boards limit CEOs to two outside boards, and 32% set the limit at one outside board. One board does not allow the company CEO to serve on any outside corporate boards, and two boards allow their CEO to serve on three outside corporate boards.

This may be why I had not heard about governance policies limiting board service; it seems these policies may be relatively uncommon.  I know from experience that CEOs do serve on outside boards and often consider that service an important way to learn valuable things that can be implemented at the firm that enjoys them.

What is the ostensible purpose of a policy restricting the outside board service of a firm's CEO?  Perhaps it is obvious.  It seems that most firms imposing this kind of restriction on CEOs desire to prevent the CEO from spending significant time on his or her service as a board member of another firm to the detriment of the firm by which he or she is employed as chief executive.  An online article succinctly captures the capacity for distraction.

. . . CEOs must weigh . . . the potential disadvantage of having to navigate a crisis. David Larcker, a professor at Stanford Law School and senior faculty at the university’s corporate governance center, says that while most CEOs would say that serving on an outside board is highly valuable, everything changes if either company comes up against a big challenge.

“Where it gets really complicated for a sitting CEO is if something happens,” Larcker says. “You’re a takeover target. You have a big restatement. You’re replacing a CEO. That’s harder to predict and takes up a lot of time.”

Are there CEOs who have experienced this kind of distraction?  Yes.  A Forbes contributor offers a well-known example in an article entitled "All Operating Executives Should Never Serve On Any Outside Boards":

A good poster child of outside board distractions was Meg Whitman in her final 2 years at the helm of eBay (EBAY). During this time, she joined the boards of Proctor & Gamble and DreamWorks Animation. EBay flew Meg around to Cincinnati and LA board meetings on their private jet. EBay's stock sank. Meg bought Skype. It didn't help.

The same article also calls out two Yahoo! CEOs as further examples.  And there are others.  See also, e.g.here.

Although I was not familiar with governance policies that restrict outside board service, I did find references in readily available sources.  In describing "Board Selection, Recruitment, and Composition," for instance, one book on corporate governance observes:

Fewer CEOs are accepting directorships, for two reasons. Today, more than half of active CEOs do not serve on outside boards. As a result, boards are recruiting more retired top executives and other corporate executives. Active CEOs represented just 24% of all new directors in 2011, down from 47% a decade ago, while retired CEOs made up 19% of this year’s new recruits, up from 12% a decade ago. Division/subsidiary presidents and other line and functional leaders now account for 21% of all new directors, versus 9% a decade ago.

This trend reflects two new realities. First, many boards now insist that the chief executive concentrate fully on his or her job and restrict the number of outside boards the CEO can serve or, in some cases, prohibit it altogether. Second, as boards expand their roles to areas, such as corporate strategy, they look for directors that have risen through specific functional areas in which the company must excel in order to compete effectively—sales and marketing, global operations, manufacturing, and others. And, in the aftermath of Sarbanes-Oxley, directors with a background in finance, especially chief financial officers (CFOs), are in strong demand.

(Emphasis added.)  Note that this passage refers to an overall decline in CEO service on outside boards.  The online article referenced above substantiates that decline, although the data cited is over five years old.

According to the Spencer Stuart 2012 board index, <http://common.money-media.com/php/image.php?id=118872&ext=.pdf>, the average S&P 500 CEO sat on 0.6 outside boards in 2012, half the 1.2 average a decade earlier. What’s more, 54% of S&P 500 CEOs sat only on their own companies’ boards, compared with 48% in 2007.

The latest numbers continue a pattern that began immediately after the 2008 credit crunch, when more and more high-profile CEOs began eliminating their outside board service altogether. Directors and recruiters say that although CEOs can gain valuable experience serving on other boards, the emerging norm for a CEO is service on only one outside board — and none at all if either the company or the outside board is in a difficult situation.

It seems that at least some CEOs may be voluntarily withdrawing from outside board service--no policy required.  Yet, cause and effect relationships would need to be studied . . . .

In any event, my interest was piqued by the mere existence of restrictive governance policies on outside board service.  Not being one for extreme solutions, I begin by neither favoring nor opposing a policy of this kind.  Prudent limitations on service at the outset may avoid difficult time management and attention issues later, but in many (if not most) cases, CEOs may be able to exercise their own discretion to achieve the same objectives.  Regardless, the perceived need for a governance policy restricting outside board service is a reminder that any CEO who serves on an outside board must realistically assess not only his or her initial ability to serve but also his or her continued capacity to serve as needs change in the firms served.  And that is no simple matter, especially given the known tendency of CEOs to exhibit overconfidence.


Corporate Governance, Corporations, Joan Heminway, Management | Permalink


Sorry, the article linked to has absolutely no data to support the argument. The author himself ostensibly runs a business but has plenty of time to write articles for Forbes. It's possible a company might want to silo its CEO from any outside activities -- I mean, nonprofit boards and government advisory commissions eat up a ton of time -- just as law schools might want to prevent their faculty from serving in any capacities that might take time away from their law school work. But there's no obvious reason to think that's a good idea.

Posted by: Frank Snyder | Apr 11, 2018 9:17:12 AM

Thanks, Frank. I used the Forbes piece only to relay anecdotes that will ring true with many. I also linked to the U.S. Steel example for the same reason. It would be rare for a board to expressly note that it is firing a CEO because of distraction. But as former board advisor, I have seen it happen in specific circumstances. Sustained, those circumstances may make it difficult for a CEO to lead an organization.

Of course, I note that I am not favoring governance policy restrictions. I would hope that CEOs are voluntarily limiting their service with outside organizations in the same way that they avoid other potential distractions. That would be laudatory and seems to explain the overall decline in outside board service for CEOs better than the emergence of restrictive governance policies.

Nevertheless, the whole thing is news to me. Glad it held interest for you, too.

Posted by: joanheminway | Apr 11, 2018 10:52:53 AM

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