Leading off the second day of the annual Stanford Directors’ College at Stanford Law School in Palo Alto, California was a keynote address from Delaware Chancellor Leo Strine. Strine is surprisingly outspoken and his presentation was lively and interesting.
The centerpiece of his presentation was a discussion of the lessons for directors based on the cases he has seen over the years. As a preliminary matter, and actually throughout his discussion of these issues, he emphasized that it is very rare that outside directors are actually held individually liable. He pointed out that, for example, cops, teachers and doctors are held liable much more frequently. But even if an outside director’s chance of being held liable is low, the chance of “looking like a chump” or that you have “failed your mission” is very high if you don’t watch out for certain things.
First, from the outset, the director should understand his or her role. In particular, if the director is unable or unwilling to make a decision adverse to management, they should not be in the position. The director also needs to understand the business, how it makes money and its principal risks. The director can’t be voting on things he or she does not understand. Where people tend to get in the most trouble is when they fail to do the work to understand the company and the specifics of the issues on which they are voting.
Second, conflicts of interest cause most of the worst trouble. Making sure that there aren’t interested parties involved in the object of board attention is critical. Along those lines it is vital that the board members remain independent, which can be compromised over time if a director’s relationship with the manager. The director needs to be sure that they he or she is still able to be adverse to management when that is what the situation requires.
Third, a very specific danger arises when directors are insufficiently skeptical of M&A activity originating within the company itself, particularly through a management buyout brought up when the company is otherwise not for sale or in play. Strine said that this is not the way a company should operate. If a CEO thinks there is a strategic move the company ought to be making, then the directors should be advised and guide the process. The CEO should not be taking advantage of inside information and tampering with employees and enlisting the company’s outside advisors in the interest of a management initiated buyout. (Stine was quite emphatic when he described the problem with this type of situation.)
Fourth, one the CEO’s key roles is preparing for management succession. Strine said that if the CEO has been in office three years and there is not a designated successor, the CEO has failed in one of his or her key roles. One of the most important jobs for the CEO is the “build the bench.” Strine cited the example of Johnson & Johnson, which has been a very successful company for decades with a succession of CEOs (all of whom who have been very low profile) that have continued to move the company forward.
In response to a question, Strine discussed the massive fee award he granted to the plaintiffs’ attorneys’ in the Southern Peru case. As discussed here, that case had resulted in an award of $1.263 billion, which with interest, approach nearly $2 billion. Strine awarded fees of $285 million, which he defended saying, the only reason the plaintiffs received the massive judgment in the case was the efforts of the plaintiffs’ lawyers. He said that he has much more trouble with cases like the disclosure-only merger objection suit settlement, where the plaintiffs’ lawyers wind up walking away with a $400,000 fee award.
The real problem is not a case where plaintiffs’ attorneys produce real value. If the plaintiffs has “delivered something really beneficial, they should be rewarded accordingly.” Rather, the problem is that there are too many incentives for plaintiffs’ attorneys to bring suits where the only beneficiaries are the attorneys. We have, Strine said, an “excess of litigation” that “has no meaningful societal benefit.” Strine commented that the extra costs associated with this litigation have caused the cost of capital for American companies to rise.
Strine rejected the suggestion that the Delaware courts might be managing fee awards because of a competition from other states’ courts. Strine stressed that Delaware’s courts are not “trying to attract litigation.” Just the same, he took care to question the effort of other states to try to develop specialized business courts. You can, he said, file suits in “goofy place” and what you will wind up with is corporate law that is “junk.” The movement to form specialized business courts has been “problematic” because all too often those courts have “become places where you can forum shop.” His view is that all courts, by their own account are “overburdened.” That being the case, Strine contends, the each court should “stay in its own lane.” When something is appropriately “in someone else’s lane, then let them do it.”
On Monday evening, the keynote speaker at dinner was the CEO of Netflix, Reed Hastings. Hastings also serves on the boards of Microsoft and Facebook. Hastings focused his discussion on the role of the board at very large publicly traded companies, taking pains to emphasize that he was not discussing the boards’ roles at smaller public companies, private companies or at non-profits.
Hastings said several times that for the board of a large publicly traded company “the fundamental job is to replace and compensate the CEO.” Where the company has the resources to hire outside consultants as needed, it is not the board’s role to offer counsel or advice. He was dismissive of new directors who come in and try to “add value” by offering advice. He contends that board members offering advice creates a conflict of interest, because management might feel obliged to follow the advice even if it is poor and if the advice turns out to be mistaken, there is no accountability for the board member.
It is fair to say that Hastings remarks drew a very lively response from the audience. He emphasized in responses to questions from the audience that he was only talking the largest public companies, not other types of companies that might need the board’s involvement and guidance. He also said that he was not talking about companies in special circumstances where the situation might require the board to become much more involved. The interaction between Hastings and the audience might have been one of the high points of the conference for me. The audience was engaged in the discussion and Hastings was animated and articulate in discussing his position.
Hastings did tell one story from earlier in his career that is worth repeating here. He told the story to emphasize that a CEO must have both leadership qualities and a strategic vision. He said that when he first started working as a young software designer, he kept unusual hours and often had used coffee mugs strewn around his cubicle. He noticed that every few days the coffee mugs would appear on his desk, cleaned. He assumed the janitorial staff was cleaning the mugs. But one morning he arrived at the office at 4 am, and found the company’s CEO in the kitchen, cleaning Hastings’ coffee mugs. The CEO explained that he felt that Hastings did such great work, it was the least the CEO could do for him. Hasting said that this incident made him feel such deep personal loyalty to the CEO that Hastings would have “followed him to the ends of the earth” – which, Hastings said, is where the CEO led the company. It isn’t enough, Hastings said to be able to create a loyal work force, you also have to have a strategic vision.
For the record, Hastings did acknowledge that the whole Netflix pricing change was a mistake for which he took responsibility.