Naz News, Gappers and FLE's

[sludgehound]

The C.E.O. Is My Friend. So Back Off.
Tough to find/follow the last paragraph advice from study.

Fair Game
By GRETCHEN MORGENSON NY Times JUNE 28, 2014

It was probably a coincidence, but then again maybe not.

Just days earlier, the board of American Apparel finally ousted Dov Charney, the company’s flamboyant founder and controversy magnet. And there was Mary Jo White, the chairwoman of the Securities and Exchange Commission, standing in front of an audience that included a fair number of corporate directors, urging them to be more accountable.

In the speech, at the Rock Center for Corporate Governance at Stanford University, Ms. White emphasized their crucial duty to protect shareholders from abusive practices at companies they oversee.

“Setting the standard in the boardroom that good corporate governance and rigorous compliance are essential goes a long way in engendering a strong corporate culture throughout an organization,” Ms. White said, later adding that “ethics and honesty can become core corporate values when directors and senior executives embrace them.”

Why wouldn’t board members embrace these values? Cozy board ties with the chief executive might be one reason. A recent academic study, to be published in the July-August issue of The Accounting Review, suggests that lax oversight can result when a director of a company is friendly with the chief executive overseeing it.

But the research makes a counterintuitive finding as well. The conventional wisdom holds that when you disclose personal ties, you create transparency and better governance. The experiment found that when social relationships were disclosed as part of director-independence regulations, board members didn’t toughen their oversight of their chief-executive pals. Rather, the directors went easier on the C.E.O., perhaps believing that they had done their duty by disclosing the relationship.

The study, “Will Disclosure of Friendship Ties between Directors and C.E.O.s Yield Perverse Effects?,” was conducted by four academics: Jacob M. Rose and Anna M. Rose of Bentley University, Carolyn Strand Norman of Virginia Commonwealth University and Cheri R. Mazza of Sacred Heart University.

Back in 2013, the researchers set out to conduct a thought experiment with a group of directors on the topic of board relationships. The academics secured the participation of 56 current directors at companies of all sizes. The participants had 30 years of business experience, on average, and generally served on multiple boards — 2.64 was the mean. About one-quarter of the directors served on an audit committee.

In the experiment, the directors were asked to role-play as board members of a hypothetical biotech company that was about to report earnings for the year. The company had been expected to earn $805 million, the directors were told, but its actual profits were going to be just $800 million. That shortfall would have an impact on the compensation of the chief executive, who would receive a bonus only if the company earned at least $810 million.

The directors participating in the experiment were divided into two groups. Two-thirds were told to assume that they had a personal or social relationship with the C.E.O. of the biotech company. The remaining third were told they had no such tie.

Of those who were friendly with the executive, half were told that they had disclosed their relationship to the board, to company management and to shareholders. The other half were told to assume that they hadn’t made the disclosure.

The only option given to the directors to make up the shortfall — and thus help the C.E.O. get a bonus — was to cut the company’s $40 million budget for research and development. As they weighed this possibility, they were told that for every $1 million cut in that budget, there would be a 1 percent increase in the chance that the company would lose ground to its competitors.

Now for the results: Among the directors who counted the C.E.O. as a friend, 46 percent said they would cut research and development by one-quarter or more to ensure a bonus payout to their pal. By contrast, only 6 percent of directors with no personal ties to the chief executive agreed to reduce research and development to generate a bonus.

That’s to be expected.

The results get more interesting when disclosure is added to the mix. Of the directors who said they would cut $10 million or more from the budget — the amount necessary to generate a bonus to the chief executive — an astonishing 62 percent had disclosed a friendship with the C.E.O. Only 28 percent of the directors who had not disclosed their relationship with the executive agreed to make the cuts necessary to generate a bonus.

Only one director with no ties to the executive agreed to cut the budget by $10 million or more.

Mr. Rose, an author of the paper, said he and his colleagues were surprised that so many directors said they’d be willing to put the company at risk to ensure a bonus for their pal, the C.E.O. “If just by mentioning that you’re friends with the C.E.O. it affects their decision-making, we think the effects going on in the real world are much, much larger than what we picked up in the lab,” Mr. Rose said in an interview last week.

Even more disturbing, he said, was that so many directors seemed to think that disclosing their friendships with the C.E.O. gave them license to put the executive’s interests ahead of the company’s.

“When you disclose things, it may make you feel you’ve met your obligations,” Mr. Rose said. “They’re not all that worried about doing something to help out the C.E.O. because everyone has had a fair warning.”

There are two messages in this study. One is for regulators: Simply disclosing a conflict or friendship does not eliminate its potential to create problems.

The other is for investors.

“Shareholders should take a more active role in finding out what kinds of relationships their boards and C.E.O.s have,” Mr. Rose said, “and recognize the potential traps created by them.”