Irving Olds, Chairman of U.S. Steel from 1940-1952, once opened a speech by declaring, "Directors are like the parsley on fish – decorative but useless.” The perceived importance of directors has changed radically since the time of that speech as a result of the Sarbanes-Oxley Act and New York Stock Exchange listing requirements. The role of directors on boards may change radically once again as a result of financial reform legislation that has just passed out of a Senate-House conference and that is expected soon to be voted on and enacted into law[i].

 

The first radical increase in the perceived importance of the role of directors of public companies was due to the passage of the Sarbanes-Oxley Act of 2002[ii], which, among other things, requires the audit committee to be directly responsible for the appointment, compensation, and oversight of the corporation’s outside auditor. The New York Stock Exchange followed up on the Sarbanes-Oxley Act mandates by imposing requirements on listed companies that mandate a minimum number of independent directors be serving on the board of directors itself and on specific committees, such as the audit committee. In addition, the directors serving on the audit committee must satisfy specified financial literacy standards[iii].

 

Despite the substantial changes introduced by the Sarbanes-Oxley Act and NYSE listing requirements, industry experts have noted that shareholders of public companies still may not be well represented by their boards. As one commentator noted:

“Today, directors certainly have many more duties than in Olds’ time, and they have already been a focus of structural and legal reforms such as the Sarbanes-Oxley Act and exchange rules on director independence – reforms and rules aimed at preventing yet more leadership failures in our largest companies. The problems were compounded by compensation systems that encouraged short-term strategies and excessive risk-taking…Scandal and reform. Rinse and repeat…human beings will always be the weakest link in that tenuous chain that begins with investment capital and ends in sustainable profits…Boards carry bad directors – those who leave their spines and better judgment at the door – far too long.”[iv]

The pending financial reform legislation appears designed to address these concerns. As a result of the recent credit crisis, the pending reform legislation contains provisions aimed at increasing board transparency, eliminating compensation incentives for management to focus on risky, short-term strategies, and increasing the ability of shareholders to elect directors who will be more mindful of their interests than the interests of management.  Thus, the proposed financial reform legislation reportedly[v] would, among other things: 

  • give shareholders, under certain circumstances, a non-binding vote on executive compensation
  • mandate independent board compensation committees with the authority to hire compensation consultants
  • prohibit members that are not beneficial owners of a security (e.g., brokers) from granting a proxy to vote the security in connection with a shareholder vote for the election of directors, executive compensation or any other matter deemed significant by the SEC, unless instructed by the beneficial owner, and
  • authorize the SEC to issue rules granting shareholders access to management’s proxy statement for the purpose of nominating directors to the board

These proposed changes, if enacted into law, will increase the likelihood that large institutional shareholders, at least, will be able to nominate and elect independent directors who would tend to keep their interests in mind while still honoring their fiduciary duty to the company as directors. For example, the California Public Employees’ Retirement System (CalPERS) has created a “Diverse Director Database” in order to recruit independent directors that CalPERS can nominate for election to boards that CalPERS deems to be poorly performing[vi].  

One possible information technology impact of these corporate governance reforms is the need to design and implement intranet and extranet portals with dashboards, business intelligence tools, databases, and archives for the exclusive use of the Board of Directors and its committees, such as the audit, nominating/governance and compensation committees. These portals would have security and access controls designed to insulate Board activities and information from unauthorized access by management and other company personnel. Limited access, however, would be permitted for personnel such as chief compliance officers reporting directly to the board or audit committee, compensation consultants advising the compensation committee, legal counsel to the board and the independent auditors of the company reporting to the audit committee.