Before You Split That CEO/Chair…

Often missing from debates on fixing corporate governance is discussion about outcomes: What exactly are companies trying to accomplish by adopting new governance measures? What is the rationale, for example, for separating the roles of board chair and CEO? Advocates for having an independent chair offer an array of arguments. Here’s a sampling: “You have to reduce the power of the CEO, and one of the very few ways to do that is to separate the chairman-of-the-board position from the CEO position,” Harvard Business School professor D. Quinn Mills said in Corporate Board Member magazine (March/April 2003). “Not only will each independent chairman set each board’s agenda…the independent chairman can direct a board’s attention to the matters most in need of critical review and oversight,” SEC chairman William Donaldson stated in a 2004 speech to the Independent Directors Council. “A chairman of a board of directors who simultaneously holds executive functions cannot independently exercise the task of ultimate supervision of the persons entrusted with management,” asserted the Ethos Group in a 2005 proposal to Nestlé shareholders. Acknowledging the presumed benefits of separating the roles, reports sponsored between 1992 and 2004 by national governments, major stock exchanges, or both in at least 16 countries outside of the United States have recommended splitting the functions. Indeed, in the United Kingdom, the value of such an arrangement is an article of faith: Today, 95% of the FTSE 100 companies have an independent chair. But what do we really know about the benefits of separating the roles of chairman and CEO? In a carefully researched article (Yale Journal of Regulation, Summer 2001), Yale Law School professor Roberta Romano summarized studies on the economic impact of splitting the chair and CEO roles in U.S. companies (where combined CEO/chairs are the norm), finding that there is no statistically significant difference, in terms of stock price or accounting income, between companies that split the roles and those that don’t. And Institutional Shareholder Services, which supports shareholder resolutions that separate the roles of chair and CEO in many circumstances, acknowledged in an independent analysis that “attempts to correlate the separation of positions with market performance have been inconclusive.” In the United Kingdom, a study of UK companies in 2005 by Baruch College professor Jay Dahya concluded that “the separation of the combined CEO and [chair] position is not associated with any (statistically or economically significant) improvement in operating or stock price performance relative to benchmark companies.” A study of the results of separating the chair and CEO roles in Swiss companies by professors Markus M. Schmid and Heinz Zimmermann from the University of Basel reached similar conclusions: “We find no evidence of a systematic and significant difference in valuation between firms with combined and firms with separated functions.” Though there is no systematic economic advantage in splitting the CEO and chair positions, the arrangement may still sometimes make sense. For example, if a company promotes its domestic chief operations officer to CEO, it may be useful to have a separate chair who has broad global experience. And a firm that is subject to heavy regulatory scrutiny may find it fruitful to have a chair concentrating on government relations while the CEO focuses on running the business. One alternative to having an independent chair is to appoint a lead director who can serve many of an independent chair’s functions. In 2004, 84% of S&P 500 companies had such a post on their boards. In companies with combined CEO/chairs, lead directors can help set agendas to add or modify items that are critical to shareholder interests. Lead directors can also help companies comply with a new NYSE listing requirement that obliges independent directors to meet regularly in executive session, without the CEO or other managers. Therefore, companies considering separating the chair and CEO positions should be clear at the outset about what they hope to accomplish. The empirical evidence shows that the split does not generally enhance shareholder value, so make sure that the division is supported by the specific circumstances facing your company. Finally, if you do separate these roles, don’t install your former CEO as a permanent board chairman. Studies of companies in the United States and abroad show that this arrangement decreases shareholder value.

Before You Split That CEO/Chair…

Summary.

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