John Stout
Not long after the November 2012 election, John Stout, chair of the American Bar Association’s corporate governance committee, met with committee members in Washington D.C. Also present was former Republican congressman from Oklahoma Mickey Edwards, author of the new book, The Parties Versus The People: How to Turn Republicans and Democrats into Americans (Yale University Press, 2012). Stout thinks it’s important reading material: “The point of the book really being, we need to focus on the best interests of the country, not the best interests of the parties, regardless of which party we belong to.”
That’s where Stout thinks Washington can learn a thing or two from corporate America. In light of gridlock over issues like the fiscal cliff, tax policy, and the debt ceiling, last year his committee established a subcommittee called Public Sector-Private Sector Governance, which he believes could advance the debate “by analogizing some of the private sector governance principles into what kind of governance we want nationally, of our country.”
And as Stout looks ahead to the 2013 proxy season, he’s adamant that directors shouldn’t stand still while carrying out the duties of care and loyalty.
CorpCounsel.com recently spoke with Stout, who also chairs the corporate governance and investigations group at Fredrikson & Byron in Minneapolis, about the dilemma of director accountability, how IT and cyber-risk expertise is missing on boards, and why board turnover is a good thing. An edited version of that conversation follows.
CorpCounsel.com: What do you hope will come from the Public Sector-Private Sector subcommittee?
John Stout: I’m hoping that by focusing on what the duties of private sector directors are, we’ll get a look at what the duties of a public sector representative are. For instance, in the private sector, we all know that no matter who elects you to a board of directors, when you walk through that door as a director, you owe the corporation the fiduciary duties of care and loyalty.
Care basically means, just do a good job: be well informed, and make a decision that a prudent person would make under the circumstances. The duty of loyalty says: you have to set all other interests aside, and act in the best interests of the company. Not a particular shareholder group, or a particular special interest, or a labor union—but the best interests of the company. I think it’s important to explore whether a similar duty doesn’t exist once you become elected to public office. Shouldn’t your duty, whether you’re a Democrat or Republican, be to act in the best interests of the United States—not in the best interests of a party?
CC: Along those lines, I saw that director accountability was on the agenda in your November meeting. How did that issue come to the fore in 2012?
JS: As we went through the financial crisis, there’s been a lot of criticism of boards and financial services companies, and the issue is: Is there no accountability? Because in the cases that have been brought so far, absent wrongdoing, the courts have said: Look, directors may have been mistaken in their business judgment, but as long as they made a judgment in good faith, we’re not going to second-guess them, even if it had some really bad consequences.
We need good people to sign up to be directors. And if you’re going to really hold them accountable for some of these things, who’s going to risk their net worth to sit on a board and use their best judgment? That’s the problem.
CC: Do you think executive compensation and say-on-pay will continue to be top issues for boards this proxy season?
JS: Yes, I do. I don’t think it’s improved enough that it’s going to go away. [Though] I personally see board composition as our biggest governance issue. Whether anyone else agrees with that, we’ll see. But everything starts with who goes on the board. Everything related to board performance has to do with who’s on the board of directors. So if you, for instance, think it’s a good idea to split the chairmanship and CEO position, if you don’t have someone who’s really capable of being an excellent independent board chair, you do as much harm as good—or you could do more harm than good—when you split it.
Or if boards aren’t doing such a great job of overseeing risk, then wouldn’t it make sense to have a person or two who have spent much of their career assessing risk? Who are those people? They’re analysts, sometimes. You find them in investment banking. You find them in insurance. But they’re not so prevalent on boards. I think the model for the bigger companies is still: a high-profile CEO if you can get him or her, or maybe a CFO, or the head of a big division. And if people think boards’ decision-making is too management-centric, well, look at who we tend to put on boards.
CC: Other issues that came up last year included getting more women on boards and getting directors with more IT experience.
JS: IT experience is huge right now, as is cybersecurity. Social media experience should be considered as well. Those are huge areas. And you could add a couple more. If we’re really spending a lot of time on international matters, shouldn’t we have some very clear and some very strong international experience [on the board]? And if you’re in a heavily regulated industry, it might not hurt to have some former regulators on the board who understand that process and where regulation’s going. Or, if you’re concerned with your corporate culture—as most companies should be—who knows more about corporate culture than the people who are highly experienced, highly qualified HR executives? They live with the consequences of culture every day.
These are all categories of people that you don’t see on boards as much. And if you’re thinking about how do we diversify boards from a gender perspective, from an ethnic perspective, from a skillset perspective, you’ve got to go to these other pools.
CC: How about cyber risk? Are boards starting to deal with it?
JS: No question that they’re starting to, because there are so many stories about it. Attacks can be so severe that you have to have systems and people who can handle them almost the moment it occurs—rather than, yeah, I’ll get to that in a few days.
Go back to board composition and say: Where are the people on the board who understand social media, IT, cyber risk? A lot of times boards don’t have those skillsets, but those people are becoming increasingly in demand.
The other thing you see happening, of course, is that board size is decreasing. So you wonder whether board size can keep decreasing, and yet board responsibility for all these areas can keep increasing. Spencer Stuart does an annual report, and they see board size continuing to come down. They survey big public companies, and the average size is about 10.1, except in financial services, where it’s trending a little larger. But big picture, even in those companies, it’s coming down.
CC: Why do you think that is?
JS: There’s a concern about how big a board can be and still be effective. How many people can you have in a room before the discussion really doesn’t work? I think it’s been coming down because people felt it had grown to the point where board effectiveness was suffering. And to your point about board responsibility, there were so many people that people kind of lost that sense of personal, direct accountability. And as you bring that size down—it’s like, whoa, there’s only nine of us here to oversee the operations of this company. That begins to weigh on [board members] as a fairly awesome task.
CC: Do you have strong opinions on staggered boards?
JS: Philosophically, I like the notion of annual elections; but philosophically, I like separating the chair/CEO function, too. You have to look at the particular company, and say: OK, does the philosophical position work in reality for this company? That can very well have a lot to do with who’s on the board to do certain things.
Do I think, big picture, annual elections are a good thing? Yes. Because I think boards need to assess themselves, they need to assess the skills they need, they need to be able to turn the board over to create spots not just by adding more people or waiting for terms to expire, but by asking some people to step down. And it shouldn’t be a dishonor to leave a board . . . because board composition needs to be dynamic, not static. We constantly need at the board level to be asking that question: Are we staffed with a group of directors that meets the needs of this company at this point in time?
You go back to the fiduciary duty. What’s in the best interest of the company? Not in the best interest of perpetuating this management team, not in the best interest of perpetuating the board—what’s in the best interest of this company?
