Directors Are Emboldened To Probe Deals Earlier

As the Enron Corp. scandal reverberates through Corporate America, scores of companies, including many acquirers, are grappling with the issue of “tainted directors.” A tainted director is one whose performance as a board member at one company could create concern about his or her ability to oversee company operations elsewhere. If someone from the Enron board sits on your board, do you reappoint him without hesitation? Different Enron directors have met differing fates as a result of their association with the failed energy giant. Qualcomm Inc. allowed Enron board member Frank Savage to begin a new term despite objections from some shareholders. At Motorola Corp., former Enron director Ronnie C. Chan decided not to seek re-election as calls mounted to keep him off the ballot. Motorola said the decision was Chan’s, although it was announced a day after the AFL-CIO publicly urged the company to exclude him. Meanwhile, Robert Jaedicke, former head of the Enron audit committee, stepped down from his board position at California Water Service Co. “This is the beginning of a huge change. Who else is there to make sure that the numbers reflect what’s going on?” notes Nell Minnow, editor at The Corporate Library, a corporate governance watchdog organization. “If board members don’t exercise appropriate oversight at one company, why should shareholders trust them elsewhere?” Another expert in corporate governance, Pat McGurn, vice president at Institutional Shareholder Services (ISS), says that that while there is no personal liability for directors when companies crash and burn, they should be able to demonstrate some basic standard of care. He adds that the strategy of opposing director reelections based on their performance at other companies has been a tactic used by labor unions in their corporate campaigns. “We haven’t seen too many other uses of this technique, but it is likely to increase,” he says. Partially in response to the tainted director issue, ISS is developing a ranking system for evaluating public company directors. “The idea is to force companies to have to live with their governance rating just like they have to live with their debt and equity ratings,” McGurn remarks. For dealmakers, the issue is broader than looking to make sure that boards you are working with don’t have any overlap with companies where board oversight is being questioned. “The Enron situation will empower directors to ask more questions, including questions about potential acquisitions,” says Beth Young, a corporate governance consultant at the AFL-CIO. She points to the Hewlett-Packard Co./Compaq Computer Corp. deal as an example of a rare development – board members taking opposing sides on a merger – that may become more common as directors question potential deals with more gusto. Young says that she expects to see greater numbers of directors using more critical judgments and asking harder questions. With the ruins of Enron on everyone’s mind, she notes, it will be easier to convince companies that they have more to gain by letting directors play a more activist role. “I think it’s going to be easier for directors to raise questions about transactions before they are done than it would have been prior to Enron.” she adds. Young says that most of the responsibility for increased scrutiny will fall on the shoulders of companies’ independent or outside directors. “People expect board members who are company employees to stick to the company line.”