The Director Looks at His Job 9780231893107

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The Director Looks at His Job

THE RECORD SPONSORED GRADUATE

OF A

JOINTLY

SCHOOL

COLUMBIA AND McKINSEY FOR

SYMPOSIUM

OF

BY

THE

BUSINESS

UNIVERSITY THE FOUNDATION

MANAGEMENT

RESEARCH

The Director Looks at His Job Edited, by COURTNEY GRADUATE

C. BROWN,

SCHOOL

OF

DEAN

BUSINESS

AND

E. EVERETT

SMITH,

McKINSEY

&

DIRECTOR

COMPANY

COLUMBIA UNIVERSITY PRESS NEW

YORK

COPYRIGHT ©

1 9 5 7 COLUMBIA UNIVERSITY P R E S S , N E W

YORK

First printing 1957 Second printing 1958 PUBLISHED

IN

GREAT

BRITAIN,

CANADA,

INDIA,

AND

PAKISTAN

BY T H E OXFORD UNIVERSITY P R E S S L O N D O N , T O R O N T O , BOMBAY, AND KARACHI LIBRARY

O F CONGRESS

CATALOG

CARD N U M B E R :

M A N U F A C T U R E D I N T H E U N I T E D STATES O F

57-13485

AMERICA

Symposium the Board of

on Directors

COCHAIRMEN

Courtney C. Brown, Dean, Graduate School of Business, Columbia University E. Everett Smith, Director, McKinsey & Company PARTICIPANTS

John T. Connor, President, Merck & Co., Inc. David H. Dawson, Vice President, E. I. du Pont de Nemours & Company Charles G. Mortimer, President, General Foods Corporation M. J. Rathbone, President, Standard Oil Company (New Jersey) Joseph P. Ripley, Chairman, Harriman Ripley & Co., Incorporated David A. Shepard, Director, Standard Oil Company (New Jersey) J. Alex Smith, Director, McKinsey & Company Charles R. Tyson, Executive Vice President, John A. Roebling's Sons Corporation AND

Adolf A. Berle, Professor of Law, Columbia University Vannevar Bush, Massachusetts Institute of Technology; Director, American Telephone and Telegraph Company H. J. Heinz II, President, H. J. Heinz Company Sigurd S. Larmon, President, Young & Rubicam, Inc. Harold F. Smiddy, Vice President, General Electric Company RAPPORTEUR

Neil W. Chamberlain, Professor of Economics, Graduate School of Business, Columbia University

Contents

Introduction

1

1.

Responsibilities of the Board of Directors

8

2.

Functions of the Board of Directors

23

3.

Inside vs. Outside Directors

38

4.

Full-Time vs. Part-Time Directors

57

5.

The Balanced Board

94

6.

Interlude: Rethinking the Main Issues

7.

Problems in Connection with Strengthening the Board 108 Summary and Conclusions

102

143

Bibliographical Notes on the Functions of the Board of Directors 149

The Director Looks at His Job

Introduction

of the modern corporation—particularly the large corporation—has raised questions concerning the manner of its government and control. One aspect of this concern has been the role of the board of directors, that body entrusted under law with agency powers on behalf of stockholder-owners and charged with trusteeship responsibilities. Questions persist as to its substantive nature: Is it really "elected," and what interest does it truly represent? Does it have the capacity for independence and objectivity of judgment? Is it a reflection of management, a genuine check on management, an advisory council to management, or is it each of these things at different times and in different circumstances? Are its responsibilities broader than those which the law imposes, and, if so, how can these be reconciled with the legal formulations? T H E IMPORTANCE

These same questions which have troubled students of business have been of no less concern to business managers. It is a matter of importance to the nation as well as to business to reexamine the place of the board of directors in American corporate life and to explore the possibilities for vitalizing its role. Some have expressed the view that many boards have found it difficult to render the constructive service which bodies composed of distinguished citizens normally might be expected to contribute. If this is so, why is it so, and can the situation be improved?

2

Introduction

This book had its beginnings in the growing concern of two individuals over the need for a more understanding and more effective use of the board of directors. Disturbed by his observations, as a management consultant, of board practice in a number of business firms, E. Everett Smith, a director of McKinsey & Company, expressed his thoughts to Courtney C. Brown, Dean of the Columbia University Graduate School of Business. He found that Dean Brown not only shared his concern but had been considering what might be done to analyze and improve the situation. They decided upon joint action. It was felt that great benefit might result from an effort to bring together a group of thoughtful practitioners of high achievement level to discuss the multiple aspects of board formation and operation. A small symposium was assembled under the cosponsorship of the Graduate School of Business of Columbia University and the McKinsey Foundation for Management Research. The most active participants were: John T. Connor, President, Merck & Co., Inc.; David H. Dawson, Vice President, E. I. du Pont de Nemours & Company; Charles G. Mortimer, President, General Foods Corporation; M. J. Rathbone, President, Standard Oil Company (New Jersey); Joseph P. Ripley, Chairman, Harriman Ripley & Co., Incorporated; David A. Shepard, Director, Standard Oil Company (New Jersey); and Charles R. Tyson, Executive Vice President, John A. Roebling's Sons Corporation. Others who attended at least one of the three four-hour discussions were: Adolf A. Berle, Professor of Law, Columbia University; Vannevar Bush, Massachusetts Institute of Technology, Director, American Telephone and Telegraph

Introduction

3

Company; H. J. Heinz II, President, H. J. Heinz Company; Sigurd S. Larmon, President, Young & Rubicam, Inc.; and Harold F. Smiddy, Vice President, General Electric Co. Representatives of the McKinsey Foundation were: E. Everett Smith (cochairman), Ewing W. Reilley, and J. Alexander Smith. Representatives of the Columbia University Graduate School of Business were Courtney C. Brown, Dean (cochairman), and Neil W. Chamberlain, Professor of Economics (rapporteur). The significance of the effort became apparent at once in the willingness of business leaders to share in this experiment and in the serious and thoughtful manner in which they developed the discussions. The sessions, held in May and June, 1956, began at 4:30 in the afternoon and ran for two hours; the group then adjourned for dinner and informal discussion, resuming for a final hour of more formal discussion after dinner. All discussions were tape recorded, and for the most part the text of this book consists of verbatim conversations which took place at the meetings.* While early determination that the symposium would be restricted to three four-hour sessions made it obvious that such a broad subject could not be treated in an exhaustive manner, it soon became evident that the limitation on time served in a positive way to add to the significance of the symposium results by requiring these practitioners to indicate very clearly what they thought to be most important, what should or must be said in the limited time available. * The group is indebted to Professor Neil W. Chamberlain for his skillful editing. H e has succeeded in capturing appropriate emphasis and in preserving the informal but forthright nature of the sessions.

4

Introduction

Our initial approach was to think in terms of the functioning of a board of an imagined manufacturing and selling corporation with broad public ownership, a multiproduct, multiplant corporation with sales of about $500 million a year. We thought that a model, hypothetical board for such a company would facilitate our thinking. But as we proceeded, it became evident that the problems dependent on size of business (as well as on other factors) were sufficiently great that if we designed a model for the hypothetical case it would have limited applicability to cases of other categories. Without explicit decision, the group tended to move ; n the direction of seeking generalizations which would provide specific applications differing in particular cases according to the characteristics of the company involved. The discussion covered many problems of board composition, operations, and relationships, and certain tangible contributions to a better understanding of the board of directors resulted. A few might be mentioned: The strengths and weaknesses of different types of boards were weighed in practical terms, and a unique discussion of the full-time board by full-time board members took place. There was a productive effort to identify the major factors which contribute to effective board membership. This part of the discussion inevitably concerned itself with the contribution that could be made by a board member through special knowledge of his company and industry or of special fields, such as law, finance, science, etc. Consideration of the degree and kind of special preparation necessary to qualify a board member to perform his role effectively

Introduction

5

pointed up the deficiencies in this aspect of board operation. A major and important inference resulted from the symposium as a whole, namely, effective board membership depends primarily on two things: first, the individual selected and what he brings to the board; second, and more important, the use made of that individual by the chief executive. Because of this inference we feel that the greatest benefit from reading this record of the symposium will be gained by the chief executive of the corporate organization. It was the consensus of the group that each company, inevitably, has a different type of board problem. It was considered equally true, however, that no matter how any particular company or board might be structured, the attitudes and actions of the chief executive are the principal determinants of the degree of day-to-day utilization of the board. The chief executive is faced, then, with a real leadership problem: how to elicit the best possible contribution from each board member. This publication will have served its purpose if it causes the reader who is associated with these responsibilities, either as chief executive or otherwise, to reflect further on the many facets of the discussion. As you follow the discussion you will not only agree or disagree with the points made, but undoubtedly you will also think of points you would have made that would have added, in your opinion, to the substance of the discussion. While, as a reader, you may experience certain frustrations through not being able to join the conversation directly, you may enjoy certain advantages, too. For example, you will be able to "stop" the conversation at your convenience in order to develop your own ideas and perhaps to

6

Introduction

jot down your own ideas for later consideration. Another advantage falls to the reader: while you can derive stimulation from the lively communication between participants, you are not interrupted in your own thinking by the often diverting mechanics of other people's verbal expression. We believe you will find the whole text rich in associative ideas. This is one of the advantages of the discursive nature of the text. In addition to agreeing or disagreeing with comments made, and in addition to thinking of points you would like to have made had you been present, you will undoubtedly pass mental judgment on the significance of the direction and the emphasis of the discussion. Depending on your own conceptions you will either be reassured or disturbed by the lack of agreement, real or apparent, on the part of the roundtable participants on seemingly major points. Here are successful practitioners who, in friendly debate, question one another's statements as to pertinence, significance, or emphasis. Questions are not asked solely of one another. Here is a group of men each of whom is skilled by training and practice to ask himself uncomfortable questions. At one point a participant asks: "Isn't this a confession of weakness? Aren't we using this as an excuse to avoid tackling a difficult situation?" In particular, we feel that you will be interested in the recurring nature of human relations problems throughout the discussion. Such questions are asked as: "How can a man's objectivity or judgment be measured?"; "How can a board be rid of a director who no longer serves in a constructive role?" The qualifications and training of people

Introduction

1

and, in particular, executive development in its relationship to board activity are recurring subjects. While this publication is the record of a discussion on the subject of "The Board of Directors," we think you will find significance in the inevitable amount of time devoted by the participants to subjects that concern the operating managements of all organizations; policy and planning, operations, auditing, and the measurement of performance. This, then, is an invitation to join a group of highly qualified business leaders in an impromptu discussion of a timely subject. If the purposes of the symposium have been met, your gain from joining the discussion will result more from the provocative nature and implications of the free flow of ideas than from additions to specific knowledge, more from the insight of successful practitioners as reflected in their questions than in the answers that could be developed during so limited an amount of time. Most of all, we think you will gain from the mental exercise of joining the flow of lively discussion.

1 Responsibilities Board of

of the

Directors

does a board of directors serve? To whom is it responsible? What functions does it perform that would not or could not be performed without it? What services could it offer that would improve the performance of the corporation? While this general line of questioning permeated all of our discussions, there was specific consideration of it as well. One of the principal issues which developed, underlying the question of to whom the board was responsible, was that of the relationship of the three groups: (1) the stockholders, (2) the board of directors, and (3) the executive management. As discussion opened on the matter of the responsibilities attaching to a board of directors, one of the group urged a prior question.* W H A T PURPOSES

— Before we focus on the board and its responsibilities and authorities, shouldn't we go one step back to the stockholders? Stockholders have some responsibilities, I would think, and stockholders as a body certainly have some au* In the verbatim extracts from the discussion, which make up most of the following pages, remarks are not attributed to any individual. A dash is used to indicate a change of speakers.

Responsibilities of the Board of Directors

9

thority, and actually, in the ultimate sense, the board is the creature of the stockholders. — You are even more of a lawyer than I am. The stockholder as an individual, with his vote, is the last vanishing Indian of responsibility. He was an individual. The last thing he had was his vote. That is now being absorbed by the institutional investor, which includes the pension fund, the trusts, the big insurance companies. I imagine a group like this twenty years from now will be working with a case where there is the responsibility of the directors and that is flanked by the responsibility of institutional owners, who are not the real owners either. — In addition to which they, the stockholders, have a rather flexible sense of responsibility, because they can drop out at any given moment. — That is why we speak of stockholders' responsibility as not the same as the directors' responsibility. The stockholder can fish out, stay home, or sell. The director can't do that. — Do stockholders have a responsibility any more than an individual has a responsibility to himself to look after his property, whatever it is? If we own some stock in a company, what is our responsibility to that company beyond a purely selfish interest? — Maybe you have a responsibility to vote against the board if you don't like what they are doing. — Well, to vote for or against. If so, there are a lot of stockholders who don't fulfill their responsibility. — On the authority side, certainly stockholders have authority as defined by the charter, I suppose, and in the various stock issues that they own, that usually includes

10

Responsibilities

of the Board of

Directors

electing the board of directors, passing on unusual proposals, such as broad pension plans, broad executive compensation plans. In other words, there are at least certain unusual problems that go beyond the authority of the board of directors. There is a residual withholding of authority from the board of directors and management by the body of stockholders. IT WAS NOT the reserved powers of the stockholders but the powers which they have entrusted to the board of directors on their behalf which came in for closest scrutiny, however. On one point there was, understandably, complete agreement: the powers which the board exercised were granted to it to be used on behalf of the stockholders. This responsibility to the shareholding group has several facets. — After all, the shareholders elect the board, and when they elect them they have a right to expect that their board is going to do certain definite things for them. Now these are, I think, pretty definite. Of course they would have to carry out the usual corporate activities, which can only legally be done by directors—you know, such things as declare dividends and effect mergers and sell assets, things of that type. Those legally, under corporate law, have to be performed by directors, by the board of directors. Certainly I think the second prime responsibility of the board is to insure to the shareholders to the maximum extent possible the protection of their invested capital. Because, after all, the shareholders have invested capital in the corporation; they look for somebody to look after that;

Responsibilities

of the Board of Directors

11

they can't do it themselves. And the legal vehicle that they entrust their capital to is the board of directors. I think the next thing they look to the board of directors for is the adequacy of return on their invested capital. They don't look to management for that; they look to the board for that. I think they look to the board also for the perpetuation of the corporation. In no case that I ever heard of did anybody ever invest in a corporation with the idea that it was a temporary or a term proposition. It has an indefinite life, legally, so that I think the shareholders have a right to expect that the directors of that particular corporation are going to perpetuate its life. Certainly they realize that the actual running of the corporation has to be done by a lot of people. I'm sure that one of the things that the shareholders expect the board to do is to provide adequate management. I feel equally sure that another thing the shareholders expect of a board is to effect a reasonable harmonization of the diverse interests of all the shareholders, because any big corporation has a great diversity of interests among the shareholder group, and somebody has got to pull those together and cut and fit them and arrive at the most equitable and acceptable harmonization of all those diversities of interest. Finally I think the board—not the management, but the board—is expected by the shareholders to report to them. Now, if you accept those as being the things that a group of shareholders have a right to look to your board of directors for, then I think you immediately get to the question as to how well can the board of directors meet those

12

Responsibilities

of the Board of

Directors

responsibilities, and whether or not any of those responsibilities can be delegated. or agency relationship of the board to the corporation's stockholders is time-honored and legally supported. Much more perplexing, however, is the question of whether the board of directors—standing for the corporation—bears responsibilities to other interests. The following discussion was addressed to this issue. T H E FIDUCIARY

— Responsibility is a large term. Let's get to a few of the variables. The board's first responsibility is to keep the organization together as an organ and within that framework to be responsible in a set of private relationships which have to do with the honesty of the management in giving the stockholders something for their investment. Still in the private but more increased range, it is responsible for seeing that its customers who rely on it get supplied, if the supply is there. It also has some relationship to continuity of employment and to employment conditions. Then you get into a second phase, where the board is being held increasingly responsible—and this is especially so if it's a large corporation—for an adequate supply to the community as a whole of whatever commodity they rely on you for, whether it's altogether your set of customers who are involved or not. Between the lot of you, the leaders in the industry, somehow or other you have to do that, and at an acceptable price—I mean a price which won't excite the ire of the community. Apparently, you are responsible for the growth of the enterprise to the extent that it is necessary to maintain the supply. You can't sit there and let the de-

Responsibilities

of the Board of Directors

13

mand grow up without the means to supply it. This is a public responsibility. There is a third group of responsibilities which is more difficult to spell out, and that's in international affairs, international economics. So you have to think of your board of directors not only as keeping an organization together but likewise assuming what it seems to me is a set of more or less political responsibilities. Whether this is what ought to be true or not, I don't know, but this seems to be what you are held responsible for. — I wonder if I could ask this question? As you described these several stages of responsibility of the board, my mind was constantly running back and forth between the board and the management team, which might or might not be members of the board, and in the ultimate sense I dare say that each and every one of these responsibilities you have listed will fall back on the board if they are not fulfilled in the policies developed by the management. But does this suggest that the board and the management team are in a sense one and the same thing? Are there distinctions between the management team and the board in terms of the responsibilities you described? — Yes, I think there are distinctions that are wide and deep. They may be the same men, they may wear two hats in this business and frequently do with great success. But at long last the director is responsible, or the board of directors as a group is responsible, for assuring that the managements do, in the aggregate and as an organization, carry out the various obligations which either they directly assumed or the community holds them responsible for. The board of

14

Responsibilities of the Board of Directors

directors which is unable to see that its manager or president does not do thus and so bears the guilt or responsibility. It's the board's business to staff the corporation with men who will do it. — It has to make sure that its policy gets carried out, doesn't it? — That's it, and at long last they are the people who can be held responsible. That's one of the reasons why they are there and why custom as well as law puts them there, requires them to be there. — I would like to come back to the original question as to why have a board. Isn't it that at the beginning the corporation is nothing but a board, let's say, and from that point on there are varying degrees of delegation of authority which they grant to management. But apparently they don't and can't delegate any ultimate responsibility; responsibility has to rest with them. And then you come down to questions only of what degree of delegation is the most effective in conducting the affairs of this corporation for which they are responsible. This can vary like everything, depending on the industry, depending on individuals probably. It's one of those things for which there is no one good answer. that the board of directors must pay attention to interests other than those of the stockowners was phrased in another way by one of the participants. T H E VIEW

— I think that all of us would have to agree that the corporation is a vital and integral part of our society and economy. And it exists only because it has contributed or con-

Responsibilities

of the Board of Directors

15

tributes, in the minds of most people, the majority of people, more to our society and our economy than some other forms of organization. And it seems to me that one of the important jobs of corporation directors is to continue in the interest of the shareholders to get that kind of acceptance for a corporate form of business from a majority of our citizens. Because the minute we don't get that, our politicians are going to jump in and reflect the majority opinion of our citizens by changing the atmosphere in which corporations now thrive. And getting this kind of acceptance for the corporation as an instrument in the present-day society depends on an awful lot more things than paying dividends and making earnings. It involves labor relations heavily, because certainly if the corporation's labor policies are backward or unacceptable by average standards, it is going to lose that prestige, that feeling of acceptance. If its action as a corporate citizen in the community is unacceptable on the average, again, it's going to lose that acceptance on the part of the people of the country, every Tom, Dick, and Harry, the general run of voters. They certainly have to consider their shareholders and their investment and their return; they also have to consider the customers because those customers after all are aspects of the public generally, and there are a whole lot of different ways you can treat customers that have a bearing on whether they think of a corporation as being a good thing or a bad thing. And yet the interest, the self-interest, of these different groups, differs widely. The self-interest of the laboring man might be to get the highest possible wage; the self-interest

16

Responsibilities

of the Board of

Directors

of the consumer might be to get the product at the lowest possible price. The self-interest of the shareholder might be to get the highest possible return on his investment. Those are not compatible, and the job I think that the board of directors of any corporation has to do is to try to harmonize those things and come out with an average result that will please most people in these various interest groups. — Is that the job of the board or is that the job of the management? — That's the job of the board, and I'll tell you why I say that. It's because the board is responsible for the perpetuation of the corporation. We are interested in trying to preserve the corporation, perpetuate its life and its growth. And that is dependent upon the atmosphere in which the corporation lives. And I think it is definitely the job of the board of directors to the shareholders to assume the responsibility for seeing to it that as far as they can possibly do it the atmosphere in which that corporation lives is such that it can continue to live. As a practical matter, there may be lots of times when you have a board composition that doesn't accept and measure up to those responsibilities, but they can't escape it. They may not as a practical matter be able to assure that they're doing the best job, but they can't escape it, in my view. When you get right down to the crux, they're the ones that have to step up and face the stockholders. as to the relationship between board responsibility and executive responsibility found expression again at another point in the discussion.

T H E QUESTION

Responsibilities

of the Board of Directors

17

— Well, I wonder if this is a fair question to ask. We have said that the board is the ultimate seat of the responsibility and that it delegates responsibility to management, and management in turn presumably delegates it on down the administrative line. It is possible that the board in having once delegated its responsibility to the top management, in fact and in normal daily activities and with everything going all right in the company, has reversed the flow of authority. Because top management really, it seems to me, becomes the ultimate seat of authority, whether it's the ultimate seat of responsibility. — May I interrupt you for a moment? We apparently have all said that the board of directors has the ultimate responsibility. It really doesn't. If you take the base from which all of us stem, when our companies were terribly small, the stockholders were the ultimate authority, whether they were one or 30,000, and they in turn—although now obviously it's just by rote and a bunch of papers in a lawyer's satchel—can throw out a board of directors very quickly, if they are of a mind. But practically speaking, I would be inclined to agree with your last statement that the management or administrative executives have most, or accept most, of the responsibility. — I think that is right. In fact management, as long as it's successful and things are going well, is more than likely to have reversed the flow of authority from the boards to management so that it runs from management to boards. Because in a very practical sense the management has to pick new members of the board and present them for consideration to the board first and then to the stockholders. — I think we are talking about two different things

18

Responsibilities

of the Board

of

Directors

though—responsibility and authority. Now under the broad definition of responsibility [given by a previous speaker], the question that flows from what he said is: "To whom is the board responsible for all these things?" It's generally stated that the board is responsible to the stockholders. I think that's a responsibility point rather than an authority point. But under the broad area of responsibility that he has defined, apparently in his mind at least, this responsibility is not just to stockholders, because if it were he wouldn't have a lot of those public responsibilities. He's indicating, too, responsibility beyond stockholders to the government, to the public generally, to customers who need the product, and so forth. So this is a much broader definition of responsibility than is certainly in the textbooks. — Well, the question is, whose prime responsibility is it to harmonize those interests? I claim it's the board's. And the reason I claim that is that the board is responsible to the shareholders who invested their money for the protection of that investment and for the perpetuation of the vehicle in which that investment has been made. Now that isn't a management responsibility to the shareholders; that's a board responsibility to the shareholders, and it delegates to management the implementation of that but it has got to stand behind it as its final responsibility. And unless board members interest themselves in it they're either taking management's actions on blind faith or failing in their responsibility. — The fact is that we have millions of investors in this country today that just have no way at all of managing

Responsibilities

of the Board of Directors

19

their investment. They've got to have somebody else manage it for them. Now, if they want to elect a president of a corporation to manage it for them, let them elect a president. If they want to elect a board of directors to do it, then I think the board of directors has that responsibility. And that's really where the crux of this thing lies. We've got to figure out some way to give these millions of investors in this country a feeling that they have got somebody that they look to for being the responsible manager of their investment. Basically, representing the stockholder resolves itself into two areas. One is the area of doing, which is the management area, and the other is the area of advising, of counseling, which apparently is more widely thought of as the area in which the board is supposed to perform. I think that's probably a fair division of the way a lot of people think of business today: there's the executive group, that's the doers, and the board, who are the counselors, the advisers, exercising their tempering influence on the doers. I think, then, it gets down to the question of which is the group that the stockholders ought to look to as being the responsible group. If the group is going to be a counseling group, then the stockholders shouldn't expect them to be responsible. If the executive group is the one that is really going to do the job, and perform the actions, and make the decisions that make or break the company, then they're the people the stockholders ought to elect and the people the stockholders ought to look to as being the responsible group. T H E THREAD

of an earlier thought was picked up again.

20

Responsibilities

of the Board of

Directors

— I am wondering whether or not we ought to draw a sharp distinction between responsibility and power, or authority, as you choose. When someone used the term "reverse flow," it seemed to me he was obviously talking about authority, not responsibility. — I think I used it, but I am not sure what we mean by responsibility. I am not just playing with words either. Is it a legal responsibility we are talking about? Is it a responsibility for the health of the industry, is it the responsibility of a custodian or a steward of the enterprise? — Well, it's a legal responsibility in certain respects, certainly, toward stockholders, maybe toward certain regulatory commissions. And the rest of it, I think, is responsibilities toward the public; they are enforceable, too. I mean the responsibility is enforced usually by rather unpleasant political methods, which may be anything from a legislative investigation to a general howl. But it is there all right. I don't think there can be any doubt about it. — There may be a trend in that direction, but I don't know of anything yet that places any legal responsibility for this type of thing on a board. If the Y.M.C.A. in town is going broke and the only corporation in town is the only thing that can save it from going broke, even though there is every political and social and other compulsion, I don't see how anybody can sue the directors. — We are saying, then, that the responsibility to the stockholders and protection of the stockholders' long-term interest involves secondary responsibilities. But the primary responsibility is always to the stockholder. — Yes.

Responsibilities

of the Board of Directors

21

— There are going to be conflicts; you can dream them up by the dozen. You're going to have to close down a plant in a small town, as we occasionally have to do. And if you say that the primary responsibility is to the local people in that town and not to the stockholders, the stockholders are eventually going to lose their interest. — I certainly don't deny those responsibilities, but I think if we lose sight of the primary responsibility we get into a confused area that we might better stay out of. — You get awfully puzzled. — I know, but isn't that an important thing itself, that if you do get puzzled, the reason, I think, is that these are new areas of interest and responsibility of corporate management and the board of directors that have not been thoroughly defined, that certainly have not been given legal status. — I don't think that as a director of the XYZ Corporation I purport to represent the public. the view which appeared to have greatest acceptance in the group was that the legal responsibility to the shareholder is the primary consideration guiding board actions, but at the same time this responsibility permitted— even required—the accommodation of other interests. At least for the present, the larger obligations are to be treated not as independent responsibilities but as responsibilities which are justified by the long-run interests of the stockholders. This view was sometimes stated in terms of the board's responsibility for "public relations" or for "continuity." The very survival of the corporation as a private, profit-making institution, in the interests of the stock-

IN SUMMARY,

22

Responsibilities

of the Board of

Directors

holders, was seen to depend upon its acceptance by society at large, and this in turn to depend upon how well the corporation serves broader interests than just the immediate welfare of the stockholders. In the words of one of the group: "Acceptance of obligations to groups other than the stockholders is a part of continuity of the corporation in the longterm interest of the stockholders, because if a corporation doesn't take on obligations of a citizen it is quite likely not to remain a corporation over the long run."

2 Functions of the Board of Directors

SINCE board responsibilities can be effectuated only in terms of specific functions, the group next turned its attention to these. No effort was made to catalogue all board assignments or to concentrate on those imposed by law. At times members of the group used as their frame of reference those functions which can only be performed by a board, where the board makes a unique contribution which could not be made without it or some counterpart of it. At other times participants addressed themselves to functions which a good board should perform. One of the participants led off the discussion by suggesting that regard for public relations, in the broadest sense of that term, constituted one of the principal fields of broad activity, necessary for the continuity of the organization. — Let me just toss in what I think is the main reason for any board. Maybe it's too broad, but I think the reason for a board is to preserve the continuity of the corporation. — It's an interesting thought. Continuity of the enterprise—is that it? Couldn't that be supplied with a series of executives, not all being replaced instantly or simultaneously? — Perhaps it could, but I think that a successful continuity would demand more than successful replacement from time to time of the executives.

24

Functions of the Board of Directors

— You are not only thinking of the continuity of the management, you are thinking of the continuity of the business in terms of basic policies, physical matters and all other— — Its relationship to the public and its customers, because if these are not preserved and nurtured then the corporation's life won't continue. — That's on the theory that a formal body like a board would provide a better apparatus for continuity than one, two, or three individuals, let's say, as management. — Yes, and I think, for example, the previous question, which I think was meant to needle me, that of replacing executives one after another, in one important sense would not adequately take care of the problem of the public relations of the corporation, which seem to me to be a very important thing and one which a board could, with the breadth of observation and judgment that it would have, do much better than individual executives being replaced from time to time. of the group raised the question as to whether the board was responsible for developing the objectives and strategy of the enterprise. Another replied: O N E MEMBER

— I don't conceive of developing objectives and strategy of the business as being a function of the board. It seems to me that that is the proper function of the top management. And the role that the board might play in that activity would be to look over a formulation of objectives that has been developed by management. Perhaps pass on it in a judicial

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capacity. But I don't see how the normal board of directors, spending time in a meeting one day a month on an average, could be expected to get into that. That raises the question of the type of board you have, because a board of full-time employees, such as at Standard Oil, perhaps could do this sort of thing whereas I don't think our board could. — Your point is that the typical board, a board that is not comparable to say the Jersey or the du Pont boards, serves more in the status of a judiciary. — Yes. — That rather suggests, then, that a Jersey board of full-time directors is part board in a normal sense of the term and part executive.* Is that right? — I think we could probably agree with you that the normal board could hardly be expected to develop policies. — No, if we said instead, "sees to it that management develops objectives and strategy of the business, and reviews or evaluates—" — Yes, that's a valuable function whether you have an inside board or an outside board, to sit down and do this thing. I don't think a board should check up on everything done by management. But objectives and strategy I think are of such importance to the future of the company as well as the conduct of the present business that that type of problem should be reviewed by the board. But there are many other problems that are not in that category in my opinion and therefore there's no reason for management to bring them * Chapter 4 contains a discussion of the full-time board as exemplified by the Standard Oil Company (New Jersey).

26

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to the board or for the board members, individually or collectively, to get into them because they should be decided at the lower levels of management. — Apparently there is agreement on this one function as long as we change this phrase "develop policy" and say "approve," "evaluate," or some other— — Yes, but on the other hand that's a function that is done in some companies by the board of directors upon the recommendation of management. But percentagewise I would say it is done in very few companies, and I wonder if it would be worthwhile to pick out the things that are done by boards in all companies. Now in all companies that I know of the board reserves unto itself the responsibility as well as the authority for selecting the top chief executive officer, and that I think is generally considered to be one of the most important if not the most important job of the board. I would think that would be something on which we could all agree, that that's usually done. — That's certainly true. There's no one else to do that unless the board did it. — Is there any exception to the fact that the board elects all the officers of the company? — No, as a rule there is not. I suppose that factually you wouldn't elect a set of officers that you knew were violently antagonistic to your chief executive, quite obviously— — Well, on all the officers below the chief executive officer, however, doesn't the board act on the recomendation of the chief executive officer, whereas the selection of the chief executive officer is done on the board's responsibility?

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27

— Done on their initiative rather than on recommendation. — Well, it's usually done on the recommendation of the predecessor management, isn't it? — Yes, but not always. — There again it's a question of responsibility. — They are responsible all right. The outgoing management is usually a nominating committee, and a very good one, but they may disagree with it. — Well, I should think you'd be right that we could probably all agree on that very obvious one that it certainly is a board responsibility to select the chief executive. — Can we say that the board acts in a judicial capacity on organization? — I would certainly think the board always had a responsibility to insure an adequate organization and the development of forthcoming executives so that the organization continues effective. Is that what you mean by judicial capacity? — But isn't there a difference of degree here that becomes almost a difference of kind? We started with the question of what are the functions or responsibilities of the board that it cannot pass along to someone else. Well, in the case of the organization of the company, that is uniquely the responsibility of the chief executive and his advisers. Now he may select people from the board as advisers. — I wonder. Let's take the case of a fairly strong oneman central control over a large enterprise, and we might, sitting here as a board, objectively say that that will not

28

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ensure the continuity of the business, the growth of management succession, the proper delegation of responsibility and authority. And we as a board might very well force that chief executive to re-structure the organization. Let's say it's a business with as many ramifications, with as many operating divisions as you have, or as I believe you have. Supposing you had pulled that all into one completely central structure responsible to you only, a seat-of-the-pants type of management, wouldn't the board be responsible for trying to break your grip on that thing and force you into a structure that we felt was going to assure the continuity of the business to a greater degree? — Or someone to replace him? — What you are really doing is taking the first step to replace the president. — I want to ask what may seem to be a narrow question, but as we talk about the board do we assume that we are talking about the parts of the board? Because I know that du Pont has a situation with an executive committee and a total board where the functions are quite, quite different, and on the other hand in Standard Oil of New Jersey the executive committee is I suppose the board and the board is the executive committee. — Legally this is not true. In effect this is the case. — That's what I thought. And it seems to me that this is not a completely idle thing to bring up at this point, because I find myself as I try to go along with you visualizing my own situation, where the board does one thing, and the executive committee and the compensation committee have entirely different responsibilities and authorities.

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— I think it is a very good point to bring up. — You are saying that the board as a whole can and does delegate some of its authority to certain committees of the board and thus reserves unto a part of itself some authority that might otherwise be delegated to management. — Correct. For instance, the point here with respect to the acting in a judicial capacity on the organization—the board doesn't but the executive committee does. — Very much. — But even so, delegation of this authority doesn't mean discarding of the authority, does it? — No. — That's it. You cannot delegate and thereby discard responsibility. You can delegate power. — From a working point of view, wouldn't it be true that—guessing now that the du Pont situation represents a step between the over-all board that we have been talking about and an operating committee which is almost a management function—haven't you in effect gotten another layer in there? — Well, certainly in this case many of these functions are exercised in detail only by the executive committee which is one third of the board. Their actions are considered, ratified, and approved by the board as a whole, but as far as actually influencing the development of objectives and strategy it's done on the level of the committee of the board, and that is true of the several committees. — So you have really a board in two layers. — In a sense, yes, although the board as a whole certainly never loses responsibility and regularly reviews the actions of the committees.

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— If a committee of the board has the authority or responsibility for a certain function, then can't you say automatically that the board has that authority, because they are a part of the board? Anything that they do therefore, it seems to me, is done under the guise of the board having that particular authority, although only part of the board exercises it. — That is generally true. I agree with this. It seems to me that this attitude is reinforced by the fact, which I think is generally the case, that actions of committees of the board are subject to review and blessing by the board. — In the case of the compensation committee, isn't the committee really performing an executive function, except in so far as the compensation of the chief executive can be fixed by the board? The various committees of the board are quasi-executive organizations, aren't they? — That brings up an interesting question, and that is this thing of committees of the board and how far should they go—when do they start to get into management's backyard? — Should the board exercise authority or responsibility for setting up criteria of measurement of operating departments? — These are measurements to measure the effectiveness of an operating part of the organization? — Yes, exactly. — Is that generally done by boards? I think du Pont and General Motors have become leaders in many of these phases of management thinking, but I would guess that

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theirs is the exception, that criteria—to the extent that they are developed—are developed by management, and most boards don't get into that phase at all. — It would be very difficult to do unless you did it through committees, and through committees of board members who are active in the management. — Don't you think here again this word "developing" is the one causing trouble? That is, either the board doesn't develop them, and in many cases the board doesn't have the mechanics to do so, or it will see that some are developed. — How can the board exercise some of the responsibility for continuity of the business, responsibility to the public, etcetera, unless they have some measurement of the effectiveness by which management is carrying out these delegated responsibilities? — By criteria, you mean more than the dollars-and-cents test of net profit? — Well, what I had in mind was not only the usual dollars-and-cents criteria of investment, turnover of working capital, net sales, etcetera, that you employ, but I was also thinking of criteria such as industry position, market position, and some of those criteria that will flash warning signals often times before the financial criteria. — Well, aside from the du Pont or Standard Oil type of board, I just can't imagine the ordinary board composed exclusively or almost exclusively of outside people or even of a majority of outside people being able to do that.* — They could do nothing more than exert their influence on management. * Chapter 3 discusses "inside" and "outside" boards.

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— But they would influence the management, I think, to come up with these tools and measuring sticks, and it would have to satisfy them that those tools are adequate. — Are you saying they should do it, or that they are responsible for doing it? — I would say that they are responsible for seeing that the management gives them some good measuring sticks and tools, that sort of thing which will enable them to judge, and which will also enable management to see for itself what it is doing. — If they don't, aren't they headed straight for trouble without any warning? Some of these criteria— — Well, I think it's a wonderful idea to have such criteria, and I think the management should do it and that if the management doesn't the board should breathe on its neck and get it done. But we are talking, I think, about responsibility, not just legal responsibility but responsibility, and is a board held responsible for seeing that such criteria are developed? — Well, I think they are responsible. Maybe I am repeating this dogma too far, but it seems to me that we have developed the thought that they are responsible in the broadest sense of the word to public, stockholders, etcetera. Now how can they carry out that responsibility unless they do have some measurement of their delegated management's actions? And that raises the further question I think: can you rely on management to measure itself? — Obviously not. — I would think not. — And yet, it does it effectively I would think in the Standard Oil case and the du Pont case.

Functions of the Board of Directors

33

— Yes, but isn't the test a major company sliding down in market position very dramatically over a period of time? Many of such cases were pretty obvious to a great many people long before they became subject to the public press. Now doesn't the board have definite responsibility to equip itself so that it will be sensitive to those trends as they are developing before they become too critical? — Well, don't most boards have a committee on audit? — Yes, independent of the management, in some cases the management represented on it. — It seems to me that those boards that do have that committee, at least several that I know, have been the ones themselves that have taken the initiative in selecting, in some cases, a new firm of auditors, completely independent of the management. Of course, they got the management to agree with their choice; I don't think they would force in a firm obnoxious to the management. — Well, it seems to me that this is one area where there is some importance in having the directors and the management separate, and that for proper conduct of business and proper safeguard it should be the board—in so far as possible independent of the management—who is selecting and judging the auditing function. — I would think so but I'm not sure that it is general practice. — And yet in the Standard Oil case there is no such mechanism that I know of. And you ask the question can management set up appraisals of itself successfully, and here is at least one case— where they claim it can. — To go back for a moment to this criteria for manage-

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ment, isn't it a board responsibility to draw out from management those criteria by which they can evaluate the effectiveness and efficiency of that management? — The board, it seems to me, has a critical responsibility of observation and comparison and evaluation of departments and affiliates and a variety of parts of the organization, and the application of these critical faculties—in all sorts of ways, I should think, in all sorts of organizations— is done in many different dimensions I am sure. But I don't think a board can duck the responsibility of having to apply a critical evaluation of the functioning of the corporation. — I guess we wouldn't get any argument on that around the group. — But in the absence of a board comprising largely active members of the business, doesn't it act principally to solicit from management a development of criteria? It doesn't develop them itself. — No. — It's simply trying to urge management to do that job. — Well, as a matter of fact, if we are going to get down to some practical difficulties, the problem is not that directors are on our backs. The problem is to get them to stay hitched long enough to listen. — I think actually you are referring to something that is very important. Admittedly outside directors are helpful where you have them, but outside directors who come to a meeting once a month and don't have time to read the written material sent to them in advance because they are busy with their own affairs or they are on the boards of other companies just aren't well informed.

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35

— Do I sit back and purr at this point? * — Yes. — Then it becomes a question of trying to make an oral report at the meeting that covers the business of the company adequately and quickly so that the directors are in a position to ask questions, but this development of criteria is more fancy than fact. — Well, we're asking what are outside directors responsible for? The outside directors frequently don't stay hitched, and it's a hell of a job sometimes to get them to do any work, but this is the work they ought to do. — If they don't develop any criteria and haven't developed any, then they are responsible for not having forced the management to take the best steps that they can to bring it up to date.

was raised as to whether a board's assumption of ultimate responsibility for the corporation's performance meant that it also assumed responsibility for all the individual policies or actions of management. T H E QUESTION

— I don't see how a board can possibly be responsible, unless it's a full-time board, for the day-to-day decisions of the executives. — The ultimate results of those day-to-day decisions, though, that's different. — Yes, I think that's right. It's the cumulative result of * This remark came from a director of Standard Oil Company (New Jersey), a company with all inside (or, as it prefers, full-time) board members. See Chapters 3 and 4.

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those day-to-day decisions, and not each individual decision, for which the board must assume responsibility. — Doesn't that come right back to the men, the management itself, or themselves, who are responsible for those cumulative results? — They're only responsible to the board, though. Not to the stockholders. The board is the one that carries the responsibility. — Aren't those day-to-day matters of operations something which should be left alone to management as their responsibility? The board must also, whenever it meets, review the results of its management, and criticize the management, or take whatever action is indicated. The board has a responsibility not for day-to-day operations but certainly an over-all responsibility for what transpires as a result of management's day-to-day actions. times when a board assumes special importance? Two views were expressed.

A R E THERE

— As a business is running along in a very successful pattern there is very little spotlight thrown on the activities of the board. In some ways the board, to people outside, rides along like a fifth wheel. But when difficulties arise or a downswing occurs in a particular company, then you get a great deal of spotlight on the board. — I'd like to put in a mild objection to that emphasis on the times of difficulty. I'm not sure, but I would hope that under normal circumstances—and if we are going to talk about a normal board, then it seems reasonable to me to talk about normal circumstances—I would hope that under

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37

such circumstances the contribution to be made by a board would be more important for the times which are untroubled. I admit that competitive existence may be described as a troubled existence, and so, maybe, one could argue quite correctly that the board is in trouble of this kind all the time. But if this is only competition, not really the kind of trouble that involves acrimony and difficulties of the type you were mentioning, then I would hope that the contribution of a board was more important for the times that are not so troubled than it is during what I would hope to be the exceptional part of the period. A MEMBER of the group interposed a provocative question, although no answer was developed. — You have an annual or semiannual audit that I think is supposed to reveal that you have good management or do not have good management. Those figures are available to the board. But do you have any way of evaluating the effectiveness of the board itself? Is there any method of evaluation that can be reported annually to stockholders? was suggested. But the earlier comment of one participant is perhaps apposite: "Usually a member of a board of directors does not get fired unless he commits some overt act." NONE

3 Inside vs. Outside Directors

Inevitably, the attention of the seminar turned to the com-

position of the board. The familiar question of the relative merits of "inside" and "outside" boards occupied a good deal of attention. The group found it necessary to define its terms carefully to avoid confusion. A director may be either "inside," in the sense of having come up through the company and of being identified with its management, or "outside," in the sense of a person who has been unconnected with the business and has no operating familiarity with it. Directors may also be part-time or full-time, depending on whether they devote the whole of their attention to their director's job or only some portion of their time. Thus, at least four distinct classifications of directors can be identified: 1. The inside part-time director. This is exemplified by the director who doubles as a member of the management team in some capacity, such as vice president in charge of sales or production or as controller or public relations man. Most of his attention must necessarily be devoted to his operating job, but in addition he assumes the responsibilities and functions of director, as amplified in the preceding two chapters. 2. The outside part-time director. This is an individual

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whose principal efforts are devoted to matters not related to the corporation of which he is a director. He may be the president of another company, a lawyer, a banker, or a university president, thus engaged in other activities which consume most of his time. In addition, however, he accepts the responsibilities of serving as director of a company with which he would otherwise have no connection, attending a board meeting perhaps once a month. 3. The inside full-time director. Such a person is exemplified in the board of Standard Oil Company (New Jersey) and by the executive committee of the du Pont board. In these and other such cases men who have spent years in the service of the company, having occupied responsible operating positions, have been made directors. But, in contrast to the inside part-time director, they have been released from all operating responsibilities. The sales manager when elected to the board sheds his duties as sales manager and becomes, full-time, a director, attending only to the general welfare of the corporation as a whole, even though perhaps shouldering special responsibility for some phase of corporate activity, such as sales. But no longer does he have operating authority. He is expected to make no business decisions as an individual; his authority is exercised as one member of the directorial group. 4. The outside full-time director. This is a type of director of which there are few examples to be found in corporate life. Such a person has come from outside the company. His career has been made elsewhere than in the business into which he is now brought. Unlike the inside fulltime director he has no close familiarity with the corporation's sphere of activity. He will, however, now spend the

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whole of his time in overseeing the general health and welfare of the business, bringing to it his expertise as a lawyer or investment banker or public relations counselor, and so on, but with no power as an individual to make administrative decisions concerning the company, exercising authority only as a part of the board. The group focused its attention only upon the first two types of directors, the inside part-time and the outside parttime directors, these two types of directors being characteristic of most corporate boards in the United States, probably more than 99 percent of all directors falling into these two categories. The group was concerned with the relative advantages of relying upon the director who also "wears another hat" as a member of operating management, the insider, and the director who "wears another hat" as a member of a profession or some other business, the outsider. In general, the disadvantages of one are the converse of the advantages of the other. Expressions in the group covered the following points. The principal advantage of the inside director lies in his familiarity with the business. Typically, outside directors spend a modicum of time on company affairs. They require briefing at the once-a-month board meeting on matters which the company's executives may have spent months in deliberating. Although the conscientious outsider will make an effort to inform himself, the fact is that often the parttime outside director will not even have perused materials which have been forwarded to him in advance of the session, or will have skimmed them lightly. In contrast, the insider has fuller knowledge by virtue of his operating positions, and has a greater interest because of his more direct involve-

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ment in the outcome of decisions made. Presence of such insiders thus insures that policy will not be set or actions taken without the benefit of judgment informed by knowledge and interest. Another advantage of relying on insiders is in their ready availability. The difficulties of inducing fully qualified people to serve as directors, who would spend enough of their time to make such service worth while are sufficiently discouraging as to add to the appeal of drafting a knowledgeable and alert member of the operating staff. The disadvantages of the part-time inside director in general stem from the fact that he spends most of his time in an operating position, subordinate to the chief executive. This raises questions as to (a) whether he can effectively review the actions of his superior, when he assumes his other function of director; (b) whether he can be entrusted to review adequately his own performance and that of his colleagues, with whom he must continue to "live" and do business in an operating capacity; (c) whether he can bring to his directorial functions a breadth of viewpoint, or whether under the circumstances his point of view tends to become "ingrown." The outsider has important assets. He provides a fresh viewpoint. He is not subordinate to the chief executive, not a colleague of other members of top management, and hence is in a position when appropriate to "needle" management—sometimes effectively, even when handicapped by limited knowledge. Such outsiders probably tend to confuse less the functions of reviewing and judging with planning and executing, and hence draw a clearer distinction between the functions of the board and the functions of management.

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The principal disadvantage of relying on outside directors is in the difficulty of obtaining capable people who are willing to spend the amount of time which would be required to familiarize themselves in a responsible way with the company's activities. Discussion by members of the study group will help to give the flavor of their thinking. — Can an operating man, as director, properly review his own action in terms of his responsibilities to the shareholders previously outlined? — I think he can 101 percent, because he is a director of the company and responsible to the shareholders for the operation. Now I can't see the slightest difference between his being responsible for the operations of a third party to the shareholders and being responsible for his own operations. The only question is whether he gets bogged down too much in a lot of detail so that he can't do the broader type of thinking. — Isn't he wearing two hats in a very difficult position, though? — Let me be the devil's advocate and carry this to a logical extreme. Would there be any real need for a board that is separate from management? — Only from the point I made. I think that the board basically has to look at things more broadly than a lot of management people do, and that means they've got to have a little more time, maybe, and a little less pressure. God knows it doesn't seem to work that way but that's the theory. And therefore I think trying to combine the two jobs, that is, the management job and the director's job, while I see

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no basic objection and no ethical objection to it, as a practical matter, I think it's hard to do. — We've talked about the problem of the outside director and his lack of intimate knowledge; have we talked of the problem of the inside director who carries operating responsibilities? He's a full-time member of the organization, he carries operating responsibilities, and his difficulty is not so much being objective about himself but of having to go on living with other people in management and, therefore, being quite reluctant to be as searching as he should be in his questions or in his criticisms of other members of the management who are also on the board. Therefore, he shrinks into himself and will not voice his true feeling, for fear of losing his job, obviously. Frankly, I believe that in those instances a control by part-time directors is very important to the success of the enterprise, only because the inside members are beholden to the president. — Isn't it also true that the vice president of sales is very reluctant to criticize the vice president of manufacturing? He knows the other guy could do the same thing to him, and then they have to go on living together every day and cooperating. — If they're going to criticize each other they ought to do it in a small room together. — So it never gets in to the board where the decisions are made! — In my company we do not quite see how people who are subordinate to the president all month suddenly become anything else in an hour's meeting of the board. So we

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have a strong aversion to the operating chap who is on the board lest you just put him in the position where he is either fighting with his own boss or being a dummy; and those alternatives seem highly undesirable. We think a president who has the responsibility of being a strong chief needs some group, a group with authority that he can't get rid of, at least easily, to whom he can go and really bounce ideas around without their having to be in an embarrassing dual position, and without their being themselves saturated with the same background that he presumably has. — I don't know whether there are many of us here who have worked for a person, his boss, for whom he had not all the respect that is normally required of subordinates. There are such cases. Here is a man who is the chief executive officer of a company, who acquires his board of directors from the outside, we'll say. He also has a proportionate share of inside directors. Most of them have specific responsibility for tasks in the enterprise. Now, in comes the vice president in charge of production, who hates the guts of the man who created the board. Yet he happens to be on the board also. He disagrees with his chief's philosophy of management. He possibly disagrees with his board of directors' philosophy. Yet, he has put in thirty years of his life with the company, it's the only company he really knows. He is dependent for his livelihood and his family, his wife, and his children on the income that he gets from that company; he's not particularly interested in trying to go on the outside and get himself a comparable job.

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How can he stand up before the stockholders and say, "I endorse everything that this board of directors has done." He can't. Yet, the poor fellow can't afford to say, "I quit, because I disagree." He's spent thirty years of his life in the business. — In the average company where you have part-time board members, let's say, four or five of them, and five operating board members, then it seems to me there's a real danger that the operating board members can completely dominate the outside members, the part-time members, and therefore you couldn't get the— — Well, isn't that exactly what happens in all these corporations with outside directors? — That's what I'm coming to. Don't the management members of the board occupy a position of knowledgeableness that makes it almost inevitable that they have to dominate the board meeting? That raises this kind of a question— — That depends on how knowledgeable the outside members are. — As a practical matter it seems to me that the parttime board member, for two reasons, one, because of lack of intimate knowledge and, secondly, because of disposition not to be too critical in the first place, is not going to be any more objective and critical of management than the inside board man. He's not likely to be as critical. — I've found that doesn't work that way in practice, as I've observed them. I mean the inside board member in a good many boards is very reluctant to criticize his colleagues. As a result he does not bring out, certainly not in board

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meetings, his point of view. And when the chips are down it is the outside directors that step in and deal with the problems. — In the abnormally difficult situation. — Yes. — How do they deal with it if they don't know anything about it? — Well, because . . . typically what happens is that some of the inside guys that won't come out and talk at meetings go and talk to them privately and then they get together, and they're the guys that sit down with the president and talk turkey with him, or ask him to resign, or do whatever has to be done. — That's just a manifestation of the fact that you've got a weak board. — You've got human beings, though. — The outside director brings to us a diversity of business viewpoints and background; brings to us a status where he is not overawed by the president who works directly with him; brings to the job a willingness to serve not for the compensation or the perquisites but because this broadens his experience. — When the spotlight gets on the board of directors then the company is in difficulty. Now the spotlight focuses itself on what I choose to call the outside directors. I believe that a board should be, a majority of it should be, on the outside just for that very reason. An inside group is probably a great deal more efficient about the day-to-day problems and the long-range problems of any enterprise. But a group

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of outside directors tends to needle, if you will, the administration. I know from one very frightening experience that took place, which ended up by the president of the company being asked to leave, which is a pretty serious thing after spending 45 years of service—retrospectively very successfully but currently not so successfully, and the future looked black as the devil. of these remarks, it will be noted, tends to be critical of the inside part-time director. Despite the advantage of greater knowledge of and interest in the company's affairs, the fact that he is subordinate to the president tends to rob him of genuine independence in board deliberations. One approach to this problem is through the device of the full-time inside director, as we shall see in the next chapter. The other approach is through greater reliance on outside part-time board members. One of the group presented the case for the latter approach in the form of a "model" board arrangement, and the ensuing discussion tended to focus our thinking. T H E GENERAL TENOR

— Well, in the first place I believe thoroughly that the way to run a company is to get a damn good executive, chief executive, see that the power is completely in his hands, and back him up. — Good. — That's the first point. And I think that man needs two things. First he needs a cabinet which is his consultant group, where he is the boss and there is no question who's running the show, where he can get a consensus of opinion before he makes important decisions.

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Directors

— May I interrupt? This is an operating group of officers? — He can get that in two ways. He can get that either by having a management committee or by having a board which is an internal board, and in either case it's the same thing in essence. So he needs a cabinet, and he can always get one. But he also needs to report to somebody. He needs to report to a body where he has to support his programs, his policies, his decisions, and the body if sympathetic will back him up until they replace him. It must be a good hardheaded group where he feels that he is on the spot to prove his case. I think without that there is something lacking. I think that any chief executive who is running a company should have the full authority, but should have that privilege of going before a board and of defending his practice. Now if you have just the first there is something lacking. And the question is, how in industry at the present time do you get the second and get it right? Now unless I am mistaken—and I have lived on the outskirts of this thing for many years—we had a time in this country, when I was young, when boards were assembled with people who thought they could make something out of it on the side, when the members of the board went around the barn with inside information, with special contacts or something. That day is pretty well over. Am I right? — Right. — That day being over, how do you assemble a group that will have the complete respect of the chief executive, where he will be willing to go before them and say, "I will submit my plans for your objections. I'm damn sure I'm right, but I want to prove it to you first." Where do you get that kind of a crowd?

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Of course, what you've frequently got is a management committee, in reality. You get them because you hire them full-time. There is no board, under these circumstances, in the sense that I take it. But how do you get a real board together? Well, in some special cases you can get them. Tom's case for example. He can get strong men on that board of his simply because they are utterly enamored of the things that are going on in his laboratories, and they are willing to serve because of the kick they get out of it. In the case of the board elected this afternoon people will serve because of the kudos. But turn to the hypothetical case you've got—a company with 500million sales, no longer a personal company, control thoroughly split—how do you get people to serve on that board? And will they put their time and their effort on it and deliver the caliber that you want? There you finally put the problem. Britain solves it after a fashion by having what is known as professional directors. I don't think that solution would work in this country worth a damn. I don't see any over-all solution. But I think that is the key to the problem as it stands today. If you once find out how you can bring together a group of men of that sort that are really highly competent, that are really willing to put their time in, who are really willing to understand, who will have the thorough respect of the man who is the chief executive, then I think these other problems of how they conduct their affairs are secondary. — May I go back to one or two points that you have raised here? You mentioned the cabinet and said this cabinet was important for the man to work out his plans in consultation with, they were his associates in thinking through the basic problems. And on the other side there was the

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board against which he tests the results of his discussion. You said that it didn't make very much difference whether this cabinet was a management committee or an executive committee of the board or whatever it happened to be. — I see no problem whatever in getting together what I call the cabinet. That's easy. You have got to have a cabinet. A man who is in a tough executive post has got to be able to call together a group of his associates, his colleagues, his subordinates, and sound out his plans, thrash them out when they are in half-baked form. But, in addition, I believe very strongly that he needs one more step if you are going to have the proper safeguards, and that is the job of proving his point to an independent group that are damn good judges, who have not been participants in the plans, but who stand aside and judge. They interfere in no way with the management, but they are judges. I think that if that element is lacking you are always in danger. And I never want to be a chief executive with that element lacking. I have been and I know how damned uncomfortable it is. — Well this expression o f — — If you've got a program that is going to change the whole face of nature, see, then you've got to sum that up in your own mind and say, "All right boys, I may be right and I may be wrong, but here we go." It is a very different thing if you can walk into a group that are your judges and say, "Now, gentlemen, this is my program." Let them attack it, and you defend it, and when you finally come out of there, they say it's all right that you go. Then you go with confidence. But you've got to have that element. If that element is lacking you are in a damned difficult spot.

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— Y o u want good critics, don't you? — That's it. — Y o u are, I take it, suspicious of the quality of the criticism from people who are the underlings of the executive. — No, I just think that those two functions are quite different. — — to be to be

I do too. The man who would be a good cabinet member has in one frame of mind. A man to be a good judge has in another.

— In addition to that, to be an effective cabinet member you have to have the time, the availability, which the other man, the judge, probably would not have. — Sure. — How intimately familiar do you think that the board member has to be with the business and the mechanics and details of the business to be able to be an effective judge? — Well, usually he doesn't need to be. Doggone it, he is given his background right there. He is given his arguments, his data, his facts, his figures. He's called upon to do nothing except to judge and he can do that. I think that if that element is lacking there is something missing. — What you are saying is that a real board of directors should be composed exclusively or almost exclusively of competent disinterested outside people who have no axe to grind. — Y o u can take all sorts of forms. Try to separate in mind the two functions which I think are essential. I think the trouble in American industry is that we can get the first of those very well, and do. We get the cabinet structure in

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one way or another. But I think we do not yet get the board structure in the form that I think is essential, and I don't see how to get it. That's the central problem. How do you get men of that caliber to serve in that way, and still people, mind you, who are not going to grind axes, not going to interfere with management, but who really are going to perform the function of director? — To get the detachment that you need in what you have described as the board, I don't believe it is necessary to have a completely outside board. Now obviously I am prejudiced about this. But I think you can get the audience against which to bounce the chief executive's idea from inside a big organization. I am not sure about this 500-million-dollar one. I have some trouble with that because I don't have the experience to help me, but in a big organization I am confident that you can develop not only the cabinet but you can utilize other individuals in the organization with enough different backgrounds and adequate detachment so that you can get constructive criticism of whatever conclusion the chief executive has drawn from his work with the cabinet. — Well, on that particular point I'm sure I would agree with you in terms of native ability or developed ability, but what about the problem of beholdedness? — That's no more difficult than the problem of getting these outside people. — Possibly not. — But let me ask you one question. Would any of the cabinet be admissible on the board, except your chief executive? — Of course, and you want undoubtedly a proper connection between those two organizations.

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— Other than the president? — Other than the president—for continuity, for one thing. You may get hit by a taxi tomorrow morning. You want a deputy there. You want contact enough between the two so that if the president drops off, nothing happens. Things go on. You don't want so much contact that you get confused as to which organization you are in. — Well, I think we all agree that it is a workable scheme if you could get the directors. — Now the thing that really bothers me on this question is this. Since the board is chosen by the chief executive very largely— — We might come back to that— — And is submitted to the stockholder for approval, where the approval is always obtained, to what extent is it possible to achieve a completely objective and a critical appraisal of the management program? — Well, that's what I question. It ought not to be chosen by the chief executive without checks and double checks. — Who should it be chosen by? — Well, you do it by a committee of the board. They've got to pick their own colleagues. — But do they? — They don't, I know, but don't think this business of having a board picked by the chief executive is inevitable. — The committee of the board would include the chief executive, wouldn't it? — Oh, sure, he would present his ideas but I don't think it should be his— — Well, if you go back to your previous comment, that this board says to the chief executive, "You are my boy. I'll

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back you up as long as I think you are right," when you come to this question of the committee selection of members, aren't they almost inevitably going to agree with him on anybody he wants on his board? — No, I don't think so. — Well, you are saying that a committee of the board is going to select this group. — No. I am merely saying that the unrestrained practice of the chief executive picking his own board members is going too far. We ought to have a check on that. — Well, how could you get a check on that? — By selling it to a committee of the board. — But the committee of the board itself may have been chosen by the chief executive. — Oh, no, not ideally. It would be a group that would be a self-perpetuating oligarchy where they brought in their colleagues if they were agreed on to join the club. They would pay close attention to the suggestions of the chief executive but he could not be a one-man show. — Now in this setting what is the function of the chairman of the board? We haven't said a word about that. — Ha! You want me to throw another bombshell into this? I think the idea of making the chairman the chief executive is the bunk. — Amen! — I think the chief executive should be the president, but that you should have a separate chairman of the board. And the primary job of the chairman of the board would be to see to the composition of his board and its general health. That's his job. — Very good.

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— That ought to be his only job. — He is chairman of the board and not a member of the management committee? — No. He gets some kind of fee for being chairman of the board, but he is not one of the executive operating staff. — Well, would the new members of the board be worked out by a committee of which the chairman of the board was a member? — I think it ought to be his job, however he wants to go at it, to solve the problems that have been thrown on this table, taking the board such as it is, a typical board which you find today, and transforming it into a really good operating board. That would be his job. If he is up to his job he ought to be perfectly willing to go to John Jones and say, "Now look, John, you have been on this board for twenty years, and I am going to move you off now, and I hope you take it pleasantly." — There are not very many board chairmen who would do that! — No. There aren't very many good chief executives, either. — I suppose it would be compounding the problem too much to ask if we didn't have such a chairman where we would get him. But certainly in our typical situation we wouldn't be blessed with two sets of gems, a good effective chairman and a good chief executive officer. — Get those and you have no worries left. — That's right. — Well, you still have a worry to get this board that you are after. — That's the chairman's job.

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— Well, how is he going to do it? — I'm going to leave it the way I presented it. On that point I am stuck. I don't know the way. — I think we came awfully close to saying we just don't know how to do that. If that scheme doesn't work we can— — Okay, I'm perfectly willing to be thrown out on that basis. that reliance on a predominantly outside board does not require conformance with the other aspects of the model outlined above. The concentration of executive power in the hands of the president, the assignment of the chairman of the board to oversee the health and vitality of the board, and the limitation on executive influence in the selection of directors are not essential ingredients of an outside board arrangement. Yet these points are related. If the purpose of the outside board is to provide objective appraisal of executive policy, board members must be genuinely independent of the executive. The above discussion has therefore been reproduced in its entirety as relevant to the question of inside versus outside directors. It was pointed out earlier that there are two approaches to avoiding reliance on board members (part-time inside directors) who as operating officials are subservient to the executive officer whom they, as directors, are supposed to regard critically. One approach, examined above, is the greater reliance on outside directors. The other approach, to which we now turn, is the resort to full-time inside directors. I T IS CLEAR

4 Full-Time vs. Part-Time

Directors

of thinking of inside and outside directors, one may think in terms of "full-time" and "part-time" directors. A full-time director may be either inside, in the sense of having come up through the company, or outside, in the sense of being brought in specifically for that job. Similarly, a parttime director may be either inside, as a member of operating management, or outside, showing up only for monthly board meetings. The view was expressed that it was this distinction between full-time and part-time that was really vital, not the distinction between inside and outside. Most of the discussion revolved around board practice at the Standard Oil Company (New Jersey), which constitutes the prototype of the full-time board. A representative of that company participated actively in the discussion.

INSTEAD

— We think of our board, or any board, as a matter of fact, a little bit more in terms of whether they're full-time or part-time boards. I think that distinction is much more significant than the words "inside" and "outside." — I think that's a good point, full-time implying no operating responsibilities— — It means that he devotes full time to the responsibility of being a director of the company. I think that certainly in order to discharge its responsi-

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bilities a board of directors has to know a great deal of what's going on in the business. I don't see how they can know what's going on in the business and appraise the actions and report on the results of the company's operation unless they're pretty close to the management. I mean by that they ought to have constant enough touch with the management so that they know what's going on, they can appraise the ability and the sincerity of the management, be familiar enough with the tangible results of the operation, so that they can judge not from what the management may tell them but from their own knowledge, of whether the management is functioning adequately along the broad policy line which the board may lay down. To me, it's just inconceivable that a director in a corporation can discharge the responsibilities of a director to the shareholders as we visualize them unless he does more than attend a board meeting once a month. Unless he works in between those monthly board meetings very hard, he'd come up with a lot of statistics and have a lot of office traffic, but the real issue is whether a director of a corporation can or cannot discharge his responsibilities adequately to the shareholders who elected him as a director if he does not know enough about the functioning of the managers who are implementing board policy, and the results that they obtain, to form of his own knowledge proper opinion about what's going on. Now that means, as I say, he's got to be something more than a once-a-month director. I don't necessarily say it has to be full-time; I think that depends a good deal on the complexity of the business, the type of operation that is involved. But I do say that he's got to spend enough time at his job

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as a director to know what's going on, to appraise the management, to appraise the results, of his own knowledge and not secondhand. If that's half time or three-quarters time or full time, that's all right, but until he can do that I don't think he's meeting his responsibilities. The alternative to it is in effect to just accept on its face, or on faith, what somebody tells him. And then he has to take the responsibility for that acceptance on faith if he ever gets in the position where the shareholders say, "Well, we don't think this company's being run right; we're not satisfied with the results." He cannot say to them, "We've got a bad president and we've got a bad management." That's his job, not the shareholders'. He's got to assume the responsibility. — In this respect, the board member is the eyes and the ears and the wisdom of the shareholders. — He's the ego of the shareholders distilled down to ten men instead of 300,000. He is the shareholders. — But the shareholders can't do this job because there are too many of them. — Well, now, in this concept of yours the board member is not in a very good position to delegate any of the responsibilities very far. — Yes, he can delegate them just as far as he has complete confidence in his delegation, but he's got to have behind that the full acceptance of responsibility for what he does. — But this delegation never terminates his own responsibility. — Never terminates his own responsibility—he doesn't avoid it in any way. But if he's willing to find the fellow that

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he has absolute confidence in, the fellow that he thinks can do a better job than he can do himself—if he has complete confidence in the delegation of responsibility, then he can delegate just as far as he wants. He never avoids the moral and legal responsibility he has as a director. — Well now, the president of one company last week was making quite a point of the fact that out of nineteen board members only two of them spent full time in the company as management. And the seventeen other board members served as check and double check on the general operation of the company. — Could I ask you this question: Just how do those seventeen members check and double check? My point is simply this: It's commonly said that you're going to have a lot of outside members on the board to check and double check on what the management's doing. Now I don't know how you check what a man is doing unless you're able to evaluate it on knowledge that you have yourself. I mean, it's not so easy to sit down and say, "I'm going to check the general manager of this company." You've got to know first what to check, what to look for, what kind of standards to apply, and what kind of results to judge by. So that this business of checking people, unless you know very much about what you're going to check, is to me just a lot of words and not very much substance. — One of our group made the point, though, that all a man needed was judgment. — Well, judgment is fine in a lot of areas, but there are an awful lot of areas where what we commonly call judgment or intuition or whatnot isn't good enough. You've got to have some real technical and specialized knowledge,

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knowledge in the back of your head that helps you quickly to form that judgment. — I think the thing that one of our group was primarily concerned about, as I recall the last session, was the degree of independence of the board members. I don't think he was suggesting that a day-a-month man could exercise a good kind of judgment. I think that's one of the things we are concerned with—where you would get outside independent people to spend the amount of time necessary to be familiar with the company's operation. — But in terms of your analysis, I think you would be raising the question of actual independence of these board members. — Independence of what? — Of management. — Well, they control management, they direct management, they can fire management; they have complete control of management. — I think it gets down to a very practical problem. I agree with everything you have said but I envy you your depth of management which permits you to have those who function as directors on the one hand and those who function as management on the other hand. I think this becomes a special problem. — Well, I think I ought to try to make clear that our board of directors with few exceptions does not in any way function as management. There are one or two exceptions on our board by whom actual managerial functions are exercised, but the great bulk of them do not manage anything. They sit up there around that board table and they appraise the functions of the managerial people; they appraise

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the results of that management; they appraise the trends of the business; they lay down some broad policies as a framework for these people to work in; but they don't manage anything. — I understand that. Perhaps I didn't make my point clear. I know a good deal more about the du Pont setup than I do about Standard Oil. I expect that it may be a note of envy to start with. But you take du Pont as an illustration: they have ten men who act as the executive committee— and I think we ought to distinguish between Standard Oil and du Pont to the extent that the latter does have a board which has outside, part-time directors, if we want to keep that phraseology, which I think is pretty good—those ten men do nothing but direct. Now I refer to the depth of management material because all of those ten men, and I believe all of your directors, are products of experience in the operation. And then to have another set who are the actual operating managers of the business is a very enviable depth of management which a company such as mine doesn't have. It would take us a decade I think—even though we were brave in the appropriation for the administrative salaries involved—to bring forth a group which would do this fine job of intelligent supervision, or discharging the duties of the officers, in the depth that you have outlined. I think this becomes a practical problem with respect to this ideal. — That's true. I think that practically I was outlining what seems to me to be the ideal appraisal of the responsibilities of the board of directors. Maybe we've gone a long way along that road, but I'm sure there are many, many companies that haven't and couldn't go so far except within

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a long period of time. But I guess we're getting to talk in terms of ideals a little bit. — We are, and I almost think we have to—and, also, we prefaced the discussion by saying we were talking about large enterprise. We didn't try to fall into the trap of saying what is large, but it raises a question in my mind, whether so-called large enterprise, if the objective is worth while enough, can't start down the road toward developing a board more along the lines that have just been outlined. Not that it would be done tomorrow; but even a start—I throw this out as a question—wouldn't a start be worth while? — I don't know whether this is a useful suggestion, but if we go down the line of this ideal, I think perhaps we make a mistake in selecting one size of company for our consideration. It seems to me you have in General Motors, in du Pont, in Standard Oil of New Jersey, and in the very large companies, the very successful companies, opportunities to do things which you don't have in a billion-dollar company and a half-billion-dollar company and perhaps in a $100,000 or $250,000 company. — That's right. I would put in again—I agree with everything you've said there—it depends so much on what kind of company, what type of operation and activities, what the geographic scope is, general size, all sorts of things. I can visualize many companies, relatively important companies, that nevertheless are not companies big enough to, let's say, support the development within their own ranks of what I would call a first-class finance officer. They just can't do it. There's just no way in which they can develop a man like that in their chain of activity. And yet they're going to have financial problems. So, if they can't develop one within their own ranks, the

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next best thing is to go outside and get a good banker to put on the board. Now I don't think that's ideal because I think that when he does that if he can only spend a fraction, a small fraction, of his time on that board he is not really representing fully the job that I think a director has; but he is making a contribution it couldn't get otherwise. So, you get from what I call this ideal situation clear down to something like that, with all grades in between. — It would be helpful to me if you could describe a little more fully the responsibility of your individual directors. You started out by saying that your board must be responsible as a group. Now, you have a full-time set of directors here. Do your board members have any individual responsibility? How do they use their time? — Well, we have the thing set up this way: The management of affiliated companies, or staff, is delegated the responsibility for conducting those particular operations in all respects—financial and operating, employee relations, public relations, human relations, and whatnot. There are some broad policies or principles laid down that they're supposed to work within. Just to be specific on that, one of the things we say is that we do not want any management of any company to attempt to pay labor less than the prevailing rate in the area. That's just a broad principle. He can pay them twice as much but he shouldn't pay them less, because if he pays them less he is going against the broad policy that the board of directors has established. And you've got those guidelines, or policies of that type that are very broad, which these managements are supposed

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to observe. But within those guidelines they have the full responsibility in every respect for conducting this operation, which is a subsidiary operation of the parent company. Now we think these fellows are pretty good, but they always like to try out something very important on other people's judgment, on other people who they know are thoroughly competent and thoroughly familiar, with long experience in the business. So, as a matter of practice they will bring to our board for review anything of that type. Now lots of times they don't have time to do it and will act completely on their own, but whenever they have time they like to test out important things—and I emphasize important things—such things, for example, as executing a concession in the Middle East, which is a pretty doggone important thing. Now it might be that the president operating there would have the responsibility and the authority to do that, but he wouldn't want to do it because, he says, "I've got fourteen men here that I can bounce this thing off of, tell them my approach to it, and get their view on it," so that those things come up naturally from the management people to our board for review. It's a question of having confidence in your board of directors to be able to contribute something, to catch a weak spot, if you've overlooked something, or to add a strong argument to the proposal that you might have overlooked—just, in general, to get the benefit of what they consider to be worth-while advice.* Now that's the main area; that constitutes, I should think * Here the board of the parent company seems, in some degree, to serve as the group of independent and impartial judges for the operating subsidiaries which the discussion of the preceding chapter set up as a desirable objective.

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half, maybe, of our board's work. Another quarter of it, maybe, is the review of management personnel in the affiliated companies. We regularly schedule the review of management personnel by our board, and in those reviews we analyze each individual, going down through the major executive group; and we take them apart and discuss their weaknesses and their strengths, and if we decide there's an area where they're weak, we start searching for ways to bolster it up. We either call it to the attention of the chief executive of that company and give him the first shot at bolstering it up from within his organization, and if he can't do that—and usually he can't because if he could he would have done it already—then we go out and search around somewhere else in the family for the kind of a fellow that we think we need to bolster up that weak spot. And that particular type of management review, which includes such things as compensation and executive incentive as well as appraisal of personality and performance, I think probably takes 25 percent of our time. Then the final 25 percent—this is pretty rough division— is control. And this is an actual control, though in very few instances does our board exercise control—in most instances it's advisory. But the board controls finance. We have always before us requests from affiliated companies for additional financing, and we go in very thoroughly to the reasons why they need the financing, what they're going to do with the money, look at their earnings record and their past history, look at the future and what we think their prospects are. And we decide yes or no as to whether or not we'll give them the financing.

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Once we give it to them, then they go ahead and spend the money and implement the operation. That's about the way the thing works. — The other aspect of my question would be, since your board would obviously not be sitting continuously as a board, in between sessions is the individual board member operating on his own, so to speak, or is he utilizing his time under the direction of the board itself? — No; he's utilizing it as an individual. For instance, just as a matter of making this system work better, we divide up the world into half a dozen different areas and say "Jones, you act as a point of contact for this one," and "Smith, you do this," and "Brown, you do this." — These assignments are made by the board? — These are made by the board, made by the board as a group. They're recommended by the president, and the chairman and the board approve. But all that simply means that, if the president of the company operating out in the Philippines wants to put something before the board he's got to have somebody to come to get it before the board, as a matter of practical operation. And so he comes to Jones and he says, "Here's my project," and he comes in and he and Jones present it to the board. — And the president would be powerless, then, to draw these board members, as individuals, into any kind of operating assignment, under his direction? — Well, yes; I don't think he could, so far as the board members are concerned. Of course, it's a team play. As I pointed out a while ago, I think any board would have to operate as a group; you've got to have group decisions. But

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just to implement this kind of work, you divide the thing up so that each fellow has an area of particular interest. Now you ask what he does between board meetings. Well, what he does between board meetings is confer and discuss and develop all this multitude of projects in the particular area that's reporting to him so that when a thing does come before the board he's really got it pretty well covered in its first aspects. — Do you have an executive committee of the board as well? — Yes. — What are the functions of the executive committee? — Well, there is a regularly scheduled board meeting once a week, every Thursday. And at that time we take all legal actions that we have to take, such as the granting of a proxy or the declaration of a dividend, those kinds of things. And that has to be done in accordance with our corporation charter and corporation law. In between those Thursdays we have a meeting every day of the executive committee, which under our charter is permitted to function for the board in every area except these corporate areas. Now that simply means that in effect the board as a whole knows that there's a lot of traveling, a lot of absences at a lot of meetings, and if it tried to have a board quorum every day it probably couldn't do it, so we have a meeting of the executive committee every day which every board member is invited to attend. As a practical matter, I think every board member who is in New York attends every executive committee meeting, every day.

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— Does he attend as a member of the executive committee? Or are the members of the executive committee specified? — The members of the executive committee are specified, and every other member who is not named as an executive committee member is designated as an alternate member, so that in effect and legally he can function as an alternate member. So that we really, for all practical purposes, I think, have a board meeting every day. — May I ask how nominations are made for new board members? — Of course, the board members are elected at the shareholders' annual meeting, from a slate which is prepared by the board members themselves and presented to the shareholders. We have on occasion had other people nominated for directorships from the floor. — In place of a name to be presented to the stockholders? — Yes. — What criteria of selection would be used by the board? — Well, we usually have been pretty well satisfied with the members we already have, so we put them up for renomination. When we have vacancies due to death or retirement, or something of that type, under our bylaws the board can fill that vacancy on a temporary basis until the next shareholders' meeting. And we do that. If we have a man who dies or retires, let's say in December, why, we elect another man to fill out his unexpired term from December to May. Then in May this man the board has elected to fill this vacancy is put before the shareholders and they elect him for another term.

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— At the time he is elected by the board to fill out this term, he sheds his operating responsibilities? — That's right. — There are two questions that seem to me to need clarifying before we can go on to accepting the full-time board as the ideal. One is the matter of recruitment. I take it the full-time board almost of necessity must be recruited from inside the company? — Oh, no. — Well, it ought to be so, I would say. Is there a fulltime board that isn't recruited from inside the company. — Yes. We've got two directors, one from the Federal Reserve and one from a New York bank. They're full-time men now, but they certainly were not brought up through the company. — Are you indicating that you brought them from outside and put them immediately on the board? — No. They were given a period in which to get a more intimate understanding of the company. — But there would be no reason why you couldn't bring in an outside person and put him directly on the board, full-time. — No; but it's never done, that I know of. — It does severely limit the capacity of the average company, the smaller company, say, to operate with a full-time board, if the normal and usual way of recruitment is from the inside. The second question that I think we ought to explore more deeply than we have is this business of ingrownness. The fact that you can bring in outside influences, consult-

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ants, and people who because of their past history will obviously be critical, the fact that there can be some safeguards built up, is certainly true. But I think that further examination of the specification in this area would do much to strengthen the case for a full-time board, because it is in this area that principal criticism is usually raised. If we can get over these two basic issues, then I think you could begin to see that the full-time board might be the thing for all companies to work toward. — I'd be willing to discuss these points. Discuss the first one first—that's the easier one. It seems to me that it's quite possible, in fact I know it's quite possible, to have the objective of developing as a board of directors of any corporation a knowledgeable, expert, all-around group of people who are thoroughly familiar with the business and who have demonstrated an ability to think in pretty broad terms outside the narrow confines of the business. But in a lot of companies it may be difficult to get enough people to cover all of the areas that the board ought to interest itself in. And I don't see any reason in the world, then, why you can't go outside and select anybody that you think will fill the bill and offer him a job and say, "Look, I can't put you on this board because that's the shareholders' prerogative, but what I would like to do is offer you a job as treasurer, or general counsel, or public relations manager, or what-have-you; and just as soon as we come to our next shareholders' meeting I'll put you up for election before the shareholders to be a board member, to serve us in this particular area." As a matter of fact, in lots of cases you can even raise the number of the board by board action through the by-

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laws. With the kind of knowledge that you need in any area, I don't see any reason in the world not to go outside and pick them up wherever you can find them. — Why do you need to take that intermediate step of bringing them into some kind of company operating position briefly before he is nominated? Why couldn't you secure his assent to being placed in nomination before the shareholders? — You might have 11V2 months before the meeting, and you wouldn't want to wait. These kinds of people don't grow on trees and when you get your hands on one you want to cling on to him. — Aside from that, I mean, there's no real need for bringing him in through this channel? — No. — There's one thing that bothers me about that. One of the values we were getting from this full-time board was the fact that these men knew the company and knew the business intimately. Now, if we are going to recruit them and bring them in from the outside— — We certainly don't want to do that as a general thing. I think we were thinking of it as an emergency operation. — Only when you couldn't go the other route. — Let me say this: If you acquire such a fellow as I'm talking about here on a full-time basis, if he's the kind of fellow you want, he's going to learn about things pretty fast. Now if you don't have a full-time job for a man of that caliber, why, then I think you ought to use a consultant probably. Because you only need that kind of advice and information on a relatively part-time basis.

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— A moment ago we used the term "the ideal type of board" and I'm reminded of what one of our group gave us last time as his ideal type of board, from which there's a very substantial difference here. He compared it to the government of a company, and the job of the board was to pick the chief executive, and the chief executive would have a cabinet which he would take from management. And this cabinet would help him bounce his ideas around, and then after the policies had been developed by this chief executive—not by the board, but by this chief executive—he would from time to time bring the whole package to the board of directors, which would review it and suggest modification, looking at it from the standpoint of the stockholders. It was a board which in his judgment could be recruited—but he didn't say just how— to assign enough of their time and their energy and their knowledge to be a good review board. — This is a very different picture—just 180 degrees around. — That's right, that's right. — Well, I really believe very sincerely that most of the objections that are raised of full-time boards by people who are not full-time directors are due to the feeling that such boards get to be narrow-minded and ingrown and fail to take into consideration factors that certainly are important, that fall outside the immediate purview of that company's operation. — That's right; those are the principal objections. — That's about 99 percent of the objections. — And that is a danger, of course.

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— And it's a danger that you have to guard against very carefully. — Well, let's look at that now. How do we guard against that in the full-time board? What are the means that have been devised in du Pont and in Jersey Standard— — What do you think I'm sitting here for? This kind of discussion is one of the things—I'm serious; I'm very serious—I'm not the only board member who does it. We all do it. And we constantly have people coming in from the outside to talk to us critically and we have a lot of consultants; we invite that kind of criticism. We have a great deal of participation by our directors in extracurricular or outside activities. And maybe this isn't a good answer in too many cases, but just the very fact that we're constantly dealing with problems of all kinds all around the world, all kinds of political atmospheres and public relations atmospheres, you just can't get too narrow-minded. — I think the dangers of ingrowing in a board of fulltime directors is much less than in a board of operating management people, the part-time inside directors. — I think that's right. — As soon as—or assuming—you give them a responsibility in over-all policy and get them away from the responsibility of running some segment of the business, I think you develop a different attitude of mind, you develop a little more leisure and freedom to get away from the immediate problems, than if you have the direction of sales, of research, etc. — Our objective basically is to have our board, not only in the parent but also in the big affiliated companies, con-

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sist almost exclusively of non-managerial people. Now, I say "almost" because we think that the president ought certainly to be on the board, and of course he has managerial responsibility; and there are usually two or three other exceptions. But, in general, we like to have on our board people who do not have managerial responsibility. — Well, then you follow the same thing in your subsidiaries—each will have a group of full-time directors— — There are a lot of variations in the thing, but that is the basic objective and we are working toward it. We can't do this thing in a day; we've been working on this for thirty years. And we haven't arrived at the end point yet. But we do have on every board in every affiliate at least a group of directors who do not have managerial responsibilities. Maybe it's two or three of ten— — Do you find that workable— — They're full-time directors but they do not have managerial responsibilities. — If you find that workable for the smaller parts of a large company, then it ought to be workable for a smaller company. — I should think so. The only thing I had trouble with on your previous comment, that you saw nothing wrong with the board member wearing two hats, is that you can't get away very well in practical terms from your ingrown tendencies or the lack of severity of criticism or objectivity if you're wearing both hats. — Well, you put it on a different basis, though. You put it on a basis that when you wore two hats you were sampling your own whiskey. I don't see it that way. I see it only from the standpoint of the impracticality of doing this

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sort of broad-gauge introspective objective thinking and being burdened down with the operating details of management. Because, after all, a director has responsibility to the shareholder for what any manager does, whether he happens himself to be the manager or it's a third party. But as a practical matter I think he ought to have more time for the broad-gauge type of thinking and introspective type of analysis of what's going on in the business than he might be able to get if he wore the two hats, if he had a full managerial job. — Is it possible that the amount of responsibility, or the authority that goes with responsibility, that is delegated is a function of the nature of the board? I notice that in the case of the full-time board the functions of the board are far more extensive than they could possibly be in the case of the board where only the chief executive and maybe one associate are on the board and the rest are outside men. Is this beginning to blur the distinction that we have tried to fix here between the board and management? To what extent is the full-time inside board in effect a management board, and to what extent is the outside board simply a review agency that has as its one responsibility, that it cannot evade, the appointment of the chief executive and the setting of his salary? It cannot delegate that responsibility. There is no other place for it to go. But all the other responsibilities presumably can be to a degree delegated to management. — You do have that shading effect there—one fading

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right into the other. When do you stop becoming management and become a board? — That's right. I think the discussion has served to illustrate very clearly that the sharp distinction between the board and management does not exist, that it's a function in part of the nature of the board and perhaps also of the nature of the business, rather than being a legal matter. — Well, it depends on what you are talking about. I think the responsibility remains whether the men do any work or not or whether they can be corralled sufficiently to do it—I think that is there. If we are talking about power and what they actually do from that position, and if the question is whether a board does get into management, it can; whether it should is a matter of business judgment. — The board in a sense is legally conceived, isn't it, to protect the stockholders' interest? It is a representative of the stockholder, if you will. — Yes. — There's the implication there that there might be a difference between the interest of the management and that of the stockholder, and the board is there to see that it's properly cared for. The implication of the inside board (as it seems to me this is beginning to emerge) is that there is no distinction between the interest of the management and that of the stockholder. — I don't follow your conclusion that there is no difference in interest; obviously there is an adverse interest any way you look at it—by adverse I don't mean hostile interest. — No.

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— The more management takes for itself the less there is available for stockholders. So there is that basic conflict of interest. — Well, it may well be that management is the best representative of stockholders—that may well be. The theory, of course, is that one is made up of people who seek to distribute profit and the other of people whose business it is not to distribute profit if it should be conserved by the business to do a lot of things that stockholders don't like because they do not understand. — Is the inside full-time board as likely to be as perceptive to the political requirements of a corporation as some of the outside people might? — Isn't that largely a matter of degree— — It depends on what kind of people you have. — Right. — I think you're retreating a little from the line. Let me just put this as a slightly unrealistic case, to bring the question before us. Suppose you took a minister, put him on the board. — That would be novel. — It would be very novel. But there are ministers that have been very perceptive in social matters. I should imagine it would be extremely helpful in certain cases, particularly the bigger the company. But is he likely to be more helpful, more understanding, or less, as a result of not knowing about the business? — More perceptive of what? — Of what the public expects of a major company operation.

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— I'm sure he wouldn't. If you're thinking in terms of whether he would be more likely to think in terms of a broader scale of employee benefits or a broader scale of corporate giving or support of education, those kinds of things, I have a feeling that in general he very likely might think more generously in those terms than the corporation management would. — That's not what I'm thinking of at all. I'm thinking of, basically, the stockholders in the long run. I'm not thinking of greater generosity. — You know, the stockholders' interest is only one facet of the thing, really. I said, a while before dinner, basically the stockholder's interest is to have stability and protection for his investment and an adequate or reasonable return on that investment. And I think too that it also involves the perpetuation of the corporate life, of the investment vehicle that is used. Now certainly to meet those objectives you've got to be sure that you're going to be able to keep on living as a corporation, and I'm just as sure as I can possibly be that that involves acquiring the approbation of the majority of the voters in the United States. If the majority of them believe that the corporation as we know it in this country is the best thing for the country as a whole, taking everybody's interest into consideration, why, we're going to keep on having corporations. But if the majority of the people don't believe that, why, I'm damned sure that our politicians are going to change that. Now the things that will make the majority of the American people think that the American business setup is the best thing for the country, as compared to some other

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form of activity, is a composite picture; it's how you treat your employees; it's how you live in your community as a corporate citizen; it's how your management people conduct themselves, how you cooperate with government, what kind of product or service you give your customers—a composite of all those things. And you can't go overboard in any one of them but you try to achieve the maximum total effect from all of those that you can, weighing and harmonizing all these various interests. And I think that a person that has that kind of a concept about corporation management responsibility is definitely looking after the interests of the stockholders. — You come from a company that has thought about these things for a long, long time, and developed them more highly than any company that I've ever been close to. I wonder whether you're not thinking in terms of people that are more ideal than exist in most places, and whether a good many businesses—where you find people are just amazingly blind to things that are very apparent to outsiders, about the shortsighted way of running their business —don't need the minister or the investment banker or some outsider to challenge some of those things. I don't think that generally speaking you find that— — I have a lot more confidence in the sincerity and the understanding of the average American corporation. I've talked with hundreds, actually thousands, I suppose, of corporation executives every year, and by and large they're growing up in this philosophy that's being expressed here— it's amazing. I've got a lot of confidence in it. It's only the exceptions and the bad cases—and you're going to have those as long as the world lives—that really

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come to attention and create a lot of criticism of American business. — In an extreme form I agree with you, but the reason we have outside auditors is because even honest and capable accounting executives recognize the need for an independent check on their judgment; and isn't there a need for some kind of external check, and isn't it likely to be welcomed even by capable people? — Well, are you going to get that through an outside part-time director? — A s one possibility, not the only one. — I think that you'd get it a lot better through education of full-time directors. — T o provide a contrast, we have no employees of the company on our board except the president and a board chairman. The other directors, fifteen in number, are all truly nonaffiliated directors. They are gentlemen who themselves have very heavy responsibilities, most of them business responsibilities, but in a wide variety of businesses. They are representative of a great diversity of industry. They are deliberately chosen to come from a wide geographic spread across the country. They are carefully chosen to fit that kind of pattern as replacements are made. Our feeling is that anything you can do with the full-time inside board you can do with some kind of an executive staff inside the company, and get the advantages, which we think are very real, of the outside board in addition. Putting that the other way, if you substituted our present president's advisory council for the board and lost the board, of the kind I described, we think it would be a terribly real loss to us.

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As between the strong board, which is a full-time payroll board concerned only with this company, and the board of the kind I described for our company, we prefer the latter on the premise of the danger of getting ingrown—it seems to us to be too real the other way, the danger of overcentralizing too great the other way. Men who have come to a full-time board position through talent and ability as strong executives inside the company carry that symbolism in front of the people in the organization into their new full-time directorate job; they are executives inside the company. We do not think that brings the independence on their part, or the capacity for taking an objective view on their part, or the relationship with the people still in the executive and operating setup, on the other hand, that you can and should get. — Granted that the full-time inside board is the ideal, and granted that there are difficulties in getting it, I'd like to leave that for a moment and get you and the others to talk to this point: There are many, many companies, including my own, where you today have a board which is either almost altogether composed of outside directors or at least has a majority of outside directors. — Using part-time as the further description here? — All right; part-time. Now you have said, very correctly, that the primary responsibility of the board is to the stockholders. My question is: Of course, we can say to them, "You're going to have an inside board from now on; gentlemen, you're going to like it." But have we any information—and I ask this really as a question, I think it's a question on which a great deal revolves—have we any in-

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formation on the attitude of the stockholder toward the composition of the board? Has the average stockholder more confidence in a board on which he sees names, the principals of a great many other companies and representatives of a great many other businesses? If I can personalize it a little bit, are you ever asked if it wouldn't be better if you had a little advice from other than just your own group? — I think you've raised a very pertinent question. I don't think there's the slightest doubt in my mind that a great many shareholders have a feeling of satisfaction when they see the names of some very prominent people on their board of directors. I have a feeling also that they place a great deal more confidence in the contribution the big name people make to the company than is justified. But they certainly have a feeling of satisfaction about it; they would like to see, oh, President Eisenhower on the board. It just makes them feel good to have those kinds of people. — I think the general run of stockholders rather favor outside part-time boards of directors. Not only because they're used to it but I think they're more comfortable about the operation of the company. Now I'm not going to be so simple as to challenge, even by inference, the setup of some of our full-time boards. But the companies of which I am a director, outside of my own business, which is completely owned by the board of directors, are companies not so large, and in each case the outsiders, part-time, constitute a majority. But I must say I'm rather shocked by your remarks—and I made some notes as we went along. You said you didn't see how outside directors could appraise management. Now, I really think that I do—if you

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don't mind—in the three companies of which I am a director. Now you might say, "How do you?" And I do it by comparison, the same way that you value securities. I know when any one of my companies is well managed; I know it by all kinds of figures; I don't have any doubt when I'm appraising it that it is very well managed. You said it's inconceivable—and I completely agree with you—that a director can really direct and do so by attending one day a month, but I can't go so far as to agree that he has to be there eight hours a day every day. — How much work does it take— — I don't know; it's a matter of degree. But I would say I spend a substantial amount of my time with the three companies where I'm a so-called outside part-time director. And I do not applaud at all those directors, of which I'm afraid there are far too many, who dash to a meeting, collect a fee, whatever it is, and run away. I don't like that at all. — You made a point a while ago that kind of hit me pretty hard, that is, you said you thought you could appraise management in the way in which you function as a director of a company. I just want to raise this question: Basically, don't you appraise them largely on results? I mean, you see the earnings of the business and the growth of the business, and so forth. I imagine that's the way most appraisals would have to be made of management when a person wasn't really living with management. But the thing that strikes me about that is this: you might see good results for a long time, all the while that basically

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the competitive situation, the market position, of that company was deteriorating. When the results finally show up the true state of affairs, the damage has already been done. I don't see how your ability to appraise management would prevent that kind of a thing from happening; you might look at good results for quite a long time, but underneath there was something wrong. Now that's the thing we try to avoid, and even though living with our people we still have some of those cases. — Well, I would answer that I could not appraise that far down in depth, so to speak, and I grant that I make the appraisals by results, as you put it. When I see one of my companies capturing 50 percent of the over-all market, I say its performance must be pretty good. — But it might be better— — I can't answer there; it's true it might be better. — Certainly, there are many cases we all can think of where the figures, and even the share of market, if you want to get away from the financial criteria, would hide a deteriorating situation for a considerable period of time. — Well, I'd like to ask this. Let's assume that there is a gradual diminution in the share of the market which a company is getting, or a part of a company. It goes on for let's say five years. Now how do you, with an internal board, a full-time board, measure that decline in participation of market, and how quickly can an inside board do something about it, rather than an outside board? — I think I can answer that with a great deal of assurance. I think that our board would be much more sensitive to the development of that kind of a situation than the outside or part-time director would be. I'm positive of that, be-

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cause we look at the thing all the time, we live with it all the time. I'm also sure that we would be able to evaluate the basic factors, the reasons that are behind that decline, much more quickly and much more readily than part-time directors would, and institute some kind of action, if action is indicated, much more readily than a person who is not close to the business. Now, we have that same situation all the time, as I suppose most every business does. You look at your business in one area and you've lost some market position. You know what the growth of the over-all industry is and you haven't kept up with it—that's one of the things we watch very closely. The minute that you get that kind of indication you get hold of the management that's involved in that area, and you say: "What's going on here, what is the reason for this? What's happened?" They tell you the story and may make some recommendations of what you ought to do about it. Then it's up to you to move. But I think being close to the business is very important for a director. — I get the feeling here that the sense of the group is fairly sympathetic to the concept of a full-time board. Possibly you'd have to move toward that slowly in steps. The only query that I detected on it is the good point that there could well be exceptions, that a qualified outside individual, working as diligently and as intelligently as time and other things would permit, could make a contribution and could make a review, even though only a part-time board member. Would you in your comments limit that to the exceptional

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individual who is willing to devote the time? I assume you would. So that in itself wouldn't be any disagreement from the basic thought of the desirability of the full-time board. — There's no other way out—I think every director should make a job of it and he can't do it by merely attending monthly board meetings. — I wonder if I might make a comment before we resume. We have tended to gravitate toward some kind of a full-time board subject to a number of considerations, availability, and so forth. It certainly seems to have certain clear advantages over having once-or twice-a-month board members, and it's such an important thing to think clearly about the board of directors and its composition and place in contemporary business that before we go all out on the fulltime board, or the board that may be part full-time and part part-time but moving toward full-time, it would be a very useful thing if we could concentrate for a little while on some of the potential weaknesses of the full-time board and see whether they are really weaknesses in fact or whether they are weaknesses which exist that could be mitigated by administrative arrangements or other considerations. — Well, I hope that this panel isn't going to hang its hat entirely on that concept which, ideal as it may be, is awfully theoretical in terms of attainment for most companies. And we ought to address ourselves to the problem that is faced by 99 4Vioo percent of the companies in the country, and that is the problem of the inside directors who have other responsibilities, and some of the other considerations. I mean, people are going to listen to something that may be

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ideal, but they're going to say, "I'm not going to be able to achieve it," so that I think that's where we ought to address ourselves, to the possibilities that are realistic. I'm not at all denying your question. I think it will bear very much on the problem, of course. But I hope we're not going to end up by saying that we think the solution to the problem of the board of directors for corporations is the full-time inside board, because— — I'm sure we're a long way from that. — We must address ourselves to some of the other problems. But I think your question is a good one because it raises the question, even if you could achieve it, would it be a good thing? — Well, what are some of the things that would concern you, who work with full-time boards, as you look at the health and welfare of a full-time board? — I think that the thing that you may really worry about in connection with a full-time board is whether they retain a broad enough viewpoint; whether they get so concerned and immersed in the problems that relate to their own business that they fail to have a proper appreciation of the atmospheres and the factors outside of their own business that have a very direct and important impact on it. That's the one long-range problem that seems to me you really have to fear in the full-time board setup. Now I think, again, that depends a great deal, first, on the type of people you have to start with; secondly, on the pressures and the examples that are set to the, let's say, new directors coming on the board by older ones that have been indoctrinated in the proper type of thinking about that sub-

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ject; thirdly, maybe on the opportunity that exists for them to attain a breadth of viewpoint. I think those are the things that to me affect the question of a full-time board more importantly than any other. — You're touching on, to paraphrase it, the common problem of management development. You're talking about director development really, in terms of the example that your older members of the board set for the new members coming on, and so forth. Are there any other dangers or problems involved? — Well, I'd say this, just to finish, that I think one of the things that might be argued in favor of getting, in this case, outside directors into the picture, rather than those that are being brought up through the ranks of the company, is the fact that you will put on the board a completely new viewpoint, because they haven't got a heritage or any background of tradition or preceptorship that has been drilled into them through many years of association with the organization. So I think that is one of the arguments for at least a leavening of that type of addition to a full-time board. — I just want to reiterate again that I think that the composition of the board is so highly dependent on what the problems of the company are and what kind of a company it is, that it's impossible for me to think that you can really generalize or draw a pattern for an ideal board. I have a very strong feeling that you should never have anybody on a board who is not prepared to stand up before the stockholders and say, "I'm serving as your representa-

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tive on this board, and I of my own knowledge and my own belief and my own understanding assume the full responsibility for what this board has done." Now I think, carried a little bit further, that if you want to have a man on a board who has a limited knowledge of the company's operations and whose function on the board is to contribute in a very narrow and limited area, even though it may be a very important one, that he has got to assume the responsibility for, in effect, going along with and just endorsing the actions of the other people on the board who know much more than he does about the broad aspects of the business. It's quite possible that if that man has adequate confidence in the other members of the board that do know, let's say, pretty much all about the business, that he's willing to do that. But I'm impressed, I think, with the fact that I have known so many directors who have taken that as the easy way. Certainly, I would agree that probably there are many more companies than not who cannot afford and just simply physically can't command a board of the caliber that I'm talking about—they just can't afford that kind of board. As I said before, I think that in those cases the board has to rely for the specialized advice on staff people or outside consultants. And in effect they're taking those people's advice and subscribing to it, passing it on as their own. I think that certainly, also, it's quite possible, depending on the type of company and size of company and the complexity of it, that a man can do a very adequate job fulfilling his responsibilities as a director without spending 100 percent of his time with that company. I don't think that's

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true in our case, but I think it would be true in many other cases. A l l I'm trying to get across is the thought that I don't think any director of any company ought to be a director of that company unless he is willing to assume full responsibility to the stockholders for saying that "I am completely satisfied as one of your representatives that this company is being run the best way we know how."

IN SUMMARY, the philosophy behind the advocacy of the full-time director is that the meaningful discharge of a director's responsibilities requires a more extensive knowledge of corporate operations than can be acquired through part-time contact. Especially in the large corporation, some of the panel felt, directing is a full-time job, requiring substantial work on the part of individual directors between board meetings, to understand the full range of the business' affairs. Moreover, if the one overriding function of the board is to select the management and to continue to evaluate it, this requires a more continuous contact with management than is possible through even monthly board meetings. Appraisal of management must include more than simple inspection of results as they appear in certain operating statements, if costly mistakes are to be avoided. The responsibility of the board is a group responsibility, and it is difficult to make this operationally meaningful when the members of the board assemble only briefly and at intervals. Moreover, the danger of a board's becoming ingrown through too much reliance on home-grown talent is reduced when its members can be released from all opera-

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tional responsibilities, even if they come from the inside (that is, have been brought up through the ranks). Finally, the fear that inside board members will subordinate independent judgment to the will of the chief executive is partly removed since any who have come up through the ranks shed their administrative or executive functions upon assuming the directorial function. Their job specifications change in a more complete and thorough way than is possible when they continue to serve dual functions. There are, however, serious practical problems in the full-time arrangement. The questions of cost and availability of personnel were raised. Could any except the largest corporations afford the luxury of a full-time board? Do most companies have sufficient "depth" in management to permit the assignment of key talent to nonoperating functions on a full-time board (and to the extent such home-grown talent is supplemented by full-time outside personnel, are there enough of the latter to go around)? Nevertheless, this conception of a full-time board of directors, while differing in important respects from the "ideal" version which had been blueprinted during the discussion of inside versus outside directors, held a great deal of appeal for a number of the members of the study group. * The inside-outside blueprint had evoked a favorable response because it emphasized the independent character of the board and appeared to sharpen the distinction between the functions of the board and those of management. At the same time, the conception of a full-time board had the * One member, however, entered two specific provisos: "I agree with the thought if it is limited to very large corporate enterprises, and where there are some big stockholders to police the situation."

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attractive quality of providing a knowledgeable group in whose judgment management might have greater confidence, on whom it might rely to a greater extent because of its familiarity with the firm's operations, even though the actual organizational arrangements might tend to blur somewhat the lines dividing directorial from management functions.

5 The Balanced Board

THE CONCEPT of the "balanced" board evolved independently out of the thinking of the group, although its prototype is to be found in at least one major corporation, E. I. du Pont de Nemours. It combines aspects of both the parttime outside and full-time inside boards, and would appear to be adaptable to corporations of varying sizes and characteristics. — Well, the things that we've been talking about so far, on the one hand, are the part-time boards, on which there may be members of the management team who supplement the outsiders, and, on the other hand, the full-time boards, most of whom have been recruited from the management team of yesterday. Now, is there an in-between here that might be able to supply the values that we are seeking, that would be in part characteristic of the full-time board and in part representative of the part-time board? Is there a balance here between the two? — Could I say this? I don't want to be considered hidebound on this 100 percent full-time board question. What I have said is this: that I don't think any director is fulfilling his responsibilities as a director to the shareholders unless he is able to devote enough time to his job as a direg-

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tor so that he knows enough about the company's operations and the company's affairs, so that he can pass on the things he has to pass on of his own knowledge. I can visualize in some companies that you can know all there is to know about the company by spending two days a week. I don't think you can do that with a lot of them. But it isn't so much a question of whether you put in eight hours a day six days a week as whether you put in enough time on the job to know what's going on in the company and be able to appraise the results and appraise the management and feel that when you report to the shareholders you're doing it of your own knowledge and not just passing on somebody else's. — Well, following up that thought, wouldn't it be possible to operate with a board that might be composed to a substantial extent of your inside members, spending the whole of their time on general company problems, and supplement these with outside directors, part-time directors, who may not be so well versed in the intimate operation of the business but who might be in a position to render great constructive wisdom in some of these broader social areas— and who might at the same time carry a certain degree of confidence to the stockholders themselves? Does it have to be either wholly full-time or wholly parttime, or can't you mix these two? — Du Pont has attempted to do that, practically, by having at present 11 out of the 29 board members as full-time members; 16 out of the remaining 18 are members who are no longer, or have never been, employees of the company. In our case they are principally either substantial stockholders or retired executives. But at least we are function-

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ing without a full board, as Standard does, of full-time board members. Actually a minority of the board are fulltime board members. — There's no essential reason why one or more of these eighteen might not be recruited from individuals who are not substantial stockholders or who had been employees of the company? — That's right. There have been such. — Do you find that these eleven full-time members dominate the deliberations of the board? — Many of the major functions of the board are delegated to the executive committee or the finance committee, subject to ratification by the board, and only in this manner do the full-time members have any dominating influence. The executive committee presently comprises the president and eight vice presidents; the finance committee includes the chairman of the board, the president, two vice presidents, and four members of the board who are not officers of the company. — The members of the executive committee are all fulltime? — The executive committee members are all full-time, and four of the present finance committee are full-time directors, as we have defined that term here. But to answer your question, much of the major functioning in the sense that we are discussing it here is undertaken by these two committees, and primarily by the executive committee, although subject to discussion and ratification by the full board. Certain areas are reserved to other committees of the board (audit, bonus and salary) made up entirely of part-time directors.

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— I can think of businesses, and I'm sure we all can, that would have a very ingrowing tendency on the part of a fulltime board, and there might well be need to offset that somehow or other. Whether it be by only partial use of full-time board members and partial use of part-time board members I don't know. — I still think we come back to the problem of finding able outside directors. — There have been some people who have been willing to spend 20 percent of their time in the interest of one corporation. I think that an outside director who takes that kind of interest would be invaluable. But I would still want a part of the directors to be inside full-time directors. — Then carry on from there. — Oh, a third perhaps. — Actually running the business— — Yes. — Let's back up on that for a minute. I think we've got a matter of words here. I don't think you meant operating management. — Oh, no. I mean full-time directors actually being directors, not running a segment of the business but looking at the whole thing. — Very good. — Looking at the operations of the business. — That's right. — Well, then, doesn't that obviate the danger that you and others were bringing out of plumping for any one form or the other, the board of part-time outside judges or the board of full-time insiders? We've come down to the thought that there might be advantage, as you've ex-

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pressed it, in a certain group being full-time directors, balanced with part-time directors. And obviously we would hope those latter would be exceptional individuals who would spend enough time to really get to know the business. on which the concept of the balanced board rests may be summarized as follows: T H E GENERALIZATIONS

1. There are valuable contributions to be made by both inside and outside directors and both full-time and parttime directors. 2. The limitations of part-time inside directors are recognized: dependence on the chief executive, limited ability to review objectively their own administrative actions and those of their colleagues, and the danger of ingrowness in thinking. In view of these limitations, inside directors might be limited to (a) the chief executive, (b) an executive associate, to insure informed "backstopping" of the chief executive, and ( c ) those serving full-time as members of the board, thus not serving in any subordinate or operating capacity. A more extensive use of part-time insiders is regarded as open to question for the reasons suggested above. It is appreciated that circumstances may make reliance on such board members necessary, for long or short periods of time, but however necessary this may be as a practical matter, it is to be recognized—generally, not always—as a second-best expedient. 3. The more widespread use of full-time board members by large corporations deserves encouragement. It is not, however, necessary that all members of the board serve full-time. The desirable number of full-time directors de-

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pends on the nature and complexity of the business. Smaller businesses might well require none, apart from the chief executive. 4. To the extent that enough inside personnel cannot be released for needed full-time board service, they could be supplemented by outside full-time members, recruited— like any corporate executive—but specifically for the director's function, and subject, of course, to stockholder election. 5. The number of full-time directors may be less than the total complement of the board; how many would be needed depends on the nature and complexity of the business. The remaining places would be filled by outside parttime members, who perform service as evaluators and judges, bringing greater objectivity to deliberations because they are involved in current planning and company traditions to a lesser degree, thus broadening the range of philosophy and experience within the board. 6. The amount of time such outside part-time people would be expected to apply to their directorship duties would depend on the same two factors, the nature and complexity of the business. In almost all instances, however, it seems probable that the amount of time applied should be more than most outside directors now are able to devote to their functions, if their responsibilities are to be fulfilled. 7. It is recognized that adequate inducements must be offered to secure such part-time service of responsible individuals. This matter, because so important, was given separate consideration and will be discussed in a later section. A balanced board, based on these generalizations, offers certain advantages:

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1. A balanced board would appear to offer sufficient flexibility to be adaptable to a considerable number of corporations, except relatively small enterprises, where closely held stockholdings and the limited degree of public interest involved make the problem less significant. 2. Such a board would avoid members who are dependent on the very managements whom they are supposed to appraise or members who are themselves part of such managements (except in the case of the chief executive and his associate). 3. It permits the integration of outside members with independent insiders in a manner which combines the freshness of viewpoint of the former with the experience of the latter. 4. It combines the qualities of a group which is a review board and judge with those of a group which is in continuing touch with management, capable of providing shortnotice assistance and guidance as may be necessary without usurping management's executive functions. DESPITE these apparent advantages, one member of the group pointed to an unresolved problem. — It seems to me impossible to have some full-time and some part-time directors unless you employ such a device as du Pont employs, with full-time directors on the executive committee only. With all the powers of the total board except, I suppose, to declare dividends, the executive committee thus becomes the true board. Unless some device of this kind is employed, it would seem to me that you would have an oil and water situation.

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I pose the question as to whether two units—meaning an executive committee and a full board—or a single group, a single unit, is preferable. I sit on boards which do not have an executive committee (except when an insufficient number to make a quorum is present) and another where an executive committee meets between board meetings and has all the powers of the full board. What can we say for each of these practices? this question of the relationship between the full-time and part-time board members, between the executive committee and the full board, was not pursued, it was subsequently noted that the use of a balanced board, with most or all of the full-time directors forming its executive committee, has two advantages:

ALTHOUGH

1. It allows the part-time outside directors to act as a critical board of review in much the same manner as the full board of outside directors. 2. It allows the reservation of two critical board functions—audit and compensation of full-time board members —to the outside directors not associated with the management. This is particularly important when incentive compensation plans tied to earnings are in use.

6 Interlude:

Rethinking

the Main

Issues

As OFTEN happens in seminars of this nature, after considerable discussion had taken place on the issues which have been examined in the preceding chapter, a member newly joining the group cast doubt on the essential significance of all that had transpired before his arrival. The alternative approach which he suggested was sufficiently intriguing to the group, however, that it warrants a few pages to insert here a record of his views and the subsequent exchange. This chapter thus constitutes something in the nature of an interlude in or digression from the main stream of the group's thinking. — The real problem of the large corporation, the corporation of the size that your model here embraces, may be the public misgivings when individual companies get an identifiably large amount of the business of the total economy. I mean the integral percentages of the business of the total economy. I think at that point, when anything gets that big, the public at large tends to question. I don't think they question it from thinking it undesirable or that its products aren't good or that it doesn't add to the national defense, or even to their comfort or their standard of living. I think they question it because at that point they size up not just the company but the individual whom they

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see and they wonder, knowing themselves as human and thinking of this fellow as a human, whether any human should have that much untrammeled authority, or whether at that point they should do what happens in government, introduce some kind of balance of power scheme or a checks and balances scheme like our traditional executive, legislative, and judicial approach, to limit the autocratic growth of personal power. I think what they are reaching for really is a curb on the possibility of excessive power being granted to individual corporate executives, and I think they are distrustful that the present board setup gives them the checks and balances they want, especially where the management can itself perpetuate the board, and the board perpetuates itself and then perpetuates the management. They know in reality that the stockholders don't elect it. Nor in the main, in the typical case today, do the stockholders want to. If they are dissatisfied with the management they rarely come down and try to remove it; they sell the stock and put it in something else where they have more confidence in the management. Let someone else assume the function of displacing the management. I'm not talking of family-owned companies or that kind of thing, but it is a fact that these managements largely, or these boards at least, are self-perpetuating, and the public knows it. So, I think they look at the individual corporation president and they just say, "He puts his pants on one leg at a time the same as I do, and I don't think he's that big, and therefore I am fearful of it." I think that until you get to coping with that problem in that depth and where the real source of the public's distrust

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lies, namely, in the questioning if any individual is of that capacity and should be that powerful, that you haven't got at the real problem. And if you haven't, I question whether we are able to rule on what should be the future function of the directors in the future type of publicly owned corporations of this kind. I suspect we ought to be reaching for ways within these corporate structures, since I don't think this type of enterprise is going to disappear—it hasn't; it exists whether in state-owned economies or privately-owned economies. I think we should be reaching for something that we could ultimately go to Congress with and propose as a better set of checks and balances, more acceptable to protect the public interest and these other interests that are involved here, as well as the share owners. I think these are the kinds of questions that we will have to think through before we know what to do to replace the present rather obsolete type of board philosophy. If the answer to this public concern can't be approached and resolved and made known and presented so that those of us within industry get public understanding, then alternative answers will be proposed by others outside of industry. — Isn't the crux of the problem in the case of these institutions their economic impact and through it their deeper impact on society as a whole? — The society that we're in is classing us as being no longer able to isolate our economic system from our living system. I mean, the man who ran his farm and grew his pig and his cow and his sugarcane and lived pretty comfortably, though he didn't range very far, is gone. Today we're in a society which our technologies have made so terribly inter-

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related that an individual in it, while in most respects he's still just as independent as he was or wants to be, is much more economically helpless. And I don't think he's going to like giving up his freedom to a corporation executive any more than he liked giving it up to a king. Instinctively he isn't going to surrender his liberties that easily. If some have taken that much power into their hands over his life and living, then he wants a say about how the thing is run that he doesn't get from the present setup. — Aren't you arguing size here? — No. I think the size is itself a function of the psychology and the knowledge we've developed and made available. We can't stop it; I think it's going to result in larger companies, not smaller, if not for economic reasons for reasons of sheer military survival. And those things are the facts of life in the age in which we are living and about to live, and they are exhilarating. These kinds of developments are coming at a faster rate, not a slower rate. And this is why I wonder if we shouldn't be putting our time into these problems which certainly no one else will solve, rather than rationalizing something which has been thoroughly well rationalized but doesn't sell. — May I raise a question here? (I'm talking too much— this is really very interesting.) You spoke of the distrust of the public in general, of the concentration of power in the hands of individuals, unchecked, and the desirability of checks and balances. Now does this come back then, really, to our opening question of the responsibilities of the board? Is there this distrust because of a feeling that corporations are not serving broader interests, which they should be serving? Pre-

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sumably, this is distrust which arises because of fear of an economic impact, the impact on the individual. Now this could mean then that the public is really trying to impose a responsibility on the corporation to the employee and to other groups in society, as well as to the stockholders. And perhaps the fear that this is not being done is really the cause of the alleged distrust of the concentration of power in the hands of individuals. But that does bring us back, then, to this question of the responsibilities of the corporation: Where do they run to— to the shareholder, society, or what not? — No. I think that's the wrong question entirely—where they are. It's where they should be that's the question. — Doesn't your line of thought suggest an analogy between the modern corporation and political institutions as they existed two or three hundred years ago? — I don't believe the public two or three hundred years ago was particularly disturbed about political institutions— authoritarian, autocratic—until they became dissatisfied with the results of those. — That's right. Now I don't believe that the public is very seriously distrustful of the modern corporation today. I think it's much less distrustful than it might have been twenty-five years ago. But what you're saying is that we are going into this new great expanding world, that corporations are growing larger, and that technological development insists on them growing still larger. But some place along the line, strains and stresses are going to become greater, and at that point all of these—what now might be acceptable— weaknesses or soft spots in our basic structure will cause us a great deal of trouble, just as it caused the politicos two

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or three hundred years ago a great deal of trouble. And as a result of these old strains and stresses, society began to get, to evolve, a set of political institutions which became more responsive through a system of checks and balances. — We really have two parts of this job, don't we? One is this you speak of: of the evolving world, in which we don't quite know what form it will take or what will be called for. And then we have an immediate problem today in thousands of companies that have relatively poor, weak boards of directors, where something could be done within a short period of time to improve that system. And perhaps because the company might do a better job itself, this would tend to slow down some of this pressure, maybe, and give us more time to think through and to make some of the fundamental long-term changes. of the group was that it was the latter approach—improvements in the functioning of the board of directors within today's corporate framework—which was the focus of their present interest. Although all tended to agree that the long-run question of corporate control involved questions of a more fundamental nature, warranting the earnest attention of business leaders, the feeling was that this constituted another subject in itself, which should be separated from the more immediate questions with which the group had concerned itself. T H E CONSENSUS

7 Problems in Connection

with

Strengthening the Board

of the pattern which a board follows—whether composed predominantly of part-time outside directors or full-time inside directors or whether it is a balanced board— there are certain problems which necessarily must be encountered in any effort to reinvigorate the institution of the board of directors. Some of these questions were explored in this seminar. Some issues were identified with only an indication of the nature of the problems involved. REGARDLESS

FUNCTIONS OF THE CHAIRMAN

The view was expressed by one of the group * that the primary function of the chairman of the board was to see to the board's own general health and needs. He would serve as a kind of "general manager" of the board. It would be his responsibility to "ride herd" on members in seeing to it that they measured up to what was expected of them, to scout for additions to the board that would strengthen it, to suggest to present members the desirability of retiring when they no longer served their function, to act as the general administrative agent for the board, to function as its continuing liaison with operating management, to see to it that individual members of the board were adequately * See Chapter 3.

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serviced with information and technical assistance as necessary for them to perform their jobs. He would himself carry no operating responsibilities and should studiously refrain from interfering in executive responsibilities. In this conception, the functions of the board and the functions of operating management would be demarked. Each of these groups would have its own chief executive officer—the board its chairman, the operating management its president. These groups and their chief officers would be integrated in their functioning, but they would not overlap. This view, while eliciting considerable interest and a measure of sympathetic response, also led to some sharp questioning, as the following exchange indicates. — There's something I would like to see explored a bit, and that is the role of the chairman of the board. Now, for instance, it has been suggested that he would ride herd on the board composition problem and make sure that the board is virile, and so forth. What would be the relationship of such a chairman to the president? — We don't have any such function for our board chairman. — Well, in our company the functions of a board chairman are to apply rules of order at the meeting and to act as a member of the executive committee. — But within your firm you do have a somewhat extraordinary situation, in that your chairman in effect reports to the president. — I don't think that's extraordinary. It's historic in our company, and if you checked exactly what there is in companies generally you'd be surprised how many companies have it.

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— Well, that may be, but it may not necessarily be the ideal, and it certainly doesn't answer the question. — No; you would call the "ideal" situation that in which the chairman of the board keeps the board vigorous and active and competent and so forth. But is he the boss, or is the president the boss? Since the president is the chief executive officer for all other things, suppose the chairman thinks that the board composition should be thus and the president thinks it should be so—who prevails? — A good question. Maybe the chairman of the board puts some individual on the board as the man to fill a vacancy and the president has another man: what happens then? — In our company we would look on this as dual management. Just why will two heads be better, rather than worse, than one? And would somebody like to write a job guide for these two gentlemen in this relationship? I think you'd get an illuminating experience if you tried to spell out a job guide for the two and the relationship between them. I would suggest that you would then put the ideal in quotes. — In effect, what you say is that the chief executive officer has to be the chief executive officer. — We think so. — Well, I'm raising the question— — In that sense, then, do you need a chairman? — As a parliamentarian. — You obviously don't need him because a great many companies combine the offices. — I would think it would be much easier to have an effective chairman of the board, such as we're talking about, in an organizational structure like du Pont or Standard Oil

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of New Jersey, where you do not have the single chief executive concept to the extent that you do in, for example, General Electric. If you do have that single chief executive concept, then I would think the suggestion about having an independent official called chairman of the board, who makes all decisions with respect to board composition and so forth, would be very difficult. ONE of the participants harked back to the digression which was noted in the preceding chapter, where one of the group had called for rethinking the basis for corporate control and had suggested that public suspicion of the large corporation, as he discerned it, was actually an inchoate expression of a desire for a better system of checks and balances on those wielding the power of the corporation executive. — I wonder if in a chairman of the board, of the type that has been suggested, independent of the executive, stimulating the more effective discharge of board responsibilities, but somehow not encroaching on executive functions—I wonder if in a chairman of that kind you might begin to get some of the checks and balances that you are looking for. In other words, you get somebody checking the chief executive. COMPOSITION OF THE BOARD

Two contrasting views as to the desirable composition of the board were presented by members of the group. On the first approach, the expertise of the individual member was not so important as his general competence, in particular, the soundness of his general judgment. The presence of

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specialized talents on the board in fact carries the danger that such directors might have difficulty curbing their tendency to interfere in management functions. On the second approach, which appeared to win greater acceptance in the group, the board should have represented on it specialized abilities and knowledge which tend to cover all the major problem areas with which the company is normally concerned. This does not mean that every operating area must have its counterpart representation on the board. If some specialized area of operations is of insufficient importance— relative to the total range of the company's interests—to warrant the selection of a director to supply special competence in that field, the board might rely from time to time on a consultant for assistance in appraising the company's activities in that specialized field. What fields should be represented on a board depends on the nature of the company's operations. Only two seemed to win general approval: finance and law. * Others mentioned as possible areas in which a director's specialized knowledge might be useful were merchandising, employee * One of the members of the group commented as follows: "This brings up some big questions. One of the leading law firms in Philadelphia (where corporate law was more or less born) refuses to permit any of its partners to sit on a board of directors. It firmly believes that a lawyer cannot appropriately give legal advice to a board of directors of which he is a member. I am not suggesting that lawyers should not sit on boards of directors, but I do think that it is best that a line of demarcation be drawn between legal advice, on the one hand, and acting as a corporate director, on the other hand. I fully expect many to disagree with this view, but I say that I somewhat applaud the practice of the Philadelphia law firm to which I refer. Next, about the use of the word 'finance'—I would say that this depends on the situation. There are many corporate enterprises which do not have financial problems indicating the necessity of having a director who is well versed in the field of finance. In other words, I cannot see that a board of directors necessarily has to have a member who knows his way around in financial circles."

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relations, and public relations. The desirability of having on the board a number of businessmen in noncompetitive but related fields was expressed, whose experience might be fruitfully tapped if their interests could be sufficiently enlisted. The question of board composition was first raised at a time when the discussion was being led by proponents of a board predominantly composed of part-time outsiders, who would serve as disinterested judges of operating management's plans and policies. The first question is addressed to the discussion leader: — How big is the board of this "model" corporation of $500-million sales that we are talking about? — Twelve. — And how many of them are outside? — Ten. — And that means that the number one boy and the next in command are the two inside directors. — That's my ideal. — Now what's the balance of these ten outside directors? — Men who in their combined talents cover the range of interests of the company. — The range of interests of the company? Well— — Well, you certainly have a legal mind on there, you've got to have a financial mind on there, and so forth. — That's one and one. — Well, you've got to have a scientific mind because a company that big just starting fresh couldn't get along without somebody who knows something about— — That's not very important because as a matter of fact scientific matters never get up to a board, anyway.

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— Oh, sez you. — I really started something, didn't I? — You've only catalogued three. It's seven to go. — Oh, you want a fellow who knows merchandising in that field, and, oh, half a dozen things. — One who knows merchandising in that field, so either he has to be a former employee of that company or a former employee of one of its competitors. — Yes. Well, there are lots of ways of doing that. He might be a dean of one of the business schools for that matter. — This company presumably has some foreign activities, so you have to have somebody who knows something about foreign areas. At least if— — Yes. You'd like to have somebody who has been out of this country once. — Well, seriously, are the specialized knowledges that might be available to those people as important as the basic question of whether this board is going to be an independent and a completely objective judge? —• Experienced judges! — Well, on the need for specialists—do you agree that's not necessary? — No, I don't think that's very important. Even your financial end. You can always go out and get your financial advice. I think there's a certain danger in having specialists on the board. They are too tempted to butt into management sometimes. — Well, I have kept a careful list. You have five men, who can be added to by five businessmen. — Well, fill the rest out with people. I don't give a damn

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what their background is, provided they are men of judgment. — College professors? — No. No. No. — How do you know they are men of judgment? — How do you know anything about a man? session, when the focus of attention had shifted to the full-time board and the balanced board, discussion reverted to the question of board composition.

A T A LATER

— Now, can you start to strike a balance as to what you want on that board in the way of directors? — Well, as far as experience with the business is concerned, this is going to be supplied presumably by your socalled full-time inside directors. Do you want to tap similar businessmen in other fields—which has always seemed to me, for instance, in my own business, to be a very valuable thing? To have some point of view brought to bear from men who have had a lot of experience and been successful in selling drygoods or other types of merchandise of all kinds has seemed to me to be a good thing. I think last time I made a note—because somehow we seem to get diverted from time to time to other things. We were making up an ideal board, and we had a banker and a lawyer and merchandiser and somebody who knew the foreign field, and a college president—I don't know how he got in. We stopped there and I have five blanks left—which seems to be an ideal board. Those are your first five, and they're the outside members of your balanced board now. — Would you have to start doing that the other way

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around? I was thinking that if you first moved part way toward the full-time board that you'd—let's say, using your numbers there—that you'd draw on three or four of your management people and promote them to the board level full-time. Wouldn't it then depend on the types of skills that you got out of those people what skills you were looking for on the outside? Let me assume for a minute that you're predominantly a marketing-oriented company. If you drew on your marketing vice president and put him on the board level you probably wouldn't feel as great a need for a part-time director who was a well-versed marketing man. — Let me pursue that just a little bit further with one or two additional questions. The board, as we've defined its responsibilities—and you used a very good phrase a few minutes ago—holds the position of ultimate responsibility for balancing the activities and the interests of a lot of different people: the shareholders, the customers, the public at large. Now should every board member feel a responsibility for intimate knowledge toward all phases of the company's activities as a means of discharging his responsibility to the stockholders? Or should there be some directors, and perhaps an increasingly large number of directors in the modern day, that are not especially attuned to the operational phases of businesses, whatever they might be, but are because of their experience better able to judge, say, the public relations aspects of the business or some of the political aspects of the business? In other words, the typical company today is getting into the position where it is faced increasingly with

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problems that are of vital importance to stockholders but that are not of an operating nature. Now what does this do to the concept that we're talking about here of the composition of the board? — Well, if you want, let's say, advice in the public relations field, one of those specialized areas that you're talking about, or the employee relations field, and you do not have enough of that requirement to justify having a fellow on the board who is knowledgeable, adequately knowledgeable in that field, then I think what you ought to do is call in a consultant. — Would you put him on the board? — Why would you put him on the board? All you want is his specialized field of knowledge from this fellow. on a board may be as important as interest distribution. It was pointed out that until recently companies have made little provision for the retirement of board members. The consequence has been that members, once appointed, tend to serve until they take themselves off the board, since the practice usually has been to nominate present members for reelection. On many boards there has thus been a clustering of older members, numbers of whom have not been nominated by the present management but by its predecessors. Some boards have been virtual gerontocracies. With the present tendency to establish a retirement limit for board members of 70 or 72, there may be some danger of going to the opposite extreme, ruling off boards men capable of making significant contributions out of their years of experience. Although the group came up with no sugA G E DISTRIBUTION

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gestion for implementing its recommendation, it was of a view that care should be exercised in securing an age distribution that insured continuity and vitality. The closest to any suggested policy came in a participant's opinion that a regard to the age composition of the board should be one of the chairman's responsibilities, and that a good chairman should seek to hold on to those people, whatever their age, who could contribute to the company's advancement, while tactfully suggesting to those whose useful period of service was past that they should make room for new blood. Some of the comments follow. — Some boards consist of very elderly people and they are all concentrated, or most of them are concentrated, in that one age bracket, which, to me, is bad from the point of view of continuity. Now, if in practical fact the chief executive officer who may then be in office picks a board member, he should have, or probably does have, the responsibility of causing his board, if he wants continuity, to be in different age brackets. And then you don't run into the problem someday—and I have seen it happen—of a majority of the board passing out in six months. I believe that there should be a retirement age for board members. I believe if you have a spread of board personnel by age groups you get continuity in the enterprise itself. You do not get a stagnant board. You do not get a board which has a predominance of elderly men, which to me is a mistake. — I think this business of trying to put an age limit on the board is just a confession, a confession of weakness, just an excuse to avoid tackling a difficult situation. I would

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rather have a board chairman with the courage to get a director off the board when he has outlived his usefulness. — Well, isn't it also a device that is helpful if you don't find that chairman that gets them off? I should think— — Oh, you got to do something. It's better than nothing. Of course, the reason that I object to it, you know, is that I can see it apply to me before very, very long. — Isn't it a better way to have written retirement rules, and then nobody has to have the courage to apply them? The chairman simply writes to the man that these are the rules. concerning the composition of the board of directors was made. In previous discussions it had been suggested that the discharge of the responsibilities of a board today required the consideration of interests other than those of stockholders, if stockholder interests were to be safeguarded in the long run. Moreover, there had been recognition of divergent interests among the stockholders themselves. Obviously, minority stockholders who are able to muster enough votes behind their candidate or candidates are entitled to representation on the board. Cumulative voting may facilitate such efforts. But such independent efforts to secure board representation are quite different from a conscious attempt by management or board chairman to structure the board so that individual members become representatives of special interest groups, whether of stockholders or nonstockholders. "Labor" directors, for example, would fall in this category. While there would be no objection in principle to a labor union president serving on a board as an O N E LAST POINT

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individual, there would be strong objection to a union president serving on a board as the representative of labor, or to any board member serving other than the general interest of the corporation. — I think that actually a board of directors is elected as a group; sometimes there are classes from year to year, but in general a board is elected as a group. In no case do the shareholders favor one director who has superior authority or responsibility over the other directors. They are all equal in the eyes of the law, and I think they're pretty much equal in the eyes of the shareholders. That argues, to me, that you have to have, really, group decisions and group action on the part of a board of directors. They are elected as a group; they are looked to as a group by the shareholders. And there's no legal difference in their responsibility or authority. And that means the general philosophy of putting on boards of directors people who represent special interests is just basically wrong. And I think that intrinsically the shareholders have a right to expect their board of directors to function as a group and think as a group and report to them as a group. That doesn't mean that you don't have a lot of differences of opinion there, because you do. In fact you should have. If you don't, you probably haven't got a very strong board. But in the final analysis I think the majority has to rule, and I would think that—as a matter of professional ethics, I guess—if one director on a board found himself in an irreconcilable variance of opinion with the majority of the board, or even if he found himself constantly in opposition

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to the majority view of the board, then you must conclude that he's just out of place on that board and that he really is not a representative of the general function that a director ought to perform, and that is to serve as part of a body that, with a high degree of unanimity, is trying to protect the general interest and discharge their long-range responsibilities to the stockholders. SOURCES OF DIRECTORS AND INDUCEMENTS TO SERVE ON A BOARD

Repeatedly throughout the group's deliberations the question was raised of where the American corporation can secure the kind of people who can do an effective job as directors. No clean-cut answer to this question was developed, but several observations are pertinent. What are the numbers of people who would be involved? What is the general magnitude of the problem? A count suggests that there are just over 400 firms, in the fields of industry, transportation, utilities, and trade with sales of more than $100 million a year. If we assume a board of from 12 to 15, two of whom would be the chief executive officer and his Number 2 man, each board would require an additional 10 to 13 individuals. Thus a total of from 4,000 to 5,000 directors would be needed to man boards in all the companies in this category. Of these, some in the largest companies might be assumed to be full-time inside personnel, who have come up through the company. The problem in securing such inside full-time directors is no different from the problem of securing a capable executive vice president, and should be met by internally administered executive training programs.

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The real problem comes with the supply of part-time outside directors who are willing to spend enough of their time to discharge their directorial duties adequately. Three possible sources of such people were suggested. 1. Compulsory retirement of business executives at age 65 is now a widespread policy; where not compulsory, retirement is generally indicated at that age. In this group there is a pool of experienced management leaders of superior ability which can be more effectively utilized than it has been. In many instances such individuals might be willing to serve as full-time directors, if that were desired. * 2. Business might itself supply a pool of able management leaders to man directors' posts. If a company's executive staff were sufficiently well backed up in depth so that individuals could afford to take time off to serve on the board of another (noncompetitive) company, everyone might profit. The company supplying the part-time director would benefit from the greater breadth of outlook and experience which its executive would be gaining; it in turn might receive a part-time director from some other business, with similar gain. However most of the group viewed this possibility with a good deal of scepticism. As stated by one of the participants: * One member of the group commented: "The utilization of retired business executives on boards seems to me to be fraught with some danger. If the man is not available until he is 65 and if he should not be continued on the board beyond 70, and if the company is a complex operation, it seems highly doubtful whether such people would generally prove useful. An exception, of course, is a retired employee of the company who presumably has sufficient background to avoid the indoctrination period of a year or more, which certainly would be involved. Certainly this source should not be overlooked, but I doubt if it is as important as seems indicated by the discussion."

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"The thought that members of the company's executive staff could afford to take the equivalent of one week a month to oversee the affairs of another noncompetitive company is, I suspect, a delusion, first, because the employing company's interests would probably not be best served, and, second, because a man in such a position would hardly be willing to accept such a substantial diversion of his time and energy from his primary job." 3. The final major source of part-time directors is the body of professional talent, for example, lawyers. University administrators and some educators may also render effective service. There is a possibility that groups now not normally tapped for directorial service—ministers, publishers, e t c . — might be found especially helpful in interpreting the "public" point of view in various phases of a company's affairs. Such professional men are perhaps in a better position to accommodate part-time duties within their schedules than are the men with more regular and fixed work schedules. — The simple fact is that we haven't got in this country enough people to man our boards with the type of people whom we would love to have, ideally. We don't know how to find them. They don't exist. Now, along with that goes the fact that where there is an able fellow he isn't on one board, he is on six. And then he doesn't have the time to know thoroughly any one of them. — This is really jumping way out of context. Would that comment suggest, then, that one of the real problems facing American management is to develop a director group, or is that too simple a statement? — I don't know, what do you think, gentlemen, isn't

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that quite a point here, that that's a thing lacking in this country? We haven't got enough of them. That's why I object so strongly to this age limitation on directors, because I don't think we have got enough people so that we can afford arbitrarily to exclude a very large number of possible candidates. — Well, as part of that question, wouldn't the subsidiary question in there be, have we done something to elevate the executive, versus the board member, to the point where people would rather be an executive than be a board member? We have put the emphasis possibly on the executive rather than the board member, as against European countries where the emphasis is on being a board member. — Let me say it the other way for a minute. It doesn't take very many. If we insist, and I think we should, that a man should retire from executive responsibility when he's 65, or whatever you want to name, then it follows that in this country we most certainly have got plenty of men beyond 65 who have the qualifications for the sort of thing we are talking about. The question then is not whether they exist but how do you find them and how do you get them to serve? — And how do you get them off when they have gone beyond their really useful period? — Yes, that's right. — This guy has sweated away his forty years. He's got a good pension, he's got all the income he wants. He might be a good director. How do you get him to be a board member? — Do you call such retired executives inside directors? — Well, that's my question.

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— We call them outside directors. — These would be retired executives about 65 who are now sitting on the board. — Not full-time employees, but in a position to exercise independent judgment because, I take it, they are not beholden in any way to the chief executive officer. But yet their business life for the most part has been confined to the experience of that company. I think whether you'd call such a retired executive an inside or an outside director depends upon where you sit. We have several such people on our board, and to me, as president of the company, they're outside directors because they are not representatives of present management. But to the really outside directors they are regarded as inside directors because their only business affiliation is still with the company. — And what are they to themselves? — I think they're outside directors, but they're outside directors who don't share many of the disadvantages and limitations that come from lack of familiarity with the business. — Well, that raises an awfully good point that I have heard kicked around a number of times, and I am sure you all have. Does a man in that position in the first year or two after leaving active officer operating responsibility— does he actually cause more trouble on the board than he's worth? I have heard of situations where they make a gap occur there for a year or two, after leaving operating responsibility, before a man can serve on the board. That's one approach. With the thought that in his first days of, shall we say, retirement he is looking over the shoulder so

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much, he tends to put his finger so far into the pie because of his familiarity with operating problems, that he bothers the man more than he assists him, that he is not truly wearing the director's hat. — Well, that depends on the individual. But on this question of whether he is an inside man or not, inside means somebody who is or can be influenced by the chief executive officer, and certainly a man in that category shouldn't be called an inside director. — Don't you have to divide that character you have just described in two parts, probably, or by various stages of life? In the beginning I would call him an inside director, that is for the first short period of time, because he is still so familiar with inside operations that he practically assumes the same role. But gradually he becomes a quasi-outside and then an outside director because of his detachment from a knowledge of current operating functions. — Does that mean to say if a fellow who has been senior vice president of your company retires at 65 that such a fellow shouldn't continue on the board of your company because his experience has been limited to that company? — If he's likely to be an embarrassment to management. — So that he should get off— — And I don't think he ought to go sit on the board of a competitor. But I think if he's been a senior vice president of my company he might become a board member on an outfit outside of but perhaps related to our field. He could be damn useful. — Get some cross-fertilization. Go to a different industry. — Would you go with me on that kind of an idea?

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— Oh, I think so, yes, but I am a little uneasy about his chances of getting a directorship. — That's another point. — And that can't always be the only point because I certainly agree with what's been said about the board needing a good range of ages so that you don't have them all over 65. of company executives taking the point of view that part of their job as executives is to serve on other noncompeting boards fared rather badly.

T H E IDEA

— In our industry it would be a rare situation if a top executive of one company either would have the time, the inclination, or the permission of his board to go on the board of a competitive firm, certainly, or even of another big firm that would take as much as 10 to 15 percent of his time. Because in addition to his executive duties in his own company usually he is on the Conference Board and on CED and perhaps a few trade associations, and he's expected to make speeches here, there, and yon, and he's on a bank board or two, and he does quite a few other things, all of which relate directly to the proper performance of his job for his company. Now, how in addition to that he could be expected to spend 25 percent of his time on the board of American Can Company and 25 percent of his time on the board of General Motors, we don't know. — That's putting the problem in perspective! — One other point to the perspective: it is further made difficult by the fact that most companies today are in a

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period of unusual growth; diversification is felt across the board; and, therefore, there is just barely enough executive talent to go around. I don't know when competition is going to be less vigorous or when the opportunities or desirabilities of trying out new fields, of prospecting, of diversifying intelligently in proportion to your human and capital resources, are going to be any less pressing on the executive group. — Well, is it really that you're thinking in terms of a man as a part-time director assigning 25 percent of his time to that job? — Not if he's an executive in another company. — If he's retired? — Retired, or something like that. — That's one thing, but if he is active in some constructive work, in other words, in another company, in the law or banking or a university, he's not going to be able to spend 25 percent of his time with a company for which he is serving as a board member. — The complexity and uniqueness, though, of these hundred-million-dollar companies are so great that it might require that much time of a man when he started off. If you had a company that was doing a half a billion dollars or three billion dollars or 12 billion dollars or something— — If you went at it the same way that you went at the selection of some of your management, isn't it conceivable that you could find qualified people that could make a real contribution? Instead of with one hat selecting your management and then taking that hat off and just pulling names out of the local Chamber of Commerce roster or something.

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If we took a different point of view there, I think it would go a long way toward solving that problem. — There are friends of yours and mine who are good friends, and we serve on one another's boards, but in all honesty we might say of each other: "I like so and so and I appreciate his economic views; in a practical business proposition I like to talk with him privately; but as a board member on my board, he's no damn good at all." — That involves the suggestion that your two associates may have picked each other as directors in a very different way than they would hire a sales manager; and maybe they ought to line out what the director's job is and what they're looking for and that sort of thing; write a job description out and then go looking for a fellow that fills that. And if he fills it, he's in; if he doesn't, buy him a drink or something, he's a nice fellow, but he isn't on the board. Take the mystery out of it. — When all that is done, would you want your advisory council to each take 25 percent of their time serving on the boards of other corporations? — My guess is, if we address ourselves properly to this problem, that on a year-in-and-year-out basis it wouldn't take any 25 percent; it would probably take less than ten. If you organize to do it properly. — You can make an effective contribution if you narrow down the things in which you're going to make the contribution, if you organize properly to do it. If you get the proper mechanics for putting people in a position to have the knowledge and the judgment, you eliminate a lot of the kinds of time-consuming things that don't really contribute.

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— And then, as to the things you do take up with them, don't bring them in on a crash basis. to the question of the possible sources of directors is the question of what inducements can be provided to secure the services of an individual. Repeatedly the query was raised as to why anyone should consent to serve as a director. Five kinds of inducements were suggested. 1. Compensation. This was regarded as perhaps the weakest of possible inducements, in view of the fact that most individuals who would be drawn upon would probably have a sufficiently high income as to leave only a small increment from director's compensation (due to high tax rates in upper income brackets). Nevertheless, more consideration might well be given to increasing directors' salaries as a measure of the responsibility attached to the position and of the performance expected of them. * 2. Kudos. The prestige attaching to membership on at least certain boards is an important incentive. There is, however, the danger that some individuals may go in for "collecting" titles without genuine interest. 3. Personal associations coming from membership. Close personal contact with men and women of accomplishment can be rewarding. The experience of such association can be as emotionally satisfying to an older person as membership in a college fraternity is to a younger one. 4. Personal interest in the work of the company. Some types of operations have a particular appeal to certain individuals: an outstanding scientist might be attracted by COMPANION

* One member of the seminar remarked: "I suggest . . . a salary plus a fee for attendance at meetings. I like the salary idea, but I think that the director who attends regularly should benefit thereby."

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the experimental work taking place in a chemical corporation; a person with interest in international affairs might become intrigued with the foreign operations of a company with heavy overseas commitments, and so on. 5. Experience. At least for businessmen and other administrators, serving as the director of another corporation may prove to be a valuable educational experience. It would be erroneous to attempt to rank these types of inducements in terms of their efficacy. All should be used. But on one point there seemed to be common agreement. The interest of individuals in serving on a board, and the reputation which a board comes to have, depends on how exciting, pioneering, and genuine is the work of that board. No person worth his salt can be induced to spend much time or effort on a board whose function is purely formal. The role of the board—and of its individual members—must be kept vital and intriguing. — Suppose you want as a director a prominent merchandiser or a man who is the head of one of the great chemical companies, who can bring to bear a valuable point of view with respect to your own aspirations in research and development. I don't get him. He says just exactly what I say when I'm approached: I've got a job to do. And I'm not going to go into something and just lend my name to it; if I'm going to be in it, I'm going to be sincere about it and I'm going to do the job. How do you sell him? How do you sell him on taking this job? — What do you use to induce him, convince him that this is something that—

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— The only argument that I have found that has worked in a relatively small proportion of cases is that the experience may be directly applicable to his own particular problems; and this is a kind of weak argument because he can throw you right out of the water by telling you that spending the same amount of time on something of direct application would do him a lot more good. So then you come to the other category—and I think there's some very valuable material in this other category— the men who are active at the colleges; we've had two in succession on our board; they've been very valuable men. And you have the man who can bring you a great deal of valuable participation, I think, in the investment banking field. Occasionally you find a lawyer who is a very useful gentleman, who can do more for you than just second-guess your law department. But if you're going to have a board that's going to give you the kind of balance that I think a board such as ours should have, you've got to dress it up with a number of men who are what I call businessmen— maybe that's a lame word but it means the men of accomplishment in the business end. And these men are hard men to get if they're good. — Furthermore, why should they do it? — Yes, why should they do it! — I have been through this business of trying to get outside directors. Golly, it's a real job. It's an ideal thing from the point of view of a company such as mine, for instance, with the kind of board structure we have, to try to induce men from other fields of business activity to join our board so that they can bring to bear on some of our basic and

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major problems the experience and the point of view they have gained in another field. — But why should they do it? — A real question. — Unless it serves some selfish purpose of their own. In some cases outside directors who are able to get business either directly or indirectly from the company concerned have an incentive to come on the board and perhaps even give a certain amount of time. — If it does you don't want them. — If that's all they have. — No, but we are being practical. — That's right. — I have known of other cases where presidents of companies have gone on the boards of other companies for the major purpose of learning how they operate, for broadening themselves, by finding out how they handle some of the problems they are wrestling with. It's self-education and in the process they contribute some time and effort. But those aren't too many I suppose. — Well, you are almost jumping to the thought that it may well be that the pattern of du Pont and possibly Standard of New Jersey is one that smaller companies than those two might very well have to move toward—in other words, the development of professional, if you can, home-grown, not ingrown, home-grown board members. — It seems to me that you have to choose between that and outside directors who are what I would call professional directors—bankers, college presidents, lawyers, people who derive a benefit from the experience of participation, which is their compensation for being on the board. And

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this means that for a balanced board it seems to me that the business background element has to be recruited from your own ranks because increasingly you are going to have the— well, I don't want to make it personal, but if anybody wanted me to go on a board I just couldn't justify the time that it would take with the job to do it properly; and I won't do it, and neither would any other man who is worth his salt do it, just for a name-collection reason. — Well, if part-time boards of directors, members of boards, were given more adequate compensation, and it was made very clear what was expected of them, would this go some distance toward solving the problem that we're worried about? — How do you provide that adequate compensation? — What is adequate? — Well, the typical board member would take away, what, three to five thousand dollars a year from attending the meetings— — I think the difficulty there, from a practical point of view, is that with the present tax structure that we have, the average man that you'd want is a highly successful individual and his present tax bracket would make those few thousand dollars that you're talking about, or even ten or twenty, completely inconsequential, or relatively so. — It might, but it would nevertheless serve as a measure of the work that he was expected to do. — As an investment banker, I would think, you have a certain advantage, and I don't mean to imply any hidden motivation; in your profession, you have, I would assume,

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much more reason to serve on boards than would many other people because of your historic financing arrangements and other such— — In our little company we have a cast-iron rule against anybody going on any board unless he has the consent of either the president or of myself; and we don't like it, because it takes their time away from their own job. And I can't speak for any other people, but I certainly don't serve on any board for any advantage that may come to our business. We're just as apt to get it if we don't sit there. Without naming the firm, one of our leading investment banking houses has practically no directorship; they're quite opposed to it, and yet they seem to occupy a leading position in the business. — How do you get really able men who would be good board members to serve? I think one point we might look at with great interest would be this: How do you make his service on the board satisfying to him? — Right. — So he gets some satisfaction. Certainly, if you make a rubber stamp out of him you don't. — Let's assume for a minute that you are a qualified board member, one of these gems that we are talking about. Then doesn't it come down to the question of the ability of the chief executive officer to make that board a living, functioning thing that will continue to attract you? — I think you ought to enlarge on this kudos thing, to say that men serve on a board at times not only because of the kudos but also because of associations. If it's a good

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board that has won respect and admirers, he is willing to join the club because it is one with which he would like to be associated. If you think that's— — That's an important point. — Take this a little further. This appeals particularly to the man who has laid down the cudgels of active administration, doesn't it? — Yes. — We have found that our company will attract men if they figure that they will get from this relationship contacts with other directors of this kind, if you make them a real board and if they do pass on truly major objectives and policies and aims. We do believe in turn that then you've got to play the game with them. You must bring to them questions that are well digested and that are well presented and that they have time to reflect on before you ask them to act. If we have a major problem to bring to this board of ours our president will customarily alert them, unless there is some kind of emergency, six to eight months ahead; we lay it up two or three times and he'll have a really orderly presentation on those initial and interim occasions. By the time they come to handling these relatively fewer number of things that they get into at all, if they attend regularly—and on our board, if they don't, they don't stay— then they are informed on those questions. — Am I right, do you think, in feeling that a capable board member is willing to spend enough time to have a real understanding of the organizational structure in ade-

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quate detail for the same kind of reasons that he is willing to be on the board at all. I suppose that if he has either the interest in what the company is doing or the pleasure in the association or the kudos from being a board member, that these influences on him are strong enough so that he will take the necessary time, which is quite a lot, more than half a day a month, he'll take the time to find out these things. ACCESS TO INFORMATION

If the board is to undertake the effective discharge of its responsibilities it must have ready access to all relevant information. This raises the question of whether it should be entitled to independent access to such data as it may in its own judgment require, by direct contact with people in the operating organization, or whether its access should only be through the chief executive, by request. The difficulties in both approaches are apparent. In the first instance, there is the danger that direct contact between board members and operating personnel at all levels may tend to undercut executive authority by suggesting the presence of two lines of authority. On the other hand, funneling all requests for information through the chief executive always raises the possibility—however seldom it becomes an actuality— that the chief executive may unconsciously screen data to present as good a showing as possible to the board which is evaluating his performance, and, in any event, means that the board's information is not firsthand but depends on its clarity of comprehension of another person's understanding of the problems. The thought was expressed that a sharp distinction should be made between the request for information, either by the

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whole board or individual members, and any suggestion of the issuance of an order to subordinate members of the operating organization. The former would be freely permitted, any abuses being safeguarded against only by the discretion and tact of members of the board, but the latter should be rebuffed promptly and firmly. — To be the kind of director we're talking about, it seems to me, implies that you have to have a greater degree of familiarity with the executives and with the problems of the company than you get from a monthly board meeting. — How does a board get really good knowledge of the business without butting into management, without circumventing the chief executive? — Is it possible to have some understanding so that a board member can circulate around for purposes of information and become acquainted with the business and the people in it without at any time, by implication or otherwise, making a channel around the chief executive? And it applies to the chief executive too. How does he know what's going on in the business without cutting around his subordinates? That's part of the problem of being a good chief executive. It's one of the primary criteria of whether a man is a good executive or not, whether he can get his information, to know without cutting around his own people, and the same thing applies to a board member. I don't think there is any general answer to it. But I do think one formula that's useful is that contacts for informational purposes should not be limited or circumscribed but that any transmission of orders, even by implication,

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through improper channels should be knocked down so damn hard that people won't forget it. — It's to a very large degree, I assume, the manner in which the individual board member handles himself. — Can't the board also consider telling the chief executive the kind of information it wants and the way that it wants it presented, which doesn't involve going around anybody, saying, "We would like to have a presentation of your annual program and the results in relationship to this program, and we would like to have this presented by the people who have the responsibility for doing it," so that to a considerable extent the board can at least get close to the thing. RECONSTITUTING AN OLD BOARD

Another problem which came up from time to time was this: Every corporation already has its own board of directors. Supposing there is an interest in moving toward a more active type of board, which has been pictured in this report, how does one go about it? How is an old board reconstituted along new lines, whether or not those suggested above? What is the path of transition from the usual board, composed of a number of operating management supplemented by outsiders who come together for perhaps part of a day once a month, to a board which has largely eliminated part-time insiders and whose outsiders are spending as much time as is necessary to the adequate discharge of their responsibilities? At some point in the period of transition, rather than

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having the board reconstituted along the lines of a few people's thinking, it would seem appropriate to engage the board in a program of self-study. Not only is it possible that the result may be fresh ideas which can be put to use, but it is also possible that the result of the inquiry may lead those individuals who do not see themselves fitting into the new type of board—either because of disinclination or lack of time—to take themselves out of the picture on their own initiative. One further advantage may be in making it easier to explain to stockholders why a corporation which had always emphasized the desirability of part-time outside directors should now accept the idea of at least some full-time inside directors, or why a corporation which had stressed the contribution of part-time inside directors should now seek to replace them with part-time outsiders. The board's participation in the new programming should facilitate the acceptance by stockholders of the "successor" type of board. Finally, by no means should it be assumed that the present members of a board would all be reluctant to find their role enhanced in importance. It seems possible that at least some of the existing directors would respond with alacrity to a program which was designed to bring into sharper focus the nature of their contribution, and to endow them with functions commensurate with their responsibilities. — I have a company which for years and years and years and years has been devoted to the principle of a predominantly outside board and a predominantly outside executive committee. It's been sold to the stockholders for — I think this coming July meeting will be our twenty-ninth

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annual meeting—and they've been told that this is the McCoy, this is the ticket that suits. Now suddenly we're going to turn around. We're going to rely heavily on full-time inside people. Well, I first have the problem of getting this board to go along, because if they decide that they're going to vote themselves out of office, then they're going to have to vote in a bunch of insiders. This is a practical problem. Then you reverse yourself in your stand, your traditional stand with your stockholders. I think this is a practical problem. — That gets us down to the more practical question of how do we take a step towards a board which is more thoroughly cognizant of company operations, from the more common type of board that has part-time outsiders who can only be familiar in general with the operation of the company? — You could solve the problem by reconstituting the old board to incorporate some full-time directors by the simple device of expanding the number and adding the number of full-time directors you want. If, for example, we have a board of 15 outside directors and wish to incorporate fulltime inside directors, why not simply add five full-time inside directors, expand the number of the board to 20, and allow it gradually to contract to the original number of 15 as outside directors retire? There may be some legal complications, but they should not be insurmountable. — I think you have to assume that any successful business has got a few people in it that know a heck of a lot about it. I mean by that, there must be within the business, within the management—

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— Well, then, would your thought be that you would move them up to a board— — What I would do is: I'd put them on the board, and if I didn't have a good substitute for them in management I'd let them keep on managing until I could develop a good one. As soon as I could develop one I'd let him take over.

Summary and Conclusions

the informal story of how a group of business leaders explored the broad question of how the board of directors in the large corporation in the United States might be vitalized. On many points there was no consensus but a number of viewpoints. On other points there was substantial agreement. Most members of the group believed they had profited simply by considering specific problems for a period of concentrated thinking. Many basic questions relating to the organization and functioning of the board of directors were brought into sharp focus. The overriding responsibility of the board was seen as the traditional one of safeguarding and advancing the stockholder's interests. The long-run interests of the stockholder can only be served, however, if there is due regard for the interests of others in society—the employees of the corporation, its customers and suppliers, and the community at large. The board may delegate its authority to operating management, but it can never unburden itself of its direct responsibility to the stockholders for corporate performance. This means that its chief function is a continuing review of the plans and policies of the executive staff, which it has chosen, and of the effect of past operations. Several views were expressed as to the kind of board which could best perform this function and discharge its

THIS HAS BEEN

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Summary and Conclusions

responsibilities. One opinion held that the presence on the board of persons who are also members of operating management (aside from the president and perhaps one associate, for continuity) is undesirable, ( 1 ) since such men are subordinate to the chief executive in their management roles, and hence in no position to make an independent review of his record and plans, and ( 2 ) since these men may themselves be partially responsible for such records and plans, and hence in no position to make an impartial review of them. For these reasons, it was maintained, reliance should be placed on outside directors who would spend as much time in the discharge of their duties as was required, and who would form a body of impartial judges of the soundness of management's actions and policies. A contrary view was argued. The affairs of a large corporation are sufficiently complex that part-time people cannot adequately understand them, it was said. For truly informed judgment, full-time directors are needed, to a large extent consisting of men who have come up through the company and whose experience aids them in understanding its operations. A third possibility emerged as a synthesis of the above two approaches. A "balanced" board might consist of a number of full-time inside directors, perhaps forming an executive committee with powers of the board in all except a few limited areas, supplemented by a number of part-time outside judges who would provide a greater degree of objectivity and prevent the danger of ingrownness. The use of part-time insiders, such as the production manager who doubles as a director, was generally discouraged within the group, although there was appreciative recognition that

Summary

and Conclusions

145

under some circumstances the use of such people would be preferable to the available alternatives. Several problems were anticipated in any effort to strengthen a board of directors. In most instances, there can be no clear-cut answers to these problems, but awareness of them helps to avoid difficulties. One concerned the relationship of the president and the board chairman. Should the latter be more or less independent of the former, with definite responsibilities for assuring the effectiveness and impartiality of the board as a review agency for management's operations? Or does this give rise to a dualism in leadership within the company which may create confusion as to where authority lies? Should the president have the right to choose or to approve those who are to pass on his business conduct? As to the composition of the board, two views were apparent. There were some who believed that definite functional areas, such as public relations, finance, labor relations, and so on, should be represented by specialists on the board. Others believed that such specialization might encourage board members to interfere unwisely in management matters, and that what is wanted are directors of general competence, whose judgment can be trusted in all matters coming before the board, regardless of their own specializations. Neither of these views was rigidly supported, however. In general, the group agreed that while a board should not attempt to secure expertise at the expense of general comprehension, a well-rounded board should bring in people of divergent backgrounds who would naturally have specializations. No board member should regard himself as representing a special interest. He should regard him-

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Summary and Conclusions

self as a part of a group representing the general interest of the corporation—which is identical with the long-range interest of the stockholders. There was agreement, too, that there should be an age distribution of board members that would insure smooth continuity by avoiding the bunching of retirements. Where can directors be secured? How can qualified people be induced to serve as directors? Satisfactory answers to these related questions were regarded as perhaps the key to all attempts to improve the functioning of boards of directors. There was considerable disparagement of the notion that the executives of one corporation might serve as parttime directors for other corporations, at least if such parttime service is viewed as entailing that expenditure of time and effort which the group thought would be necessary for the proper discharge of directorial functions. Retired executives constitute a pool of talent which might be tapped to better advantage, but their service would be confined to a period of perhaps five years (thus limiting their value to companies other than the ones in which they served in an executive capacity—or ones very similar to them, though not competitive with them), and the need for proper age distribution of the board sets a ceiling on the number of such people who can be utilized. Finally, directors may be drawn from professional groups whose more flexible calendar permits drawing off a portion of their time into board service. Five chief inducements to individuals to take on the duties of directors were considered to be compensation, prestige of membership on certain boards, the high value attaching to personal associations with men and women of outstanding ability, personal interest in the work of the company,

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147

and the broadening of individual experience gained by insight into the workings of another company. None of these can be said to be more effective than any other. All must be relied on. For boards to discharge their duties adequately, they must have access to necessary information. The attempt of individual board members directly to contact operating executives to secure data leads to the danger of undercutting the lines of executive authority, which run to the chief executive rather than to the board. On the other hand, board members ideally should not be limited only to materials which the chief executive considers to be relevant to their duties. The suggestion was offered that a board could perhaps best work through the chief executive to obtain such information as it itself decided was relevant. Informal contacts between directors and executives would not be discouraged, but any suggestion that board members were exercising an authority over operating personnel should call for prompt and decisive action to prevent a recurrence. The practical problem of how an interested management or board goes about reconstituting the board along lines which would improve its performance led to the suggestion that if the thinking of this group were followed, and less reliance was placed on part-time insiders (operating management) for board positions, the part-time outside members, serving as impartial judges, could be supplemented by members of management who would be released from operating responsibilities and promoted to full-time board service, being removed from any role subordinate to management. This approach would call for the training of replacements for certain members of the management team

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Summary and Conclusions

in exactly the same way that would be necessary if such management people were to retire at an earlier age. In the course of this discussion numerous issues were left unexplored. The group did not delve deeply into such long-run questions as whether the present corporate device will prove satisfactory in times of stress to a public which is potentially critical of concentration of corporate authority in the hands of top officials, who largely influence the composition and activities of the board. Moreover, there was not time to examine closely such subjects, pertinent to the functioning of boards as presently constituted, as cumulative voting, the adequacy of the present proxy machinery to reflect stockholders' desires, stock ownership of directors, their compensation, the staggering of terms of office of directors, a retirement policy for directors, and the use of committees by the board. This has been, then, an examination of some of the issues of an important subject. It is offered in the hope that it may stimulate other people, both in business and out, to think through these issues, the satisfactory resolution of which will have ultimately a significant impact on the acceptability of the private corporate form to the American public. Just as the board of directors may serve as a body of impartial judges to pass on the performance of management, so may the American people function as a body of impartial judges to pass on the adequacy of the private corporate system as a whole, including not only its material effectiveness, but also the manner in which its power, authority, and responsibility and its system of social relationships are harmonized with the basic values of a democratic state.

Bibliographical Notes on the Functions of the Board of Directors

exception, the books listed below relate solely, or to a considerable extent, to the function of directors and reflect various viewpoints or industry practices of interest. The exception is Mr. Gilbert's book, which is included because of its unique viewpoint as to the relationships among shareowner, director, and chief executive. W I T H ONE

Baker, John Calhoun. Directors and Their Functions: A Preliminary Study. Boston, Harvard University Graduate School of Business Administration, 1945. Copeland, Melvin T., and Andrew R. Towl. The Board of Directors and Business Management. Boston, Harvard University Graduate School of Business Administration, 1947. Gilbert, Lewis D. Dividends and Democracy. Larchmont, N.Y., American Research Council, 1956. Jackson, Percival E. Corporate Management—The Directors and Executives. Charlottesville, Va., The Michie Company, 1955. What Every Corporation Director Should Know. New York, The William-Frederick Press, 1949. In addition, almost all books on executive work, administration, organization, or management include one or more chapters relating to the functions of directors. Below is a representative list of some of the wellknown books and some of the more recent books which contain considerable comment on the functions of directors. In general, the referenced chapters present diverse points of view which are of interest equal to that of magazine articles, published speeches, and pamphlets listed separately in this bibliography. Doris, Lillian, and Edith I. Friedman. Corporate Secretary's Manual and Guide. Rev. ed. New York, Prentice-Hall, Inc., 1955. Chap. 30, pp. 1217-42. Drucker, Peter F. The Practice of Management. New York, Harper & Brothers, 1954. Chap. 14, pp. 161-81. Gordon, Robert A. Business Leadership in the Large Corporation. Washington, D.C., Brookings Institution, 1945. Chap. 6, pp. 116-46.

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Notes

Holden, Paul E., L. Spaight Fish, and Hubert L. Smith. Top-Management Organization and Control. Stanford, Stanford University Press, 1941. Part D, pp. 213-38. Martindell, Jackson. The Scientific Appraisal of Management. New York, Harper & Brothers, 1950. Chaps. 2 and 3, pp. 11-41. Newman, William H. Administrative Action. New York, Prentice-Hall, Inc., 1952. Chap. 14, pp. 237-56. Owens, Richard N. Introduction to Business Policy. Homewood, 111., Richard D. Irwin, Inc., 1954. Chap. 14, pp. 224-45. Petersen, Elmore, and Edward G. Plowman. Business Organization and Management. Homewood, 111., Richard D. Irwin, Inc., 1941. Chap. 10, pp. 281-315. MAGAZINE ARTICLES, PERIODICALS, SPEECHES, AND PAMPHLETS

Baker, John Calhoun. "The Board of Directors," Dun's Review, Feb., 1946, pp. 11-15. Bates, George E. "The Board of Directors," Harvard Business Review, XIX (Autumn, 1940), 72-87. "Boards of Directors," Modern Industry, Jan., 1952, pp. 50-53. "Directors: Doing More Directing," Business Week, March 12, 1955, pp. 101-2. Maurer, Herrymon. "Boards of Directors," Fortune, May, 1950, pp. 107-8. Mylander, William H. "Management by Executive Committee," Harvard Business Review, XXXIII (May-June, 1955), 51-58. A case study of du Pont practice. National Industrial Conference Board. The Corporate Directorship. 1953. Study of Business Policy, No. 63. Patterson, Richard C., Jr. Responsibilities of Directors. 1940. An address before the Harvard School of Business Administration at Cambridge, Mass., March 15, 1940. Ruml, Beardsley. "Do Boards of Directors Satisfy Today's Needs?" Dun's Review, Feb., 1951, pp. 23-25. Swope, Gerard. "Some Aspects of Corporate Management," Harvard Business Review, XXIII (Spring, 1945), 314-22. Towl, Andrew R. "The Directors as a Functioning Part of Business," Dun's Review, Sept., 1949, pp. 17-19. Weinberg, Sidney, Jr. "A Corporation Director Looks at His Job," Harvard Business Review, XXVII (Sept., 1949), 585-93. An article prepared from a speech given May 31, 1949.