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Column

John J. Castellani
President
Business Roundtable

Investor reform: The next governance milestone
Boards have to be tougher and smarter to operate in the new activist environment.

By John J. Castellani

After half a decade of historic, almost dizzying, changes in corporate governance, companies and boards are understandingly wondering what comes next.

They have worked diligently to restore confidence in the marketplace by generating reforms ranging from greater board independence to more transparency and improved shareholder communications. This sea change has benefited companies and investors.

Unfortunately, as we look ahead, there is a real danger that the shareholder activism that helped move those reforms forward will move beyond fixing what is wrong to changing what is right.

That activism was initially fueled by scandals and supported by responsible corporate leaders who wanted to demonstrate integrity and accountability. A certain level of activism is always needed, of course, because it can spark constructive dialogue.

Stoked Appetites
But the desire to continue to push for change--without stepping back and first gauging the effectiveness of the already dramatic reforms--seem to have stoked appetites for new, worrisome kinds of changes.

We are not only seeing more activism than ever, but much of it is focused on the wrong agenda. Many of the small cadres of newly energized investors have narrow-interest agendas--Social Security reform, health care reform, environmental issues  that are unrelated to the long-term performance of companies.

Need for a New Model
In the coming decades, they will continue to try to use boards of directors to make the changes in society that they can’t achieve through federal or state legislation. Boards will have to find a model for operating in this activist environment while still achieving their primary mission, increasing shareholder value.

Effective boards will begin by accepting the fact, however reluctantly, that they and their actions will continue to be under a high-magnification microscope. Successful directors must ensure they pursue due diligence when conducting board business. At the same time, directors can expect small groups of investors with narrow interests will conduct very public, noisy campaigns for their issues, withholding votes on directors, including the CEO.

Future boards will have to be both tougher and smarter to do their jobs. They will have to grow thicker skin to keep from reacting to every demand that comes their way. At the same time, they will have to develop a greater political sophistication so they can avoid becoming mired in issues that could distract them from their primary purpose--ensuring viable company operations that enhance shareholder value.

Ramp Up Your Political Skills
In the longer term, boards must reform investors. That is, they will have to use their new political skills to remind investors our economy is the envy of the world because of companies that are run by trained managers who focus on long-term performance. Boards will have to energize the majority of shareholders who are happy with the way companies are run, so the companies don’t become gridlocked by the narrow agendas of a few.

If future boards fail to reform investors, they may be forced to pick the specific investors or the specific agendas to which they want to respond. That’s a path that could lead boards to become the business equivalent of a New England town hall meeting.

During the past five years, boards changed corporate governance for the better. In the next 30 years, the challenge will be to protect the positive changes, without allowing the activism to go off course and jeopardize a system that has worked so well for so long.

John J. Castellani is president of Business Roundtable, an association of chief executive officers of leading U.S. companies that comprise nearly a third of the total value of the U.S. stock market (http://www.brtable.org). The organization, which has been cited by the Financial Times as “the most influential chief executive lobbying group in the U.S.,” has weighed in at key moments over the past three decades to react to and help influence the evolving nature of corporate governance. This article originally appeared in the 30th anniversary edition of Directors & Boards published in October 2006.