William W. George was the CEO of Medtronic, a Minneapolis-based medical technology company, from 1991 to 2001. He was the chairman of the Medtronic board from 1996 to May of this year. He has served on the boards of nine for-profit and two dozen nonprofit organizations. Following are edited excerpts of his recent conversation with HBR’s Gardiner Morse about the failure of corporate governance and the solutions he has put to the test. Enron. Kmart. Global Crossing. What’s gone wrong with corporate governance? Governance starts—and ends—with the board of directors. The board’s overarching responsibility is to preserve and build the enterprise. But instead of fulfilling that responsibility, many boards fall prey to thinking that their role is to maximize short-term shareholder value. In doing so, they may put the whole enterprise at risk, sometimes without even knowing it. Rather than focusing on short-term stock price, boards should be asking questions like, “Are we being true to our mission and our values? Are we building shareholder value for the long term? How are we sustaining our growth? What risks are we taking to get there?” Other boards are just complacent. They fail to challenge management about how earnings are generated, what the risks might be, whether investments are sound, or if the accounting numbers accurately reflect results. Or they’re ignorant about these things. When the company collapses, it’s no excuse for a board member to say, “I didn’t know what was going on.” Some boards don’t have the will—or the courage—to challenge a powerful CEO who is reporting good numbers. They let him run roughshod over them, which is what apparently happened at Enron. Too many CEOs use their boards as a rubber stamp and actively discourage input or challenges from their independent directors. I’ve seen CEOs orchestrate a show for the board in which they present such detailed strategies, investments, or acquisitions that there is no time left to discuss or question the risks. These CEOs are just seeking rapid approval, and that’s a big mistake. I’m not blaming strong-willed CEOs for trying to assert as much power as they can; we need them in this time of global turmoil and corporate survival of the fittest. But the best CEOs also respect the need for a strong board and the importance of following sound principles of corporate governance. That’s how their companies achieve success. Numerous ideas are being proposed for new laws to control board governance. But new regulations won’t solve the governance problems we’re seeing today. Those problems can only be solved if independent directors step up to their legal and fiduciary responsibilities by reasserting the proper balance of power between boards and management. Directors who aren’t prepared to do this should resign. Otherwise, we’ll be stuck with outsiders trying to control board conduct through legal actions. How do boards restore the balance between themselves and management? Fixing the imbalance starts with a written set of principles that clearly defines the board’s responsibilities and establishes a crisp line between the board’s job and management’s. This is especially important when the board chair and the CEO are the same person. Well-run boards rely on these principles to carry them through rough times, such as difficult CEO successions and earnings downturns. The first step is to establish a corporate governance committee to draft the governance principles. This committee must be composed entirely of independent directors. If the CEO is also chair of the board, then the independent directors themselves should elect the chair of the governance committee, making him or her the lead director. The principles should spell out job descriptions and responsibilities for the board chair (or lead director), the CEO, and each of the board committees. And the principles should codify a formal review process for the CEO, the board itself, and each of the board members. The governance committee should meet regularly in executive session—without the CEO present—to assess the CEO’s performance, to propose new candidates for election to the board, and to evaluate the performance of each director being proposed for reelection. At Medtronic, I had a written review of my performance as CEO every year. One of the items we covered was board relationships, and we would talk about the balance between the board and management, with a healthy give-and-take. Isn’t it hard for the board to evaluate itself? A self-evaluation of the board as a whole is straightforward, and many boards do it. At Medtronic, we use standard forms so that each member can comment in writing on the board’s overall performance. What’s not so easy is the evaluation of individual board members. For the Medtronic board, the chair of corporate governance appoints a nominating subcommittee to review the performance of each board member coming up for reelection by the shareholders. If there are performance problems, the governance chair speaks directly to the board member in question about the issues. There have been times when directors were not asked to stand for reelection. At Medtronic, how did you ensure that the board didn’t become just a rubber stamp? We assembled board members who had a broad range of experience, expertise, and opinions, and we worked hard to make sure this expertise was fully tapped. We sought out people with an independent spirit and a willingness to stand up against management—and their colleagues—if they disagreed with the company’s direction. As CEO, I used this diverse group as a sounding board to explore new strategic directions, new business ventures, possible acquisitions, and sticky legal issues. Many times the board saved me from bad decisions or encouraged me to take significant strategic risks. To ensure that the views of the independent directors were fully heard, we held two executive sessions at every board meeting—one session with the CEO present and one without. These sessions were explicitly designed to open up discussions, invite an exchange of opinions, and get issues on the table. Sessions without the CEO—an idea that I know scares some chief executives—allow candid dialogue that wouldn’t happen with management present, like sensitive conversations about CEO succession. CEOs who are uncomfortable about having the board meet without them should consider whether they’d rather have board members convening for a late-night rump session. The open exchange we had in these executive sessions strengthened board chemistry, which is very important, and it assured that every voice was heard. To make sure there was plenty of time for in-depth discussions of strategic issues, we held an annual, three-day, off-site board meeting that encouraged this open style of discussion. Good governance requires a balance of power between the board and the CEO, and a healthy tension between them. That requires trust, the free flow of ideas, and a board that is comfortable challenging management. Maybe it’s unfair to play Monday-morning quarterback, but it’s hard to imagine that the failures at Enron, Swissair, Kmart, and other companies would have happened if they’d had robust governance systems in place.
