The Wheatley Institution

Fellow Notes


Why Good Corporate Governance is So Important

“In business, the board of directors and executives establish the ethical culture known as the “tone at the top.” ”

W. Steve Albrecht | May 20, 2016
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A leader demonstrates proper corporate governance in a meeting



For the past 13 years, I have had the opportunity to serve on 9 different corporate boards of directors, as well as 4 public company and 5 large private company boards.  The board of directors of a company is the group of individuals that is elected as -- or elected to act as -- representatives of the stockholders to establish corporate management related policies and to make decisions on major company issues.  The board of directors oversees top management, hires and fires the CEO, establishes compensation levels for executives and ensures that the company’s financial reports are accurate.  The board of directors acts in an oversight role for the shareholders and in an advisory role to management.  Having a good, honest board of directors is critical for the success of a company and for the success of the capital markets in the U.S.  In business, the board and executives sit at the top of organizations and the ethical culture they establish is called the “tone at the top.” 

Every board of directors, and the top management it oversees, is supposed to have a system of corporate governance that ensures that the company acts in the best interests of all stakeholders and that the “tone at the top” is appropriate.  The goals of good corporate governance systems are:

1. Ensuring integrity and ethical behavior in the company.

2. Ensuring that all shareholders are treated equitably.

3. Ensuring that the board has sufficient relevant skills and understanding to review and challenge management’s performance and actions and to provide oversight and advice to management.

4. Ensuring full disclosure and transparency to all stakeholders of the company, including the reporting of financial information.

5. Considering and balancing the interests of all stakeholders, including those to whom the company has legal, contractual, social, and market driven obligations, as well as to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.

Many people argue that, in reality, most companies don’t have good corporate governance practices or an appropriate tone at the top and that if it weren’t for laws, regulations, competition and the markets holding firms accountable, executives and boards would always act in their self-interests.  One famous critic, a former Economics Nobel Prize winner stated:

So basically we have a system in which the corporate executives, the CEOs, are trying to make sure the legal system works not for the companies, not for the shareholders, not for the bondholders—but for themselves.  So it’s like theft.  These companies are basically now working for the CEOs and the executives and not for any of the other stakeholders in the corporation, let alone for our broader society.  (Joseph Stiglitz, University of Chicago)

In addition to serving on boards of directors, I have also had the opportunity over my career to be an expert witness in many of the largest corporate frauds in the United States -- cases like Enron, Tyco, Cendant, Adelphia, Lincoln Savings and Loan, and others.  I must admit that in these cases, there were major breakdowns and even an absence of good corporate governance.  In these companies, the tone at the top was the opposite of what it should have been.

As a result of these expert witnessing experiences, I have worked hard on the boards on which I have served to ensure that the directors and executives have good systems of corporate governance and that they understand practically what that means to them.  In this fellow note, which is probably my last, I want to share what I believe the five elements of good corporate governance means on a very practical and personal level.

1. Ensuring integrity and ethical behavior in the company.  

We should always act with the highest integrity.

To me, this element of corporate governance means that we should always act with the highest integrity.  That means regardless of the situation, we should always seek to find the truth and then do the right thing.  Integrity means always acting honestly and truthfully without deception, standing for what you believe, keeping promises, being true to the company’s purpose, not taking unfair advantage of others, living by the Golden Rule, respecting others, being rule abiding, always giving my best effort, accepting responsibility, and being accountable. Integrity should be a fundamental requirement in choosing corporate officers and board members.  We should develop a code of conduct for our directors and executives that promotes ethical and responsible decision making and we should follow that code religiously.  We should never compromise what we know is right.  This means we should always do what our mothers would expect us to do; we should never do anything that would be embarrassing if reported on the front page of the Wall Street Journal or that would bring harm to the company if it was made public.

Personally, I have faced many board and corporate decisions where it would have been easy to “go with the flow” and not vote my conscience or raise objections when faced with questionable issues.  But, I couldn’t live with myself if I had done that.  These decisions have involved restating financial statements, publicly revealing fraudulent behavior, voting against CEO and board chair recommendations even though they wanted consensus opinions, and voting against CEO pay increases I thought were exorbitant. 

2. Ensuring that all shareholders are treated equitably.

Our first interest as board members must be to the shareholders or those who own the company.  We should not serve the executives who are stewards for the shareholders, but rather make sure that they do their best to represent the shareholders.  In addition, we should respect the rights of shareholders and help shareholders to exercise their rights.  This is true whether it is a private or public company.  This means that for directors every decision we make must be made with the perspective that when we are spending the shareholders’ money we must act as if we are spending our own money.

Our first interest as board members must be to the shareholders.

As an example of a director who didn’t follow this corporate governance principle, one day in a board meeting, my colleagues and I were debating whether or not to buy a $150 million dollar company based in Los Angeles.  The CEO, who strongly supported the acquisition, was being very persuasive.  Because of the heated debate, we went around the table, giving our opinions and votes one at a time.  The first eight directors all supported the CEO.  The ninth director said, “If it were my own money, I’d vote against the acquisition but since it isn’t, I’ll vote for it.”  Being the tenth director, I voted against the acquisition, making the final vote 9-1 in favor of buying the company.  My respect for the 9th director dropped dramatically that day because of his inability to follow this important corporate governance principle.

3.  Ensuring that the board has sufficient relevant skills and understanding to review and challenge management’s performance and to provide oversight and advice to management.

Without a good board, management isn’t held accountable.  Boards must be independent of management and the company and able to represent shareholders.  For me personally, this means I must always be contributing and independent and should resign when I’m not and should expect the same from other board members.  Boards wouldn’t tolerate a non-performing CEO and shouldn’t put up with non-performing board member. 

Without a good board, management isn’t held accountable

As examples of why this corporate governance principle is important, one day in a board meeting, we discovered that a fellow board member had failed to disclose on his Director and Officer questionnaire that he was a major investor in an asset investment company that managed several hundred million dollars of the company’s cash.  In other words, he was not independent.  Immediately, upon discovering that information and learning that he was not independent and had not disclosed his relationship, he was asked to leave the meeting and resign from the board.  He couldn’t represent the shareholders if he had a vested interested in earning returns for himself.  In another case, an aging board member was starting to become somewhat senile, suffering from Alzheimer's Disease.  She was asked to resign from the board immediately, even though we all felt badly for her.  Finally, in considering a new board member, we discovered that he had an extramarital relationship while supposedly happily married and the father of four children.  We decided that if he would “cheat on his wife” he would “cheat on the company” and decided not to extend a board position to him.

4.  Ensuring full disclosure and transparency to all stakeholders of the company, including the reporting of financial information.

We should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability.  We should implement procedures to independently verify and safeguard the integrity of the company's financial reporting and assets.  Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.  For me personally, this means that I should take my responsibilities as audit committee chair and member of other committees seriously (e.g. reading 10-Ks and 10-Qs) and if our companies have information that would affect investor decision making we should disclose it as soon as possible.  Our F/S should be beyond reproach.

For example, in merging with another company, one of my companies wrote off $133 million of the merged company’s inventory.  The write-off was done because the gross margins on the inventory was too low (approximately 10%) and didn’t meet the company standard of 40%.  However, after the inventory was written off, some of the line managers wanted to sell it rather than scrap it because written off inventory if sold has a gross margin of 100%.  Certainly that is not appropriate and cannot be allowed.  

5.  Considering and balancing the interests of all stakeholders, including those to whom the company has legal, contractual, social, and market driven obligations as well as to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.  

For me personally, this means that I must know and care for every stakeholder as if he or she were myself and consider their views when making boardroom decisions.  As an example, when I first joined a public company board, there was an SEC Wells Notice (meaning the SEC was investigating) against the company as well as its CFO and controller.  In my first board meeting, we asked the controller and CFO if they had done anything wrong or illegal.  Their answers were an unequivocable “no.”  After studying the facts, I agreed with them.  Because they are key stakeholders to the company, I determined it was my obligation as a board member to do all I could to help them.  Because I had worked with the SEC as an expert witness in major fraud cases, I worked with the company’s attorneys to schedule a conference with the SEC where I was able to explain why the company, the CFO and the controller were innocent.  A month later the SEC dropped the Wells Notice and the investigation.  In another case, because of bribes being paid in Europe, we ceased operating a very profitable subsidiary because it wasn’t in the best interest of the company, our shareholders or the citizens of that country.

Why is good corporate governance so important?

So why is good corporate governance and the appropriate tone at the top so important?  There are many reasons.  Serving on a board can be highly stressful and highly rewarding.  Board members affect real people’s lives.  They spend real money.  They make real differences in society.  They affect capital markets.  But, they must do it all with the highest integrity.  If board members follow good principles of corporate governance:

At the end of the day, the greatest asset we all have is our reputation.  Compromises and shortcuts always come back to haunt us.  Once we start down that slippery slope of compromise, it’s very difficult to climb back up.  It is the seemingly unimportant decisions or “SUDs” that can ruin us.   I saw this as an expert witness and I have seen it as a board member.  I have a firm conviction that one high integrity board member can make a huge difference in the boardroom.  If you are reading this article and are a board member or corporate leader, you need to be that person. (These same principles are true in any organization or group.)  Good corporate governance (including high integrity) is critical for both you and your companies.  As Warren Buffet once said, “We can afford to lose money, even a lot of money. We can’t afford to lose reputation—not even a shred of it.”  In whatever organizations you are involved in, may you do all you can to help set the appropriate tone at the top and the appropriate corporate governance framework.