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Reader Profile

Richard S. Hill
Chairman and CEO
Novellus Systems, Inc.

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase. This Reader Profile is adapted from a keynote speech delivered by Rick Hill at the National Association of Corporate Directors’ annual conference held in mid-October in Washington, D.C.

In your view, have the various reforms directed by regulators at the corporate boardroom been effective?

One only has to look at the recent scandals in Corporate America to know that there was a need for reform, but the issue before us is whether or not these reforms have gone too far and have lasting effects on the industrial competitiveness of the nation. Corporate reform has three major fronts it is trying to attack with three distinctly negative consequences. These three fronts are as follows:

1.    Corporate Internal Controls as outlined in the Sarbanes Oxley 404 compliance requirements.
2.    Corporate Certification, more affectionately referred to as the criminalization of failure complete with written confession.
3.    Option Expensing.

Let’s talk first about Sarbanes Oxley 404. Right now there are hundreds of corporations both big and small scrambling to enable systems that ensure internal controls are in place to make sure reporting to the investing public is as accurate as possible and that instances of fraud and corruption can more easily be rooted out by the auditing community. Unfortunately, these controls are expensive and cumbersome and threaten the competitiveness of small businesses as investment here diverts resources away from development that is the most important thing to the long term growth of our economy. Auditing firms who have been shell shocked since the dissolution of Arthur Anderson interpret SOX 404 mandates in their most stringent application.

Can you really blame them? Probably not, but can our economy afford to burden American corporations with bureaucracy that our own government can no longer afford? This burden threatens to make the public markets unavailable to small businesses, and small businesses only available to the most sophisticated investors at a time that capital availability is critical to the success of our economy.

We can’t discuss SOX 404 without addressing the second key debacle of the Enron error, CEO/CFO certification. There are many types of CEOs and CFOs. Tall ones, short ones, and some that play on rocks, making little ones out of big ones of course. But there are no CEOs of major public corporations who are capable of certifying that the financials of their corporation are perfectly accurate. I think all good CEOs and CFOs can certify that their financial statements are accurate to the best of their knowledge, but unfortunately that is not the requirement. Every day, judgments are made on the level of reserves for account receivables, the accuracy of the value of goodwill on the books, inventory values and reserve levels—all of which will prove to have been incorrect the day after you declare bankruptcy! So when you fail and the shareholder loses money, you have a signed statement affirming your stupidity and/or guilt.

So, what is the real impact on business?

Today there are higher levels of cash reserves in corporations than any other time in history and yet corporations are not spending. There is a greater threat to American competitiveness than since before World War II. Yet why are we not investing? There can be only one answer to this question. The risk of failure today is so high America is milking the cow. And as with all cows without care and feeding they will go dry and make no mistake there are desert winds blowing in the U.S.

Let’s also focus on stock options. Make no mistake, the crimes committed were fostered by greed. But the question is, the greed of whom? The corporate executive, the Board of Directors, the investment industry, or was it the investor himself? If one understands a stock option, one understands that it is a right given to the holder by the owners of the company through the management. It recognizes the importance of human capital to the success of the business. The theory is the price today of a stock is a representation of the earning potential of the company in the future, the owner says, that if we can earn more than the market predicts I will give you a small percentage of that growth. For the stock to rise, earnings must go up. If earnings go up, they are going up because the employee contributed to that growth, not only in his labor, which is compensated by salary, but also because he brought to the company his knowledge, skills and abilities, which only he can own, not the corporation.

So why then did so many make so much during the ‘90s? The answer of course is greed. Greed on the part of the investment community hell bent on driving transactions, greed on the part of executives prognosticating “a new economy” defying fundamental economics, and greed of investors who were convinced to buy stocks with price earnings multiples that made my Christmas Club account at the Savings and Loan in Chicago look good to me back in the ‘50s; and absolutely nothing more caused this. And as the investors flee the market and multiples come back to where they should be based on economic value, options will continue to expire worthless.
By the way, Sarbanes/Oxley, CEO certification or stock option expensing did not fix this problem. Letting Enron, Worldcom, Adelphia and Internet companies go bankrupt did. And letting United and U.S. Air and other poorly run companies go bankrupt will help further. In short, let capitalism work.

But, as I have been told by people in the know, that train has already left the station and stock options will be expensed. Why? Not because it is right but because our accounting system is not capable of dealing with the concept and value of human capital to corporations. So we will live with a huge distortion of financial statements to avoid the inevitable, an overhaul in our accounting standards.

Clearly, you strongly favor stock options. Why?

The driver of wealth creation since the industrial revolution has been and remains the right of the individual to acquire and keep property. Capitalism is about individual ownership. The increase in human lifespan, in knowledge, in quality of life and in personal wealth are all tightly tied to rising participation by individuals in economic growth through a greater ownership in the economy.

To me, an option is much more than a financial security that derives its value from an underlying stock and a time window for execution. To me, an option is about economic ownership. So, not surprisingly, I don’t share the opinion that this is an accounting issue first and foremost. I believe very strongly that this is an ownership issue and that expensing options threatens our rich heritage of granting ownership in our economy to individuals.

Let me be the first to acknowledge that I’ve benefited from stock options. Wealth wasn’t handed to me. Like so many who have achieved success in this country, it wasn’t my birthright. But I’d like to think that’s what makes America great. I had to work hard to become CEO of a successful company. And in Novellus Systems, I found a company with an ownership culture—one that makes owners of its employees by offering options to the rank and file workforce.

In fact, much of the economic growth we’ve enjoyed over the last twenty years has come from companies like Novellus that represent a new American technology industry. It’s an industry that was largely born of an options culture of ownership that ramped up in the eighties and gained momentum in the nineties. Remember back in the early eighties when the eulogy for American business was being written and the best-known symbol of America’s economic future was the Rust Belt, rather than Silicon Valley? Well, in my opinion, the options culture changed that. But, that shouldn’t surprise us. Economic ownership has always been the key to driving economic growth.

Richard S. Hill has been Novellus' chief executive officer (CEO) and a member of the board of directors since 1993. He was appointed chairman of the board in May of 1996.

Before joining Novellus, Mr. Hill spent 12 years at Tektronix, Inc., where he held a variety of positions, including president of Tektronix Development Company, vice president of the Test and Measurement Group and president of Tektronix Components Corporation. Prior to joining Tektronix, he held engineering management positions at General Electric, Motorola and Hughes Aircraft Company.

Mr. Hill holds a bachelor's degree in engineering from the University of Illinois and a master's degree in business administration from Syracuse University. He is a board member of the University of Illinois Foundation and also serves on the boards of Agere Systems, Semiconductor Equipment and Materials International Association (SEMI) and LTX Corporation.