Economics has long taught that the division of labor in an organization is specific to said organization at a point in time. In each organization, the fundamental issues of governance, oversight, and management must be addressed and understood. The issues differ between organizations, often radically, and they differ within a firm over time.
CPAs can help ensure there is a clear understanding of governance, both in general and as it exists in a specific organization at a point of time. Unfortunately, some people have the misconception that governance relates solely to financial controls dictated by regulatory requirements and thus is always unnecessarily bureaucratic. On the contrary, governance refers to the processes and procedures used to direct and manage an organization to achieve its operating and strategic objectives, including how the organization is governed, how the required oversight occurs, and how management responsibilities are addressed at all levels. The consequences of governance failures in general, as well as specific examples, are discussed in our May/June column, “The Ongoing Evolution of Organizational Governance.” The governance failures at Boeing and Wells Fargo Bank—and before them Enron, WorldCom, Tyco, Adelphia, and others—make clear these challenges are faced by organizations of all sizes.
Responsibility
It is important to keep in mind that the ultimate responsibility for organization governance is clear. In a May 2005 University of Pennsylvania Law Review article, “What Happened in Delaware Corporate Law and Governance from 1992-2004? A Retrospective on Some Key Developments,” retired Delaware Chief Justice E. Norman Veasey stated that, “The board of directors will actually direct and monitor the management of the company, including strategic business and fundamental structural changes.” Delaware Chancery Court Chancellor William B. Chandler, III, while delivering his opinion in the Walt Disney shareholder derivative litigation, often referred to as the corporate governance case of the century, noted that, “Delaware law is clear that the business and affairs of a corporation are managed by or under the direction of its Board of Directors.”
In a September 7, 2021, memorandum opinion in the Boeing shareholder derivative litigation (https://courts.delaware.gov/Opinions/Download.aspx?id=324120), Delaware Court of Chancery Vice Chancellor Morgan T. Zurn set out the Boeing board’s failure to address safety issues and stated the board chair lied to the public twice following the two Boeing 737 Max crashes that were the source of the litigation. Separately, the federal courts have ruled that Boeing is potentially subject to criminal prosecution, that Boeing is subject to being sued for the pain and suffering of 346 passengers (during the crashes), and that Boeing’s directors are required to meet with the families of said passengers.
Following a series of scandals involving customer abuses, Wells Fargo’s CEO-Chair, lead director, and other directors were removed by order of the Federal Reserve. In a press release, the Federal Reserve stated it “has sent letters to each current Wells Fargo board member confirming that the firm’s board of directors during the period of compliance breakdowns did not meet supervisory expectations” (https://tinyurl.com/5kua3bnt). The CEO-Chair and the lead independent director were further criticized (“Board Oversight and Governance: From ‘Tone at the Top’ to ‘Substantive Checks and Balances,’” Business Law Today, February 14, 2019).
The Walt Disney matter involved the hiring and subsequent termination of Michael Ovitz as president, after his predecessor Frank Wells died in a helicopter crash. It was alleged that the defendant directors breached their fiduciary duties when they blindly (per plaintiffs’ allegations) approved Ovitz’s employment agreement. Compensation policies have historically been an area of material risk for boards. The Disney directors were said to have failed to exercise any business judgment and failed to make any good faith attempt to fulfill their fiduciary responsibilities to the company and its stockholders. Basically, the plaintiffs complained that Disney’s CEO, Michael Eisner, was allowed to hire a friend, Michael Ovitz, overpay him, and not terminate him for cause.
H.S. Grace & Co.’s team saw things differently, namely: 1) Ovitz was well qualified for the position; 2) the Disney hiring process was sound; 3) Ovitz’s compensation was in line with Disney executives and other exceptional non-Disney executives; 4) Ovitz struggled within Disney’s structure, as can and does occur in many situations; 5) the termination process was handled properly; and 6) Ovitz’s termination compensation was acceptable. As stated above, Chancellor Chandler found Disney’s actions imperfect, but satisfactory, and Disney was not found liable for damages.
A Framework
Governance is an ongoing process, because there is a framework for change in place that is explicit and unequivocal in both its demand for an increased level of responsibility from boards, board committees, and senior management, as well as in its requirement that board and management positions be understood to be positions of service and not entitlement or privilege. Governance responsibilities will continue to broaden and deepen as boards, board committees, and senior management will be subject to increased scrutiny.
This framework of change driving the evolution of board responsibilities is not our own design. It arises from the writings and thinking of numerous social scientists, political scientists, spiritualists, philosophers, and economists over many years. The views of these thinkers point toward investors (both individual investors and institutions representing these investors) becoming more demanding of boards, management, and board committees as they participate in the organization’s governance, including CPAs serving in these roles or assisting individuals in those roles.
Walt Disney Company’s board in its period of emergence to greatness (1983-1995), brought tremendous knowledge of and hands-on experience with Disney to their responsibility to “actually direct and monitor the management of the company,” to repeat Chief Justice Veasey’s quote above. At Buffet’s Berkshire Hathaway, ownership understands its responsibility for governance, oversight, and management. The representatives of the three general partners comprising the Greenway Plaza G.P. (Northwestern Mutual, Equitable, and Century Corporation) were informed, involved, had skin in the game, understood their responsibilities, were accountable in addressing them, and brought an attitude of service, not entitlement.
Testing Structures
These three organizations contrast with those organizations who see director roles limited to oversight. The approach to governance, oversight, and management of these three organizations will be examined in greater detail in later columns as the authors illustrate the “stress testing” of corporate governance structures.
The evolution of organizational governance highlights the importance of the relationship between the management team and the board of directors when it comes to addressing the economic reality of such organizational interactions, both formal and informal. The array of risks that all organizations face requires that organizations embed strategic risk into literally all discussions between management and the board. This also requires integrating risk analysis and discussions across all committees supported by the governance structure in order to provide effective oversight in today’s complex and multidimensional environment.
Corporate Governance Corner draws upon the experiences of H.S. Grace & Company, Inc. (HSG, https://www.hsgraceco.com) in its litigation and consulting assignments, HSG articles published in peer reviewed business and legal publications, and the best-selling book, Corporate Governance–Understanding the Board-Management Relationship, authored by HSG and published by the ABA. The HSG Advisors have, collectively, more than 1,000 years of senior management and board experience across a variety of industries. The co-authors of this article are all members of the Board of Advisors of Grace & Co: H. Stephen Grace, Jr., PhD, president and CEO of H.S. Grace & Company, Inc., Al Fenichel, CPA, MBA, retired senior financial officer at Equitable Life Insurance Company and CBS, Inc., Frank Gatti, CPA, MBA, NACD Fellow, retired C-suite financial officer at ETS and The New York Times Company, Steve Grace, COO of H.S. Grace & Company, Inc., and Steve Lilien, PhD, CPA, professor emeritus at Zicklin College of Business at Baruch College.
