Appraising the Board of Directors

By Wilbur T. Blair
VERYBODY agrees that "management" is one of the major considerations in appraising potential company performance. Accordingly one would expect questions about the board of directors to be particularly important; the typical state statute, for instance, makes the director responsible for managing the business of the corporation, and the board is always shown at the top in organization charts. /Nevertheless, those interested in judging the probable success of corporations security analysts, for instance are likely to admit that they have devoted very little time to investigating the composition and performance of directorates. Nor does a scrutiny of the published material on directors reveal much about appraising the board in terms of the effect on the company's financial position. What approach should be used? What factors should be considered? How is information obtained? The purpose of this article is to suggest answers to these unanswered questions. Although it is designed primarily as a contribution to the techniques of security analysis, the fact that its key is the "spotting" of strengths and weaknesses in boards of directors should make it a useful guide also for those directly concerned with improvement of company performance. A summary study of the factors going into such an appraisal obviously cannot deal with all of approximately 447,000 United States corporations and over 2 billion shares listed on the New York Stock Exchange, and yet retain specificity of analysis and conclusion. Accord-

ingly the present article deals only with the directorates of large industrial corporations, excluding public utilities, banks, insurance companies, and carriers. For convenience, the appraisal factors will be considered under three headings: (1) composition of boards of directors, (2) performance of boards of directors, and (3) remuneration paid to directors. But first a few preliminary observations are called for about the role of directors and the way they are selected. Role of Directors It might be emphasized, in beginning, that "management" is not the only consideration in a general appraisal and that the function of management is only in part the responsibility of the directorate. As a matter of fact, the division of responsibility between directors and executives varies widely with individual corporations. Perhaps a brief sketch of that relationship is appropriate here. Important functions predominantly exercised by corporate boards are selecting the president, other top executives, and auditors; setting the salaries of the president and other officers; and appropriating sizable funds for new projects. Selecting depositaries for company funds and determining sources and amounts of working capital are functions of the board rather than of the executive management in over half of the larger corporations. As often as not, directors and executives share the responsibility for formulating and administering employee benefits and preparing stockholder reports. In a strong minority of
pressed are the author's and do not necessarily reflect the opinions of the Board of Governors of the Federal Reserve System or of the Federal Reserve Bank of Cleveland with which the author is associated as Counsel and Secretary.

AUTHOR'S NOTE: This article is based on material submitted in partial fulfillment of the requirements of The Graduate School of Banking conducted by the American Bankers Association at Rutgers University. The ideas ex101

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Harvard Business Review slate of director-candidates for submission to the board, endeavor in most cases to select persons who will meet with approval of the existing board, large stockholders, and other interested groups. He will, furthermore, probably take counsel with these groups in regard to qualifications and identity of persons to be nominated. The listing in the proxy statement of candidates to be voted upon at the annual meeting of a corporation provides stockholders and others an opportunity to investigate the qualifications of such candidates. There is a growing school of thought, supported by the Securities and Exchange Commission among others, that greater detail with respect to qualifications of directors should be set forth in the proxy statement. Such detail might include pertinent biographical material covering, at the least, principal occupation, other directorships held by the individual, and any dealings the candidate may have had with the company as a customer, supplier, attorney, or creditor. The SEC already requires the proxy notice to state the principal business of each director and his business with the company. I submit that corporations for the most part have performed satisfactorily in the past in selecting members of their boards of directors, but that improvements may be effected in the future. Whether the directors are actually chosen by the executives, the incumbent directors, or the stockholders, is not important; what we are interested in is whether the group with the power of selection is keeping its standards for directors on a high plane. The question of the means of evaluating that function leads directly to the first group of essential considerations, the composition of directorates. Composition of the Board A board's performance depends inevitably on the capabilities of its members. What the board actually does is, of course, the ultimate criterion in a management appraisal. Yet, I submit, no one can fully comprehend all aspects of directors' performance without first understanding the human relationships that motivated it. An appraisal of the composition provides us "leads" with which to approach the appraisal of performance. It makes possible the three-dimensional understanding of a board's acts and policies which, while not in-

corporations directors determine or approve company organization, financial relationships with subsidiaries, changes in product lines, and labor policy. Selection of Directors. The mechanics of director selection are of secondary importance. What counts is the practice. Are the persons with the power of selection using their power to obtain the best available men on the board? The duty of selecting directors is vested by law in the stockholders. The history of director selection, however, reveals that except in times of crisis the stockholders, although electing the directors, play a small part in actually choosing them. The use of proxies to elect the slate of directors nominated by the executives and incumbent directors results in stockholders' fulfilling a rather mechanical role in bringing about the election of persons chosen by either or both of these other groups. Most stockholders in large corporations recognize the futility of endeavoring to oppose the proxy machinery. (As the oft-quoted British statement maintains, it may be at least half true that it is often less difficult to upset a government than to turn out a board of directors.) In addition, the average stockholder is not interested in improving the quality of directors elected as long as the stock of the corporation is providing dividends and holding its own in the market. 'There is no actual proof that greater stockholder participation at elections would improve the composition of directorates^ Copeland and Towl point out that in closely held corporations where stockholders actively participate in selecting directors, an excellent board of directors is not always found.^ It is their opinion, furthermore, that in corporations where there is a great diffusion of ownership and the directors are not actually selected by stockholders, the directors perform their functions more effectively than in closely held companies. It would seem that active stockholder participation in the selection of directors and the various mechanics designed to insure such participation are not in and of themselves sufficient to insure the election of a good board. An executive will, in fact, when preparing a
^ Melvin T. Copeland and Andrew R. Towl, The Board of Directors and Business Management (Boston, Division of Research, Harvard Business School, 1947), p. 178.

Appraising the Board of Directors dispensable to us as passing observers, is nevertheless indispensable to us as analysts looking ahead. Inside versus Outside Directors. One of the foremost issues at this point concerns the question of inside and outside directors inside directors being active officers or employees of the company; outside directors being all others. Outside directors may be subdivided into (1) those who are substantial stockholders and (2) those who are not. There is a wide variety of reasons why corporations elect outside directors. In a survey of nearly 3,000 outside directors made by the National Industrial Conference Board, however, the overwhelming majority were found to be elected either because they owned or represented large stockholdings or because they were prominent business executives, financial counsel, or lawyers.^ The real objective of a corporation in considering the proportion of inside and outside directors should be to secure balance. A wellbalanced board will count toward a high rating for the management of a corporation. What is a balanced board? It is one which represents all the points of view needed by the particular corporation to promote sound management. These points of view may include manufacturing operations, sales, advertising, management techniques, economics, research, finance, law, and others, depending upon the company concerned^ In making management surveys of various corporations, an analyst will be confronted with boards of directors which are composed as follows: (1) all directors are full-time salaried officers; or (2) all directors are from outside the company except a few top executives; or (3) about half are full-time officers and the other half are from outside the company. It is difficult to praise or condemn the composition of a board because of the single fact that it falls in any one of the above three classifications. The significant question is whether it fits the needs of the company concerned. Such corporations as Standard Oil Company (New Jersey), Standard Oil Company (Ohio), Bethlehem Steel Corporation, and The Ameri' Paul W. Dickson, "Compensation and Duties of Corporate Directors," Conference Board Reports, Study No. 16 (New York, National Industrial Conference Board, 1946), p. 6.

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can Tobacco Company, for instance, have no outside directors and yet have attained success in their highly competitive fields. In these companies, presumably, the particular advantages of inside directors outweigh the particular disadvantages. In general terms, the basic advantages and disadvantages to be weighed in considering a board composed largely of inside directors are as follows:
Advantages (1) Inside directors know the details of the business intimately. (2) The corporation is their primary interest. (3) They devote almost full time to the affairs of the company. (4) Firsthand participation by executives in policy making insures better execution of those policies. (5) A senior officer speaking as a director occupies a strengthened position. (6) Key executives can be attracted and held more easily. (7) With all key executives on the board, most important functions are represented when problems and policies concerning these functions are being considered. (8) Special or emergency board meetings can be held with greater facility. (9) The board may meet with greater frequency. Disadvantages (t) Inside directors often lack the independence of outside directors because of a feeling of owing an allegiance to superior executives. A director should be in a position to deal on equal terms with the other directors and the executives of the company. (2) There is greater temptation for inbreeding and self-perpetuation. (3) There are no outside points of view on questions of finance, expansion, economics, and the like, with which executive management may be less familiar. The policies adopted by the board are not subject to review by disinterested persons scrutinizing the same from the standpoint of the stockholders as a whole or from the standpoint of public reactions and relations. (4) Unless officer-directors own a substantial portion of the company's stock, the stockholders are further removed from their representation than if the board were composed of outside directors. (5) The board of directors is almost a legal fiction because it does not exist as an independent supervisory body. (6) Because the board of directors is virtually eliminated, the officers incur a larger responsibility

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The percentages of inside directors on the boards of 518 companies are set forth in EXHIBIT I. Note that the larger the company, the more likely it is to have outside directors.
E X H I B I T I. COMPOSITION OF CORPORATE BOARDS Board Includes Less than so% Full-Time Paid Officers Board Includes so% or Mere Full-Time Paid Officers Total 67 205 143 103

and, accordingly, are accountable for a higher degree of performance to stockholders and others. (7) The chief executive may head a virtual dictatorship, which may be beneficial at the moment but may cause great hardships to the company in the future if abused or when the chief executive is removed suddenly from office because of death or incapacity. (8) Difficulties are encountered in setting salaries and profit-sharing arrangements for director executives. (9) Members of an officer-board pass on their own fitness to be re-elected officers. (10) An adequate check on executives cannot be effected if executives and directors are the same persons. (i 1) Large shareholders who are not officers do not have a voice on the board. (12) The corporation already has the full-time services and abilities of the officers. The second type of board, composed almost completely of outside directors, is the most recently developed of the three. It is found most frequently in public utilities, railroads, and financial institutions. One big manufacturing company which follows this theory of composition is the General Electric Company. For this type of board, obviously the advantages and disadvantages listed above are in effect reversed. Its advocates argue, in addition, that when a corporation becomes large and widely held, its more or less quasi-public character requires the trusteeship and fiduciary stewardship supplied by outside directors. In dealing with this general question, one can find plenty of instances where the same type of board serves to the benefit of one corporation and to the detriment of another, because of special factors involved in the type of directors available, the location of the company, its product, its financial problems, and other items. But, in general, the appraiser should look with most favor on the board which is composed in almost equal proportions of inside and outside directors. Extremes in any direction are often dangerous, requiring special justification. T h e in-between form may have many of the advantages of both the other types without all the corresponding disadvantages. The presence of outside directors who are trustworthy and able, for example, does much to give stockholders and the public confidence in the enterprise; yet to secure the desired effect it is enough to have only a part of the board in that category.

Asset Group (In thousands ol dollars) Less than 1,000 1,000-9,999 10,000-49,999 50,000 and over

Total

Number Percentage Number Percentage 26 61% 39% 41 no 95 46 54 . . 87 56 39 61 _36 35 67 65

275 243 47 53 SOURCE: Paul W. Dickson, op. cit., p . 5.

Stockholder Directors. Most state corporation statutes do not require directors to own shares of stock in the company being served. As many observers have noted, large stockholdings by an individual do not assure that he will be a good director. Actually, though of course extent of stockholdings is no gauge of competency, the trouble may be that the typical large stockholder, rather than lacking the abilities of a director, simply does not have available the time to devote to the company. In such cases it is better for a competent and qualified agent to be appointed to represent the large stockholdings. If he does have the time, however, the large stockholder may well be an able director. Frequently, the interests of majority and minority stockholders are in conflict. This situation often arises in connection with the declaration of dividends. There have been many cases where large stockholder directors have insisted upon dividends' being paid when, for the best interests of the corporation, the funds should have been retained in the treasury of the company. There have also been cases where large stockholder directors, because of personal income tax considerations, have opposed the payment of dividends which could have been declared without harm to the company and which the smaller stockholders would have liked to receive. The appraiser should be alert to such dividend policies. Professional Directors. During recent years there has appeared in this country the so-called professional director. This type of director has long been common in England. A professional director is an individual who devotes most of his time to his duties as a direc-

Appraising the Board of Directors tor of one company or a small number of companies. He possesses an adequate background of business experience. He is compensated for his services by payment of substantial remuneration which, in many cases, will be his only source of income. In the NICB survey company executives were asked whether or not they favored well-paid directors who would serve on boards of several noncompeting companies, hold no executive positions, and represent no particular groups. More than one half answered that they favored this type of director.* Most of the writers on this subject, however, oppose the service of professional directors. As reasons for such opposition, these writers have given the increased possibility of friction with executives, on the one hand, and the desire for popularity with executives as a motive for failing to provide an independent check upon those executives, on the other hand. The alleged likelihood of perfunctory performance and of overconservative policies are further reasons. It cannot be denied, however, that a professional director will probably be able to draw upon the many advantages afforded by time and diversified experience. It is also possible that he may be less susceptible to management collusion. In corporations where there is factional strife, the election of a professional director may be agreed upon by a group which otherwise would nominate one of its own lesscapable candidates; he may likewise be acceptable to actively participating stockholder groups unable to agree on a common nominee from their own ranks. It is my judgment that the presence of professional directors on the board of a company should be looked upon with favor, unless, of course, it is found that there is friction between the professional directors and the executives. But the absence of professional directors on boards should not be regarded with disfavor if it appears that there is already "balance" on the board, performance of proper audit functions, and a competent group of executives. "Big-Name" Directors. During the past 20 years considerable criticism has been leveled at certain corporations which have permitted "big-name" directors to serve on their boards
"Paul W. Dickson, op. cit., p. 18.

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without requiring them to perform full duties of directorship. In discussing appraisal of boards of directors with representatives of some large institutional investors, I found that it is quite a common practice among analysts to appraise favorably a board merely because prominent names appear on the directorate list. It is obvious that this criterion does not provide any real information about the performance of the board in question. The board may meet most infrequently, and when it does convene, the session may be perfunctory. No knowledge is gained about attendance, research activities, asking of pertinent questions, and scope of matters considered by the board. The practice of big-name directors' serving in an inactive capacity on a board would seem to be as improper for the individuals in question as it is for the corporation. No person should permit his name to be used as a director of a company unless he actually has a share in directing the affairs of the enterprise. Court reports are abounding with cases of idle directors who became liable for mismanagement of corporations. The fact that they had merely loaned their names to the directorate was no defense. Of course, the specific motives of the company in wanting to appoint such directors may be entirely honest, if mistaken in total import. The company benefits in public relations by having directors of national prominence. Also, these important big-name directors will often attract other competent persons to the directorship who, although not so prominent, have more time available to devote to the corporation. Directors Representing the Public. During the past 15 years the theory has been advanced sporadically that directors representing the public (i.e., the government) should serve on boards of directors. Most of the authorities who have made any detailed analysis of this proposition from a practical standpoint, however, have reached the conclusion that the principle is unworkable. Certainly the presence of such a director on a board would, in the rare event of its happening, be an unfavorable sign. The reasons for opposing this proposition are strong: (1) Political pressures would be exerted on the internal operations of the company.

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influential position in connection with the management. Ordinarily, a corporation does not make available a seat on the board to creditors unless they are in a position to demand representation. To be sure, the fact that creditors are represented on a board of directors of a company should not be construed, without closer examination, to mean that the management is necessarily ineffective and incompetent without such representation, or that the company's financial standing is shaky. Business history reveals that many financing institutions, in making large loans to a corporation, will insist upon representation on the board, not becau^se the lender is of the opinion that the board is incompetent,. but because the lender will be in a better position to keep informed as to the use of its money and the debtor company's progress and operations. Even so, it is a fair inference that the company did not have the financial standing to resist the creditor's request. Directors Representing Customers or Suppliers. Considerable question has arisen aboiit the practice of electing directors who are executives of either customer or supplier companies. While it is possible to generalize concerning this subject and reach a conclusion that this type of director may not serve the best interests of the company, difficulty arises when an attempt is made to apply such a generalization to specific cases. The most common objection to this type of director stems from the possibility of favoritism's being shown. It is the writer's opinion, however, that a complete investigation of business dealings between corporations and suppliers or customers who are represented on the board would reveal little favoritism which could be classified as contrary to company interests. Very few customer or supplier directors would venture to seek unusual favors which might be detrimental because of (1) the interests of fellow directors representing stockholders; and (2) the desire of officer directors to make a good earnings record for the company. Moreover, customer or supplier directors are in a position to advance many suggestions for improving products or services and for lowering the material costs of items produced. During periods of economic recession, further* Loyall McLaren, Annual Reports to Stockholders (New York, The Ronald Press Company, 1947), p. 312.

(2) The corporation would not benefit by securing special information from the government because the men selected would not ordinarily be close enough to those who develop and carry on government policies to be aware of anything that was not open to all. If they were, they should not and would not reveal it. (3) The means that might thus be made available for securing special favors from the government would not be legitimate. (4) With a government director present, the other members of the board might not feel free to exercise independent judgment. (5) A government director would often be entangled in conflicts of interest.

Directors Representing Labor. There are a number of corporations which have elected to their boards directors representing employees. The main argument for this device is that it serves to keep labor informed about the problems of management and the expenses of operation and provides it a means of limited participation in policy making. The practice is, however, opposed by some labor leaders.* One company on the West Coast has appointed a junior board of directors for each of its plants, composed of office, sales, and factory employees. Other companies have made similar moves. But the operations of such junior boards do not affect the activities of the senior board or regular industrial relations administration. The writer regards boards having directors representing labor with some apprehension. A manufacturing enterprise must have labor, material, and capital to produce its products; nevertheless, it is not the function of labor to manage the affairs of the corporation. Nor are the standards of good management measured by a profit yardstick necessarily consistent with the standards of popular labor representation; the two are, in fact, often basically opposed. The right to choose the management is vested in the owners the stockholders, who in turn delegate to the directors the right to select the executives. It is quite foreseeable that friction, which would be detrimental to the company, and perhaps to labor as well, will arise in boards with labor representatives serving as directors. Directors Representing Creditors. Investigation will sometimes reveal that certain directors represent company creditors. This situation usually indicates that the creditor occupies an

Appraising the Board of Directors more, it may be most helpful for corporations to have on their boards executives of prominent customers. The same argument may be advanced for having supplier directors during periods when materials are difficult to obtain. Accordingly, it is submitted that the rating of a corporation's management should not be lowered because customers or suppliers are represented in the directorate, unless further investigation reveals evidence of favoritisni. Interviews with corporate executives can be used to determine whether positive contributions are being made by such directors toward improving products or services and lowering material costs. Expert Directors. During recent years there have been many discussions among businessmen concerning the use of so-called expert directors for the sake of specialized advice of one kind or another. Some of the smaller corporations utilize this device to obtain the services of an expert for the extremely low cost of a director fee.^ Many executives of larger corporations believe that experts should be hired to consult with the board and officers of the company, thereby obviating the necessity of placing them on the board where they would be required to vote on many subjects other than their specialties. A board of directors composed largely of technical experts wo\ild not be a "balanced board" as heretofore described; and more general matters such as industrial relations, relations with the public, and board policies involving business judgment might not be given adequate consideration. Among the individuals considered as experts are bankers, financiers, lawyers, accountants, advertising men, architects, real estate men, and engineers. Many of these might be tempted to accept directorships because of the hope of obtaining profitable connections with the corporation. This practice might narrow the freedom of choice and selection which is often desirable in connection with important business transactions. in appraising a directorate consisting in part of experts, the important determination is whether the presence of this type of director causes any unbalance on the board. In addition, there is the question whether the corporation, by having an expert in a certain field on the board, is unduly limiting the expert talent

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which it might hire. If both the foregoing inquiries are answered in the negative, the rating of the management of the corporation in this respect should not be lowered; in particular cases where special problems of unusual magnitude face a company, the rating might well be raised. Chairman of the Board. Of extreme importance is the ability of the chairman of the board of a company to guide the board's discussions. One of the most harmful situations which may render a board ineffective is the existence of cliques and dissensions among the members of the board. Frequently these dissensions arise during deliberations in connection with controversial issues. The chairman is usually in an excellent position to prevent personal hostilities from arising during the consideration of such issues. He must be impartial, honest, persuasive, and respected, and also must possess an abundance of leadership abilities. The argument has been advanced that, because of his strategic position, the chairman of a publicly owned company should be chosen from outside the executive staff of the company to prevent the latter from dominating the board. This statement, like all generalizations, has its exceptions when applied to specific cases. Other things being equal, however, we should note with favor an outside director's holding the position of chairman in a large corporation whose stock is for the most part publicly held. Age of Directors. Considerable information is available on the age of retirement for labor, white-collar workers, and executives, but relatively little has been published concerning the retirement of directors because of advanced age. While a number of companies prescribe retirement ages for employees, most make no requirement for directors. Standard Oil Company of New Jersey, an exception, retires directors at the age of 65. A great deal is to be said in favor of directors' not retiring as early as executives. Their duties may not be so arduous. In addition, for directors serving as counselors to the executives of a corporation, experience is a particularly valuable asset. Favorable judgment must be qualified, however, when the average age of the board is too high. I know, for instance, of two boards of seven men each where the average age

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(3) Better continuity and stability of board policy are provided. (4) It is less confusing for stockholders to elect only a portion of the board. The fact that proxy statements and notices do not usually set forth names of the full board or of a slate of nominees for the full board makes it difficult for stockholders or appraisers to study the qualifications of all nominees and incumbent directors. Size of the Boards. The recent figures of the National Industrial Conference Board indicate that for 535 nonfinancial corporations the number of directors per company ranges from 3 to 35. Few companies have more than 15 directors, and the average is approximately 9. The average number of directors for companies with assets of I50 million or more is 12.** Size is one of the appraisal factors. A board may be so large it is unwieldy and ineffective; or so small that, though effective as a working group, it does not ensure the diversity and background necessary for balance. While quality of composition is considerably more important, size may affect working ability so much that the potential of the board is seriously reduced. Large unwieldy boards, furthermore, are a haven for inactive and, perhaps, "big-name" directors. The size of the directorate has no necessary correlation with company size. National Dairy Products Corporation, with gross assets of $194 million, has 27 directors, while Gulf Oil Corporation, with assets of $523 million, has only 7 directors. Most authorities agree that a working board cannot exceed 10 or 15 members. Large boards, however, can avoid this difficulty by working through committees, as they frequently do. The real directors of companies with boards of over 15 members are often the members of the executive and financing committees. The optimum size of a board depends, of course, upon many factors. Scope of corporate activities, complexity of operations, the number of stockholders and diversity of their stockholdings, and whether the business is local or national are among the important ones.
" Melvin T. Copeland and Andrew J. Towl, op. cit., pp. > 26-27. ' Paul W. Dickson, op. cit., p. 15.

is 72 and 73 years, respectively. A large percentage of vacancies, due to death or incapacity, would be most harmful to the welfare of both companies, yet they are running that risk more than seems necessary. At the other extreme, of course, are boards consisting of too many young men to provide adequate experience. But we will not find this situation very often; immaturity of members is a rare complaint about boards of directors. Tenure of Directors. It will be wise to examine the "turnover" history of the board being appraised. Rapid turnover usually indicates administrative incompetency, just as a lethargic rate of turnover during a long period is a sign that the board may be operating in a rut. Average turnover, according to tenure statistics, is about one directorship vacancy per year for most corporations. Modest increases in this rate, however, are not causes for alarm. A study of this subject by Copeland and Towl for the years 1925-1944 revealed that in every case substantial changes in the composition of the boards of 50 companies had taken place over the 20-year period.^ Refusal to be re-elected on the part of directors who have not served for as many years as might normally be expected may be an indication of dissensions within the board or between the board and the top executives. If examination should reveal that many able businessmen had served on the board and then resigned, there would be evidence of even greater internal dissatisfaction than if they had merely refused to be re-elected after serving to the end of their stated terms. The practice of certain corporations of staggering directors' terms of office, instead of electing a full board each year, deserves attention. Although such companies are in the minority, the procedure has important advantages; and it is permitted, expressly or by implication, under the business corporation statutes of most states. T h e staggered terms are usually two or three years each. The advantages of such classification are as follows: (1) Directors are more likely to serve the company for a definite number of years than under the conventional year-to-year method of elections of all members. (2) There is less chance of sudden and complete changes' being made in the personnel of the board.

Appraising the Board of Directors Multiple Directorates. One of the most frequently heard criticisms has to do with multiple directorates. An individual with business of his own can hardly serve on the boards of a number of companies and have anything but a superficial knowledge of the complicated affairs of any one. There are men who are exceptions, but they are perforce rare; there are not enough of them to go around. Directories of directors are available for determining the number of directorates upon which a member serves. If a director serves on more than five or six boards, his connections should be regarded prima facie as excessive. The fact that some of the companies are small is not an excuse; many small companies require as much time and ability as large corporations. Conflicts of interest between companies not infrequently confront a multiple director. In any such dilemma of divided allegiance, he cannot be an asset to both companies or, sometimes, to either one. Furthermore, he may subject himself and his corporations to liability for interlocking directorships. Many of the arguments against multiple directorates are ignored by businessmen, because their experience has proved that there may be only a few persons available to a corporation who (1) are competent, (2) will undertake the responsibility, and (3) will perform in an outstanding manner. They base their reasoning on the premise "that it is much better to have a few hours from a very able man of quick perception and sound judgment than the full time of a less competent man." The presumption, however, is against such a possibility. Performance of the Board The question^ of the quality of performance of a board of directors is a difficult one. The ultimate test, again, is what directors actually accomplish or fail to accomplish for their companies. But as a practical matter we cannot measure the particular contribution of the board to the success of the company or even evaluate directly the capabilities of individual directors. For our present purposes we must consider what seem to be evidences or signs of good performance or the opposite. There is prevalent among many directors an opinion that their obligations commence when they enter the board room and cease when they leave it. In part, the opinion seems prompted by the fact that the only remuneration most of

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them receive is a fee for attending board meetings; also, most directors are preoccupied with their other business duties. In contrast, there stands the practice of those directors who communicate informally with the executives of the companies they serve at luncheons, by exchange of letters, committee meetings, telephone calls, or during visits to the company offices and plants. The rating of corporate management should not go down when the powers of initiation of decisions have been vested in the executive group but, rather, when the directors have yielded also their powers of supervision of the executives or because they are not functioning effectively as advisers to the executives. Other "must" functions of the board are auditing the management periodically and making reports on company progress and quality of leadership. A number of states have adopted statutes providing that, if a director is successful in defending any action against him arising out of alleged misfeasance of duty, he shall be entitled to indemnification by the corporation for his expense, including attorney fees in such amount as the court determines to be reasonable. The common law does not recognize such a right, but in states without such statutes corporate bylaws may provide for some sort of indemnification procedure. Since the rule puts a company in a better position to attract directors who are capable but who do not care to risk having to expend personal funds to defend themselves in court against groundless claims of stockholders, creditors, and others, the appraiser will want to check the state corporation statute and, if necessary, the corporate bylaws of the particular company. Many boards of directors of large corporations, in serving as ratifying bodies for the decisions of executives, are interested merely in obtaining from the executives statistics concerning savings, increased profits, and lower operating expenses, without bothering to examine the means of accomplishing these results or the plans being considered for the future. These boards, and there are many, will receive low ratings when they are appraised. Operating Boards. Just as detrimental to the progress of a corporation as "rubberstamp" boards are the so-called "operating" boards. An operating board of directors is one that performs functions usually assigned to the company executives. Carrying out executive

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Harvard Business Review sibility for preventing factions and dissensions from developing within the directorate. Research Activities. In virtually all industrial corporations there is a need for an active interest by the board in the subject of research. In the process of appraisal, we should develop a part-answer to the ever-present question whether an enterprise is abreast of the times in the fields of invention, management, operations, and sales. It is not safe to conclude that the research activities of a company are sufficient simply because they consist of a research department and a vice president in charge of that function. Research results must be used; research activities must be integrated into other company operations. The board of directors, as much as any other group, must be constantly concerned with the over-all aspects of the research program if the company is to succeed in the manufacturing field. Board Meetings. Reference has already been made to the principle that a board of directors can act only when convened in a properly called meeting. Although, as has been emphasized, the duties of directors do not begin when they enter the board room and end when they leave it, the board meeting is important because that is where the final deliberations and actions of the board take place. Therefore, the analyst will be especially interested in the frequency of board meetings, the attendance thereat, and the scope of the matters referred to the board. Although the frequency of meetings is quite inconclusive evidence of a board's activities or ability, it does provide some indication of the time formally devoted by board members to company affairs. If boarcls of large industrial corporations meet less than quarterly each year, serious doubts should arise whether the board is sharing its responsibility in management. From the NICB study of 535 companies in 1946, it appears that one out of every two companies meets monthly or more often. The tendency among smaller corporations is to meet quarterly; among companies with assets in excess of $50 million, directors meet once a month or oftener.''
' P a u l W . Dickson, o p . cit., p . l i .

functions is not the correct role of a director. At law, directors have no power or authority except at properly convened board meetings. The directorate should concentrate on its activities in policy making and policy revision. It must avoid crowding out the operating officials. If the board is dissatisfied with the way the executives are doing business, it should hire new ones, not take their places. The disadvantages of operating boards should be so apparent from the foregoing discussion that giving them a low rating needs no further discussion. Committees of Directors. One of the most effective means by which a board of directors may discharge its responsibilities, whether it consists of 7 members or 32, is through active committees. Standing committees may keep abreast of subjects concerning audits, finances, research, personnel, and public relations. The membership of each of the committees may be small, thereby making it more workable. A committee can devote hours to a subject which the entire board, because of time limitations, must consider in a matter of minutes. Committee members, furthermore, have an excellent opportunity for asking management detailed and discerning questions. The use of the executive committee for very many major decisions is an abuse of this device. Under the best procedure, major problems will be first considered by standing or special committees, then passed upon by the full board. The procedure of an executive committee's making recommendations to the full board permits the crowding of many important issues through that body, a result which is not so likely to happen when preliminary consideration is by standing or special committees.
Existence of Factions and Dissensions. Al-

though it may be difficult to obtain information as to whether there are factions and dissensions on the board, trying to answer the question is indeed important enough to warrant considerable effort. Frequently, when such factions and dissensions exist on the board, the same conditions permeate down through the executive staff and the employees. Obviously, the chance of profitable operations suffers greatly from such conditions. As has been stated earlier, it is the chairman of the board who carries the greatest respon-

Appraising the Board of Directors Attendance is another important factor. Of the 3,905 directors covered by the NICB survey, almost 40 fo were present at every meeting held in 1945. At that time there were still wartime restrictions on travel. In excess of 65% of the 3,905 directors attended at least four out of five meetings that year. The qualifications of a director and his ability to ask discerning questions can contribute very little to the welfare of a corporation if he is frequently absent from meetings of the board of directors. Poor attendance suggests that board members may lack interest in the enterprise or that their abilities are not being utilized. A corporation may gain many benefits if the items submitted to the directors are carefully chosen, so that prior consideration is given to the more important matters of policy and operations. According to the NICB figures, only about one out of four companies sends agenda to directors in advance of board meetings.^ Yet sending out agenda and advance reports prior to board meetings is one of the best means of giving individual directors an opportunity to prepare themselves for the meetings. With advance notice, directors can and do find it profitable to discuss the problems to be considered with business associates who are not connected with the company, of course presenting the facts as a hypothetical problem if the situation is one of a competitive character or otherwise confidential. The opportunity for advance consideration is most valuable when coupled with informal discussions between the executives and the directors. Reports to Members. Some companies follow the commendable practice of submitting reports to their directors during the interim between board meetings. Other companies submit reports only at board meetings. A number of them, it will be found, submit reports both between and at board meetings. A good appraisal will include a finding as to whether the company forwards reports to directors between board meetings and, if so, what subject matter is covered and in what form. Many directors speak of their studying of company reports away from board meetings as "homework," indicating the use to which written reports are put. There are two reasons why
* Francis Lusardi, "Keeping Corporate Directors Informed," Conference Board Reports, Studies in Business Policy, No. 24 (New York, NICB, 1947), p. 5.

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this practice is an appraisal factor: (1) formal written reports can cover complexities which oral reports cannot; and (2) because of the usual short duration of board meetings there is not sufficient time to master the contents of a report made there. Some 70% of the companies surveyed by the NICB had established the practice of sending interim reports to directors to acquaint them with operating and financial details.* In other words, there still are a substantial number whose failure to do so must weigh unfavorably in our appraisals. Remuneration of Directors An important step to be taken to improve the boards of most large companies is to increase the remuneration of board members. This is probably the most underpaid group of individuals in the American business system today, in view of its responsibilities and at least potential services. The average outside director received approximately $850 during 1945, with other directors averaging $625.^ By 1946, according to a study of 184 directors of large companies, about 3 out of 5 were receiving in the aggregate over $1,000 per year an improvement, but still by no means sufficient. The importance of director's functions, together with the desirability of providing incentives for the best men, makes the remuneration problem a vitally important one. From a strictly psychological point of view, the director who is receiving only a nominal fee for attending board meetings may unconsciously devote to the affairs of the company only as much effort and time as the fee seems to warrant. In the case of professional directors, for whom salary is the prime incentive, the importance of compensation is obviously magnified. A development of particular interest is the growing practice of paying salaries to directors. These, depending upon the size and earning capacity of the company, may range from |2,ooo to $15,000 per annum. While a director who is compensated this way could not be expected to devote his full time to the company, neither would he, at the opposite extreme, limit his activities to the board room. He would be available for committee meetings, consultations with officers, plant visits, and reviews of reports.
' Paul W. Dickson, op. cit., p. lo. " Ibid., p. 8.

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Harvard Business Review notice of the company. Such statements, where present, are specific evidence that certain stockholders lack confidence in the board and are of the opinion that it is not functioning properly. The company which is endeavoring to gain the confidence of stockholders in its board of directors presumably deserves a high rating. One of the best ways of establishing |;his confidence is by making information concerning the board of directors available to the stockholders, both present and prospective. One excellent means of making such data available lies in the annual report. Many companies do not publish the principal business affiliations of the outside directors. The mere fact that this information is listed in the proxy statement is not adequate; the proxy statement is frequently not preserved, and it is not distributed to prospective stockholders. Some companies, on the other hand, even publish photographs and brief biographies of all board members. As has been stated, there is a growing school of thought that the company's annual statement should set forth the qualifications of each director and the role he is expected to fill on the directorate. Another phase of the stockholder relationship may be revealed in suits filed against directors by stockholders. Of course, there are many stockholder suitsfiledwhich are of questionable character and motive; but even these must be examined for their import. It has been developed that stockholders can exercise great control over a board of directors, and this control is quite likely to be manifested when the stockholders become dissatisfied. This dissatisfaction may result, for example, in the sale of the company's stocks in such volume as to create a bad market. Securing the Necessary Information. During recent years, the practice has been prevalent among representatives of large institutional investors, corporate directors, and others, of visiting the head offices of large corporations. These visits have been for the purpose of obtaining detailed information regarding the operations of companies visited. Conferring with a number of these representatives leads me to believe that large corporations are usually most cooperative in making available information about their affairs. It is often advisable to interview one or more of the outside directors to obtain facts concern-

In addition, a substantial salary is an incentive for being constantly alert to ideas and plans which might improve company earnings and operations. This sounds, to be sure, like a rather intangible benefit, but it is by such constant awareness of the problems of the company and thinking about their solutions that directors, as well as executives, have brought into focus the ideas which have resulted in tremendous savings and earnings for many corporations. We need not be concerned with the remuneration of inside directors if they are compensated adequately as officers of the company. In their executive capacity they are supposed to devote their full time to the corporation, although officers assuming a directorship of course undertake greater legal responsibility to stockholders and others. Other reasons for deeming increased remunerations desirable include the fact that legal liability may jeopardize the director's personal fortunes. There have been many cases where, even after his death, his estate has been involved in litigation for years. Another reason is the fact that executives are likely to feel greater freedom in using the abilities of directors who receive reasonable compensation. In turn, most directors will not be willing to accept substantial compensation unless they are able to give to the corporation commensurate performance. Obviously, the company which recognizes the importance of all these factors should be rated up. Conclusion Perhaps it can serve as a conclusion to emphasize that in addition to all the specific factors set forth above there is the general criterion of what the stockholders think of the board of directors of their company. A low rating must go to the board which does not enjoy stockholder confidence, because without that confidence the success of the company may be placed in jeopardy. The lack of confidence of stockholders may show itself at the annual meeting when it is apparent that stockholders are making many embarrassing questions concerning the performance of the board without receiving satisfactory answers. The regulations of the SEC grant to stockholders the right to have proposals supported by a 1 oo-word statement included in the proxy

Appraising the Board of Directors

ing the directorates. If the analyst is alert, personable, intelligent, and clearly acting in good faith, he will discover from most directors interviewed considerable information concerning the performance of the boards on which they serve. Of course this method of obtaining facts is not inexpensive. Many analysts cannot afford it. In addition, it is an investigation which will probably have to be repeated periodically, especially after major changes in the personnel of the board have been made or a new chief executive has been appointed. However, as I have suggested earlier, experience points very firmly to the conclusion that the analysis of corporate boards, while but one aspect of a general appraisal, is a fundamental part of an accurate over-all point of view, and as such it is usually worth the expense. T h e following sources for information concerning boards of directors are available: 1. 2. 3. 4. 5. Annual statements Registration statements filed with SEC Listing statements stock exchanges Prospectuses Interviews with, the following: (1) Executives of the company (2) Directors of the company Competitor companies Labor unions Trade associations Other analysts Government officials Bankers Stockholders and stockholder associations 6. Industry studies 7- Articles in newspapers and trade journals Questions at stockholders' meetings (3) (4) (5) (6) (7) (8) (9)

The foregoing list does not include minutes of board meetings because, in most companies, they provide an inadequate picture of board performance. It might also be repeated that evidence of stockholder dissatisfaction is often an important "lead" to internal trouble in the corporation. An unusual volume of stock selling, stockholder suits, proxy fights, and the active opposition of stockholder associations are all tentative indications that something may be wrong in management. Of the eight methods outlined above, the two which in my own experience have proved most useful are (1) interviews and (2) asking questions at stockholders' meetings. It is usually possible, by exploiting these, to round out most of the factors that should enter into an appraisal of the corporation's board of directors.

From: Myles L. Mace, The Board of Directors in Small Corporations In a small corporation the chief operating executive not only must direct the operations of the enterprise but also must perform the many specialized functions pertaining to the business in which he is engaged. He is at one moment the sales manager and at the next the chief of production; at the same time he must be the financial officer, the comptroller, and the advertising manager . . . . The variegated requirement of personal qualifications for small corporation managements emphasizes the complexities, difficulties, and demands of the entrepreneurial job. Few persons are natively endowed with the breadth of management capacities called for. It is important, therefore, that more be known about the ways in which the small business manager can supplement his own abilities with those of others . . . . It would be misleading and erroneous, of course, to conclude that competent boards of directors in small corporations are touchstones of business success. It can be concluded, however, that active and able board members constitute one source of management assistance to small corporation managements and that this source of help can be tapped for advice and counsel on any problem involved in the operations of the business. . . . Boston, Division of Research, Harvard Business School, 1948, pp. 9 and gt.