Should the chair and CEO roles be split?

Board independence has been a hot topic in governance circles for some time, especially independence of the board’s lead role: the chair. The position sets the agenda, establishes the tone at the top and is the main source of effective oversight of management. As debates continue over the future of Wall Street and the best methods to prevent situations like the financial crisis from recurring, many are starting to recognize what we have reported for years at GMI Ratings: it is the people involved that matter most. Characteristics such as experience, gender and independence all play a role – and it is the last of these that will be explored here, with the focus being on the independence of the chairman’s role specifically.

The board of directors’ purpose is to represent owners’ interests and provide independent oversight of a corporation’s management, but the combined CEO/chair model – where one individual assumes both roles – seems to undermine that intended power structure. Consequently there has been an effort over the years to address this situation; the percentage of S&P 500 companies with a combined CEO/chair has declined slowly from 73.4 percent of the index (367 companies) in 2004 to 57.2 percent (or 283 companies) in May 2012. (The number of S&P 500 companies in the 2012 sample is 495.) Yet even if a board separates these roles, the independence of the individual elected as chair is not guaranteed.

As of early June 2012, we have seen 37 shareholder proposals filed at S&P 500 companies calling for separation of the CEO and chair roles and often specifically calling for the chair to be an independent director. So far, two of the 35 such proposals with voting results available have garnered over 50 percent support from shareholders (those at KeyCorp and Sempra Energy).

Independence on the rise

One of the two alternative board leadership structures that are on the rise in the S&P 500 is selecting a truly ‘independent’ director, meaning someone who is not an employee of the company or otherwise involved in related party transactions, and has not held any former executive positions or the like.

Back in 2004, a mere 6.4 percent of S&P 500 companies had independent chairs, and now we are seeing 20 percent – one fifth – of the largest companies filling the chairman role with an impartial individual. One example of this is Reynolds American, where CEO/chair Susan Ivey resigned from both roles and the board elected independent director Thomas C. Wajnert to replace her as ‘non-executive chairman’; Daniel Delen assumed the CEO title. Reynolds American explained that its election of an independent chair was due to the CEO’s ‘relative newness’ and the desire to allow him ‘to focus on the day-to-day operation of the business’.

The company also added that it reserves the right to recombine the roles in the future if the board ‘determines that returning to such a leadership structure would be appropriate’. Other companies that recently adopted an independent chair are CVS Caremark, JCPenney and SanDisk. Although many companies explain their board leadership structure decisions along with a caveat that they may change arrangements in the future and reserve that flexibility to do so, JCPenney did not include such language in its 2012 proxy disclosure, simply stating: ‘The board of directors, as part of its continuing review of corporate governance matters, decided to separate the chairman and CEO roles and elect a non-executive chairman of the board after careful consideration and upon recommendation by the Corporate Governance Committee.

The board believes that JCPenney’s current leadership structure enhances the board’s ability to ensure that the appropriate level of independent oversight is applied to all management decisions.’

Another alternative that appears to be on the rise this year is electing the former CEO as chair. Historically the percentage of S&P 500 companies whose former CEOs have led the board has fallen – from 14.2 percent in 2004 to 11.4 percent in 2010 – but for the first time this year we have seen an increase to 13.9 percent of the S&P 500. One company that changed from having a combined CEO/chair to a former-CEO chair within the past couple of years is IBM, where CEO Sam Palmisano was succeeded by Virginia Rometty as CEO yet held on to his chair position. Rometty and Palmisano serve together on the executive committee. Interestingly, IBM provided some counterbalance to this former-CEO chair appointment with ‘three independent presiding directors’ (chairs of committees) who oversee certain executive sessions. Some other companies that have former CEOs serving as chairs are Avon, Amgen, Google, Marriott and Occidental Petroleum.

Sticking to their guns

Other options for the chair role include electing related directors or other executives or past executives, but such situations are in the extreme minority in the S&P 500. The majority of companies in the index (57.2 percent) still insist that a combined CEO/chair is the optimal structure, including household names from a variety of industries such as Goldman Sachs, Amazon, FedEx and Coca-Cola. These companies have disclosed various rationales for this position in their proxy statements filed with the SEC.

Goldman Sachs defends its much-protested combined CEO/chair structure (which it claims to ‘annually assess’) by saying that it ‘demonstrates clearer accountability to our shareholders’ and ‘enhances transparency between management and our board’. The disclosure also praises Lloyd Blankfein’s contributions to the company, including his being ‘a knowledgeable resource for our independent directors’.

Of course, relinquishing the chairmanship would not preclude the CEO from being a resource for directors.

At Amazon, the combined CEO/chair structure is defended on the basis of ‘[chairman and CEO Jeff] Bezos’ role in founding Amazon.com and his significant ownership stake. The board believes that this leadership structure improves the board’s ability to focus on key policy and operational issues.’

FedEx goes into detail about its belief that the combined CEO/chair and lead independent director structure it has adopted ‘strikes an appropriate balance between consistent leadership and independent oversight of FedEx’s business and affairs’. The company also states that it relies on its governance guidelines to ‘help ensure that strong and independent directors will continue to play the central oversight role necessary to maintain FedEx’s commitment to the highest quality corporate governance’.

Coca-Cola similarly asserts that its combined chair and CEO role, together with a presiding director, ‘provides a very well-functioning and effective balance between strong company leadership and appropriate safeguards and oversight by independent directors’.

Indeed, many companies with non-independent chairs go to some length to explain the reasons why they believe their boards nevertheless act as a counterbalance to management. They often cite features of the board that they believe will ‘ensure oversight’, such as a lead or presiding director, strong governance policies or excellent independent directors. Investors may wonder, however, if it might be simpler just to establish an independent chair, making such workarounds unnecessary. Indeed, many companies have adopted this practice, and their numbers are on the rise.