CHAPTER SIX

The Real Duties of a Director

SINCE JUNE 1978 THE BOARD OF DIRECTORS of every company listed on the New York Stock Exchange has been required by Exchange rules to have an audit committee of independent directors. Only in a few companies, however, has a key question yet been sufficiently explored: What are the responsibilities of this committee, and how should it go about its job?

Indeed, the responsibilities and work of the board of directors as a whole is a subject that has received too little attention in most companies. Yet it is increasingly clear that this will be a central question and a major challenge to top management and directors alike. The regulatory agencies, such as the Securities and Exchange Commission, increasingly demand more responsibility from the board and proof that the board takes these responsibilities seriously. Increasingly the courts are holding boards and board members to very high and demanding standards of accountability in stockholder suits. The only way for a board to protect itself against what might otherwise be unbearable liabilities is to think through its responsibilities carefully and to organize itself for discharging them.

The law still calls the board the “managing organ” of the corporation. This nineteenth-century formulation has become totally untenable and is not taken seriously by anyone. What the boards are, and must be, is the organ that makes sure that the company is being managed, to paraphrase a recent California decision.

The first requirement, therefore, is that the board makes sure that the company has a top management competent to run the business. The first task of a functioning board is to insist that company management design adequate yardsticks of performance for itself. In most businesses such yardsticks are needed in four areas, in addition of course to the traditional return-on-investment yardstick. Top management needs to be judged by its performance in allocating capital, by its performance in appointing people to managerial and other key positions, by its performance in respect to innovation, and by the adequacy and reliability of strategic plans.

In each of these areas top management should be required by a functioning board to spell out its expectations and to be judged, a few years later, by results as measured against these expectations.

Equally important is the duty of directors to make sure that top management itself is properly structured and properly staffed. It is the duty of the board not to tolerate mediocrity in high places. Today most boards will act only if there is gross malfunction in top management—and this is not enough.

The board also needs to make sure that top management has thought through the succession to top management jobs. Directors are responsible for making sure that top management and the company are properly organized. And finally, the board needs to make sure that the company, especially the larger one, has an adequate program for developing future managers and for testing executives before putting them into responsible and decision-making positions.

It is the job of the board to make sure that top management think through what business the company is in and what business it should be in. But equally important—and very rarely paid any attention—is the question of what business or businesses a specific company should not be in, what it should abandon or play down, and what it should slough off to keep itself lean and muscular.

The board of directors cannot work out a company’s strategy. This requires both full-time work and inside knowledge of a business, its markets, its products, its technologies. But it is the duty of a board to make sure that a company, and especially a large publicly owned one, has adequate strategies and that these strategies are tested against actual results.

A board, to live up to its responsibility to make sure the business is being managed, must demand of top management that it think through and set goals for the productivity of resources. This is, after all, the first duty of any management: to make resources productive is what management is being paid for. A board needs to demand that top management know the productivity of capital in its business and set specific goals to improve productivity wherever substantial amounts of money are being invested, whether this be plant and equipment or receivables. The company needs, similarly, goals for the productivity of people, for the productivity of key physical resources (such as shelf space in a retail business), and—most crucial of them all—for the productivity of time for such groups as salesmen, engineers, researchers, or service personnel, whose main resource is time.

Finally, the board is responsible for making sure that a company has adequate policies for its key outside relationships—with government, with labor unions, with the public in general—and that it has adequate policies with respect to its legal and regulatory responsibilities. And then a board has to demand that there are adequate performance standards in these areas against which a company’s actual results can be measured.

There is one additional area which should probably be included among the responsibilities and the work assignments of a functioning board of directors—the pension fund. The pension fund is increasingly going to be the main recipient of a company’s earnings. And pension liabilities are increasingly going to be the greatest liabilities of American businesses. The board will not, as a rule, be able or willing to manage the pension fund itself. But it needs to supervise the management of the fund, both in respect to the adequacy of pension-fund contributions and the performance of pension-fund management.

In addition, in every business there are specific matters which top management will bring to the board, or should bring to the board: decisions on an acquisition or on dropping a product line; decisions on any lawsuit brought against the company; decisions on long-range research programs. Any board will supervise operating results, the company’s liquidity, and all the other matters which today occupy the time and attention of the board, practically to the exclusion of concern with the fundamentals of managing. But in the areas which determine whether a company is indeed being managed or whether it drifts—that is, in the areas mentioned above—a board needs increasingly to think through its own role. It needs increasingly to develop its own goals and objectives. And it needs to think through which individuals should be held accountable for achieving the board’s objectives.

Today there is a great deal of discussion regarding the membership of the board of directors of the American corporation. Harold Williams, the chairman of the SEC in the Carter Administration and himself a former board member with broad experience, argues strongly for our switching to a board which is totally independent of management in its composition, with the chief executive officer the only member of management on the board. There is strong criticism of the tradition of putting people on the board who render services to the company, such as lawyers or underwriters. And there are many people who question the propriety of retired executives continuing to sit on the board of a company which they once served as full-time members of management. Equally, there is increasing debate as to whether the board needs its own staff: To whom, for instance, should a company’s internal auditors report—to top management or the audit committee of the board? (The answer is, clearly, to both.)

And beyond the present debate there is going to be another major task: the board functioning as the company’s representative for relationships with different publics and constituencies, whether racial minorities or women or consumers or employees.

But the first item on the agenda is not the membership of the board. Before we can intelligently discuss how to staff, we have to know what the work and the assignments are. The first item on the agenda, therefore, is the specific responsibilities of the directors and the work needed in order to discharge them.

(1978)