Financial Executive Insights

Tipping Point for Combined Chairman and CEO?

Shelly K. Schwartz | Special to

The combined role of chairman and chief executive officer, a corporate governance structure favored by many Fortune 500 firms, may soon go the way of the pension plan.

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Indeed, the financial crisis of 2008, which left many of Wall Street's biggest institutions in the trash heap of history, has prompted a growing contingent of shareholder activists, regulators and financial services firms to demand greater accountability of leadership at publicly held companies.

And many, including the Chairmen's Forum, a group of 50 corporate leaders, investors and governance experts, have set their sights on companies that designate a single person board chair and CEO.

The group, whose members include Harry Pearce, non-executive chairman of Nortel Networks and former American Express head Harvey Golub, was convened by the Millstein Center for Corporate Governance and Performance at the Yale School of Management.

It is calling on public companies in the U.S. and Canada to separate the roles of chairman and CEO, and hire an independent chairman to help restore the power balance in boardrooms.

Financial services firm Spinnaker Trust in Portland, Maine, is also leading the charge for change. The firm unsuccessfully filed a proposal last year on behalf of shareholders to separate the CEO and chairman role at oil giant ExxonMobil .

"Shareholders have the right to the best possible representation on the board, and we believe it should be balanced and independent," said Spinnaker Trust senior investment adviser John Higgins, noting the company will likely file the same proposal at next year's annual shareholder meeting. "If the CEO is also setting the agenda for the board, there is an inherent conflict because the board is supposed to supervise the CEO."

The percentage of U.S. firms that split the CEO and chairman position is rapidly growing, but lags behind Europe, where such division is widely considered best practice.

Some 43 percent of S&P 500 companies in 2012 separate the job of chairman and CEO, up from 25 percent in 2002, according to executive search firm Spencer Stuart.

By comparison, 79 percent of the largest British businesses name an outside chairman on their annual reports, according to the Millstein Center.

Publicly held corporations in the U.S. are required to have a board of directors to oversee top management and ensure the mandate from the corner office reflects shareholder interest.

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When the board chair and the CEO are one and the same, the CEO is effectively overseeing him or herself — a potential conflict of interest, said Stephen Davis, senior fellow at Harvard Law School's Program on Corporate Governance.

"If you have a combined chair and CEO, there's an argument that the CEO has no boss, and shareholders are more inclined now than ever before to want accountability from top executives," he said. "It's hard to have a fully independent board that is able to hire and fire the CEO when the CEO is also the chair. Not impossible, just hard."

The same concern exists with respect to executive pay, since the board of directors must vote to approve an increase in executive compensation. If the chairman is also the CEO, that person is voting on his or her own raise.

Shareholder activists also note that it costs more to combine the roles, a premise supported by a 2012 report by research management firm GMIRatings.

The study, which focused on 180 North American firms with market capitalization of $20 billion or more, found the cost of employing a combined CEO and chair is 50 percent higher than the cost of employing a separate CEO and chairman.

Executives with a combined CEO and chair position earn a median total compensation of just over $16 million, while a separate CEO and chairman earn a combined $11 million.

The study also found that five-year shareholder returns are nearly 28 percent higher at companies with a separate CEO and chair.

In efforts to improve transparency, the Securities and Exchange Commission in 2010 issued rules that require companies to disclose details about their leadership structure, including whether it combines or separates the chairman and CEO position, and its reason for doing so.

The Dodd-Frank Act, enacted to protect consumers in the wake of the Great Recession in 2008, includes a similar provision.

Activists who champion checks and balances in the boardroom have had some success.

Most recently, Blackberry maker Research in Motion buckled to pressure by shareholders including Canadian-based mutual fund company Northwest & Ethical Investments to separate the roles of co-chairman and co-CEO — which were shared by two men for more than 20 years.

The company, which separated the positions and retained an independent chairman in January, lost significant market share and suffered a stock price slide under the old regime.

Depending on the industry, however, a valid case can also be made for keeping the positions combined, said Don Keller of PricewaterhouseCoopers Center for Corporate Governance. Keller said individual companies are best positioned to determine the leadership structure that serves their business and shareholders best.

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"We acknowledge both arguments and believe that every situation probably warrants its own consideration," said Keller, adding a separation of chairman and CEO roles may not be practical or prudent for some firms. "You have to look at the circumstances."

Many mega-cap firms, for example, maintain that the dual role results in more effective communication between management and the board of directors, largely because the CEO has in-depth knowledge of the company's daily operations and is thus best suited to set the boardroom agenda.

In a 2012 proxy statement ahead of its annual shareholder meeting, for example, ExxonMobil noted the unique challenges and opportunities in the energy industry make it critical that the company retain decision-making authority over how best to organize the capabilities of the directors and senior managers to meet those needs.

Its shareholders agreed.

In May, they rejected the proposal by Spinnaker Trust (then called Ram Trust) for the 11th consecutive year to split the chairman and chief executive officer role held currently by Rex Tillerson.

Proponents of the dual role also argue that it fosters more cohesive leadership. And they suggest the balance of power shareholders seek can still be achieved by designating an independent lead director of the board.

Lead directors typically lead the CEO evaluation process and executive sessions, help set the agenda, review materials sent to the board by management, and act as a liaison between non-executive directors and the chairman.

"We believe this is best left for each board to determine based on the companies' circumstance," said Peter Gleason, managing director of the National Association of Corporate Directors. "However, we believe the key is that each board has an independent leader to lead the work of the board."

That leader can be a separate chair, he notes, or, if the board determines that a combined chair and CEO is best, the independent leader position can be accomplished through the appointment of a lead director.

Jeffrey Sonnenfeld, senior associate dean and head of the Yale School of Management's Chief Executive Leadership Institute, adds there is "zero research" that suggests public companies that separate the chairman and CEO are better run — or less risky to shareholders.

"Lawyers, investors, economists and pundits love to fall into this debate because it's easy to measure but it's misleading," he said. "Every disaster involving a public company, including Enron and Worldcom, had separate chairmen and CEOs. It's a canard. What really matters is the character of who's there. If they're asleep at the switch, it doesn't matter what titles you put together."

That said, many corporations are re-evaluating their leadership structure in response to shareholder activism. That trend is likely to continue, said Davis.

A study of 860 public company directors earlier this year by PriceWaterhouseCooper's Center for Corporate Governance found that among the companies that still have a combined chairman and CEO, nearly half of their boards are discussing splitting the role at their next CEO succession.

"The old assumption that the combined chair and CEO model is universal best practice in the U.S. is dead," said Davis. "We're getting close to the tipping point where almost half of American corporations have a separate chair and that's a fundamental shift. My guess is that this is the beginning."

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