The CEO's Boss: Tough Love in the Boardroom 9780231547307

Table of contents :
Contents
Acknowledgments
Preface
1. The Social Contract
2. Tough Love in the Boardroom
3. Why the Right Partnership Matters
4. Leadership Metrics
5. How the Partnership Can Go Wrong: Take-Two Interactive
6. What Directors Need to Know Before Committing to a CEO
7. The Board’s Commitment to the CEO
8. Effective Board Dynamics: How Directors Interact as a Team
Epilogue Is Prologue
Appendix A: Outstanding Directors
Appendix B: Interview with Glenn Hubbard
Notes
Index

Citation preview

THE CEO’S BOSS

Columbia University Press Publishers Since 1893 New York Chichester, West Sussex cup.columbia.edu Copyright © 2019, 2010 Columbia University Press All rights reserved Library of Congress Cataloging-in-Publication Data Names: Klepper, William M., author. Title: The CEO's boss : tough love in the boardroom / William M. Klepper. Description: 2nd edition. | New York : Columbia University Press, [2019] | Includes bibliographical references and index. Identifiers: LCCN 2018029223 (print) | LCCN 2018031446 (e-book) | ISBN 9780231547307 (e-book) | ISBN 9780231187503 (cloth: alk. paper) Subjects: LCSH: Chief executive officers. | Corporate governance. | Decision making. | Leadership. Classification: LCC HD38.2 (e-book) | LCC HD38.2 .K58 2019 (print) | DDC 658.4/22—dc23 LC record available at https://lccn.loc.gov/2018029223

Columbia University Press books are printed on permanent and durable acid-free paper. Printed in the United States of America Cover image: © George Doyle/Stockbyte/Getty Images

contents

1

Acknowledgments

ix

Preface

xi

The Social Contract

1

A Productive Partnership: Tyco

1

Tyco Vision and Values Prescription: The Social Contract

2

3 5

Commitment to Values Commitment to the Stakeholders Commitment to Risk Assessment Commitment to Transparency Commitment to Coaching

6 9 10 10 11

The Social Contracting Process Case Study: BP: A Company in Peril?

12 14

Tough Love in the Boardroom

25

Practicing Tough Love

27

The CEO’s Behavioral Style and Leadership Practices The Organization’s Needs Matching Needs with Leadership

27 29 30

vi

CONTENTS

Finding the Correct Match Internally Finding the Correct Match Outside the Company

3

CEO Tenure and Company Performance Uncertainties of Business Cycles: JetBlue Case Study: Procter & Gamble in 2013: A Board Adrift?

32 35 39

Why the Right Partnership Matters

53

Leadership Style

53

Driver Leadership Expressive Leadership Amiable Leadership Analytical Leadership

4

5

30 32

57 58 59 61

The Right Alignment, the Right Partnership Case Study: The Wounded Warrior Project in 2016

63 66

Leadership Metrics

96

Measuring Leadership Practices Applying the Integrated Leadership Model Diagnostics: The Use of Soft Metrics Case Study: Demoulas Market Basket: A Governance Challenge

97 99 104

How the Partnership Can Go Wrong: Take-Two Interactive

The Gamer Generation Leadership in the Beginning and Early Stages Changes in 1998 and 1999 The First Signs of Trouble New York Times Exposé, May 12, 2003 Shareholder Activism Hindsight: How the ILM Could Have Helped Case Study: Wells Fargo and Company: Corporate Governance Crisis

108

126

126 127 129 130 132 133 134 136

C O N T E N T S  vii

6

What Directors Need to Know Before Committing to a CEO

159

CEO Alignment

160

Step 1: Strategic Context and Intent Step 2: CEO’s Agenda, Practices, and Style Step 3: The Alignment of the Business System Step 4: The Congruence Among Strategy, CEO, and Business System Hindsight: The Ewing Township Board of Education The Dangers of Bias and the Power of Persuasion Case Study: Update of CaseWorks: Corporate Governance at Hewlett-Packard 1995–2005

7

The Board’s Commitment to the CEO

168 169 173 176 180

Putting Tough Love to Work

180

Agreeing on Metrics CEO Feedback Identifying the Gaps Solutions and Action Plans

181 182 186 188

Case Study in Progress: Workforce Partners

8

161 164 166

Effective Board Dynamics: How Directors Interact as a Team

Team Stages and Team Roles Failure of Tough Love: The Learning Studio Formula for Success Know Yourself Control Yourself Know Others Do Something for Others

193

203

203 205 207 207 208 211 211

viii

CONTENTS

Requirements for Teamwork The Lead Independent Director The Chief Process Leader Case Study in Progress: Small Cap Industrial Company

212 215 217 217

Epilogue Is Prologue

227

Appendix A: Outstanding Directors

235

Appendix B: Interview with Glenn Hubbard

247

Notes Index

255 273

acknowled gments

I could not have written the first edition of The CEO’s Boss: Tough Love in the Boardroom without the encouragement and support of a number of Columbia Business School colleagues. Rita McGrath, the most prolific writer among our executive education faculty team (her latest offering being The End of Competitive Advantage: How to Keep Your Strategy Moving as Fast as Your Business, 2013), was my central catalyst. We were delayed by weather on one of our return flights from Buffalo, New York, after working with M&T Bank. During that three-hour layover at the airport we wrote the initial outline for the book. David Beim, whose case study of Take Two Interactive is the cornerstone of chapter 5, was my entrée into working with the Outstanding Directors Exchange (ODX). After a twentyfive-year career in investment banking, David is now a retired professor of professional practice at Columbia Business School. His recent writing on the root cause of our financial crisis is indicative of his insight, such as his March 2009 article in Forbes, “It’s All About Debt: Who Caused the Global Economic Collapse? We All Did.” Bill Duggan, the author of four recent books on strategic intuition as the key to innovation—Napoleon’s Glance: The Secret of Strategy (2002); The Art of What Works: How Success Really Happens (2003); Strategic Intuition: The Creative Spark in Human Achievement (2007); and The Seventh Sense: How Flashes of Insight Change Your

x

ACKNOWLEDGMENTS

Life (2015)—was my mentor in my work with Columbia Business School Publishing (CBSP). He encouraged me in my journey and alerted me to the talents of Myles Thompson, publisher, and Brian Smith, editorial assistant. In addition, I want to give a special thanks to Bridget Flannery-McCoy, the editorial assistant who was assigned to do the final developmental and fine editing of the first edition—she understood “tough love” and how it could make this author’s writing even better. Finally, Troy Eggers, associate dean of executive education, who brokered my first edition work to CBSP and told them of the executive education faculty’s proven record of translating the school’s thought leadership into practice—as are the works of Eric Abrahamsen, David Beim, Joel Brockner, Noel Capon, Mike Fenlon, Don Hambrick, Rita McGrath, Willie Pietersen, and Mike Tushman, who are referenced in the book. I have had the privilege to serve as the faculty director of the ODX/ Columbia Business School partnership. During that time, I have worked with a team of professionals who have supported my case work and presentations to directors at their ODX meetings in New York, Chicago, and San Francisco. Special thanks go to Maureen Neary, executive director of ODX; Janet O’Neil, program director of ODX; Heather Wolf, director of the Outstanding Directors program and the annual classes of Outstanding Director winners; and Gavin Daley, executive editor and managing director at Money-Media, a Financial Times company and producer of ODX. In the second edition, the Columbia CaseWorks case studies were added to the book, thanks to my partnership with Elizabeth Gordon and Ronnie Sacco. Each case gives attribution to the excellent writers they resourced to help construct them. In the Demolus Market Basket case study, Eric Gebaide was the independent director from that company board who collaborated on the case and continues to bring his superior knowledge and teaching to my EMBA classroom. Within that same EMBA classroom, Ed Gormbley, the founder of his Workplace Partners family business, continues to serve as a role model of exemplary executive leadership for our Columbia Business School students. Finally, I want to acknowledge Susan Klepper, my fellow faculty member (now retired) from Columbia University, who models tough love in our family boardroom. Bill, Caroline, and Michael, our children, can attest to her skill and the effects that this love has had on their leadership in business and in life. This book is dedicated to them and their ongoing success.

pre fac e

The purpose of The CEO’s Boss: Tough Love in the Boardroom is to help boards operate more effectively as the boss of the CEO—guiding them in selecting the right CEO, establishing a working relationship, and giving effective feedback. The core argument is that the CEO’s style needs to be matched to the business’s point in its cycle and that the board needs to intervene actively with the CEO to help him or her close any gaps between their capabilities/style and the requirements of the company to address its current challenges. The need for this book has been amplified by the financial meltdown and the American public’s view of chief executive officers (CEOs) as greedy and self-serving while their companies flounder. The questions then become: Where was the board? How could so many companies demonstrate poor management and step away from common sense without their boards getting “tough” with their managements? The consequences of this abdication of authority will haunt America for the next ten years. In its first year of publication (2010), The CEO’s Boss was ranked as one of the Top Five Books by the Wall Street Journal’s livemint.com. Consistent with this standard, I have continued to study the governance practices within companies, both public and family businesses, and I have worked directly with the not-for-profit organization, the Wounded Warrior Project.

xii

P R E FA C E

Through these case studies my thought leadership presented in the first edition of The CEO’s Boss is, in the second edition, integrated and applied in my corporate case studies published by Columbia CaseWorks: r
BP: A Company in Peril? r
Proctor & Gamble in 2013: A Board Adrift? r
The Wounded Warrior Project in 2016 r
Demoulas Market Basket: A Governance Challenge r
Wells Fargo and Company: Corporate Governance Crisis

In addition to these case studies, which have been lightly edited and updated from their original forms to suit publication here, the original CaseWorks Corporate Governance at Hewlett-Packard 1995–2005 was updated to address it having replaced its CEO four times in seven years. Finally, two case-studies-in progress—Workforce Partners, which is led by one of my former EMBA students, and a small cap industrial company that I serve as a consultant—will serve as further examples of the application and integration of the knowledge offered in The CEO’s Boss. The improvements of this second edition of The CEO’s Boss: Tough Love in the Boardroom are the lessons learned over this decade.

Lessons Learned Chapter 1: The Social Contract

The heart of the idea of the social contract may be stated simply: Each of us places his person and authority under the supreme direction of the general will, and the group receives each individual as an indivisible part of the whole. JEAN-JACQUES ROUSSEAU

The lesson of the social contract is that a board-CEO partnership cannot be sustained by good intentions alone: it must be defined by an explicit statement of the beliefs and behaviors that are essential for the general will of the organization. The case study in this chapter is BP: A Company in Peril?

P R E F A C E  xiii

Chapter 2: Tough Love in the Boardroom

Tough love is an expression used when someone treats another person sternly with the intent to help them in the long run. The lesson is that a board can benefit from those who study CEO tenure and company performance as well as the requisite leadership behaviors to achieve success in at the various stages in the lifecycle of their business. Boards must intentionally address these realities with the appropriate amount of tough love in the boardroom to prevent the company and CEO from becoming dysfunctional. The case study in this chapter is Procter & Gamble in 2013: A Board Adrift?

Chapter 3: Why the Right Partnership Matters

The point of inflection: A moment of dramatic change, especially in the development of a company, industry, or market. The lesson is that it is essential that the board constantly assess and adjust its leadership in order to survive. Business cycles are unavoidable and uncertain. What goes up will in time come down. Because every board needs to face this reality, they must be ready to adjust their leadership to meet the challenge of changing conditions. Having achieved the right partnership between the board and its CEO is central to that survival. The case study in this chapter is The Wounded Warrior Project

Chapter 4: Leadership Metrics

Culture: The way we do things around here. The lesson is that the battle between a new strategy and an old culture will evidently conclude in the old culture winning. Boards are loath to change what brought a business success, but the price is often the lack of new practices that are needed to succeed in the future. The case study in this chapter is Demoulas Market Basket: A Governance Challenge

xiv

P R E FA C E

Chapter 5: How the Partnership Can Go Wrong: Take-Two Interactive

What gets measured gets done, what gets rewarded gets done repeatedly. The lesson is to measure what the board wants done and reward what it wants the CEO to continue to do. When the CEO’s leadership practices are directly linked to the organization’s needs and subsequently measured and rewarded, the metrics are right and focused on what really matters in the board-CEO partnership. The case study in this chapter is Wells Fargo and Company: Corporate Governance Crisis

Chapter 6: What Directors Need to Know Before Committing to a CEO

Alignment: The correct position or positioning of different components with respect to each other or something else so that they perform properly. The lesson for directors is that there is no shortcut to making an informed choice of their CEO. Their due diligence should include investigating the behavior of the prospective CEO in both good and bad times; always being aware of the biases that can cloud a board’s judgment. The case study in this chapter is an update of CaseWorks: Corporate Governance at Hewlett-Packard 1995–2005

Chapter 7: The Board’s Commitment to the CEO

Commitment: Devotion or dedication, e.g. to a cause, person, or relationship. The lesson is that directors need share a common set of commitments with their CEO: r
Commitment to values: A leadership credo that answers the question, “What do we stand for as organization?” r
Commitment to the stakeholders: Customers, employees, shareholders and community. r
Commitment to risk assessment: A willingness to manage the company’s risk profile.

P R E F A C E  xv

r
Commitment to transparency: Complete honesty in financial and nonfinancial matters. r
Commitment to coaching for continuous improvement: Supporting the CEO and board’s continuous improvement

The case study in this chapter is Workforce Partners

Chapter 8: Effective Board Dynamics

Teams have members with complementary skills and generate synergy through a coordinated effort, which allows each member to maximize his or her strengths and minimize his or her weaknesses. The lesson for directors is that the group dynamics of the board is influenced by the stage of the board’s development, the mix of its members’ styles, and the leadership behavior and roles directors employ. Effective board dynamics optimize the conditions for a successful partnership between independent and internal directors in the boardroom. The case study in this chapter is in progress: Small Cap Industrial Company

Epilogue is Prologue

“What’s past is prologue” —SEBASTIAN

IN ACT II, SCENE I OF THE TEMPEST

The Corporate Governance Predictions (2010–2020) offered in the first edition of The CEO’s Boss are reexamined for lessons learned: r
Boards will become more egalitarian, participatory, and regulated. r
Directors will “run” for a seat on the board, not dissimilar to a political election. r
Shareholders will have input in deciding the best board chairperson. r
Lead independent directors will become the chief process leaders of their boards. r
The strategic risk profile will be a recurring item on the board’s regular agenda.

THE CEO’S BOSS

1 The Social Contract

The heart of the idea of the social contract may be stated simply: Each of us places his person and authority under the supreme direction of the general will, and the group receives each individual as an indivisible part of the whole.  JEAN-JACQUES ROUSSEAU, THE SOCIAL CONTRACT

Directors and CEOs alike are entrusted with remarkable responsibilities. The key to the successful leadership of a company is a strong partnership between these two parties. With the collapse of the housing market and the bankruptcy of such giants as Lehman Brothers and General Motors, the importance of this relationship has come sharply into focus and it has become increasingly clear that CEOs cannot be held solely accountable for failures such as these. When the news of Lehman’s demise broke, for instance, the question raised by the Wall Street Journal was, “Where was Lehman’s board?” It noted, “As the world nervously awaits the effects of the unprecedented Lehman Brothers liquidation, one can’t help but wonder how and why this board let its longtime chairman and patron, Richard Fuld Jr., cling to both hope and power.”1 It is time to reexamine the role of the board and to explore how board members can best achieve their role as “the CEO’s boss.”

A Productive Partnership: Tyco

If an unsuccessful relationship between the board and the CEO can lead to disaster, then a productive one can help restore or avert it. A known success

2

THE SOCIAL CONTRACT

story is the rescue of Tyco International through the partnership of Jack Krol, lead director, and his CEO/chairman, Edward D. Breen. Breen, previously the president and COO of Motorola, was appointed the new chairman and CEO of Tyco in 2002 and came to the company in the midst of a devastating failure in leadership. The former chairman and CEO, Dennis Kozlowski, and former CFO, Mark H. Swartz, had been accused of stealing $600 million from the company. In 2005, after a retrial, both men were sentenced to eight to twenty-five years in prison. Breen believed that drastic change was needed to save the company and he saw it as his responsibility to be hard on the problems facing Tyco. Bringing a world-class leadership team with him, he immediately acted to stabilize the company and restore shareholder confidence. To this end, he committed to replacing the board of directors and the leadership team under Kozlowski with a team of independent directors. In August 2002, with the priority of improving the company’s corporate governance, Breen announced the appointment of Jack Krol as lead director.2 Like Breen, Krol believed that big changes and tough decisions were necessary to get the company back on track. The stage was set for a partnership based on strong but shared beliefs. By the end of 2005, Tyco’s revenue had reached nearly $40 billion under this leadership team. However, despite the company’s renewed success, on January 13, 2006, Tyco and its board of directors announced its intent to separate Tyco into three separate, publicly-traded companies. According to Breen: In the past several years, Tyco has come a long way. Our balance sheet and cash flows are strong and many legacy financial and legal issues have been resolved. We are fortunate to have a great mix of businesses with market-leading positions. After a thorough review of strategic options with our Board of Directors, we have determined that separating into three independent companies is the best approach to enable these businesses to achieve their full potential.3

This decision further emphasized the difference between the dysfunctional leaders that had left and the proactive team that had taken their place. Following the separation, Breen remained at the head of Tyco International. In October 2007, at a meeting of the Outstanding Directors Exchange (ODX) in Chicago, I attended a table discussion with Jack Krol in which

THE SOCIAL CONTRACT 3

he and Ed Breen discussed the recent changes that had taken place within the company. Although their presentation on the separation was interesting, what was most compelling to the audience was the story that Krol and Breen told about their partnership as lead director and CEO/chairman. The men talked about how they maintained a successful relationship by being clear with each other on their strategy, priorities, and the gaps they had to close. Coming into the job, both knew that the business was in a turnaround stage in its life cycle and that they had to challenge the status quo and make informed decisions to save Tyco. Adding force to their determination was their collective commitment to their “Ethical Conduct and Board Governance Principles,” a document that acted as a social contract to promote and ensure integrity, compliance, and accountability. Breen and Krol, in their presentation at ODX, emphasized how these three principles were the foundation for their partnership. Without these behavioral standards, they could not have clearly defined the change they envisioned for Tyco. Over their five years together, these three principles were expanded to “Tyco Vision and Values.”

Tyco Vision and Values

Tyco International’s board of directors were responsible for directing and providing oversight of the management of Tyco’s business in the best interests of the shareholders and in being consistent with good corporate citizenship. In carrying out its responsibilities, the board selects and monitors top management, provides oversight for financial reporting and legal compliance, determines Tyco’s governance principles, and implements its governance policies. The board, together with management, is responsible for establishing the firm’s operating values and code of conduct and for setting strategic direction and priorities. While Tyco’s strategy and leadership evolve in response to its changing market conditions, the company’s vision and values are enduring. So too are five governance principles and, along with the company’s vision and values, they constitute the foundation upon which the company’s governance policies are built. Tyco believes that good governance requires not only an effective set of specific practices but also a culture of responsibility throughout the firm, and governance at Tyco is intended to optimize both. Tyco also believes that good governance ultimately depends on the quality of its leadership

4

THE SOCIAL CONTRACT

and it is committed to recruiting and retaining directors and officers of proven leadership and personal integrity. Before the separation of Tyco into three separate companies in 2007, its Vision and Values were published in its Board Governance Principles: tyco vision: why we exist and the essence of our business To be our customers’ first choice in every market we serve by exceeding commitments, providing new technology solutions, leveraging our diverse brands, driving operational excellence, and committing to the highest standards of business practices—all of which will lead to Tyco’s long-term growth, value, and success. tyco values: how we conduct ourselves Integrity: We demand of each other and ourselves the highest standards of individual and corporate integrity with our customers, suppliers, vendors, agents and stakeholders. We vigorously protect company assets and comply with all company policies and laws. Excellence: We continually challenge each other to improve our products, our processes and ourselves. We strive always to understand our customers’ and suppliers’ businesses and help them achieve their goals. We are dedicated to diversity, fair treatment, mutual respect and trust of our employees and customers. Teamwork: We foster an environment that encourages innovation, creativity and results through teamwork and mutual respect. We practice leadership that teaches, inspires and promotes full participation and career development. We encourage open and effective communication and interaction. Accountability: We will meet the commitments we make and take personal responsibility for all actions and results. We will create an operating discipline of continuous improvement that will be integrated into our culture.4

Jack Krol left the Tyco board in March 2008 but his reputation as an “outstanding director” was acknowledged at ODX in 2007. Quoting from the Agenda article that profiled Krol’s accomplishment: “When Breen signed

THE SOCIAL CONTRACT 5

on, he believed that Tyco’s core manufacturing businesses were solid, but he wasn’t sure how far across the organization the corruption reached. Nor was he exactly sure how to avoid bankruptcy. He needed a partner, and fast.  .  .  . Krol’s reputation and total commitment to the task were major factors in both saving the company and restoring its respectability.”5

Prescription: The Social Contract

A social contract, if developed correctly, can provide a prescription for strengthening and maintaining the partnership between the board and its CEO. I am defining a social contract as a clear set of behavioral statements willingly subscribed to by the board and CEO that details the mutual expectations of their partnership. In layman’s terms, the social contract puts forth “the rules of the road.” The roots of the social contract are in the postconventional moral reasoning that is at the core of a democratic government. (See Kohlberg’s moral development theory, stage 5, which is social contract driven.6) As an alumnus of Saint Louis University, I consider my education Jesuit in nature, with a core emphasis on philosophy and all its applications. Thus, although my real academic focus was management, I have maintained an interest in the philosophy behind it. The social contract is particularly interesting to me, as it is fundamentally a philosophical document that results from a philosophical discussion. It is a contract between a board and its CEO that is developed through a conversation about what’s important to ensure their commitment to the welfare of the business. Each of us places his or her person and authority under the supreme direction of the general will—in this case, the board-CEO partnership. From my experience as a board chairman, I have found that the best way to start a discussion of a board-CEO social contract is to come up with five behavioral standards to present to the CEO. Five is a deliberate choice—I’m a believer in Miller’s law, the work of cognitive psychologist George A. Miller of Princeton University’s department of psychology, who measured human short-term memory capacity and found a 7 ± 2 limit.7 I prefer keeping the number at the lower end of the range so that the standards can be readily remembered. The five I use are: r
Commitment to values: a leadership credo that answers the question, “What do we stand for as an organization?”

6

THE SOCIAL CONTRACT

r
Commitment to the stakeholders: customers, employees, shareholders, and community. r
Commitment to risk assessment: a willingness to manage the company’s risk profile. r
Commitment to transparency: complete honesty in financial and nonfinancial matters. r
Commitment to coaching: supporting the CEO and board’s continuous improvement.

These five standards can help the board consider the critical aspects of the company and discuss its general leadership expectations.

Commitment to Values

I’ve worked with a number of boards to develop a leadership credo by articulating an answer to the question, “What do we stand for as an organization?” It may sound simple, but it goes to the core of the way things are done around the organization—its culture. The culture of the company dictates the general will and behavior of the CEO and the board. Johnson & Johnson has one of the most noteworthy credo statements of any company. As they state on their website: The values that guide our decision-making are spelled out in Our Credo.  .  .  . Robert Wood Johnson, former chairman from 1932 to 1963 and a member of the Company’s founding family, crafted Our Credo himself in 1943, just before Johnson & Johnson became a publicly traded company. This was long before anyone ever heard the term “corporate social responsibility.” Our Credo is more than just a moral compass. We believe it’s a recipe for business success. The fact that Johnson & Johnson is one of only a handful of companies that have flourished through more than a century of change is proof of that. our credo We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs, everything we do must be of

THE SOCIAL CONTRACT 7

high quality. We must constantly strive to reduce our costs in order to maintain reasonable prices. Customers’ orders must be serviced promptly and accurately. Our suppliers and distributors must have an opportunity to make a fair profit. We are responsible to our employees, the men and women who work with us throughout the world. Everyone must be considered as an individual. We must respect their dignity and recognize their merit. They must have a sense of security in their jobs. Compensation must be fair and adequate, and working conditions clean, orderly and safe. We must be mindful of ways to help our employees fulfill their family responsibilities. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified. We must provide competent management, and their actions must be just and ethical. We are responsible to the communities in which we live and work and to the world community as well. We must be good citizens— support good works and charities and bear our fair share of taxes. We must encourage civic improvements and better health and education. We must maintain in good order the property we are privileged to use, protecting the environment and natural resources. Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.8

A joint commitment to a common set of instrumental values between the board and the CEO is central to a healthy partnership. Without a collective agreement as to the company’s values, the leadership team will not have a complete set of tools to navigate through good and bad times. In 1982, Johnson & Johnson proved just how committed it was to its credo and how the credo helped shape strategic decisions with its response to the Tylenol crisis. On September 29th of that year, a twelve-yearold from Chicago died after taking a capsule of Extra Strength Tylenol. Another Chicagoan died shortly thereafter, as did his brother and sisterin-law after taking pills from the same bottle. There were two more deaths

8

THE SOCIAL CONTRACT

in the area before investigators discovered the Tylenol link. They believed that someone had stolen bottles of Tylenol off the shelves of various supermarkets, poisoned them with solid cyanide, and then replaced the bottles. This suspicion was confirmed when three doctored bottles were found in supermarkets. I have worked with a number of “Big Pharma” companies and have referenced Johnson & Johnson’s response to this incident as a clear example of a company that stuck to its credo in a crisis. The company warned hospitals and distributors, issued a nationwide recall of Tylenol products, and offered to exchange all capsules already purchased by the public with solid tablets. This recall of Tylenol products had a retail value of more than $100 million. These decisions were strategic and could only have been guided by a clear set of principles that served as both a moral compass and a recipe for business success in a time of crisis. As a result, Johnson and Johnson was able to navigate through this difficult time with the Tylenol brand intact. The market share of Tylenol, which collapsed from 35 percent to 8 percent, rebounded in less than a year and the brand regained its former popularity after coming back on the market in a triple-sealed package. Johnson & Johnson has continued (https://www.jnj.com/our-heritage /8-fun-facts-about-the-johnson-johnson-credo) to champion its original 1943 credo and in 1979, wording was added to outline the company’s responsibility to “protecting the environment and natural resources,” which reflected larger changes in the at that time. Today its executive leadership continues its commitment to these core beliefs and values. In addition, more companies have incorporated the credo to their mission statements. Bristol-Meyers Squibb (B-MS) is one company I am currently working with that has an equally powerful statement of its commitment: To our patients and customers, employees, global communities, shareholders, environment and other stakeholders, we promise to act on our belief that the priceless ingredient of every product is the integrity of its maker. We operate with effective governance and high standards of ethical behavior. We seek transparency and dialogue with our stakeholders to improve our understanding of their needs. We take our commitment to economic, social and environmental sustainability seriously, and extend this expectation to our partners and suppliers.9

THE SOCIAL CONTRACT 9

For more of a comprehensive application, the cascading of these stated beliefs and values can occur by adding them as a premise to each employment contract—a further augmentation of the company’s existing code of conduct. The board should reinforce this cascading and request in its board materials an annual assessment by management of employees’ understanding and living of its company’s core values.

Commitment to the Stakeholders

One of my custom clients at Columbia Business School’s Executive Education program refers to his list of stakeholders as the “four legs of the stool” of the business. If any one of the legs is weak, the entire organization is out of balance. If you look back at the Johnson & Johnson credo, you’ll see that these four stakeholders constitute the focus of the company’s values, and all four were considered in its reaction to the Tylenol crisis. M&T Bank is another example of a company with a clear commitment to its stakeholders. Its vision statement reads, “M&T strives to be the best company our employees ever work for, the best bank our customers ever do business with and the best investment our shareholders ever make.”10 It then speaks about its role in the community: “M&T Bank has a long tradition of being involved in the cities, towns and neighborhoods in which we operate. As a community bank, we understand that the well-being of our company is connected to the well-being of the communities we serve.”11 This clear statement of commitments has helped M&T Bank’s longtime CEO and chairman, Bob Wilmers, and his board turn the business into one of the twenty largest bank holding companies in the United States. An article in Fortune magazine captured the essence of M&T’s credo in its lead headline, “Banking the Buffalo Way: At a time of crisis in the financial system, the big boys could learn a lot from the success of a thriving regional player, M&T Bank. Really.”12 In Columbia Executive Education’s M&T Bank Executive Leadership, which I directed from 2006 through 2008, we focused on strategic management, leadership, and growth. I saw a calm resolve from the company at the onset of the banking crisis in 2008, and this attitude was based on the executives’ shared commitment to employees, customers, shareholders, and the communities they serve. Without this credo, I doubt M&T could have weathered the turbulence of its industry.

10

THE SOCIAL CONTRACT

Commitment to Risk Assessment

The recent financial crisis has highlighted the importance of risk management, and it is incumbent on boards to see that the CEO makes a commitment to manage the firm’s strategic risk profile. A failure in risk management was one of the major factors in the Lehman collapse, and when the company went under, the press asked, “How much was Lehman’s board monitoring the company’s risk as it began accumulating its portfolio of real-estate assets and securities? In 2006 and 2007, the board’s risk committee met twice each year, according to SEC filings.”13 Michael Raynor’s research has shown that a compelling vision, bold leadership, and decisive action, even though they are the prerequisites of success, are almost always present in failure as well. In his book Innovator’s Solution, written with Clayton Christensen, he talked about maximizing the results of the business, but in his book The Strategy Paradox: Why Committing to Success Leads to Failure  [and What to Do About It], he confronts the realities of managing risk.14 His research calls on boards and CEOs to design their organizations so that managers at every level of the hierarchy understand the time horizon and degree of strategic uncertainty they deal with in order to make the right strategic choices. He introduces the phrase requisite uncertainty, which yields a clutch of critical, counterintuitive findings. In 2007, right after the release of The Strategy Paradox, I was a participant on a podcast panel with Michael Raynor in which we discussed the book’s content and implications. At the time, it was more in vogue to discuss maximizing results than to consider risk management. Now, only a few years later, it’s clear that Raynor was onto something crucial. In today’s economic crisis, boards and CEOs need to make a commitment to manage their risk if they are to survive.

Commitment to Transparency

In an ideal world, it would be a given, rather than a behavioral expectation, that a company’s CEO is honest. In reality, it’s important for the boardCEO social contract to make it clear that complete honesty is essential. This can help both to avoid gray areas by necessitating, for instance, full rather than partial disclosure. When CEOs withhold information from the board because they know it will be read as bad news, this is not dishonesty,

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but it isn’t complete honesty either. When a social contract is developed correctly, the board and CEO establish the mutual expectation of full disclosure, which will help them solve their problems together. The underlying ethic is that this partnership is “hard on problems, not on people,” and that the bearer of bad news should not be held immediately responsible. Although the ideal of “complete honesty” is hard to achieve in practice, the social contract does hold the board-CEO partnership to a commitment to transparency as the code of behavior. Transparency, when used in a social contract, implies openness, communication, and accountability. The collapse of Lehman Brothers illustrates how a failure in transparent communication between the board and the CEO can lead to disaster. Most objective observers have concluded that Lehman CEO, Richard Fuld, did not fully disclosure Lehman’s financial matters nor was there an honest assessment of nonfinancial matters, such as Fuld’s leadership, by the board. Bad news was withheld until too late. The price that Lehman Brothers paid for these errors of omission or commission will be the work of the FBI investigation and lawsuits brought by its shareholders.

Commitment to Coaching

It has become common practice for boards to support the continuous improvement of their CEO’s performance and to provide a professional coach to assist in the CEO’s professional development. CEOs should be allowed to choose, with the agreement of the board, the coach that they feel can best provide helpful resources. I’ve served as a coach for a number of CEOs, and I’ve learned that the strength of the relationship between the coach and the CEO translates into a comparable strength in the partnership between the board and CEO. In many instances, my first conversation with a new CEO client begins with a query of how things are going with the board. Inevitably, the CEO will bring up the concerns of the board and one or more areas of the CEO’s performance that are bothering them. I usually structure the rest of my coaching sessions around determining the root cause of these performance gaps and exploring the implications for the CEO’s agenda, practices, and style. These are the various aspects of the CEO’s behavior, and I explain them more fully in chapter 3. In the end, the goal is to align the CEO’s performance with the needs of the business and to determine what is required to close any remaining performance gaps.

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However, continuous development goes beyond coaching for the CEO. The board has a comparable need to improve its skills and abilities in corporate governance. During the last ten years, I have worked with ODX, NYSE (New York Stock Exchange), and NACD (National Association of Corporate Directors) in its nationwide educational meetings. These directors-only conferences cover the most challenging boardroom issues. In addition, members are provided ongoing research and information through ODX publications like Agenda. Columbia Executive Education is another organization that offers support to board members by coaching directors to higher levels of performance in their corporate governance role.

The Social Contracting Process

In its final form, a social contract answers the question of “what we stand for” in a board-CEO partnership and details the beliefs and behaviors that define their collective leadership. The process that I have successfully used with boards and their CEOs to create the social contract is straightforward and takes less than a day of the board’s retreat to complete. The schedule that I usually follow is this: r
Review the strategy and strategic priorities of the business. r
Discuss the board-CEO partnership and the key challenges to achieving the business’s strategy and priorities. r
Individually reflect on and list the three to five most important areas to build and maintain the board-CEO’s partnership and a behavioral statement under each that would guide their work together. r
Reach a consensus on the common areas within the defining behaviors that the board-CEO will commit to as a statement of their social contract. r
Post the social contract in the boardroom and on the board agenda so it can be referred to as a standing agenda and behavioral guide.

The first two steps of the process set the stage for creating the social contract. The strategy and priorities of the business should be readily available for review by the board when it begins. With that in hand, the board and CEO can begin to discuss the key challenges facing the company. In most instances, these will be performance or opportunity gaps they want to close. This discussion is meant to allow for a collective understanding of the strategic context and intent of the business.

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The next three points in the process gather individual input and flesh out the details of the social contract. During the third step, each individual compiles his or her own list of priority areas along with a behavioral statement. A list that follows my five preferred behavioral standards might look like this: 1. Commitment to values: We are a value-driven organization whose credo defines the way we do things. Our values are clearly stated for all our stakeholders (customers, employees, shareholders, and community) to know what we stand for as an organization for them. 2. Commitment to the stakeholders: We know our commitment goes beyond just doing well as a business. We feel a compelling commitment to do what is right for our customers, employees, share-holders, and communities in which we work. Seeking the right balance between and among these stakeholders is the key to our overall stability and success. 3. Commitment to risk management: We understand that we can fail if we don’t manage our risk. As much as we want to maximize our growth, we also need to constantly monitor our risk profile. 4. Commitment to transparency: We have a fiduciary responsibility that is supported by our commitment to transparency with our shareholders and complete honesty within our board-CEO team regarding our financial and nonfinancial matters. We respect the requirements of confidentiality where they apply but do not withhold information from our decision-making process. 5. Commitment to coaching: We believe in the continuous development of the board-CEO skills and abilities, and therefore commit the time and resources to learn how we can better perform in our respective roles. We view this as an obligation to our stakeholders and an investment in our future success.

Once everyone has put a list together, I ask each member of the board to read his or her individual statements while others listen for items that are similar to their own. Once everyone has read aloud, the next step is to reach a consensus on common priority areas and defining behaviors. To facilitate this process, I define a consensus as a selection from a list of mutually acceptable alternatives and suggest that the group combine items from individual statements and refine them as necessary, leaving out items that anyone strongly objects to. In the end, there will be a list of statements to choose from that everyone can support. With this list in front

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of them, I ask board members to choose their top three. After recording their individual preferences, it usually becomes clear that a select number of items receives a clear majority of support. Again, there can be some further refining and combing, but, following Miller’s Law, I try to hold the board to 7 ± 2. The board-CEO will then commit to these as a statement of their social contract. Finally, I ask the board to post the social contract in the boardroom and on each member’s board agenda so it can be referred to as the behavioral guide in their work together. My follow-on recommendation to the boards/CEOs I work with is that they revisit this document as needed and at least at every scheduled retreat. I suggest, for these continued discussions of the social contract, that they use a facilitator who is trusted by the group. This can be either an outside consultant, as in my case, or an internal consultant knowledgeable about group dynamics and decision making and is viewed as an objective and trusted advisor. The fundamental idea behind the social contract is that a board-CEO partnership cannot be sustained by good intentions alone. There must be an explicit statement of the beliefs and behaviors that are essential for the general will of the organization. With the creation of the social contract, a foundation is in place for a successful and productive partnership between the CEO and the board.

CASE STUDY: BP: A COMPANY IN PERIL? By William M. Klepper ID#120406A, Published on April 12, 2012

When the drilling rig Deepwater Horizon experienced a blowout on April 18, 2010 and sank two days later,15 killing eleven people, British Petroleum (BP) was left at the helm of the worst accidental oil spill in American history.16 The  rig, leased from Transocean Ltd. by BP, had just completed exploratory drilling roughly forty miles off Louisiana’s southeast coast.17 BP was in the process of analyzing the finds and preparing to announce a major oil discovery at the site, with one source saying that the company would have broken the news within days.18 The Deepwater Horizon blowout in the Gulf of Mexico resulted in a partially capped oil well one mile below the surface of the water. Experts estimated that the gusher was flowing at a rate of 35,000 to 60,000 barrels per day (5,600 to 9,500 sq m/d) of oil. The exact flow rate was uncertain due to the difficulty of

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installing measurement devices at that depth and remained a matter of ongoing debate for some time. However, the resulting oil slick covered at least 2,500 square miles (6,500 sq km), fluctuating from day to day depending on weather conditions. It threatened the coasts of Louisiana, Mississippi, Alabama, Texas, and Florida. In a House of Representatives’ subcommittee review of BP’s response, Representative Edward J. Markey referred to the company’s efforts as “a series of elaborate and risky science experiments.”19 Beginning with failed attempts to use remotely-operated vehicles, surface skimmers, and the blowout preventer valve on the well20 to contain the oil, BP progressed to dumping massive amounts of chemical dispersants onto and into the gulf at the same time that it endeavored to siphon oil from the leaks and to plug the well with heavy drilling fluids.21 None of these efforts resolved the problem or prevented oil from reaching sensitive coastlines. By July 15, 2010, when a temporary fix—a fitted cap—stopped the flow until permanent measures could be taken, nearly 206 million gallons of oil had spilled into the gulf.22 The impact of the gulf disaster on the people, communities, and businesses it affected was inestimable and far-reaching. For BP’s part, there was also a very real economic cost to pay: BP’s allocation of $32.2 billion for spill costs led to a record loss of $17 billion for Q2 2010. By comparison, the company had reported a quarterly profit of $4.4 billion just one year earlier. The gulf disaster raised a series of very challenging, pointed questions for BP’s leadership, including the CEO and board of directors, relating to the company’s management of risk and safety over the preceding decade. In recent years, the company had improved its growth and financial performance substantially, gaining favor among analysts and investors who helped drive stock price appreciation. And yet during the same period, BP had been associated with multiple serious lapses in safety and risk management, including a 2005 Texas refinery explosion. Now many in the industry wondered what, exactly, had gone wrong within the company and what steps the board ought to have taken in carrying out its role in corporate governance. Could the gulf disaster have been avoided through a better exercise of board control and governance? What steps could the company take to improve the functioning of its board in the future? BP on the Move: Accelerated Growth BP had a long and prominent history in the oil industry, dating back to its roots as the Anglo-Iranian Oil Company (AIOC), founded in 1909. The AIOC became the British Petroleum Company in 1954. In the years that followed, the company expanded beyond the Middle East to Alaska (1959), became the first company to

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strike oil in the North Sea (1970), and acquired a controlling interest in Standard Oil of Ohio (1987). Growth through acquisition characterized the next two decades, including the high-profile merger with Amoco (1998) and the acquisitions of Atlantic Richfield Company (Arco) and Burmah Castrol plc, both in 2000. And yet despite its early growth and development, the company remained, in the mid-1990s, an essentially mid-sized European company, albeit wellestablished. The size and scope of the company’s operations, however, was soon to change, with BP executives pursuing an aggressive growth and profitability strategy that advanced BP from its “middleweight” status to the industry’s second-largest company, behind only Exxon Mobile. In the process, BP overtook prominent competitor Royal Dutch Shell and became one of the world’s six largest oil companies or “super majors,” defined as verticallyintegrated, private-sector oil exploration, natural gas, and petroleum product marketing companies. During this run-up to improved profitability and a growing stock price (exhibit 1 shows BP’s stock price, 1978–2007), the company took some notable steps to improve performance. From its base in London, BP struck bold new deals in politically volatile areas, such as Angola and Azerbaijan, while also utilizing cutting-edge technologies in remote reaches of Alaska and the deepest waters of the Gulf of Mexico. CEO Tony Hayward characterized the company’s expanded geographical and technical efforts by indicating that BP was pursuing “the tough stuff that others cannot or choose not to do.”23 At the same time, BP also led an industry wave of cost-cutting and consolidation efforts. As part of the company’s post-merger integration efforts, executives at BP decided to eliminate tens of thousands of jobs in the wake of the Amoco and Atlantic Richfield acquisitions. These cuts took place over the course of several rounds of layoffs, leading to a streamlining of management and a related increase in reliance on outside contractors. Prior to the explosion of Deepwater Horizon, CEO Hayward had stated publicly that he was working to slay two dragons at once: safely lapses that led to major accidents; and bloated costs that for many years had left BP lagging its major rivals, Royal Dutch Shell and Exxon Mobile Corp. However, some analysts were given to wonder whether the company was, in a sense, ignoring the inherent tension between cost cutting and managing safety, as was noted in the the Wall Street Journal article titled, “As CEO Hayward remade BP, Safety and Cost Drives Clashed.”24 Moreover, analysts also questioned what role the board had played during this period of accelerated growth, particularly given a board’s fundamental responsibilities of hiring and firing the CEO and approving a company’s strategy.

6 6 6 6

                             

Exhibit 1: BP Historic Stock Price (NYSE), 1978–2007

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Risk Management at BP: Ignoring the Writing on the Wall? Even as BP’s stock and financial performance improved through the late 1990s and into the new millennium, the company’s own operational safety lapses rendered it accountable for a number of serious accidents. To wit: r
1993–1995: Hazardous substance dumping—In September 1999, one of BP’s U.S. subsidiaries, BP Exploration Alaska, agreed to resolve charges related to the illegal dumping of hazardous wastes on the Alaskan North Slope, for $22 million. r
2005: Texas City Refinery explosion—In March 2005, BP’s Texas City, Texas, refinery, one of its largest refineries, exploded causing fifteen deaths, injuring 180 people, and forcing thousands of nearby residents to remain sheltered in their homes. r
2006–2007: Prudhoe Bay—In August 2006, BP shut down oil operations in Prudhoe Bay, Alaska, due to corrosion in pipelines leading up to the Alaska Pipeline. The wells were leaking an insulating agent called Arctic Pack, consisting of crude oil and diesel fuel, between the wells and ice. BP had spilled over one million liters of oil on Alaska’s North Slope. r
2007–2010 Refinery safety violations—Under scrutiny after the Texas City Refinery explosion, two BP-owned refineries in Texas City, Texas, and Toledo, Ohio, were deemed responsible for 97 percent (829 of 851) of willful safety violations by oil refiners between June 2007 and February 2010, as determined by inspections by the U.S. Department of Labor’s Occupational Safety and Health Administration (OSHA). The situation led OSHA’s deputy assistant secretary of labor, Jordan Barab, to state: “The only thing you can conclude is that BP has a serious, systemic safety problem in their company.”25 In January 2007, an independent panel (the Baker Panel) completed a thorough review of BP’s corporate safety culture, management systems, and oversight at its U.S. refineries, producing what became known as the Baker Report, which contained the panel’s findings. Recommendation #1 of the report called on the board and senior management to provide effective leadership on process safety, while also establishing appropriate goals. Recommendation #9 of the report laid out a formal structure for the board’s monitoring of the “process safety performance” of BP’s U.S. refineries.26 (See exhibit 2 for more complete language of the recommendations.) In May 2007, the board announced that L. Duane Wilson, a member of the Baker Panel, had been appointed as an independent expert to provide an objective assessment to the board of the company’s progress towards implementation of the panel’s recommendations. In May 2008, Wilson published his first annual

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Exhibit 2: Baker Report, Select Recommendations

Recommendation # 1: Process Safety Leadership The Board of Directors of BP p.l.c, BP’s executive management (including its Group Chief Executive), and other members of BP’s corporate management must provide effective leadership on and establish appropriate goals for process safety. Those individuals must demonstrate their commitment to process safety by articulating a clear message on the importance of process safety and matching that message both with the policies they adopt and the actions they take. Recommendation #9: Board Monitoring BP’s Board should monitor the implementation of the recommendations of the Panel (including the related commentary) and the ongoing process safety performance of BP’s US refineries. The Board should, for a period of at least five calendar years, engage an independent monitor to report annually to the Board on BP’s progress in implementing the recommendations (including the related commentary). The Board should also report publicly on the progress of such implementation and on BP’s ongoing process safety performance. Source: James A. Baker III, chair, The Report of the BP U.S. Refineries Independent Safety Review Panel, January 2007.

report where he assessed BP’s progress against the panel’s ten recommendations. The report noted that while significant progress had been made, areas for improvement still remained. In 2009, the members of the board’s committee on safety, ethics, and environmental assurance spent considerable time with Wilson and were advised of evident progress with respect to safety at the U.S. refineries. In March 2009, Wilson published his second annual report, which noted that BP required investments in engineering but also to develop a “positive, trusting, and open process safety culture” with this latter step expected to take many years to complete.27 As of 2010, the BP board contained fourteen board members, nine of whom were nonexecutive directors. As is common in large, multinational organizations such as BP, the record of achievement of the nonexecutive directors was impressive, as were their collective pedigrees. The board also exhibited a relatively high degree of continuity over the years, with the majority of nonexecutive directors who sat on the board in 2007 still retaining seats in 2010. See exhibit 3 for non-executive board bios and continuity.

Exhibit 3: BP Non-Executive Board Bios

Non-Executive Directors: Continuity (since 2007) in Crisis Governance wonks could fault the group for including too many BP execs (five of fourteen directors). But if you want achievement and pedigree, look no further: Carl-Henric Svanberg, non-executive chairman r
Formerly president and chief executive officer of Ericsson, also serving as the chairman of Sony Ericsson Mobile Communications AB. Paul Anderson r
Member of the safety, ethics, and environment assurance committee. r
Non-executive director of BAE Systems PLC and of Spectra Energy Corp. r
Formerly chief executive at BHP Billiton and Duke Energy, where he also served as a non-executive director. Antony Burgmans, KBE r
Member of the safety, ethics, and environment assurance committee since 2007. r
Former chairman of Unilever NV and vice chairman of Unilever PLC. Non-executive chairman of Unilever NV and Unilever PLC from 2005 until his retirement in 2007. Cynthia Carroll r
Member of the safety, ethics, and environment assurance committee since 2007. r
Appointed chief executive of Anglo American PLC, the global mining group, in 2007. r
A director of Anglo Platinum Limited and De Beers S.A. Sir William Castell, LVO r
Chairman of the safety, ethics, and environment assurance committee since 2007. r
President and chief executive officer of GE Healthcare and a vice chairman and a director of the General Electric Company. Retired from GE Healthcare in 2006. Sir William remains a director of the General Electric Company. George David r
Became United Technologies Corp’s (UTC) chief operating officer in 1992. Served as UTC’s chief executive officer from 1994 until 2008 and as chairman from 1997 until his retirement on December 31, 2009. Ian Davis Chairman and worldwide managing director of McKinsey from 2003–2009. Douglas J. Flint, CBE r
Joined HSBC Group as group finance director of HSBC Holdings PLC in 1995 and in 2009 became chief financial officer, executive director risk and regulation. DeAnne S. Julius, CBE, PhD r
Chairman of the Royal Institute of International Affairs since 2003. r
Non-executive director of Roche Holdings SA and Jones Lang LaSalle, Inc. Source: William M. Klepper, “BP: A Company in Peril?” Outstanding Directors Exchange presentation, 2010.

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Exhibit 4: BP Corporate Governance Framework

The board’s core activities include: r
The monitoring of executive action and performance of BP r
Obtaining assurance that the material risks to BP are identified and systems of risk management and control are in place to mitigate such risks The board delegates authority for executive management of the company to the group chief executive: r
This includes management of key risk areas such as health, safety, and environmental matters and generally ensuring that BP’s reputation is maintained. r
The group chief executive is also responsible for ensuring there is a comprehensive system of controls to identify and manage the company’s material risks. Source: William M. Klepper, “BP: A Company in Peril?” Outstanding Directors Exchange presentation, 2010.

The board’s core activities and governance framework, including its expanded safety monitoring responsibilities, are shown in exhibit 4. Leadership at BP: Who’s to Blame? A number of key leaders within BP came under scrutiny in the wake of the gulf disaster, as managers, analysts, and policy makers sought to make sense of what went wrong and what might have been done differently. Among the leaders who attracted a great deal of attention and postmortem scrutiny were BP’s CEO, board, and its nonexecutive chairman. The CEO When Tony Hayward became BP’s chief executive in May 2007, he promised to refocus the company with a back to basics approach. A plain-spoken geologist and longtime company man, Hayward noted, in a speech at Stanford Business School that “BP makes its money by someone, somewhere, every day putting on boots, coveralls, a hard hat and glasses, and going out and turning valves.” He added: “And we’d sort of lost track of that.” Hayward also pledged to fix the safety problems that contributed to the downfall of his predecessor. Though the

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company would continue doing the “tough stuff,” he declared, it would make safety its “No. 1 priority.”28 However, Hayward became the second BP chief executive to leave after a major accident. His predecessor, John Browne, resigned in 2007 when he lost the support of the board after a string of setbacks including a blast at BP’s Texas City, Texas, refinery in 2005 and leaking oil pipelines in Alaska. In an article entitled, “The Gulf Oil Spill: Hayward Fell Short of Modern CEO Demands” (7/26/10), the Wall Street Journal reported the following: Mr. Hayward moved from specializing in science to understanding business in 1990 when he became the assistant to John Browne, then head of exploration and production who five years later became CEO. BP has said that Mr. Hayward’s cost-cutting drive—$4 billion in reduced costs in 2009 alone—allowed the company to put more resources into operations, including safety. Yet critics have asked whether the aggressive internal trimming also nurtured a culture of cutting corners.29 The Board Other analysts placed responsibility for safety and oversight lapses leading to the gulf disaster more squarely on the shoulders of the board. In “Who’s to Blame at BP? The Board” (7/28/10), Fortune delivered the following fact-based argument against the BP board: r
The board had known for years that something was wrong with safety at BP. r
BP assembled an independent panel, headed by former secretary of state, James Baker, to investigate safety at its U.S. refineries. While the panel worked, a BP pipeline in Alaska leaked more than 200,000 gallons of crude in March 2006. r
The panel’s report, published in January 2007, is brutally direct. While its immediate focus is BP’s five U.S. refineries, its findings go far beyond them. Calling for “leadership from the top of the company, starting with the Board and going down,” the report found that “BP has not provided effective process safety leadership.” r
Corporate-governance authority Robert A. G. Monks, who testified as an expert witness for a Texas City worker, says, “The BP board was on notice that the corporate culture of ‘saving over safety’ pervaded BP. They were on notice that the mechanisms for informing the board were dysfunctional. The board had an affirmative duty to understand the risks involved in the drilling of this well.”30

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The Non-Executive Chairman BP’s board followed the British corporate governance model in which the role of chairman and chief executive remained separate—a practice that has been the subject of controversy and discussion among corporate governance experts. Carl-Henric Svanberg became the nonexecutive chairman of the board in June  2009, following a career at Ericsson that was marked by aggressive costcutting measures taken to return the company to profitability. At the time of Svangerg’s appointment to the board, Hayward stated: “He is a businessman of international stature who is recognized for his transformation of Ericsson. Our shared views on many aspects of global business give me great confidence that we will work very effectively together on the next phase of BP’s progress.”31 Nonetheless, in the wake of the gulf disaster, some industry insiders wondered whether or not BP had in place the best board structure to properly balance the company’s growth, risk, and safety objectives. Questions for Discussion 1. What questions should the BP board have asked to ensure that the growth strategy was not putting the company at risk? 2. What could the board of BP have done to ensure the company’s well-known safety problem was being addressed before reaching a point of peril? 3. How should a board keep focused on the culture or “the way we do things around here” in order to achieve or maintain optimal performance? 4. Is a separate chairman a benefit or barrier to good governance in a crisis? 5. How can BP ensure it has the right leadership (board and C-suite) to recover from this crisis? Lessons Learned How might the BP board and its new CEO, Robert Dudley, start their learning journey together? They could return to the 2007 Baker study of the Texas City refinery explosion and answer the four questions of the After Action Review (AAR): What was our intent (recommendations from the Baker report)? What happened between 2007 and 2014—safety violations? Why did it happen—why do we continue to have safety problems? How can we make it better—mange concurrently our growth strategy and risk profile? It would be reasonable to assume that this AAR for post mortem has already occurred. As mentioned at the beginning of this chapter, “a strong partnership” between the CEO and the company’s directors is necessary. However, a strong partnership doesn’t occur simply by wishing for it. Dudley and the BP Board need to form clear, mutually understood expectations for the partnership—a social

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contract. To paraphrase Rousseau’s original work, each must place “his person and authority under the supreme direction of the general will”—the CEO-board partnership. At a minimum, the social contract should include: r
Commitment to values r
Commitment to the stakeholders r
Commitment to risk assessment r
Commitment to transparency The BP CEO-board commitment to values is not meant to substitute for the public statement of what BP stands for: We care deeply about how we deliver energy to the world. Above everything, that starts with safety and excellence in our operations; or its values: Safety, Respect, Excellence, Courage, One Team. In reading the annual reports of BP since the gulf explosion, it is the evident that there is a heightened commitment to stakeholders, risk assessment, and transparency. One can only recommend that they strengthen their resolve to their commitments through a renewed CEO-board partnership—a social contract of their governance principles. Recently Sarah Kent, writing in the Wall Street Journal (February 4, 2018) stated that “BP boss Bob Dudley has staked his legacy on reversing the company’s lost prestige.”

Summary r
A board-CEO social contract is key to sustaining a productive partnership. r
This social contract must be an explicit statement of the beliefs and behaviors that are essential for the general will of the organization. r
The corporate credo is a broad statement to its stakeholders of what it stands for within the environment it operates. r
Cascade the company’s beliefs and values throughout the company and assess their understanding and use. r
Failing of the company to live up to its stated beliefs and values can be financially and legally catastrophic.

2 Tough Love in the Boardroom

Tough love: Treating someone sternly with the intention of helping over the long run.

In a successful partnership between the CEO and the board, the directors are able to assert their independence and challenge the CEO’s assumptions when necessary. In the Lehman Brothers collapse, it is clear that the board failed to sternly challenge Richard Fuld’s assertions about the state of the business. In retrospect, he was certainly not on mission: “We are one firm, defined by our unwavering commitment to our clients, our shareholders, and each other. Our mission is to build unrivaled partnerships with and value for our clients, through the knowledge, creativity, and dedication of our people, leading to superior returns to our shareholders.”1 However, Lehman’s main beliefs, as expressed in its sustainability principles, give us an idea of the way the CEO and board should have approached their strategic issues. SUSTAINABILITY PRINCIPLES Transparency and accountability. We will report regularly on the implementation of these principles. Operations. We will aim to minimize negative environmental and social impacts of our operations.

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Employees. We will engage with employees on environmental and social issues impacting our operations and business and encourage the development of innovative solutions. Assessing risk. We will assess the environmental and social risks posed by our operations and business. We will engage with clients on critical issues (such as climate change, biodiversity loss and water scarcity). Delivering opportunity. We will seek opportunities across our business that deliver commercial, environmental and social benefit. Market-based solutions. We believe that market-based solutions can deliver commercially feasible environmental and social benefit. We will apply our knowledge and understanding of financial markets to develop and implement innovative environmental and social market-based solutions. Investments. We will build our knowledge of how environmental and social issues impact business performance into advising clients, investing on clients’ behalf and deploying our own capital. Thought leadership. We will conduct research and analysis on key environmental and social issues and make the results publicly available. We will engage in public policy dialogues to contribute to the development of effective policies. Governance. These principles are approved and owned by our Executive Committee. The Executive Committee will oversee and receive regular reports on implementation and performance.2

The sustainability principles show that the board had methods in place to address issues as a group rather than relying solely on the CEO. Further, it had an advisory body that was focused on risk management: the Finance and Risk Committee, composed of five independent board members. This is the committee that should have challenged Fuld in 2007. So what went wrong? The committee members did not provide an independent assessment of the company’s risk but instead relied unquestioningly on Fuld’s assertions. The Finance and Risk Management Committee met only twice a year in 2006 and 2007—years when Lehman’s crisis was brewing, according to testimony by the Corporate Library research group to Waxman’s congressional committee. “A company in this sector should have a risk management committee that is vitally involved and has a great depth of expertise,” Corporate Library editor Nell Minow testified to lawmakers. “A company that had $7 billion in losses after becoming embroiled in the global credit crisis had a risk management committee that

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didn’t understand or manage its risk.”3 And many have criticized the directors placed in that committee. Of the five, “one was a Broadway producer; one had a long and distinguished career in the US Navy; and one had run a Spanish-language TV station.”4 In the years leading up to the collapse, the board failed to show Fuld the “tough love” that could have saved not only his job but the company as well. “Fuld took a franchise he’d built from almost nothing, brick by brick, and then trashed it in less than two years,” said Sean Egan, president and founder of Egan-Jones Ratings Co. in Haverford, Pennsylvania. “His biggest mistake was in not understanding the risks that had evolved since he was last active in debt markets. And he relied on the support of others whose interests were aligned with him.”5 Fuld, when asked to explain his company’s downfall to the congressional committee on October 6th, had no answers. “I wake up every single night,” Fuld said, “thinking, ‘What could I have done differently?’ ”6

Practicing Tough Love

It is clear, from the collapse of Lehman Brothers and the joint failure of Fuld and the Finance and Risk Committee, that having a statement of intent or a social contract in place is not always enough to ensure a successful partnership. For the board to be able to work effectively with the CEO, it must be able to ask questions, think independently, and show “tough love” when necessary. It is the board’s responsibility to: r
Know the CEO’s behavioral style and leadership practices. r
Know the organization’s needs (strategy, priorities, and gaps). r
Match the organization’s needs with the leadership that is required. r
Look first at the CEO and then the senior team to find the correct match. r
Look elsewhere if the correct match isn’t found.

The CEO’s Behavioral Style and Leadership Practices

Knowing the general behavioral styles of executives can help the board provide tough love to the CEO. The idea of distinct personality types evolved out of the work of Carl Jung. Today one of the most straightforward assessments is based on the behavioral styles research of Merrill and Reed.

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They define four social styles: driving, expressive, amiable, and analytical.7 In later chapters I discuss how these styles can be modified and expanded into leadership indices that are appropriate for CEO evaluation and I deal more extensively with the assessment of the CEO’s behavioral style and leadership practices. For now, however, let’s consider how different behavioral styles can impact a company. The CEO changeover at Coke, from Roberto Goizueta to Doug Ivester, is a classic example of the effect different behavioral styles and leadership practices can have on a company. From 1980 until his unexpected death in 1997, Goizueta created more wealth for Coke’s shareholders than any other CEO in history.8 His expressive/innovative behavior was a stark contrast to his COO, Ivester, whose analytical, process-oriented behavior was legendary within the company. In October 1997, although still in shock from losing Goizueta, Warren Buffett and the other directors were convinced that they had the right successor in Ivester, and the board meeting to appoint him lasted only fifteen minutes. Given Ivester’s history with the company and years of working side-by-side with Goizueta, the choice seemed selfevident. As Fortune magazine wrote in 2000: For two decades Ivester had toiled away patiently inside Coke, the last ten years aiming directly at the top spot and dazzling Goizueta with his hard work and creative execution of company strategy. A onetime accountant and outside auditor, he was carefully groomed by Goizueta and put through all the paces to give him the breadth of experience he would need in marketing, in global affairs, in charm and public speaking. But for all his brilliance—and nobody doubts that Ivester is brilliant—he somehow failed to grasp the vital quality that Goizueta had in abundance: that ethereal thing called leadership.9

When making its decision, the board did not allow enough time to step back and ask whether and how Ivester’s behavioral style would align with the organization’s needs. The directors apparently assumed that by going with the Number 2 to Goizueta, things would continue as in the past. However, what resulted was a mismatch of a CEO’s style and the needs of an organization. It is reported that Warren Buffett and Herbert Allen, two powerful directors at the time, met with Ivester in a private meeting in Chicago and informed him that they had lost confidence in his leadership after little more than two years on the job. Ivester resigned, and Douglas Daft was appointed to the position soon after.10

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When planning succession, the board failed to see that Goizueta was not grooming Ivester as much as he was utilizing his contrasting strengths in his leadership team. When Goizueta and Ivester worked together, Coke functioned at its peak, but a leadership gap was created when one of the players was taken away. If the board had been tougher and more deliberate in its assessment of Ivester’s behavioral style and leadership practices, it might not have had to be so tough on him two years later in assessing his performance as CEO.

The Organization’s Needs

If the board hopes to help its CEO in the long term, it needs to focus on the few things that will make the biggest difference in the performance of the business. There is a hierarchy of needs in every organization that is typically expressed in its strategy, priorities, and the performance and opportunity gaps—the measurable difference between the current and desired future state. In many instances, an organization will distill its needs down to a goal statement. For instance, Tyco has Board Governance Principles that clearly state its goals: TYCO GOALS: WHAT WE SEEK TO ACHIEVE Governance: Adhere to the highest standards of corporate governance by establishing processes and practices that promote and ensure integrity, compliance, and accountability. Customers: Fully understand and exceed our customers’ needs, wants and preferences and provide greater value to our customers than our competition. Growth: Focus on strategies to achieve organic growth targets and deploy cash for growth and value creation. Teamwork and Culture: Build on the company’s reputation and image internally and externally while driving initiatives to ensure Tyco remains an employer of choice. Operational Excellence: Implement best-in-class operating practices and leverage company-wide opportunities. Financial Strength & Flexibility: Ensure that revenue, earnings per share (EPS), cash, and return on invested capital objectives are met.11

With these goals stated and jointly owned by the Tyco board and its CEO, the needs of the organization can be the focus of the board’s work.

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Table 2.1 

Business Stages and CEO Practices The Stage of the Business

CEO Practices

Low Success/Beginning Time Frame Rising Success/Early Time Frame Growing Success/Middle Time Frame Peak Success/Late Time Frame

Challenge the status quo Inspire the Future Enabling Others Model the Way

Matching Needs with Leadership

As was the case with Ivester at Coke, there can be a mismatch between the current needs of the organization and the leadership practices of the CEO. Ideally, this is the point where the board steps in and either shows the CEO “tough love” or takes more extreme action, such as removing him or her from office. Warren Buffett and Herbert Allen did the latter when they met with Ivester and delivered the board’s message of no confidence. The CEO’s leadership practices must be aligned with the business in general, and the CEO must be flexible enough to change leadership style with each stage of the business. My original work linked the business cycle to critical leadership practices identified by James M. Kouzes and Barry Z. Posner: challenge the status quo, inspire the future, enable others, and model the way (see table 2.1).12 In a start-up or turnaround, the organization needs a leader to challenge the status quo and build a viable business. Once the business is functional, the leader needs to provide a clear vision that inspires the future. As success is being achieved, the organization needs its leader to enable others to contribute to the growth of the business. Finally, as the organization continues to advance, the leader must model the way to continually improve the business while exploring opportunities to reinvent itself in the future.

Finding the Correct Match Internally

At Coke, the board’s choice of Ivester to follow Goizueta made sense, as he was the COO under Goizueta and part of a senior team that had achieved significant success. Succession planning is built on the premise that an organization needs to have the bench strength to maintain its momentum.

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Boards should continually review their succession plan and determine whether their senior team matches up well with the demands of the business. Coke’s board did not take the time to consider its succession options sufficiently when Goizueta died unexpectedly. Instead it immediately appointed Ivester as the obvious choice. Not only did Ivester’s leadership style contrast with Goizueta’s and therefore clash with Coke’s needs at the time, but once appointed he did not foster a strong senior team and refused to appoint a COO, even at the board’s urgings. Ivester failed as a leader, and he amplified this leadership crisis by neglecting to build an effective senior team that could complement his own style. Richard Fuld is another example of a CEO who was not building an indepth management team. For many years, he too refused to appoint a number 2: Christopher Pettit, a longtime friend and ally of Fuld’s, was forced out as chief operating officer when he balked at an executive reorganization in 1996. Six years would go by before Fuld installed another chief operating officer. The man Fuld finally appointed chief operating officer was Gregory, a trusted lieutenant who had worked at Lehman since 1974. He would make it his mission to keep Fuld’s life uncomplicated by debate.13

Both Ivester and Fuld failed to build strong senior teams. For Coke this meant having to go outside the senior team to find a successor. The board quickly promoted Douglas Daft, who ran the company’s Middle and Far East divisions, to COO and then to CEO. Had it challenged Fuld and questioned his leadership ability, the Lehman board would have found a similarly lacking senior team. An example of a successful senior team builder is Jack Welch, the onetime CEO of General Electric (GE). Welch was known for his top team, and he insisted that his colleagues share the best practices rather than operate in isolation from one another. All the members of his senior team understood the total GE business, and this resulted in a lengthy and well-publicized succession saga prior to his retirement. James McNerney, Robert Nardelli, and Jeffrey Immelt were all considered candidates for the position. Immelt was eventually selected to succeed Welch as chairman and CEO. The tradeoff for having such a strong group, however, was that the candidates who weren’t chosen looked to outside opportunities to advance their careers. Nardelli became the CEO of Home Depot until his resignation in early 2007 (whereupon he was tapped by Cerberus, the private equity firm, to

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run Chrysler), while McNerney became CEO of 3M until he left that post to serve in the same capacity at Boeing. The positions these men went on to attests to the strength of Welch’s team at GE, and this gave the board a number of options when it came time to choosing Welch’s successor.

Finding the Correct Match Outside the Company

One of the toughest decisions that can be made in the boardroom is the decision to go outside the existing management team to find a CEO. However, if a board does not have the leaders to match up with the needs of its business, it must look elsewhere. The Tyco board made this decision when it selected Breen as CEO in 2002. Granted, it took a New York Times exposé and Manhattan district attorney indictment to initiate the former CEO’s resignation and CFO’s departure, but the board nonetheless made the right decision by looking elsewhere for a CEO. Rarely do we learn of the performance review by the board and its CEO unless it warrants removal or public recognition, nor should we. Tough love is based on an open and honest but confidential dialogue.

CEO Tenure and Company Performance

In fulfilling their role as the CEO’s boss, boards can benefit from studies of CEO tenure and company performance. Donald C. Hambrick and Gregory D. S. Fukutomi have identified five distinct seasons of a CEO’s tenure, each of which is accompanied by a specific set of behaviors.14 According to their model, the first season of the CEO starts when he or she is hired and given a mandate from the board to advance the business. After an initial period of legitimacy building, the CEO is moved into a second season of experimentation and trying new things. If all goes well, he or she enters into a third season during which the CEO selects what works best and sticks with it. If what works endures, there is a fourth season, when actions converge to reinforce and bolster the culture of the company. That strategy becomes the “way we do things around here.” Unfortunately, this convergence invites only incremental change to improve things. Eventually, the point of inflection, when success begins to shift downward from its highest point, is reached in a business cycle. This is the fifth season of the CEO: dysfunction. Hambrick and Fukutomi’s model parallels the

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Seasons of a CEO’s Tenure and the Business Cycle. Source: W. M. Klepper, adapted from A. Henderson, D. Miller, and D. C. Hambrick. “How Quickly Do CEO’s Become Obsolete? Industry Dynamism, CEO Tenure and Company Performance,” Strategic Management Journal, May 2006.

common belief about the business cycle, often referred to as the “S” curve (figure 2.1a). Businesses start strong, experience a short-term decline as they try to find a winning strategy, and become more successful as they figure out what works and what doesn’t. They will stick with that strategy as long as possible. However, without a parallel effort to begin a second wave, or “S” curve, dysfunction can occur—both in the leadership and in the business. Overlaying the five seasons of the CEO’s tenure on the “S” curve allows us to graph the success of the CEO at different stages in the company’s growth (figure 2.1b). Thus, the behaviors associated with every season can be

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understood as the ideal agenda for each stage of the business cycle. When the business is just getting started, for instance, the best agenda for the CEO is to respond to the mandate from the board and to act consistently according to this mandate. At the peak of business, on the other hand, the CEO should not attempt any major changes and should instead reinforce the strategies that have been successful in the past. If the CEO cannot make his or her agenda conform to the needs of the business, they will become dysfunctional. Many CEOs have modified their leadership style and practices to avoid collapse, and in a few instances they have achieved greatness. James Collins’s Good to Great (2001) documents the most notable of these companies. However, without the CEO and company continually adapting to changing conditions, dysfunction can result. Another Collins book, How the Mighty Fall (2009), paints the picture of these stages of decline, depicted on an “S” curve.15 In these economic times, there are references to “L,” “W,” and even “√” curves, but the “S” curve is an accepted model for explaining the business cycle time frame. CEOs can join a company at any point in the business cycle and thus the seasons of the CEO do not necessarily happen chronologically. Further, a flexible CEO can modify his or her leadership style and avoid dysfunction. Looking back, it is clear that there were signs of dysfunction on Fuld’s part before Lehman’s collapse. He was underpowered to figure out the right risk/reward ratios and make the right decisions, and he took relatively few actions to confront the risk profile of the firm. “A CEO needs good managers reporting to him to figure out the right risk-reward ratios and make the right decisions. Increasingly, Fuld wasn’t getting good dope. He became isolated in recent years, people familiar with the firm’s operations said. He countenanced little debate and delegated more responsibility to Joseph M. Gregory, 56, who became president and chief operating officer in 2004.”16 The board must address these realities with tough love or share in the responsibility for the company and CEO becoming dysfunctional. In the case of Lehman, it is legitimate to ask, “What was the board doing to confront the CEO’s dysfunction?” As some have concluded, it was not doing enough: As the world nervously awaits the effects of the unprecedented Lehman Brothers liquidation, one can’t help but wonder how and why this board let its long-time chairman and patron, Richard Fuld Jr., cling to both hope and power. Perhaps it was because Mr. Fuld wanted it that way. Over the years, Mr. Fuld had become the living embodiment

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of the securities firm, creating a top-down culture that sometimes had a military feel to it. Most mornings, Mr. Fuld rode alone in an elevator up to his executive suite. His colleagues simply call him “The Chairman.” And it is telling that press accounts of Lehman’s capital-raising efforts focused entirely on the efforts of Mr. Fuld, and make nary a mention of the 10 other members of Lehman’s board.17

Uncertainties of Business Cycles: JetBlue

The problem with business cycles is that, given their inherent uncertainties, it can be difficult to predict what the next phase in the cycle will be. The “S” curve will emerge over time, but in the short term it can be hard for a company to gauge where it is situated. The JetBlue board, under the direction of its founder, David Neeleman, found itself in these uncertain conditions. When board members realized their company was faltering, they were able to show tough love and shift their leadership—even when it was the founder who needed to be swapped out. JetBlue Airways was founded in 1999 with the premise of “bringing humanity back to air travel.”18 Neeleman had had success in the business before—he co-founded his first airline, Morris Air, when he was only twenty-five, and later sold it to Southwest Airlines, the leading low-lost carrier (LCC) in the industry. He’d also served for three years as the CEO of Open Skies, the company that helped develop e-ticket technology. When JetBlue opened for business in 2000, Neeleman distinguished it from other airlines by offering such perks as seatback television, comfortable seating, and blue corn chips. In the company’s own words: “No exorbitant airfares, no cattle-train mentality, no hassles. In their place, add simplicity, friendly people, technology, design, and entertainment. JetBlue is a different kind of airline . . . younger, fresher, and more innovative. We’re looking at creative ways to reduce the hassles of flying and simplify the travel experience.”19 Despite its emphasis on how it differed from existing airlines, JetBlue also emulated some of the most successful features of Southwest Airlines, such as investment in human resources.20 This mix of innovation and emulation worked. At a time when big airlines were losing money, JetBlue continued to post profits, and the forty-year-old Neeleman became an icon in the airline industry. Delta and United soon launched their own LCCs to compete with the budding airline.

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But, even given its initial success, the question remained: Could the fledgling company really “fly” in such a difficult industry? As Warren Buffet once remarked, if capitalists had been present at Kitty Hawk when the Wright brothers’ plane first took off, they should have shot it down. When JetBlue entered the market, the U.S. airline industry faced daunting problems. Fuel costs were high, and even airlines that had made successful hedges against these higher costs, like Southwest, were straining under the pressure. Coupled with that were the large fixed costs—namely, aircraft— and a consistently competitive environment. Despite these industry difficulties, JetBlue’s position as a second-tier airline was advantageous. “The second tier, composed of newer airlines that never put in place huge legacy costs before deregulation unleashed price competition, limits the top tier’s ability to pass along costs to customers.”21 JetBlue seemed to have the right business plan to succeed in a difficult market. Initially flying only between New York and Florida, the airline expanded to California, Utah, and Vermont during its first few months of business and celebrated its millionth flyer before its one-year anniversary. It launched international service in 2004 and continued to expand its domestic service. However, in 2005, JetBlue began to falter under the weight of increased fuel prices and its own rapid expansion. Discussing the full-year results in 2005, Neeleman said, “We are very disappointed in our performance this quarter as we continued to feel the effects of record-high fuel prices and a tough revenue environment, compounded by the impact of Hurricane Wilma and the residual effects of Hurricanes Katrina and Rita. Although we saw a 7.4 percent increase in revenue per available seat mile (RASM) in the face of 25 percent capacity growth, it was not nearly enough to offset the impact of high fuel costs.”22 JetBlue continued to lose money in 2006, and just as business was picking up in 2007, the East Coast was hit by a paralyzing snowstorm over Valentine’s Day weekend. Unlike other airlines, JetBlue did not heed weather warnings and did not cancel flights until it was too late. In a business disaster that the press dubbed the “Valentine Massacre,” thousands of customers were stranded on planes and in airports, with some customers stuck at John F. Kennedy airport in New York City for days. In response, the company released a press report stating: “JetBlue apologizes to customers who were impacted by the ice storm at our home base of operations in New York, specifically at John F. Kennedy International Airport,” and gave a full refund and a free round trip to any costumer kept onboard planes for more than three hours.23 More candidly, spokeswoman

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Jenny Dervin said, “We ran into an operational death spiral. We let our customers down, and we’re terribly sorry it happened.”24 JetBlue’s initial rise and subsequent fall are a good illustration of the uncertainties of the business cycle, and this case provides a good platform for exploring both how a CEO’s style impacts the company and how “tough love” from the board can be used when this style is no longer working. Neeleman, with one successful airline behind him and the drive to get companies started, was obviously in his element during JetBlue’s infant years, but he was also cognizant that the company required flexibility from its leader as it expanded in 2006 and 2007. I heard Neeleman describe his leadership capabilities in his own words during a lecture for a group of MBA students in the marketing club at Columbia Business School on January 23, 2007. He was very forthcoming about his leadership style and its accompanying strengths and weaknesses. He was well aware of the realities facing JetBlue at that point. Although his business had gotten through its startup phase and was starting to build momentum, he recognized that 2005 had been a point of inflection. Efficiency and cash flow became the priority when the company started to falter, and it was important to know the “numbers” on an hour-by-hour basis so that JetBlue could change fares as needed rather than staying locked into a standard rate structure. Although Neeleman had the right entrepreneurial, innovative style and industry know-how to get the business started, he knew he wasn’t the right person to lead a detail-oriented intervention. Operational efficiency is more the diet of an analytical style, a process person tied to an operational drive that thrives in the tactical, and the company changed its revenue management leadership to address this. However, despite his awareness of his own shortfalls as a leader, Neeleman’s innovative spirit shone through during the lecture and he excitedly discussed new plans for the company such as letting the customer buy the middle seat and spread out during coast-tocoast flights. As it turned out, Neeleman would have little time to develop these ideas. On May 10, 2007, three months after the Valentine’s weekend debacle, Jet Blue announced the appointment of Dave Barger to the position of chief executive officer, replacing Neeleman immediately, while retaining his responsibilities as president. “This is a natural evolution of our leadership structure as JetBlue continues to grow,” Neeleman said. “As Chairman of the Board of Directors, I will focus on developing JetBlue’s long-term vision and strategy and how we can continue to be a preferred product in a commodity business.”25

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The board also realized that Neeleman’s leadership style no longer fit with the needs of the company and showed the tough love necessary to get the business back on track. The board confronted Neeleman after the “Valentine Massacre” and they jointly arrived at the decision to replace him as chief executive. Circumstances are not ideal when a board assesses its CEO at a time of crisis, and it is an even more unique challenge when the founder is at the helm. Indeed, from my discussions with people involved with the company at the time, the members of the board all had considerable admiration for Neeleman and the fact that he knew of his shortfalls as a leader indicates that he was in communication with his board about what kind of leadership style was best for the company. However, after the events in February, it must have become clear that despite their amiability toward him and regard for him, Neeleman had to be replaced. This is an example of tough love in action. The positive results of this change in leadership were immediately apparent, with the company reporting a net income of $18 million in 2007 compared with a net loss of $1 million in 2006.26 This was the first profitable year the company had had since 2004. Dave Barger emphasized at the release of the 2007 Annual Report that soaring fuel prices contributed to their fourth quarter loss, they believed they were well positioned to move into 2008 with a strong brand, superior product and solid financial position.27 At the first edition’s writing, JetBlue had been affirmed as a unique offering in the airline industry, receiving top honors in three categories in the 2008 Zagat Airline Survey: “Best Large Domestic Airline” for economyclass seating, “Best Inflight Entertainment” for domestic flights, and “Most Eco-Friendly” airline. In 2009, the company was named the “Top Low-Cost Airline for Customer Satisfaction” by J. D. Power and Associates. Southwest Airlines continues to be the gold standard of LCCs, but JetBlue has made its mark through its innovative and unique offerings to its customers. From this observer’s standpoint, JetBlue appears to be navigating safely through the competitive turbulence of the low-cost-carrier business environment. And, as a follower of the creative leadership of David Neelemnan, I look forward to watching his career in the airline industry develop. Although he stayed with JetBlue for a year as chairman of the board, on April 8, 2008, he notified the Corporate Governance and Nominating Committee that he would not be standing for reelection at the annual meeting. He was leaving to do what he’d done successfully twice before—found an airline. In December 2008, he launched the Brazilian domestic airline Azul, which had already captured 5 percent of the market by July 2009. The JetBlue board, by showing

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Neeleman tough love when the company was faltering, both regained success for the company and freed Neeleman to pursue other endeavors. The airline business is a very difficult one under any circumstances and the board must constantly assess and adjust its leadership in order to survive. Finding the right partnership between the board and its CEO is central to a company’s success. When JetBlue was in a period of growth, it was a perfect match for David Neeleman’s entrepreneurial style; but as the business expanded, a more operationally efficient leader was needed. It took a crisis to make the change but the change was made. How is a board to know when this change needs to happen? The best advice is to assume your business is always at the point of inflection and to be prepared to make a shift in practices and encourage your CEO to do the same. The following chapters offer additional guidance. Because a CEO’s leadership style is so central to a company’s success, boards can benefit from those who study CEO tenure and company performance as well as the requisite leadership behaviors to achieve success at the various stages in the life cycle of their business. If the board doesn’t address these realities with the appropriate amount of tough love, the company and CEO can become dysfunctional.

CASE STUDY: PROCTER & GAMBLE IN 2013: A BOARD ADRIFT?

By: William M. Klepper ID#140419, Published on December 5, 2017 INDIVIDUAL, BUSINESS

AND SOCIETY Abstract In the wake of the company’s recent poor financial performance—and activist investor William Ackman’s actions—Procter & Gamble CEO Bob McDonald stepped down from his role in May 2013. P&G’s board quickly replaced McDonald with his predecessor, A. G. Lafley. Did the board act in the best interest of the company during these turbulent times?

Introduction The Procter & Gamble Company (P&G) board of directors faced a challenge in 2013. Well-known activist investor William Ackman, whose hedge fund, Pershing Square Capital Management, had acquired 27.9 million shares of P&G stock worth about $2.2 billion in 2012, was exerting strong public pressure on the company’s CEO, Robert A. McDonald—calling him unfocused, insisting on faster progress in the company’s cost-cutting efforts, and ultimately lobbying for his removal.

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This case explores the duties and responsibilities P&G’s directors owed the company’s stakeholders—its shareholders, employees, and executives—as they responded to Ackman’s public statements. To what extent did Ackman’s efforts influence their decision making, and, most crucially, did they make the right call? As P&G’s board considered Ackman’s overtures, a number of related governance questions emerged: Given how the board was composed and structured, was it prepared to handle an activist shareholder like Ackman? What are the implications of a board composed of “all-star” members? Should board members, early in McDonald’s tenure, have approved a strategy that bet the company’s fortunes on emerging markets? For what other missteps might the P&G board be held accountable? Had the board provided for adequate succession planning? Was the board sufficiently independent of the CEO—either in structure or in fact? Most importantly, how do boards maintain their own internal integrity in the face of an activist investor? Ripe for the Picking? At the time Ackman began placing pressure on P&G’s board, the company had failed to meet the ambitious goals the storied consumer products firm’s thirteenth CEO had laid out when he took the reins after the retirement of his predecessor, A. G. Lafley: r
When the board appointed McDonald to the chairmanship in July 2009, P&G’s revenue was $75 billion. r
McDonald set a bold goal of $102 billion in revenue by 2013. r
In 2012, however, P&G was nowhere near McDonald’s goal, with revenue at $83.7 billion. r
The company’s net revenue had declined 20 percent since 2012. The situation at P&G was perhaps ripe for the picking by Ackman, an activist shareholder who had made his career—and some $1.2 billion28—buying large stakes in public companies, taking a seat on their boards, and using his position to influence corporate strategy at the highest levels. Ackman would typically exit his position once the company’s stock moved in response to his changes. At first blush, McDonald’s missteps seemed apparent. He had staked P&G’s fortunes on an aggressive push into emerging markets, a challenging space where giant consumer products firms—including P&G’s archrival Unilever— were already well established. But McDonald believed his emerging markets strategy was the correct one for the company’s long-term growth, and, publicly at least, he wasn’t concerned about the short-term losses and missed earnings forecasts his company was racking up under his leadership. During the tenure of McDonald’s predecessor, Lafley, P&G had revamped its structure for

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developing new products and creating new markets with the goal of cutting costs and shortening the product development cycle. The goal of this effort, dubbed Connect + Develop (C+D), was twofold: establish an assembly-linelike process for creating new brands and pioneering new markets; and cut costs. Using the Connect + Develop program, P&G forged partnerships with outside firms to create new products rather than relying solely on in-house research and development. Writing in the Harvard Business Review in 2006, two P&G executives described the C+D program as crucial to the company’s future. “By 2000, it was clear to us that our invent-it-ourselves model was not capable of sustaining high levels of top-line growth.”29 The program was successful at controlling costs but, according to industry observers, it had also made P&G’s innovation less dynamic.30 McDonald, who believed in the cost-cutting mission his predecessor had outlined, kept Lafley’s C+D program in place when he took over, even as he reiterated P&G’s commitment to developing new products and markets. In a 2011 article in the Harvard Business Review, McDonald said, “We know from our history that while promotions may win quarters, innovation wins decades.” At the time, P&G was spending nearly $2 billion a year on research and development, a significantly lower percentage of revenues than previous decades.31 P&G Company Background William Procter, a candle maker, and James Gamble, a soap maker, established their firm in Cincinnati in the early nineteenth century, when the two men married sisters Olivia and Elizabeth Norris. Their father-in-law convinced them to become business partners and they opened Procter & Gamble in an office on the corner of Sixth and Main Streets in 1837. Growth and expansion into new markets were part of P&G’s DNA, and by 1859 the company had attained more than $1 million in annual sales and employed eighty people. By 1890, the company opened its first manufacturing facility outside Cincinnati, in Kansas City, followed in 1915 by a new plant in Ontario, Canada. To meet the growing demand for its products, the company engaged in almost constant expansion. “As each new plant opened, P&G would embark on plans for another.”32 In 1930, the company purchased Thomas Hedley & Co. Ltd., the English manufacturer of Fairy Soap, one of P&G’s most venerable brands. It marked the company’s first foray overseas. Marketing and research were the other pillars of P&G’s success. The company was among the first in the United States to build a laboratory for researching and developing new products, and its marketing innovations—the company invented the soap opera in 1934 to advertise its products to housewives—are legendary.

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In the three decades following World War II, P&G continued to expand overseas, first in Mexico, then in continental Europe and Japan. One tenet of P&G’s marketing strategy was that it was crucial to have a presence on the ground in these new foreign markets in order to better understand the local consumer. “By 1980, P&G was doing business in 23 countries around the world, with sales of nearly $11 billion and earnings 35 times greater than in 1945.”33 The year 1993 was the first that overseas sales accounted for more than 50 percent of P&G’s revenues, a proportion that stood at approximately 60 percent in 2013. As the twenty-first century dawned, however, the company’s fortunes took a different turn. In July 2000 P&G stock hit bottom, dropping 50 percent in the space of several months. Lafley, who had taken the helm in June, refocused P&G on a set of core concepts the company refers to as its Purpose, Values and Principles.34 Within five years, Lafley had led the company to a 40 percent increase in sales and a doubling of net revenue, and he had overseen a $70 billion increase in market capitalization. Lafley’s strategy had been simple yet effective; he focused the company’s formidable marketing prowess on its biggest-selling brands. P&G did not have a lock on the consumer staples space, however, and the company faced stiff competition from companies such as Colgate-Palmolive and Kimberly-Clark. The Anglo-Dutch consumer staples giant Unilever had been P&G’s archrival for decades and was well established in the emerging market space from which Lafley and his successor believed its revenue growth would come. Over the course of its modern history, P&G maintained a remarkable continuity at the helm, with just twelve CEOs in twelve decades. Having successfully led the company to doubling its sales during his tenure, Lafley enjoyed a hero’s exit in 2009. A CEO for a Turbulent Era In July 2009, the board named Lafley’s handpicked successor, Bob McDonald, as chairman and CEO.35 McDonald, P&G’s fifty-nine-year-old COO, was a company man who had spent much of his thirty-year career working in its nonU.S. operations in Canada, Japan, and the Philippines, among other posts.36 McDonald’s accession to the top job at P&G had been the product of a careful, years-long succession planning process. As Lafley put it, “We benchmarked internal candidates against strong external CEOs that our directors knew. We  concluded that an outside option wasn’t needed and wouldn’t be as good a fit for P&G.”37 The difference between the outgoing and incoming CEOs was striking. A native of New Hampshire, Lafley was a genial, professorial presence in the

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boardroom who began his career at P&G as a brand assistant for Joy dishwashing liquid. In a 2002 profile, Fortune magazine dubbed him “the ‘un-CEO’ ” and member of “a new breed of turnaround specialist” whose forte was not rallying the troops but rather listening to them—a marked contrast to the superstar CEOs of many of P&G’s peer firms.38 Lafley’s predecessor, the legendarily combative Durk Jager, had suddenly retired in early 2000, shortly after the dot-com bubble burst and P&G shed $70  billion—half its market value—in the ensuing stock market correction. Jager served just seventeen months at the head of a company that prizes stability and longevity in its leadership; his tenure as CEO was the shortest in P&G’s history. McDonald, who had served for five years in the 82nd Airborne Division after graduating with an engineering degree from West Point, was by contrast a bit more removed from his top executives. While Lafley had achieved success by rebooting Olay as a high-end beauty brand and shepherding Swiffer and Febreze to billion-dollar status, McDonald believed that the key to reinvigorating P&G’s fortunes lay in systematizing processes and increasing efficiency. The company McDonald inherited in 2009 was relatively healthy, with twenty-three brands with at least $1 billion in annual sales, including Pampers, Gillette, Crest, and P&G stalwart Tide. To maintain its competitive edge, P&G spent heavily in research and development (R&D) of new products, to the tune of approximately $2 billion annually. The company, however, was not without its problems. The firm—known for not only launching new products but also conjuring up entire new product categories—hadn’t had a successful launch since the late 1990s when Swiffer and Febreze hit the market. While large in total terms, P&G’s R&D spending during Lafley’s tenure relative to its competitors had been in a steep decline, a reflection of Lafley’s determination to cut costs. (See exhibit 1, P&G R&D chart.) Moreover, Lafley had implemented a power-sharing structure that gave human resources and marketing executives more sway over product areas at the expense of brand managers, who were the heart of P&G’s creative dynamism. Lafley’s laudable goal had been to foster a collaborative ethos among his executives. This decentralized approach to decision making grew more complex under the process-obsessed McDonald, and three or four executives often had to sign off on decisions as simple as the wording on a bottle of laundry detergent. Brand managers no longer felt a sense of ownership over their product areas and morale suffered as a result.39 Under McDonald, the company attempted to maintain its long-held focus on developing innovative products with the C+D program and more moderate investment in in-house R&D. At the same time, McDonald planned for an

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Exhibit 1: P&G’s Research & Development Budget as a Share of Total Sales During Lafley’s Tenure

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Source: Lauren Coleman-Lochner and Carol Hymowitz, “At Procter & Gamble, the Innovation Well Runs Dry,” BusinessWeek.com, September 6, 2012, graphic “Losing Its Innovation Lead,” http://www.businessweek.com/articles/2012-09-06 /at-procter-and-gamble-the-innovation-well-runs-dry.

aggressive and renewed push into emerging markets, where it would go toe-totoe with well-established companies in that space, including Colgate-Palmolive and Unilever. P&G’s 2010 Annual Report contained a succinct summation of the strategy under McDonald: “P&G’s single, unifying growth strategy is rooted in our enduring purpose: We will grow by touching and improving more consumers’ lives in more parts of the world . . . more completely.” P&G served 4.2 billion customers globally in 2010, and McDonald set an ambitious goal of serving 5 billion consumers by 2015. McDonald and His Board A board of directors has two basic roles: to hire and fire the CEO and to approve the CEO’s strategy. What role did the board play in approving and/or refining McDonald’s aggressive emerging markets strategy? Was making a large bet on emerging markets the optimal course of action, particularly given Unilver’s well-established presence in many markets, particularly British Commonwealth nations such as India?

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In March 2012 McDonald announced an aggressive expansion into China and the construction of a new manufacturing facility in the southern city Guangzhou. The plant, slated to begin operating in the second half of 2013, would provide baby care products including Pampers to the rapidly growing Chinese market. The investment was the first stage of a long-term $1 billion commitment to China by 2015. The move reflected McDonald’s belief that the developed markets of North America and Europe had reached a saturation point and that volume growth and market share expansion would come from serving customers in the vibrant economies of the emerging world. McDonald set a goal of building twenty new manufacturing facilities in China, Brazil, and Eastern Europe by 2015 and adding 1 billion new consumers to P&G’s customer base.40 McDonald’s push into emerging markets was accompanied by cost cutting at home and he laid out his goals in P&G’s 2012 annual letter to shareholders: “Earlier this year, we announced our objective of delivering $10 billion in cost savings by the end of fiscal year 2016. This program includes $6 billion of savings in cost of goods sold, $1 billion from marketing efficiencies, and $3 billion from non-manufacturing overhead.”41 Despite McDonald’s best efforts, P&G struggled during this period, with net earnings down and the stock largely flat, even as P&G’s competitors were outperforming it in the crucial emerging markets space. Yet this statement from the 2012 Annual Report indicated the board’s ongoing commitment to McDonald’s strategy: “We see significant remaining growth opportunities as our business in developing markets is still smaller as a percentage of sales than the developing markets businesses of some of our competitors, and we will continue to focus on growing our business in the largest and most important of these markets.” Enter Activist Investor Ackman Ackman’s reputation as an activist investor42 preceded his involvement with P&G. He had been at the center of recent tumult at J. C. Penney Company, where the board, at Ackman’s urging, replaced its CEO and undertook a remake of the company, with a resulting 30 percent drop in revenue. Ackman himself lost $500 million during his involvement with J. C. Penney and was ultimately forced off the board. Ackman founded Pershing Square Capital Management in 2004 and quickly guided it through a series of high-profile activist campaigns. His first notable investment was in Wendy’s International, where Ackman amassed enough stock to become the quick-service restaurant giant’s second-largest shareholder. He used his influence to force the firm to spin off its popular Canadian donut chain, Tim Hortons, whose 2006 IPO raised $670 million. Ackman also successfully pressured Wendy’s to return more money to its shareholders in the form of dividends

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and share buybacks and spend less on store improvements. After a dispute over CEO succession, Ackman exited his Wendy’s position in September 2006.43 In addition to Wendy’s and J. C. Penney, Ackman had launched activist campaigns against McDonald’s Corporation, Target Corporation, and Herbalife International, where he stirred controversy in early 2013 by publicly attacking the nutritional and weight loss supplement company as a pyramid scheme and took a billion-dollar short position in its stock. Fellow activist investor Carl Icahn clashed publicly with Ackman over his Herbalife claims and shares of the company’s stock rose more than 110 percent through December 2013.44 Ackman Versus McDonald In 2012 Ackman revealed that Pershing Square Capital Management held roughly 1 percent of P&G’s shares, making him one of P&G’s largest shareholders. He immediately began agitating for change at the consumer products giant. His initial overtures to P&G’s board of directors—at least those publicly disclosed to the press—were peaceable. He described P&G’s board as “first class” and made clear that his expectation was that the board would do the right thing. Ackman, however, did not spare McDonald in his public statements and criticized him for a lack of focus, his inability to achieve adequate performance in emerging markets, and the slow pace of cost cutting.45 As it turned out, Ackman’s criticisms of P&G may have had merit. In 2012, analysts began criticizing the company along the lines Ackman had laid out. McDonald’s dual role as CEO and chairman and the board’s clubby roster of superstar CEOs were also characteristics that analysts who track corporate adherence to good governance practices often criticize. “Not only does this suggest an incredibly strong fraternity of like souls, but directors who are active CEOs or are otherwise overcommitted may have difficulty devoting sufficient time to their other board obligations.”46 Ackman decided to take his public critique of McDonald private and in September 2012 he met with two of P&G’s directors—Kenneth Chenault, the CEO of the American Express Company, and W. James McNerney Jr., the chairman and CEO of the Boeing Company—to make the case for McDonald’s ouster. Details of that meeting have not been publicly disclosed, but when news of the summit was reported in Bloomberg BusinessWeek later that month, P&G’s board reiterated its confidence in McDonald. McNerney vowed in a public statement that P&G’s directors were monitoring McDonald’s strategy and added, “The board also wholeheartedly supports Bob McDonald as he leads its implementation.”47 In the wake of this public contretemps and the embarrassing disclosure of Ackman’s private meeting with McNerney and Chenault, McDonald intensified

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his efforts to get P&G back on track and, potentially, blunt Ackman’s attempt to oust him. As Pershing Square’s history with Wendy’s and other target companies had demonstrated, Ackman tended to use his leverage to pressure boards to return cash to the shareholders, either in the form of one-time dividends or share buybacks. In November 2012, P&G announced an aggressive $4 to $6 billion stock buyback program for 2013, something that McDonald had strenuously argued against earlier in the year. The announcement came a month after P&G reported that its fiscal 2013 first-quarter profit had declined 6.9 percent and sales were off 3.7 percent.48 McDonald also took this opportunity to reiterate P&G’s cost-cutting goals, including plans to lay off between 2 percent and 4 percent of the company’s workforce, and reaffirm the “40-20-10” strategy he articulated in P&G’s 2012 annual report. In short, McDonald had charted a course to growth by pledging to refocus the company on its forty most profitable products, its twenty largest innovations, and the ten developing markets with the highest growth potential.49 For his part, Ackman remained undeterred, responding, “We’re delighted to see the company’s made some progress, but P&G deserves to be led by one of the best CEOs in the world. We don’t think Bob McDonald meets that standard.”50 On January 25, 2013, McDonald led the quarterly earnings call with Wall Street analysts at which he announced a 12 percent increase in earnings per share, handily beating the consensus forecast, but it was not enough to placate Ackman. At the eighteenth annual Ira Sohn Investment Conference, held at New York’s Lincoln Center on May 8, 2013, Ackman delivered a presentation in which he detailed Pershing Square’s P&G investment thesis. Ackman described the company as “one of the ‘great businesses’ of the world” but maintained that it was wildly underperforming given its “intrinsic earnings power.” As part of his presentation, Ackman posted a slide listing the twenty-one different corporate and philanthropic boards on which McDonald was then serving.51 McDonald’s Exit On Thursday evening, May 23, 2013, P&G issued a press release announcing that McDonald would officially step down on May 30 and that Lafley would come out of retirement and return to his former role as CEO and chairman of the board.52 Under unrelenting pressure from Ackman and another disappointing quarter at P&G, McDonald had finally resigned and Lafley was brought back in to take his place. Publically, McDonald’s exit was described as a resignation of his choosing, rather than an ouster by the board.

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Nonetheless, we are left to wonder about Ackman’s role in bringing about the change in CEO. To what extent should a board pay attention to an activist’s public pressure for a change in CEO? What is the board’s duty in such an instance? Is there a sense that the P&G board may have given in to the pressure created by Ackman? Perspectives on the Board’s Role P&G’s board was composed of high-profile executives from a variety of companies, but there was a split between insiders and outsiders on the board that, given P&G’s strong culture, may have posed governance problems. Many members of the board were regarded as first-class or had all-star reputations. They were highly respected business minds running leading companies, including Boeing, American Express, Archer Daniels Midland Company, and WellPoint. (See exhibit 2.) Director loyalty is crucial, and the laws against self-dealing are clear and strict. In this regard, there had been a recent black mark on the P&G board. Rajat Gupta, the former managing director of McKinsey & Company, had resigned his directorship under the cloud of an insider trading investigation by the SEC in 2011. Gupta was later convicted of conspiracy and securities fraud and sentenced to two years in federal prison. The black-letter fiduciary duties of P&G’s corporate board members are set forth in the corporation’s statutes and case law of the state of Ohio, but in practice, one of a director’s most important—if not the most important—roles is to act as a check on the CEO and be willing, when necessary, to replace him. In this chapter, I outlined the five attributes of the “tough love” that is required of directors. They must: 1. 2. 3. 4. 5.

Know the CEO’s behavioral style and leadership practices. Know the organization’s needs (strategy, priorities, and gaps). Match the organization’s needs with the leadership that is required. Look first at the CEO and then at the senior team to find the correct match. Look elsewhere if the correct match isn’t found.

The board’s role is particularly important during succession planning. In the timeframe of this Procter & Gamble case, the board had two important leadership decisions to make: replacing Lafley in 2009 and replacing McDonald in 2013. Again, as mentioned in this chapter, “[t]here is a hierarchy of needs in every organization that is typically expressed in its strategy, priorities, and the performance and opportunity gaps—the measurable difference between the current and desired future state.” If there is a mismatch between the current needs of the organization and the leadership practices of the CEO, then that is the point where the board must intervene, either with guidance (tough love) or action, such as removing the CEO. (See exhibit 3.)

Exhibit 2: P&G Board of Directors in 2013 Board Composition The Board of Directors at P&G consists of men and women who are leaders in the fields of business, government, law, medicine and education. The Board has general oversight responsibility for the Company’s affairs pursuant to Ohio’s General Corporation Law, the Company’s Amended Articles of Incorporation and Code of Regulations and the Board of Directions’ By Laws. In exercising its fiduciary duties, the Board of Directors represents and acts on behalf of the Company’s shareholders. Additional details regarding the role and structure of the Board are contained in the Board’s Corporate Governance Guidelines. Angela F. Braly Former Chair of the Board, President and Chief Executive Officer of WellPoint, Inc. (healthcare insurance). Director since 2009. Age 52. Member of the Audit and Governance & Public Responsibility Committees. Kenneth I. Chenault Chairman and Chief Executive Officer of the American Express Company (financial services). Director since 2008. Also a Director of International Business Machines Corporation. Age 62. Member of the Audit and Compensation & Leadership Development Committees. Scott D. Cook Chairman of the Executive Committee of the Board of Intuit Inc. (software and web services). Director since 2000. Also a Director of eBay Inc. Age 61. Chair of the Innovation & Technology Committee and member of the Compensation & Leadership Development Committee. Susan Desmond-Hellmann Chancellor and Arthur and Toni Rembe Rock Distinguished Professor, University of California, San Francisco. Director since 2010. Age 56. Member of the Audit and Innovation & Technology Committees. A. G. Lafley Chairman of the Board, President and Chief Executive Officer of the Company. Director since 2013. Also a Director of Legendary Pictures. Age 66. Terry J. Lundgren Chairman, President and Chief Executive Officer of Macy’s, Inc. (a national retailer.) Appointed to the Board on January 8, 2013. Also a Director of Kraft Foods Group. Age 61. Member of the Governance & Public Responsibility and Innovation & Technology Committees.

W. James McNerney, Jr. Chairman of the Board, President and Chief Executive Officer of the Boeing Company (aerospace, commercial jetliners and military defense systems company). Director since 2003. Also a Director of International Business Machines Corporation. Age 64. Presiding Director, Chair of the Compensation & Leadership Development Committee and member of the Governance & Public Responsibility Committee. Margaret C. Whitman President and Chief Executive Officer of Hewlett Packard since September 2011. Former President and Chief Executive Officer of eBay Inc. (ecommerce and payments company) from 1998 to 2008. Director since 2011. Also a Director of Zipcar. Age 57. Member of the Compensation & Leadership Development and Innovation & Technology Committees. Mary Agnes Wilderotter Chairman of the Board, Chief Executive Officer of Frontier Communications Corporation (communications company specializing in providing services to rural areas and small and medium-sized towns and cities). Director since 2009. Also a Director of Xerox Corporation. Age 58. Member of the Audit and Compensation & Leadership Development Committees. Patricia A. Woertz Chairman, Chief Executive Officer and President of Archer Daniels Midland Company (agricultural processors of oilseeds, corn, wheat and cocoa, etc.). Director since 2008. Age 60. Chair of the Audit Committee and member of the Governance & Public Responsibility Committee. Ernesto Zedillo Former President of Mexico, Director of the Center for the Study of Globalization and Professor in the field of International Economics and Politics at Yale University. Director since 2001. Also a Director of Alcoa Inc., Citigroup, Inc. and Promotora de Informaciones S.A.. Age 62. Chair of the Governance & Public Responsibility Committee and member of the Innovation & Technology Committee.

Source: Procter & Gamble, “Board Composition,” http://www.pg.com/en_US /company/global_structure_operations/governance/board_composition.shtml.

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Exhibit 3: The CEO Alignment Model  $ERDUGQHHGVWRIXOO\XQGHUVWDQGLWVRZQVWUDWHJLFFRQWH[W DQGLQWHQW²FROOHFWLYHO\LWVVWUDWHJ\²EHIRUHLWFDQKRSH WRHQJDJHSURGXFWLYHO\LQWKHSURFHVVRIVHOHFWLQJD&(2 2QO\WKHQFDQWKHERDUGPRYHRQWRWKHQH[WVWHS  'HWHUPLQHJLYHQWKHFRPSDQ\·VSRVLWLRQWKHDJHQGD SUDFWLFHVDQGVW\OHUHTXLUHGRILWV&(2  7KHERDUGPXVWDVVHVVWKHDOLJQPHQWRIWKHOHYHUVRILWV EXVLQHVVV\VWHPVWUXFWXUHSURFHVVSHRSOHFXOWXUH DQG LGHQWLI\DQ\JDSVEHFDXVHWKHVHJDSVZLOOEHFRPHWKH &(2·VVWUDWHJLFSULRULWLHV7KHILQDOVWHSRFFXUVDVDUHVXOW RIWKHILUVWWKUHHVWHSV  $FKLHYHDGHJUHHRIFRQJUXHQFHEHWZHHQWKHVWUDWHJ\WKH &(2DQGWKHEXVLQHVVV\VWHP &(2$JHQGD SUDFWLFHVDQG VW\OH 6WUDWHJLF FRQWH[W &XVWRPHUV &RPSHWLWRUV &RPSDQ\ ZKHUHLQLWV EXVLQHVV F\FOH" (QYLURQPHQW

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Source: Klepper, CEO’s Boss, 70, Figure 6.1, “CEO Alignment,” adapted by William Klepper, 2008, from D. C. Hambrick and J. W. Fredrickson, “Are You Sure You Have a Strategy?,” Academy of Management Executive, 15, no. 4 (2001); Tushman and O’Reilly, 2001).

As mentioned in chapter 6, there is a four-step process for determining whether a prospective CEO aligns with the needs of a business. The board must: 1. Understand its own strategic context and intent, i.e., its strategy, before it can begin the CEO selection process. 2. Determine the company’s position and the agenda, practices, and style required of its CEO. 3. Identify key gaps in structure, process, people, and culture, because these gaps will become the CEO’s strategic priorities. 4. Achieve a degree of congruence among the strategy, the CEO, and the business system.

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Rethinking Lafley’s Reappointment Whether or not the board chose to remove McDonald or was simply reacting to Ackman’s aggressive overtures, it did most decidedly choose Lafley as McDonald’s successor, giving him days of notice—rather than weeks or months.53 Was Lafley the best choice for the role? Some industry insiders, including Jason Tauber, a research analyst with the Large Cap Disciplined Growth team at Neuberger Berman Group (which then held 8.7 million P&G shares), suggested that bringing back Lafley “highlights poor succession planning by the board.”54 In the wake of the sudden change at the top, many additional questions emerged relating to the performance of P&G’s board: r
Does the all-star nature of a board, which included luminaries from the highest echelons of business and politics—including Archer Daniels Midland CEO Patricia Woertz; Frontier Communications Corporation CEO Maggie Wilderotter; and former president of Mexico Ernesto Zedillo—necessarily translate into the extraordinary leadership qualities that are required to oversee a giant multinational corporation? r
Did board members have enough “skin in the game”? The lack of large shareholders—both individuals and institutional—on the board was an additional concern. According to Frank Feather, chairman of Torontobased corporate strategy consulting company Geodevco. “There should be some directors who own significant amounts of shares that were not paid for or issued to them by the company. Directors should have skin in the game.”55 r
Finally, was the board sufficiently autonomous? Did the directors fulfill their fiduciary duty to the shareholders by acquiescing to Lafley’s choice of McDonald in the first place? Or did the board rely too heavily on the expertise and will of a storied CEO? Lessons Learned At the 2013 meeting of the FT-ODX conference, the case of P&G board’s handling of its CEO’s strategy and activists was discussed. Throughout this book, I stress that there is a hierarchy of needs in every organization that is typically expressed in its strategy, priorities, and the performance and opportunity gaps—the measurable difference between the current and desired future state. If there is a mismatch between the current needs of the organization and the leadership practices of the CEO, then that is the point where the board must intervene, either with guidance (tough love) or action, such as removing the CEO. It was expected that Lafley would lead a successful second turnaround of P&G during his second term as CEO. He definitely left at the end of his first term as a hero, but at the end

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of the first year of his second term he has yet to significantly move the needle on the P&G stock price from where McDonald left it—around $80 per share. Lafley did not achieve a turnaround during his second coming. David Taylor replaced Lafley in November, 2015. Taylor, like Lafley and McDonald, was an inside candidate who joined P&G as a production manager right out of college. Today, Taylor and the P&G board are facing another activist investor, Nelson Peltz, whose Trian Fund Management owns $3.3 billion PG stock and is looking to boost shareholder return.56 In the future, it is recommended that the P&G board look both inside and outside the company for the best match of a CEO for its needs.

Summary r
Boards can benefit from those who study CEO tenure and company performance. r
There are specific leadership agenda, practices and behaviors needed to achieve success at the various stages in the lifecycle of their business. r
Knowing the organization’s needs (strategy, priorities, and gaps), look first at the CEO and the senior team to find the correct match, look elsewhere if the correct match is not found. r
Not addressing the mismatch of the CEO’s agenda, practices, and behavior can result in the CEO and the company becoming dysfunctional. r
Activist investors will seize on the indecisiveness by the board to confront a mismatch.

3 Why the Right Partnership Matters

Point of Inflection: A moment of dramatic change, especially in the development of a company, industry, or market.

In the opening chapter, the social contract—a clear set of behavioral statements willingly subscribed to by the board and CEO—was prescribed to strengthen and maintain the partnership between these parties. In chapter 2, tough love was presented as a requirement to make this partnership work. These two elements are crucial to a company’s survival. Every board needs to face the reality that business cycles are unavoidable and uncertain, and the board and CEO must be willing to work collectively to meet the challenge of changing conditions.

Leadership Style

As was depicted in table 2.1, each stage of the business cycle requires a specific leadership practice. And, as was depicted in figure 2.2, each stage requires a specific agenda. The CEO’s practices and agenda, which describe what the CEO does, are important, but how the CEO carries them out and the leadership style used can make the difference between success and failure. My work with leadership styles draws from the “social styles,” developed by TRACOM, the company founded by David Merrill and Roger Reid.

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In the 1980s, I taught the social styles material in an MBA course with Martha Stodt, a fellow faculty member from Columbia’s Teachers College. The course was called Managing Interpersonal and Group Dynamics; today it would be called Social Intelligence. We had previously published a book and designed and developed workshops along the same theme. When I moved to Columbia Business School from my executive leadership role at the College of New Jersey in 1996, I began to focus my executive education teaching more on executive leadership, but I continued to apply the social styles material in that work. The Klepper Leadership Model that was published in Noel Capon’s Key Account Management and Planning (2001) was one of the first iterations of that application.1 My article “What CEOs Have Yet to Learn,” published in Effective Executive, reports on my research on the leadership practices of CEOs. The information presented in this chapter is the natural evolution of that research and the research of others (A. Henderson, D. Miller, and D. C. Hambrick; J. M. Kouzes and B. Z. Posner). It illustrates my continued application of the social styles material of Merrill and Reed to CEO and board leadership strategies. I’ve worked with executives over the last twenty years in the application of this social style model to leadership. First, the executive takes a social style assessment, which yields a description of how assertive and how responsive a person is. One can both self-assess and have others provide this assessment (a “360” assessment). The social style model is based on the assertive and responsive dimensions that are measured by this assessment (figure 3.1): r
Assertiveness—the degree to which people see themselves as tending to “ask” (ask assertive) or as tending to “tell” (tell assertive) in their interactions with others r
Responsiveness—the degree to which people see themselves as tending to “control” (keep feelings and emotions inside) or “emote” (outwardly display feelings and emotions with others)

Combining these dimensions produces a fourfold social style scheme (figure 3.2) r
Driving—tell assertive/control r
Expressive—tell assertive/emote r
Amiable—ask assertive/emote

r
Analytical—ask assertive/control

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As Capon’s Key Account Management and Planning explains, a social style is: the most persistent, socially evident, pattern of behavior that a person demonstrated to others. All social styles have value, but people interact differently with one another based on these observable, repetitive patterns of behavior. The driver is primarily assertive, serious and makes an effort to tell people what they think and require. The expressive is more willing to make their feelings public and is decisive and forceful. The amiable displays feelings openly, but is less assertive and more interested in being agreeable and cooperative. The analytical person tends to ask questions, gather facts, and study data seriously.2

I have expanded on this research to define the leadership styles appropriate to various business stages. Combining the CEO agenda and practices from chapter 2 with the CEO style and situating all these in terms of the business cycle can give us a complete idea of the CEO’s leadership requirements (table 3.1). An understanding of each style’s need, orientation, and response to stress in interactions with others can provide additional understanding of a CEO’s leadership style. However, although each individual may tend naturally toward a certain style, this does not mean that leadership styles are fixed. Most CEOs have one primary style and one or more secondary styles that they can draw on when necessary. Since businesses are constantly changing, the most successful CEOs can modify their leadership styles to suit their company’s needs. Jack Welch, onetime CEO of General Electric (GE),

Table 3.1

The CEO’s Leadership Requirements The business cycle

CEO agenda

CEO practices

CEO style

Low success/beginning time frame

Low success/beginning time frame

Low Success/beginning time frame

Rising success/early time frame Growing success/ middle time frame Peak success/late time frame

Experimenting; trying new things Enduring; doing what works Converging on the status quo

Inspire the future

Low success/ beginning time frame Expressive

Enabling others

Amiable

Model the way

Analytical

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is a prime example of a versatile leader. As I present each style, I will discuss how and when Welch adopted it in his leadership of the company and I will offer examples of other CEOs whose leadership styles have or have not worked for their companies.

Driver Leadership

CEOs with a driver style need to see results from their work with others, and they approach work from an “action” orientation. Driver-type leaders work effectively when these conditions exist; but if they are not seeing results from their actions, they will take control until things change. Driver behavior is most helpful during a downturn in a business cycle— a “trough,” as it is often called—such as at the start of Jack Welch’s tenure as CEO at GE. Welch made drastic changes to the company as soon as he arrived, downsizing from 411,000 employees at the end of 1980 to 299,000 at the end of 1985. These major cuts earned him the nickname “Neutron Jack.” Just like a neutron bomb, which damages people but not buildings, Welch left the infrastructure of GE intact but eliminated many of the jobs. A closer look at the driver style can provide a fuller understanding of Welch’s leadership practices and of why he was so adept at taking action and achieving results (figure 3.3).

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Driver leadership. Source: Adapted from Merrill and Reed and updated in “Improving Personal Effectiveness with Versatility,” The TRACOM Corporation, 2007.

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When Welch became CEO, he knew that he couldn’t wait for change to happen on its own. He acted appropriately as a new CEO, challenging the status quo and making dramatic cuts across the board. By 1982, Welch had gutted the leadership team of his predecessor, Reginald Jones. And he went to extreme measures to ensure that the company ran with maximum efficiency, infamously firing the bottom 10 percent of his managers every year. Known for his candor, Welch did not apologize for this practice, and wrote in his book Winning (2005): “As for the bottom 10 percent in differentiation, there is no sugarcoating this—they have to go.”3

Expressive Leadership

CEOs with an expressive style need approval of their vision for the future and they have a “spontaneous” orientation to their work. To put it succinctly—they trust their gut. I’m not surprised that Welch chose Straight from the Gut as the title of his first book. It was well known that he confronted poor performance when he saw it, and this is the prototypical reaction to stress by an expressive. If businesses couldn’t achieve the goals he set for them, Jack would “close, fix, or sell” them. This style, diagrammed in figure 3.4, was used by Welch during the rising success of GE. It is characterized by a willingness to experiment and try new things.

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Expressive leadership. Source: Adapted from Merrill and Reed and updated in “Improving Personal Effectiveness with Versatility,” The TRACOM Corporation, 2007.

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GE came out of its trough during Welch’s early tenure, and under him annual revenues grew from $27 billion in 1980 to almost $130 billion in 2000. As the company grew, Welch took on the qualities of an expressive leader, and he used these strategies in concert with his characteristic driver style. He was able to challenge the status quo through his driver behavior but also to inspire others through his expressive behavior. These two styles worked well for him as he responded to the mandate of change from the board and the need to redefine the future of GE. The ability to look toward the future is another hallmark of an expressive leader and Welch demonstrated his future-oriented mindset when he acquired NBC in 1986. In 1919, GE founded RCA, which grew into an industrial giant. It returned to its media roots through this acquisition. However, along with these positive expressive traits, Welch also showed some of the negative ones. For instance, some view GE’s acquisition of Kidder as an impulse buy. The company was involved in a trading scandal shortly after being acquired by GE and was quietly sold off to PaineWebber in 1994. Another downside to an expressive leadership style is a short attention span when it comes to routine activities. This explains why many entrepreneurs populate this style—they would rather move on to the next big idea than deal with the nitty-gritty of seeing a project through. David Neeleman, JetBlue’s founding CEO, is an example of this style in action. Such leaders can become bored with process improvement as their daily diet. Nonetheless, Jack Welch understood that attending to routine matters was necessary, and he sought outside resources to support these efforts. In 1995, for instance, Welch adopted Motorola’s Six Sigma quality program. If you have a mature product line, you can reap greater return from your portfolio by manufacturing and delivering products in the most efficient and effective way possible. Six Sigma quality is a proven practice to provide efficient and effective processes and resultant outcomes. Ed Kangas, whom I observed during my work with Deloitte beginning in the mid-1990s, is a prototypical expressive leader. As the global head of Deloitte Touche Tohmatsu (DTT), he inspires his partners to embrace the vision of seamless global service for its clients—then among the “big eight” firms, today among the “big four” still standing.

Amiable Leadership

CEOs with an amiable style seek a sense of personal security in their work with others. Their leadership is oriented around the quality of their

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Amiable leadership. Source: Adapted from Merrill and Reed and updated in “Improving Personal Effectiveness with Versatility,” The TRACOM Corporation, 2007.

relationships with those being led. This leadership style is most effective in a period of growing success, a time when the business is enduring and a culture is being established based on “what works for us” (figure 3.5). Jack Welch was no amiable leader, but he surrounded himself with amiable personalities who shared his vision and goals for the GE businesses. Welch’s appreciation for amiable leadership was most apparent in his commitment to GE’s Leadership Development Center at Crotonville, renamed the John F. Welch Leadership Development Center after he retired. There was a concerted effort to build quality relationships between and among the managers of GE, and the amiable leaders at Crotonville allowed GE managers to interact and learn the “GE way of doing things” in an unhurried, supportive, and secure environment. Welch continued to be the agent of change but at Crotonville managers were given the space to improve the processes for implementing this change. During his tenure, Welch routinely visited Crotonville to interact with the managers. (The only year he didn’t was in 1995, when he was recovering from triple bypass surgery.) Welch used Crotonville and the amiable leadership within the Leadership Development Center to reinforce his strong interest in shareholder value. He knew that this was the way that GE would endure and that Crotonville was where values like this could be ensured. GE’s former chief learning officer, Bob Corcoran, says, “Crotonville is embedded in the GE

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culture and the GE values. All of our major change initiatives—cultural change and business change processes—have either originated at Crotonville as a result of best practice assessments and evaluations or executive leadership summits, or have been broadcast, trained, amplified or rolled out with Crotonville as the change agent. We owe to our shareholders the absolute best management team we can field.”4 The amiable leadership style has achieved even more credence since Jim Collins completed his work on “good to great” companies. Along a spectrum from “highly capable individual” to “level 5 leaders,” he classed as “level 5 leaders” those CEOs who had, over time, built strong cultures and leveraged a set of beliefs and behaviors that drove their organization’s success.5 David Neeleman had this amiable style in his overall leadership package as CEO of JetBlue. Although he was primarily an expressive leader, as are most entrepreneurs, he believed that innovation plus a service culture was JetBlue’s competitive advantage. Another example of an amiable leader is GE’s former CEO Jeff Immelt, who replaced Welch. Immelt confirmed to me in a conversation that amiable leadership was his style and that it was in contrast to Jack Welch’s driving style. He continuing to build the GE culture but suffered from the comparison with his predecessor’s unprecedented results. During Immelt’s tenure, the terrorist attack of 9/11 and the deep recession confronted his capability to confront crises. By Immelt’s retirement in October 2017, GE’s total shareholder return had significantly lagged behind the broader market.6

Analytical Leadership

CEOs with an analytical style are strongly driven to “get it right” and their orientation is to “think things through.” Analytical leaders look for trends in the data in order to predict outcomes and this makes them more cautious and deliberate in their actions. As a result, their efforts are directed at organizing for success. Due diligence is the hallmark of their work and their singular mission is to “discover truth” and to maintain the peak performance of the business. Since facts rule, relationships are not a major consideration (figure 3.6). Continuous improvement is the focus of the analytic CEO. Jack Welch showed this analytic quality to his leadership in his adoption of Motorola’s Six Sigma quality program. He knew that GE’s businesses had reached the number 1 or number 2 position in their fields but to keep

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Analytical leadership. Source: Adapted from Merrill and Reed and updated in “Improving Personal Effectiveness with Versatility,” The TRACOM Corporation, 2007.

them there he needed to make efficiency and effectivity top priorities. Larry Bossidy, whom Welch chose to lead his Six Sigma program, went on to become a successful analytic CEO himself. Bossidy’s book Execution (2002) tells how he transformed Allied Signal into one of the world’s most admired companies, whose success was characterized by an intense focus on growth and the Six Sigma—driven productivity that he became known for while at GE.7 Jack Welch increased his versatility as a leader by surrounding himself with the right people for the needs of GE. Another paradigmatic analytic is former Procter & Gamble (P&G) CEO, A. G. Lafley. Before his retirement in July of 2009, I observed him during a three-day workshop at the Army Work College and can attest to his analytical skills. This style is a perfect match for P&G’s drive for continuous improvement of its product offerings. Analytical leaders are at their best at the peak of success on the business cycle. Unfortunately, this can also be the point of inflection for the business. As noted in chapter 1, Coke’s Doug Ivester was known as a strong analytical leader, but his inability to adopt any other styles of leadership made him an ineffectual CEO. His board had turned to him after the untimely death of Roberto Goizueta, an expressive leader, presumably with the idea that hiring the existing number 2 would help business continue as usual.

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However, the contrasting styles of the CEOs created too stark a transition for the business and the board. Ivester led the business as he had when he was COO under Goizueta—using an analytical style that complemented, but was not a substitute for, Goizueta’s leadership. In some cases, however, this transition from one type of CEO to another is exactly what a company needs. When driving/expressive leaders run into problems with their transformational strategies and the business is failing, analytical leaders, with their emphasis on incremental change, are often sought out by the board. A struggling business can be turned around by someone who understands the numbers and knows the trends of the business and industry. Rather than demand an abrupt change in the leadership style of the CEO, another option the board has is to hire consulting agencies to do the analytical thinking for them. This is often a more realistic option than tackling the problems themselves, as it is rare that a CEO and board have time to collectively engage in the situational analysis that is required to assess and redefine its business strategy. The advantage of an outside consultancy is that they are removed from the organization’s personal relationships and can offer an objective assessment of the current state. However, the downside is that the CEO and board don’t do any of the strategic thinking themselves, and thus it can be difficult for them to fully understand the proposed strategic changes. In an Agenda article, I called for more involvement of board members and the CEO with these consultancies while situation analysis is occurring. “When boards and managements haven’t gone through the hard work of thinking strategically, they can’t do the process of deciding strategically. There are just no shortcuts.”8

The Right Alignment, the Right Partnership

These four leadership styles, with their corresponding CEO practices and agenda, can all be charted on the business cycle. This chart, which I’ve dubbed the Integrated Leadership Model (ILM), shows the interplay of all the elements a board must consider in aligning its CEO with the needs of the business (figure 3.7). To use the ILM, the first question a board must ask itself is, “Where is the business?” Is it a start-up? Is it in a trough and in need of a turnaround? Is it creating new products or services, experimenting with new ways of doing things? Is it a leader in the industry at its peak performance

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and prospering by following a successful strategy? Is it seeking to get even better at what it does—or is it destined to become dysfunctional? At each one of these points on the “S” curve the board should assess its CEO’s practices, agenda, and leadership style to determine if it is aligned with the company’s current situation. Often the most helpful thing a CEO can do is manage change so that the company can adapt to the ever-changing business cycle. The work of Michael Beer, Warner Burke, and others reinforces a formula for this process.9 To manage change a leader needs to create Dissatisfaction with the current state, offer a Vision of the future and a Process to get there in order to overcome the natural resistance to Change: D × V × P > C.10 The driver leader is strongest at challenging the status quo, thus creating dissatisfaction. The expressive leader’s strength is to inspire the future with a compelling vision. The analytical leader is best at modeling the way by defining a process for achieving the vision. The amiable leader has the desire to enable others during the change process that lowers their natural resistance to change. The board must understand both its CEO’s leadership style and the company’s point on the business cycle if it is to help the CEO manage change. In the transition from Goizueta to Ivester at Coke, the board should have assessed where the company was in the business cycle before hiring a CEO with a leadership style so dramatically different from that of his predecessor. I suspect they didn’t have the luxury of time to make that assessment. However, had that assessment occurred, it would most probably

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have included a discussion of Coke’s experimentation with the brand (New Coke) and its position as the leader in the industry. According to my model, then, an amiable leader would have made for successful transition. People at Coke were feeling disoriented and insecure about the future of Coke after the death of Goizuetta, and it was a time to put a priority on relationships and stability. JetBlue’s changeover from David Neeleman to Dave Barger is an example of a successful assessment and transition to a new type of leader. During the start-up phase, Neeleman was the ideal man for the job. He was an expressive leader, with the added advantage of an amiable subset and he believed that innovation and a service culture would help JetBlue compete with the industry’s leader, Southwest Airlines. However, when business started to fail and especially after the Valentine Massacre, the board had to ask whether it had reached a point of inflection and needed a change in leadership. By appointing Dave Barger to the position of CEO, the board moved toward a more analytical driving leadership style for the company, appropriate when a business needs to be turned around. However, had the board done a more regular and honest assessment of how its leadership aligned with the needs of the business, it might have been able to make productive changes to leadership and avoid the Valentine Massacre completely. I had a discussion with John Mowell about CEO transitions. Mowell was the board chairman of EMS Technologies, a company that designs and manufactures innovative wireless, satellite, and defense solutions. He had applied this integrated leadership model to his company’s succession planning and CEO choice and he affirmed from his experience that there are seasons of a CEO’s tenure and that they can be either aligned or misaligned with the needs of the organization. EMS’s past success is a testament to the board’s ability to achieve the right partnership by reexamining its CEO’s capability at each stage of its business lifecycle. EMS had experienced one downturn in 2005 from its high in 2004 and experienced yet another in 2006, just when business seemed to be picking up. The board started to look for a CEO whose leadership agenda, practices, and style could confront these fluctuations in its business cycle. As a result, Paul Domorski was brought in to replace Alfred G. Hansen, CEO since 2001. EMS’s rise in performance through 2007 confirmed that Domorski had the leadership style needed to turn around the business. The company concluded 2007 with the healthiest cash balance in its forty-year history, and was named one of Forbes magazine’s Best Small Companies in 2007.

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The lesson learned from each of these case studies is that boards have something to learn from those who study the tenure, performance, and ideal leadership behaviors of CEOs for each stage of the business. Boards can foster the right partnership between their CEO and their business by using the integrated leadership model I’ve proposed. However, if this model is adopted too late in a CEO’s tenure, it can be difficult to make productive changes. Note that at the furthest extension of the business cycle is a point at which it is too late to align the leadership with the needs of the business. In the earlier work that I cited on the seasons of a CEO, the fifth and final stage is a state of dysfunction. The CEOs take relatively few actions to address the performance of the business and their outside interests increase. This is the point at which the CEO becomes obsolete and must be removed—tough love in the boardroom. However, this bleak outcome is not the only possibility. CEOs can reinvent themselves when they are at that point of inflection by starting a second wave of the “S” curve, which acts as a new beginning for the business before it moves into decline. When business is at its peak, this is the time to revisit the assumptions that support the existing business model and ask if the situation those assumptions were based on has changed. At this point, it is still possible to renew the business model and reexamine the way things are done around the business. The ideal leader to “restart” the business is one with both an analytical style, to make sense of the changing conditions, and a driving style, to challenge the status quo and embrace the change that is needed. If CEOs don’t want to become obsolete, they need to modify their leadership style when it is required or surround themselves with a leadership team with the qualities they lack.

CASE STUDY: THE WOUNDED WARRIOR PROJECT IN 2016

By William M. Klepper ID#170405, Published on October 28, 2016

A Veteran’s Organization Under Fire It was February 2016, and Steven Nardizzi, cofounder and CEO of the Wounded Warrior Project (WWP),11 sat in his office at the WWP campus in Jacksonville, Florida., and considered his options for responding to the latest spate of unfavorable coverage of his organization in the press. In January, CBS News had aired several stories, including a widely viewed segment on the CBS Evening News, alleging that the Wounded Warrior Project and its leadership had spent too

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lavishly on fundraising events and marketing at the expense of the wounded military veterans it ostensibly served. The New York Times had followed up with a similar story later in the month. To Nardizzi, the unfolding crisis was more than a headache that could tarnish his personal reputation. In his mind, the organization he had helped found and lead through a remarkable period of growth was facing a crisis of public confidence, one that threatened to undermine the important work it had done and continued to do as one of the largest and most effective nongovernmental organizations in the United States serving military veterans. These recent allegations were in sharp contrast to the mission espoused by the organization’s founders. In 2003, Nardizzi and several friends and veterans were moved to action by the stories of the first wounded service members returning home from Afghanistan and Iraq. The genesis of the WWP had been simply a desire to provide comfort items to wounded service men and women, but it had quickly grown into a multimillion-dollar, multifaceted rehabilitative effort to assist veterans as they transitioned back to civilian life. Many associated with the WWP had served directly in the armed forces and all lived and breathed the organization’s mission: to honor and empower wounded warriors. Their commitment was unquestioned and unwavering. Indeed, the organization could rightly look back on many successes. According to the organization’s key performance indicators, WWP had served a total of 92,351 veterans and 20,238 family members.12 Revenues to fund programs were over $262 million for FY 2015 (year ending in September) and were being directed to a range of programs and services, with costs closely monitored relative to program effectiveness. (See exhibits 1A and 1B for financial statements for WWP for FY2015.) In addition to what Nardizzi viewed as bias in the unfavorable portrayal of the WWP in the press, the coverage had been a huge distraction that had come at a delicate moment in the organization’s evolution. Over the previous thirteen years, the scale and scope of the WWP had grown exponentially in terms of its size, funding, and program offerings. The rapid growth and remarkable success of the WWP had tested Nardizzi and his team’s managerial and business leadership capabilities. Importantly, with the end of the U.S. presence in the conflict zones, awareness of veterans, their sacrifices, and ongoing needs would likely fade from top of mind and the result would be a decline in funding to groups like WWP. But the mental and physical needs of the veterans would not fade. WWP consulted with Professor William Klepper of Columbia Business School about best practices to sustain the organization going forward, leading to a collaboration with Korn Ferry International, a consultancy firm with specialized knowledge in the area of corporate governance. Taking Klepper’s advice, the governance committee made a decision to reduce the number of positions

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Exhibit 1A: Consolidated Statement of Financial Position

September 30, 2015 Assets Current assets: Cash and cash equivalents Investments Contributions receivable, net Inventory Prepaid expenses Total current assets Property and equipment, net Security deposits Beneficial interest in trust Total assets Liabilities and net assets Current liabilities: Accounts payable Accrued expenses Total current liabilities Net assets: Unrestricted Temporarily restricted Permanently restricted Total net assets Total liabilities and net assets

$ 75,369,143 281,759,434 4,286,599 2,574,485 17,402,679 381,392,340 16,359,127 989,018 766,950 $ 399,507,435

$ 22,556,219 5,601,014 28,157,233 369,378,069 972,133 1,000,000 371,350,202 $ 399,507,435

Source: Company documents.

on the board, to add some “fresh blood” to the board composition, and to establish an advisory board. With the media scrutiny now taking center stage, Nardizzi worried that the days of WWP “doing everything right” could be over for good. He got up from his desk and headed out into the corridor; a brisk walk had always helped him clear his mind. The Conflict and Its Veterans The WWP served the veterans of two significant wars. The first was the war in Afghanistan, which began in 2001 and broadly referred to the intervention by the United States and its allies in a mission to dismantle the al-Qaeda terrorist

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Exhibit 1B: Consolidated Statement of Activities

For the year ended September 30, 2015 Revenue and support: Contributions In-kind contributions Interest and dividend income, net of investment fees Net realized and unrealized loss on investments Miscellaneous income Net assets released from restrictions Total revenue and support Program expenses: Total program expenses Supporting expenses: Management and general Fund-raising expenses Total supporting expenses Total expenses Changes in net assets Net assets, beginning of year Net assets, end of year

Unrestricted

Temporarily restricted

Permanently restricted

Total

$ 381,041,310 104,095,155 5,737,770

$ 16,597 — 26,921

$— — —

$ 381,057,907 104,095,155 5,764,691

(8,902,954)

(61,668)

—

(8,964,622)

1,915,564 134,698

— (134,698)

— —

1,915,564 —

484,021,543 308,715,167 308,715,167

(152,848) — —

— — —

483,868,695 308,715,167 308,715,167

15,495,026 74,078,845 89,573,871 398,289,038 85,732,505 283,645,564 $ 369,378,069

— — — — (152,848) 1,124,981 $ 972,133

— — — — — 1,000,000 $ 1,000,000

15,495,026 74,078,845 89,573,871 398,289,038 85,579,657 285,770,545 $ 371,350,202

Source: Company documents

organization and remove the Taliban government from power. The second war, Operation Iraqi Freedom, was announced in 2003 by then-President George W. Bush with a stated mission to rid Iraq of its dictator and that government’s ability to develop weapons of mass destruction. At the end of August 2010, President Obama announced the U.S. combat mission had ended, though several thousand military personnel remained in the country carrying out programs in cooperation with the Iraqi government. In June 2011, President Obama announced that 10,000 U.S. troops would withdraw from Afghanistan by the end of the year, with the drawdown to continue until 2014, when the United States hoped the Afghan government would be capable of maintaining security in the country. Subsequent setbacks in Afghanistan, however, led to a number of delays in that plan.13

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Over 2.5 million service people14 were deployed to Afghanistan and Iraq during the course of the conflicts. Of that 2.5 million, more than one-third were deployed more than once, and, as of 2012, “nearly 37,000 Americans had been deployed more than five times, among them 10,000 members of guard or reserve units. Records also show that 400,000 service members undertook three or more deployments.”15 Of those deployed, more than 6,600 U.S. service members died, with another 51,960 wounded in action. According to a report dated February 2013, 103,792 service members had been diagnosed with post-traumatic stress disorder and 253,330 with traumatic brain injury. Further, 1,715 service people had battle-injury amputations.16 (Exhibit 2 provides a summary of casualties; exhibit 3 summarizes numbers by disability.) Approximately 1.6 million of the 2.5 million who served in the conflicts had transitioned to veteran status, with over 670,000 granted disability status and more than 100,000 further claims pending classification. Afghanistan and Iraq veterans were producing more disability claims per veteran than any other U.S. wars had. For example, although more service people (58,000) died in Vietnam, the total number of documented disabilities suffered by recent veterans was similar in number. By 2015, the Department of Veteran Affairs (VA) was responsible for the nation’s almost 22 million veterans.17 The VA had 8.6 million enrollees in its healthcare system18 and, as of 2012 (the last year for which statistics were available), administered 7.0 million life insurance policies, provided 3.5 million veterans with disability compensation, and another 300,000 with VA pensions. In addition, the VA administered 1.8 million VA home loans, offered educational benefits to 920,000, and provided vocational training to 60,000.19 The VA delivered its services through 300 Veteran Centers, 56 regional offices, 817 VA communitybased outpatient clinics, 152 VA hospitals, and 131 national cemeteries. Healthcare costs for veterans were significant. For fiscal year 2015, the VA spent $65.6 billion on medical care for veterans.20 Several factors underlay the cost—better field care and medical advances resulted in higher survival rates than in earlier conflicts; many who survived lost limbs and would need care for the duration of their lives; and longer tours of duty resulted in increased long-term mental health issues. The average cost of treating veterans with post-traumatic stress disorder was four to six times greater than those without that condition. The VA estimated that up to 20 percent of veterans who served in Operations Iraqi Freedom and Enduring Freedom suffered from the disorder. The VA’s costs for care were expected to increase rather than decrease. Linda Bilmes of Harvard’s Kennedy School of Government noted in a 2013 paper that rather than decreasing, injuries compounded over time, with the peak years for compensation twenty to fifty years after the conflict (e.g., peak of 1969 for World War I veterans, the 1980s for WWII veterans). More than 50 percent of veterans

Exhibit 2: Casualty Statistics OPERATION IRAQI FREEDOM (OIF) U.S. CASUALTY STATUS∗ FATALITIES AS OF: MAY 2, 2014, 10 a.m. EDT

OIF U.S. military casualties OIF U.S. DoD civilian casualties Totals

Total deaths

KIA

Nonhostile

Pending

WIA

4,410 13 4,423

3,481 9 3.4 90

929 4 933

0

31,941

0

31,941

OPERATION NEW DAWN (OND) U.S. CASUALTY STATUS∗∗ FATALITIES AS OF: May 2, 2014, 10 a.m. EDT Total deaths OND U.S. military casualties OND U.S. DoD civilian casualties Totals

66 0 66

KIA

38 0 38

Nonhostile

Pending

WIA

28 0 28

0

297

0

297

OPERATION ENDURING FREEDOM (OEF) U.S. CASUALTY STATUS FATALITIES AS OF: May 2, 2014, 10 a.m. EDT OEF U.S. military casualties Afghanistan only*** Other locations**** OEF U.S. DoD civilian casualties Worldwide total

Total deaths

KIA

Nonhostile

Pending

WIA

2,181 132 3 2,316

1,805 11 1 1,817

376 121 2 499

0 0

19,551 171

0

19,722

*OPERATION IRAQI FREEDOM includes casualties that occurred between March 19, 2003 and August 31, 2010 in the Arabian Sea, Bahrain, Gulf of Aden, Gulf of Oman, Iraq, Kuwait, Oman, Persian Gulf, Qatar, Red Sea, Saudi Arabia, and United Arab Emirates. Prior to March 19, 2003, casualties in these countries were considered OEF. Personnel injured in OIF who die after 1 September 2010 will be included in OIF statistics. **OPERATION NEW DAWN includes casualties that occurred between September 1, 2010 and December 31, 2011 in the Arabian Sea, Bahrain, Gulf of Aden, Gulf of Oman, Iraq, Kuwait, Oman, Persian Gulf, Qatar, Red Sea, Saudi Arabia, and United Arab Emirates. Personnel injured in ONO who die after December 31, 2011 will be included in ONO statistics. ***OPERATION ENDURING FREEDOM (Afghanistan only) includes casualties that occurred in Afghanistan only. ****OPERATION ENDURING FREEDOM (other locations), includes casualties that occurred in Guantanamo Bay (Cuba), Djibouti, Eritrea, Ethiopia, Jordan, Kenya, Kyrgyzstan, Pakistan, Philippines, Seychelles, Sudan, Tajikistan, Turkey, Uzbekistan, and Yemen. WIA cases in this category include those without a casualty country listed. Source: www.defense.gov/news/casualty/pdf

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from the conflicts were between eighteen and thirty-two and were expected to live for another fifty years. As such, it was expected that their injuries would likely lead to more complex and expensive health issues.21 WWP Deputy Executive Director Albion (Al) Giordano22 had explained the challenge this way: You have to understand that for all intents and purposes, these young men and women are never going to be cured, certainly not the severely brain injured with the co-morbidity of severe physical injuries, but there is no cure even for combat stress. What we can do is provide coping skills and mechanisms to alleviate some of the symptoms, so that they can continue to lead productive lives. We have to build for the long term—someone who presents as well today may be afflicted 15 to 20 years from now. Further, we never had to deal with the severe brain-injured population because in the past they didn’t make it off the battlefield. The easy approach would be to put them in a nursing home for the rest of their lives, be it 40, 50, 60 years, but they have earned a better quality of life.23

Exhibit 3: Military Injuries 2000–201238 Table 3.2

Annual New Post-Traumatic Stress Disorder Diagnoses in All Services (as of December 7, 2012) Year

Not deployed

Deployed

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 (to December 3rd)

1,610 1,694 1,697 1,609 1,777 1,912 1,893 2,272 2,589 2,676 2,638 2,806 2,376

0 0 133 1,100 3,095 7,015 7,745 11,763 14,405 13,975 14,828 15,702 14,031

Total

27,549

103,792

2000 2000 450 4,150 6,326 37

10,963

Incident diagnoses Incident diagnoses Severe or penetrating TBI Moderate TBI Mild TBI Not classifiable

Total incident diagnoses

11,830

2001 2001 478 3,553 7,760 39

12,470

2002 2002 380 3,077 8,974 39 12,898

2003 2003 449 2,643 9,770 36 13,312

2004 2004 463 2,281 10,536 32

Traumatic Brain Injury (TBI) 2000–2012 Q2 (as of August 20, 2012)

Table 3.3

Exhibit 3: (Continued)

12,211

2005 2005 407 1,906 9,857 41 16,958

2006 2006 521 2,466 13,919 52 23,174

2007 2007 591 3,708 18,665 210 28,567

2008 2008 686 3,343 21,859 2,679 29,255

2009 2009 809 3,751 22,673 2,022

31,407

2010 2010 553 4,294 24,989 1,571

33,149

2011 2011 525 4,822 25,564 2,238

17,136

2012 Q1-Q2 2012 Q1-Q2 164 2,089 13,669 1,214

253,330

2000–2012 Q2 2000–2012 Q2 6,476 42,083 194,561 10,210

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Table 3.4

Individuals with Battle-Injury Amputations by Service for OIF/OND and OEF (as of December 3, 2012) Theater

Type of amputation

OIF/OND

Major limb (e.g., leg) Minor limb (e.g., partial foot, fingers) Major limb (e.g., leg) Minor limb (e.g., partial foot, fingers)

OEF

Total

Army

Marines

Navy

Air Force

Grand total

613 156

161 31

16 4

7 3

797 194

394 16

273 8

16 1

13 3

696 28

1,179

473

37

26

1,715

Source: CRS communication with Dr. Michael Carino, Army Office of the Surgeon General, December 13, 2012.

Beyond the VA, there were 40,000 nonprofit organizations that focused on the needs of veterans. Generally speaking, they were divided into three segments: large, national veteran’s service organizations (American Legion, USO, WWP); small and mid-size local organizations that served within a given community; and hospitals, universities, drug treatment centers, and faith-based organizations. Wounded Warrior Project The Wounded Warrior Project was founded in 2003 when five friends and family members, including Nardizzi and Giordano, solicited $5,000 from family and friends and put together backpacks containing simple comfort items. They brought them to two VA medical centers and distributed them to veterans who had been injured and taken to those centers. According to the organization’s lore, the troops enjoyed them so much that, the next day, the founders received a call asking if they could bring two hundred more to the hospital. A decade later, the WWP remained the same mission-driven organization— existing to honor and empower U.S. military veterans—specifically those who suffered a physical or mental injury after September 11, 2001. The vision of the organization was simple—to focus on those newly injured and “foster the most successful, well-adjusted generation of wounded service members in our nation’s history.” And its purpose was threefold: to raise awareness and enlist the public’s aid for the needs of injured service members; to help injured servicemen and women aid and assist each other; and to provide unique, direct programs and services to meet their needs.

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By 2015, the WWP had more than 92,000 alumni registered in its database, with a goal of serving 100,000 by 2017.24 Unlike many nonprofit organizations, the WWP did not have members or customers but rather acknowledged those it served as alumni. From its perspective, the word alumni communicated a mutual shared experience. As WWP noted, “WWP alumni have earned their place in our organization and share common bonds of sacrifice.” The nature of the alumni’s injuries varied, but, according to an internal survey of alumni, mental health was the major category of injury and included PTSD25 (78 percent), TBI (51 percent), and other severe mental conditions (22 percent). Physical injuries and mental injuries were not exclusive of each other. Physical injuries included spinal cord injury (19 percent), amputation (8 percent), and severe burns (5 percent), with 59 percent having other physical injuries. The WWP saw itself as significantly differentiated in its programs and approach from the VA and other nonprofit organizations. Nardizzi explained: The government [VA] provides the basic necessities, providing subsistence-level living—providing the disability check, the basic medical care, the access to education, but based on my experience it cannot effectively empower someone. For example, the government cannot wrap their arms around a family and say, we are going to help you maintain your independence and keep you connected to your community. That’s not a government function but rather it is our role to provide that level of support. The government can help them survive, but what Wounded Warrior Project and other community organizations do is help them thrive.26 Programs WWP acted to support the mind, economic empowerment, body, and engagement of its alumni across a wide variety of programmatic offerings. (Exhibit 4 summarizes key programs addressed in these categories.) r
Mind: Mental illness was one of the most prevalent and undertreated conditions for veterans, although it was expected that one in five service people would struggle with PTSD and depression. The burden of these conditions also impacted veterans’ families, as the veteran attempted to deal with the condition and reintegrate back into civilian life. Ongoing challenges to effective treatment included the stigma of mental illness, distance from VA treatment centers, and a focus on the severely physically disabled. WWP’s core offering was its Combat Stress Relief Program, which sought to provide a mental health network and a framework for alumni in their own communities.

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r
Economic Empowerment: Employment after a military career was an ongoing challenge. An internal survey tracking unemployment statistics for alumni noted that in 2015, only 49.7 percent of alumni were employed full time.27 Economic development programs assisted alumni in taking their next step, be it education, training, or career placement. r
Body: Physical health and wellness were critical to the successful adjustment of WWP’s alumni. The organization had developed programs to assist in getting access to healthcare and rehabilitation, and in increasing quality of life. Programs also targeted fitness, nutrition, and adaptive sports. For example, the Soldier Ride was a four-day event in which alumni were fitted with a cycle that met their physical capabilities and participated in a twenty-five- to fifty-mile riding event. r
Engagement: Engagement programs were designed for every stage of the alumni’s transition, from newly wounded to ongoing support. Engagement was fostered on many levels, with alumni events and activities and a magazine, After Action Report, that sought to both inform and inspire. Two primary programs included Benefits Services and Peer Support. Additionally, the Policy and Government group advocated for veterans in lobbying and legislative matters. Revenues and Expenditures To support its programs, WWP engaged in a wide range of funding initiatives from both individuals and corporations. Despite its challenges, WWP raised $373 million in contributions and grants for fiscal year (FY) 2015, an increase of more than $60 million over FY 2014. Indeed, WWP had nearly surpassed the goal it had set for itself in 2013—to raise $380 million in FY 2017—two years ahead of schedule.28 The organization used three main channels to raise funds: direct response (70 percent of funds), major gifts and partnerships (18 percent of funds), and events (12 percent of funds). The direct response channel incorporated direct mail and direct television. While direct mail continued to be a major funding stream, the WWP’s leaders had ongoing concerns about the rising average age of donors, potentially higher postage rates, and possible changes to the deductibility of charitable donations. Direct response television had proven a new and cost-effective fundraising vehicle.29 In 2013, the WWP had secured 100,000 Advance Guard Monthly Giving Program members who collectively donated $2 million monthly. Over time, WWP did not forecast a departure away from these channels but did expect that events would become somewhat less important, with the difference being taken up by the direct response channel as it grew its donors from its current base of 1.8 million individuals. In the future, WWP also planned to

Exhibit 4: WWP Programs

WWP Programs—Engagement Alumni The Alumni program provides long-term support and camaraderie for injured service members through events and discounted services. All our programs are free and designed to provide warriors and caregivers ongoing support as they heal from their combat experiences. WWP Backpacks and Transitional Care Packs Wounded service members receive WWP backpacks as they arrive at military trauma units across the United States. The backpacks are filled with essential care and comfort items such as clothing, toiletries, playing cards, and more—all designed to make a hospital stay more comfortable. Injured warriors overseas who are evacuated from field hospitals to larger military treatment facilities stateside or abroad receive a smaller version of the WWP backpack, known as Transitional Care Packs (TCPs), for immediate comfort. The Family Support Tote offers immediate comfort, convenience, and information to family members of newly wounded service members during a strenuous and exhausting period. Benefits Service The WWP benefits team provides a wide array of services to help warriors access the benefits they need to successfully transition to life after injury. We start by identifying individual needs and match them to the appropriate tools to make warriors financially secure and integrated into the community. Our direct representation ensures claims are filed correctly the first time and warriors have a point of contact at each step of the claims process. We also educate warriors and caregivers about the benefits process so they can become self-advocates. WWP Resource Center The WWP Resource Center serves and supports warriors, their caregivers, and families through a multichannel contact center equipped to meet a wide range of needs. In addition to responding to specific resource requests, the Resource Center representatives actively reach out to warriors and caregivers to engage them in available programs and services. International Programs Wounded Warrior Project continues to grow and expand our programs internationally in Germany at Landstuhl Regional Medical Center (LRMC) and

Ramstein Air Base. LRMC is one of the first locations warriors are transported to after injury and most of the time their belongings are not transported with them. WWP fills that need by providing comfort items such as jackets, sweatpants, t-shirts, and blankets to warriors before they are flown back to the states. Additionally, WWP offers programs and benefits counseling to warriors stationed at Warrior Transition Units (WTUs) in Europe. WWP also supports the doctors and nurses caring for Wounded Warriors through a ‘thank you’ campaign with warrior stories in the form of posters and videos and an appreciation luncheon held twice-a-year, that includes a personal ‘thank you’ visit from the Wounded Warriors who went through LRMC. WWP Programs—Mind Project Odyssey Project Odyssey is a unique five-day event designed to help warriors overcome combat stress by connecting them with trained counselors and peers in an exciting, outdoor setting. Recreational activities are tailored to build warriors’ inner strength and courage as they tackle challenges such as high ropes courses, kayaking, rock climbing, and skiing. The camaraderie developed among veterans also provides a safe setting to share experiences and begin healing from the mental wounds of war. Project Odyssey is also offered to couples and internationally to warriors still on active duty and recovering at Germany’s Landstuhl Regional Medical Center. Restore Warriors Restore Warriors is a website with resources and self-help strategies for warriors living with the invisible wounds of war, such as post-traumatic stress disorder (PTSD), combat and operational stress, or depression. The website, restorewarriors.org, offers videos of warriors sharing their personal experiences and coping techniques and a brief online, self-assessment questionnaire to help warriors and their caregivers find individualized, specific help. Family Support When a service member is wounded, ill, or injured, these changes place tremendous stress on family members, who may find themselves in a new role as full-time supporters or caregivers. These individuals are an integral part of a warrior’s successful recovery and WWP is dedicated to supporting them. In addition to care from our Family Support Team, we provide retreat weekends to give these individuals the opportunity to rest and reflect in a supportive environment of peers.

Peer Support Peer support motivates warriors in transition through one-on-one friendships with fellow warriors who are further along in the recovery process. Our certified peer mentors are excellent resources and listeners who use their own life experiences to help warriors visualize what they can accomplish. Beyond inspiring warriors, peer mentors can also show family members what their warriors can achieve through hard work and dedication. Independence Program The Independence Program provides warriors living with moderate to severe brain injuries or other service-related neurological conditions the tools they need to reach their life goals. Warriors who might otherwise be left in institutional care receive employment coaches, reading tutors, and other resources to set them on a path to success. The goal is the best possible physical, social, and emotional functioning for these severely wounded service members. WWP Programs—Body Physical Health & Wellness Our Physical Health & Wellness program provides recreation, adaptive sports programs, and overall strategies to help warriors remain physically engaged while adjusting to life after injury. Warriors’ physical and psychological well-being are optimized through comprehensive recreation and sports programs, physical health promotion strategies, legislative policy change, and physical rehabilitation designed to help maximize independence. Soldier Ride Soldier Ride is a unique four-day opportunity for warriors to use cycling and the bonds of service to overcome physical, mental, or emotional wounds. Warriors are fitted with a cycle that meets their physical needs, then supported on rides over roads lined with cheering crowds. Along the way, warriors build confidence as they tackle the challenge and gain new peer support from fellow riders. Experienced riders can also enjoy our bicycle clinics and more physically demanding “challenge rides.” WWP Programs—Economic Empowerment TRACK TRACK represents the first whole-life approach to education for injured service members. This one-year program focuses on academic and vocational needs, including: the ability to earn up to 24 credit hours at a local college, health and wellness

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training, and individualized performance and goal-setting training. TRACK offers the ideal environment for students of all ability levels, including those who might not have been successful in traditional academic settings in the past. Transition Training Academy Information technology is one of the fastest growing career fields and the Transitional Training Academy provides service members, their spouse, or caregiver the instruction they need to take full advantage of these employment opportunities. TTA has perfected a unique, blended learning environment designed expressly to meet the learning challenges some warriors live with as a result of their injuries. Weeks of free, hands-on-training leave graduates ready to earn crucial A+ and network security certifications. Warriors to Work Our Warriors to Work specialists provide career counseling and assist warriors with goal-setting, building an effective resume, preparing for an interview, networking, access to internships, and assistance with job placement. These services are also open to registered family members and caregivers. Education Services Education Services is a program designed to educate colleges and universities about the unique challenges injured service members face returning to school. It also provides warriors with the information they need to make better decisions about the schools they choose as a pathway to employment, including how to access the support services needed around post-traumatic stress disorder, physical challenges, and traumatic brain injury.

leverage social media more effectively and anticipated growing its social media audience (e.g., Facebook, Twitter, YouTube, etc.) from 9,400 in mid-2013 to almost 4 million and its social interactions (e.g., replies, mentions, retweets, Twitter direct, etc.) from 1.8 million to almost 11 million by 2017. In addition to its individual donors, WWP had attracted several corporate donors. The highest level of contribution came from Visionaries with donations in excess of $1 million, with Transformers contributing $500,000 to $1 million, and Catalysts contributing at least $250,000. Other donor levels included Sentries, Champions, and Guardians. A further group of donors were characterized as Strategic Partners. While not donors per se, they were active in raising awareness of veterans’ challenges. The WWP leadership team expected this group to become increasingly important as traditional media coverage of veterans’ needs waned postwar. (Exhibit 5 provides a summary of key donors and strategic partners as of early 2016.)

Exhibit 5: Donors and Strategic Partners VISION PARTNERS (AT LEAST $1 MILLION ANNUAL CONTRIBUTIONS) Amazon Bank of America Food Lion Harley-Davidson NFL Southeastern Grocers Thrivent Mutual Funds Under Armour Warner Brothers Entertainment INNOVATION PARTNERS (AT LEAST $500,000 IN ANNUAL CONTRIBUTIONS) Nissan National Association of Collegiate Directors and Athletes StanleyBlack & Decker CATALYST PARTNERS (AT LEAST $250,000 IN ANNUAL CONTRIBUTIONS) Brawny CME Group Hershey Ladies Professional Golf Association Overstock.com SENTRY PARTNERS (AT LEAST $100,000 ANNUAL CONTRIBUTIONS) AT-A-GLANCE (ACCO Brands) BIC Graphic Boston Red Sox Charity Miles Flag Outpost GP PRO J&A Marketing (CamelBak) Jarden (US Playing Cards) NFLPA Survival Straps Victorinox Swiss Army VXI Corporation Source: 2016 Wounded Warriors Project website.

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From a fundraising perspective, Nardizzi and Giordano highlighted their success in focusing on direct response even during the recession of 2008–2009. They recalled: Our needs certainly were not diminishing—our programs needed more resources. Contrarily, we invested more heavily in fundraising as the economy was tanking, opting to focus on getting those individuals who are giving $15, $25, $30 instead of retracting. Then we added direct response television where we could tell a warrior story, show how we were helping and receive a gift and hopefully another when you tell your friends as we get them involved as well. While the increases in revenues helped fund increased program expenditures, WWP remained watchful of its spending, with 81 percent of spending going directly to alumni programs, 15 percent to fundraising activities, and 4 percent to administration. Leadership, People, and Governance (2012–2016) WWP used its core values of fun, integrity, loyalty, innovation, and service (FILIS) as the basis for its leadership. FILIS and teamwork drove action in the organization and guided decision making aligned with the mission of fostering the most successful, well-adjusted generation of wounded warriors in U.S. history. As Giordano noted, “It really is our people who identify the need, who develop the strategy, who implement the strategy, who figure out where the next great opportunity is, programmatically. So if they’re all aligned and they’re all working together as a team, they have the same value set, passion about our mission, they’re going to figure it out and create the next great success.” In 2012 WWP’s board of directors was composed of twelve men and women, with all but two having military experience. (Exhibit 6A summarizes the backgrounds of those on the board in 2012; exhibits 6B and 6C detail the situation in 2016.) In 2013, as WWP looked toward its second decade of service, it prepared a five-year strategic plan and identified three strategic objectives and three enabling objectives. (See exhibit 7.) As part of preparing that plan, several themes came into sharp focus. One significant issue was funding. With the cessation of active military involvement and with it a potential loss of focus by the public on those who serve and who have served, it was expected that public awareness and perhaps even commitment to veteran needs would decline. Some organizations would survive; others might not. But as WWP leadership noted, “many of those organizations have not reached a level of sustainability. Without an equilibrium point, many of them will close, some of them have already started closing.” Key questions included what should WWP do when funding went into decline and

Exhibit 6A: Board of Directors in 2012

Dawn Halfaker, president Anthony Principi, vice president Anthony K. Odierno, secretary Charles Battaglia, member Roger C. Campbell, member Justin Constantine, member

Kevin Delaney, member Ron Drach, member John Loosen, member Guy McMichael III, member Melissa Stockwell, member Robb Van Cleave, member

Source: Wounded Warrior Project, 2012 Annual Report.

Exhibit 6B: Board of Directors in 2016

Anthony Odierno Guy McMichael III Roger C. Campbell Justin Constantine

Richard M. Jones Ken Fisher Richard T. Tryon

Source: 2016 Wounded Warriors Project website.

Exhibit 6C: Advisory Council in 2016

Anthony Principi Matt Cavanaugh Ronald L. Chez J. Scott Di Valerio Ron Drach David Gowel Ron Loosen Edward Meagher Leo Thorsness

William Tobin Charles Battaglia Dan Streetman Joe Petri Michele Flynn Rhonda Ozanian Scott Peters Susan Duncan

Source: 2016 Wounded Warriors Project website.

Exhibit 7: Wounded Warrior Project—2013 Strategic Objectives

Strategic Objective 1: Ensure Wounded Warriors are well adjusted in mind and spirit r
Enhance and expand WWP programs that address the mental health needs of Wounded Warriors and family members. r
Increase and improve the quality of warrior and family access to culturally competent mental health and community services. r
Expand and enhance WWP programs that address the needs of the most severely injured population of Wound Warriors. r
Develop innovative technological and communicative resources to support organizational mental health initiatives and to raise public awareness. Strategic Objective 2: Ensure Wounded Warriors are well adjusted in body r
Maximize the independence and enhance the quality of life of Wounded Warriors through physical activity and engagement. r
Optimize physical fitness and wellness among Wounded Warriors. r
Ensure Wounded Warriors have access to quality healthcare. r
Encourage and support research to improve medical care of prevalent warrelated injuries. Strategic Objective 3: Ensure Wounded Warriors are economically empowered r
Increase career development support and job placement services for Wounded Warriors, their spouses and caregivers. r
Assist Wounded Warriors during the transition to an educational setting. r
Expand vocational training and certification options to provide additional opportunities for economic success and empowerment. r
Provide financial education to Wounded Warriors, spouses, and caregivers to promote future economic stability. Enabling Objectives Enabling Objective 1: Build a community of dedicated, passionate supporters willing to give the time, treasure, and talent needed to meet our organization’s current and long-term objectives

r
Implement a comprehensive communication plan to educate the public about the needs, struggles, and successes of Wounded Warriors.

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r
Develop innovative, meaningful ways to engage our constituents in their daily lives, and through technology, build emotional experiences that strengthen their connection to our mission and vision. r
Grow and protect a sustainable brand to enlist the public’s aid. r
Maintain diverse revenue streams with an ongoing emphasis on individual giving. Enabling Objective 2: Ensure WWP has the right people, processes, and infrastructure to meet the organization’s current and long-term objectives r
Recruit, nurture, and retain a passionate, dedicated, and diverse workforce to provide high-quality service to our constituents. r
Adhere to the highest standards of compliance, public discourse, governance, financial oversight, accountability, and transparency consistent with legal regulations and the rigorous standards of the Better Business Bureau’s wise giving alliance. r
Acquire the infrastructure needed to support WWP operations to provide the highest level of engagement and program service to our constituents. Enabling Objective 3: Outreach and ensure Wounded Warriors remain engaged with WWP and each other r
Provide access to WWP programs and services to ensure Wounded Warriors and their families receive the support they need, and increase their satisfaction with WWP. r
Increase and maintain two-way communication through various resources to recruit, engage, and retain alumni, their family members, and caregivers. r
Provide Wounded Warriors and their families with the representation, training, and resources they need to effectively advocate and support themselves and their peers.

whether failing organizations or their donors represented an opportunity for the WWP to grow. What were the risks and opportunities? If WWP were to continue its progress in “fostering the most successful, well-adjusted generation of wounded service members in U.S. history,” change would be needed. As the team considered the changes, it was clear that the change would need to come from the top—in leadership and direction setting. Notably, it would fall to WWP leadership—specifically the board—to create an environment that would continue to support the organization and its mission.

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What was less clear was whether the existing board and leadership had the skills needed to achieve the strategic goals. A strategy had been defined but questions remained: Did the organization as a whole have what was needed to execute it successfully? Did its leadership have the capabilities necessary to execute the strategy successfully? And was the board sufficiently diverse to see “outside in” and “inside out” of the organization—a skill set that would be increasingly important for the future success of WWP? Working with the consultancy firm Korn Ferry International (see Appendix) and Professor William Klepper of Columbia Business School, the WWP team highlighted three broad areas for consideration: r
Succession Planning: Nardizzi and Giordano were two of the founding fathers of the WWP—would their successors have the skills and competencies to lead the organization forward to the next level? Was there sufficient bench strength for an inside successor to take on an enterprise-wide leadership role? What were the skills and competencies needed to lead the WWP into the next decade? r
The Board: In 2013 WWP’s board had fourteen seats (with two currently unfilled) while most groups with decision-making responsibility functioned optimally with seven to ten members. Should WWP seek to downsize the board? If it needed to change, what should the criteria be? How should board members be evaluated? Did the current board have the core competencies to provide the oversight to get the best possible results? Did board members have the strategic competencies needed to help the WWP face the challenges of the future? Were they thinking ahead to potential successors? r
Advisory Council: A WWP advisory council could be created by a charter and report to the board. Serving a two-year term, members would be advocates and ambassadors of the WWP, creating awareness, raising funds, and creating introductions to potential major donors. Additionally, members would facilitate access to key stakeholders including military leaders and senior government officials. The members would serve twoyear terms and were expected to be representative of the WWP and could potentially include former board members. What role should this council take in the years ahead? The leadership team and the board were responsible for oversight and setting the direction for the future. On the advice of Klepper, the governance committee made a decision to reduce the number of positions on the board, to add some “fresh blood” to the board composition, and to establish an advisory board.

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Anthony Principi, vice president of the WWP board and former secretary of Veterans Affairs, addressed some of the challenges facing WWP in 2014: Today the Department of Veterans Affairs faces numerous challenges, including: allegations of misconduct at several VA medical centers; returning troops with severe battlefield wounds; a burgeoning backlog of claims for disability compensation; and rapidly changing demographics in a declining military and veteran population. As a former Secretary of Veterans Affairs I appreciate the enormity of these challenges and the need for strong and decisive leadership to chart a new course for the VA in the 21st century. The Wounded Warrior Project will play an important role in the VA’s transition, helping to develop innovative programs to meet the needs of today’s wounded warriors. The leadership and staff have propelled WWP to become the finest veterans’ service organization in the country. The future success of WWP in carrying out its mission “to care for him who shall have borne the battle, and for his widow, and his orphan” [President Abraham Lincoln] will rest on the shoulders of today’s and tomorrow’s leaders. WWP’s board of directors has the important responsibility of ensuring that the men and women who bring WWP to life fulfill Lincoln’s charge to care for all who have sacrificed.30 By 2016, the number of WWP offices had grown to eighteen, with 599 employees by FY 2015 working to provide programs for alumni.31 In an annual survey of alumni that measured performance, more wounded veterans had a bachelor’s degree or better in 2015 than in 2014. In addition, more injured service members were working to better their education levels in 2015 over the previous year. The need among wounded veterans was still acute; more than 1 in 3 (35 percent) of those surveyed said they experienced difficulty getting mental health care, had put off seeking mental health care, or did not get the health care they needed.32 In February 2016, two of WWP’s founding fathers still led the organization. Nardizzi was the chief executive officer responsible for the oversight of all aspects of the organization. Prior to taking on the role in 2014, Nardizzi had been the organization’s executive director. Giordano acted as the chief operating officer. Giordano was himself a disabled veteran of the U.S. Marine Corps. January 2016: Unforeseen Challenges Little had Nardizzi and his colleagues suspected when they commissioned the five-year strategic plan in 2013 that WWP would face a serious challenge a mere three years later.

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Nevertheless, there had been some early warning signs. The first murmurings of criticism of WWP from the philanthropy community dated to 2011, when a charity ratings organization alleged that WWP spent a relatively larger amount on fundraising than some of its peer organizations. It was an allegation that was easy, in Nardizzi’s mind, to dismiss. To make WWP as effective as possible, he had been determined to run his organization using principles and best practices from the private sector, which included a large, well-funded marketing campaign to raise awareness—and more importantly money—for veterans of U.S. military service. The amount of money Nardizzi sought to raise was, he acknowledged, large, but in his mind it was scarcely in proportion to the enormous needs of veterans of the conflicts in Afghanistan, Iraq, and elsewhere. These soldiers were returning home with wounds such as traumatic brain injuries that had initially overwhelmed the Department of Veterans Affairs and its publicly funded healthcare system. In 2013, the Tampa Bay Times and the Center for Investigative Reporting (CIR) began publishing the results of a yearlong investigation into prominent charities, including WWP. They found that WWP spent 58 percent of its donations directly on programs for veterans, significantly less than the 73 percent WWP claimed. The discrepancy lay in a widely accepted practice among nonprofits of classifying a portion of their fundraising expenses as charitable contributions in IRS filings. In addition, the Tampa Bay Times and the CIR noted that ten WWP employees earned $150,000 or more, with $330,000 in total compensation for Nardizzi.33 The implication that he was being overpaid irked Nardizzi, who knew that those compensation levels were in line with or lower than similarly situated non-profits. The Tampa Bay Times report led to further scrutiny of WWP by the mainstream media. In September 2014, the Daily Beast published an article quoting veterans and veterans’ advocates—all of whom were granted anonymity—critical of the organization. The unfavorable coverage continued through 2015 and culminated in late January 2016 in a lengthy article in the New York Times and a report that aired on CBS News. Among the allegations: WWP spent nearly 40 percent of its 2014 donations—approximately $124 million—on nonprogram related items such as payroll, marketing, public relations, lobbying, and business-class travel. One former employee recalled purchasing a last-minute ticket to attend an event in Germany for $7,000. Nardizzi’s 2014 compensation was reported as $473,000.34 The Aftermath As the press coverage unfolded, WWP’s board of directors took a number of steps to address the allegations raised by the media. Immediately following the publication of the Times article and the CBS News report, and after several internal meetings with executives and staff, the board hired Simpson Thacher & Bartlett,

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a New York-based law firm with a well-known crisis management practice, and FTI Consulting, a forensic accounting specialist, to conduct an independent and objective review of the allegations reported in the media to ensure they had all of the facts before any decisions were made. The two firms conducted a thorough evaluation of WWP’s policies, procedures, and controls, including a “deep dive,” in the words of one board member, into travel and expense reimbursement policies. This review also included dozens of interviews with current and former employees at various levels of the organization. In early 2016, the board had agreed on at least one means of addressing the ongoing reputational damage to WWP. As then-CEO Steve Nardizzi would learn, managing the situation would soon become someone else’s responsibility. On March 10, 2016, upon receiving the results of the independent investigation, WWP announced that he and COO Al Giordano were no longer with the organization.35 The board concluded that the former CEO and COO had exercised poor judgement on several occasions and negligently failed to implement certain policies and procedures commensurate with an organization the size of WWP. Board Chair Anthony Odierno noted that the board had lost confidence in the ability of the former CEO and COO to successfully lead the organization at a time when change was necessary.36 After the decision regarding Nardizzi and Giordano, two new members joined the board and one resigned, leaving the total number of board members at seven. The board also enacted new leadership of WWP, most notably the appointment of a new CEO, (exhibit 6B summarizes the backgrounds of those on the board in 2016; exhibit 6C notes those on the advisory council in 2016, including some 2013 board members.) In reflecting on the aftermath of the situation, Odierno pointed out that, even though the independent review did find that many of the claims in the media were inaccurate or exaggerated, a change in leadership was necessary and the experience had been and continued to be an important learning moment for WWP: We are taking this opportunity to take a look at everything from a programmatic perspective, from what we do to how we do it. We’ve made multiple substantive changes to move the organization forward and restore trust among those who need WWP’s services most. We now have a fulltime internal audit function in the organization that reports directly to the audit and risk committee. Originally, we made the decision to outsource this because as a board we wanted someone who was truly independent who could go in and look at controls. But in light of what’s happened over the last several months and some of the things we found in the review, we

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decided to make that a full-time position internal to the organization that reports directly to the audit and risk committee. So we are implementing some things like that, and I’m convinced that we are a stronger organization today as a result.37 Questions for Discussion 1. What should be the role of a board in times of crisis? 2. Do you agree with the board’s decision to fire Nardizzi and Giordano? What other steps might the board have taken vis-à-vis executive management? 3. What role should board members assume when an organization’s reputation is challenged? 4. Should Nardizzi, Giordano, or the board have anticipated the PR crisis and the events of early 2016? Who bears the most responsibility? 5. What lessons, if any, can be drawn from the fact that WWP’s ability to successfully fundraise continued unabated in 2015? Do you think FY 2016 will be another record-setting year for fundraising for WWP? 6. Successful start-ups frequently face leadership crises as they grow and become more successful. As Nardizzi acknowledged when he commissioned the fiveyear strategic plan, organizations’ needs change over time, particularly when, like WWP, they’ve experienced extraordinary growth. What additional advice would you have given Nardizzi and WWP’s board back in 2013? What about in January 2016? In March 2016?

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A View from Inside the Boardroom

In August 2016, Professor William Klepper and the chairman of WWP’s board of directors, Anthony Odierno, discussed the PR challenges the organization had faced and the steps it had taken to address them. Odierno discussed the difficult process that led to the firing of WWP’s top two executives and the positive steps that grew out of the challenges the organization faced during the first half of 2016: We announced that the board was going to conduct an independent review of some of the allegations that were being made and we engaged a law firm and also forensic accountants to help us to independently conduct that review. And as a result we ultimately had to make a decision to replace the CEO and COO. . . .

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Even as a board when you feel that you’re doing everything right, there’s still things that can happen. . . . We did find there were opportunities to improve, to update policies, procedures, controls. . . . But I think what gets lost in a lot of this is the good work that we do and also that a lot of what was reported was either not true or exaggerated. But, nonetheless, we put the organization through a review and we did find things that need to be improved so we’re improving, we’re adjusting and we’ll be better for it. 39

A View from Outside the Boardroom

After the media coverage of WWP in January 2016, Doug White, an expert in philanthropic giving and the former director of Columbia University’s Master of Science in Fundraising Management program, undertook an exhaustive, independent evaluation of the allegations made by the New York Times and CBS News. In September 2016, he published his results in “The First Casualty: A Report Addressing the Allegations Made Against the Wounded Warrior Project in January 2016.” Among his findings: the anonymous allegations against WWP by former employees were difficult to fact-check, the evaluations from self-described charity “ratings agencies” lacked credibility, and the widely viewed reports from the Times and CBS News contained numerous inaccuracies. Nevertheless, White viewed the reputational damage suffered by WWP, an organization that had assisted tens of thousands of U.S. military veterans with crucial services, as a largely self-inflicted wound that reflected the inability of the board to properly deal with the crisis as it unfolded. He writes: After an examination of the sequence of events and the evidence, it seems likely that the self-inflicted damage is more than the current board can handle. As a result, its members might well consider a transition strategy to effectively replace itself. This was not a senior staff problem. This was, and quite possibly still is, a board problem. doug white

Despite the PR crisis, the WWP’s fundraising had continued apace. For the fiscal year ending September 30, 2015, the WWP collected $370 million, its best year for fundraising to date.40

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One common conclusion from the WWP case study is that the commitment of the board to the CEO and COO had fractured during the media crisis. I was in communication with both Nardizzi and Giordano as well as a number of board members. I had offered to serve as a mediator, a trusted third party, to work through the crisis within the boardroom, the room where it happened. Unfortunately, the board had hired its outside advisors and were set to follow their decision-making path. The WWP FY2016 990 Form is evidence of the impact of following that path. WWP raised $70 million less than year before and took $49 million out of programs to offset this reduction. The cost of fundraising went up, admin costs went up, and programming went down.41 This was just the first six months after the Nardizzi and Giordano left. The 2017 fiscal year might see even more drop off. I have wrestled in my own mind as to why the strong partnership of the board and CEO that I wrote about in my WWP case study in 2014 at their tenth anniversary, “Wounded Warrior Project: Leading from the Front,” could dissolve in the tension created by this media crisis. I haven’t come to a single conclusion, but knowing all the parties and respecting them, my thoughts go to a breakdown in trust. Both Nardizzi and Giordano were founding fathers of WWP and were strong leaders who were able to distinguish themselves from the board but could not separate themselves from the heart and soul of WWP. I believe that their strong, directive executive leadership became a distancing phenomenon in the midst of this crisis with the board. The stress of the crisis, this point of inflection, was too severe for the board to be able to maintain its partnership with its CEO. Consequently, it was a loss for WWP.

Summary r
The board must constantly assess and CEOs be willing adjust their leadership agenda, practices, and behaviors in order to survive. r
Business cycles are unavoidable and uncertain—what goes up will in time come down. r
Every board needs to face this reality of assess and adjust to meet the challenge of changing conditions. r
Achieving the right partnership between the board and its CEO is critical to meet this challenge. r
Trust is an essential underpinning to maintaining the board-CEO partnership during a crisis.

4 Leadership Metrics

What gets measured gets done, what gets rewarded gets done repeatedly.

As I discussed in chapter 3, each stage on the “S” curve demands a different set of leadership behaviors from the CEO. To gain a complete measure of what matters and what works in their partnership with the CEO, board directors need to go beyond the hard metrics of business performance (return on assets [ROA], return on equity [ROE], return on investment [ROI], and so on) to the soft metrics of a CEO’s leadership. Soft metrics is a term for intangible indicators used to value a start-up company, but the definition has been expanded to apply to business in general—intangible assets that don’t appear on the balance sheet. It includes factors such as integrity, leadership, developing internal candidates, communication skills, and strategic thinking. An assessment of a CEO’s leadership behaviors as observed by others—directors, direct reports, customers, and so on—is the starting point for measuring the strength of the CEO’s leadership. This assessment process is standard procedure, and a number of instruments are available that offer this feedback. The CEO assessment that many companies use is exhibited in Ram Charan’s Boards That Deliver (2005) and includes segments on company performance, leadership of the organization, team building and management succession, leadership of external constituencies, and leadership of the board (if the CEO is also chair).1 The CEO would also self-assess on the same set of indices so that the board can

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identify any misalignments or gaps among the self-assessment of the CEO and the assessment of the board and others.

Measuring Leadership Practices

In most CEO assessment instruments, the questions in the leadership section revolve around strategy, confronting external realities, transforming the organization, and focusing on the right issues and execution. However, Columbia Executive Education has provided feedback to hundreds of executives using a more comprehensive feedback instrument. Titled the Leadership Compass Inventory, it was developed by Michael Fenlon while he was on the executive education faculty at Columbia Business School, in collaboration with Joel Brockner. It serves as an assessment and action planning tool for CEOs.2 The sixty-five-item multirater (360-degree) instrument provides data in four essential dimensions of leadership: 1. Leading the Organization: These scales assess effectiveness in providing organizational direction and creating focus on key priorities, promoting innovation and strategic thinking, leading change, decision making, building community, and communicating with impact. 2. Leading Groups: These scales assess effectiveness in building teams, networks, and communities. Specific issues include coordinating the work of teams as well as managing team relationships and building and utilizing networks both within and outside of the organization. 3. Leading as a Coach: These scales assess interpersonal skills, such as feedback, setting goals; confronting performance problems; recognizing and rewarding outstanding performance; developing leadership skills in others; and valuing diverse opinions, styles, and cultures. 4. Leading as a Person: These scales assess the foundational attributes of leadership, such as demonstrating confidence, projecting energy and enthusiasm, exhibiting openness to feedback and disagreement, self-awareness of personal strengths and weaknesses, and leading by example.3

I conducted a study of CEOs who had completed the Leadership Compass over a period of six years (2001–2006) and put together a group profile

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Table 4.1

Drucker’s and Columbia’s Practices of Effective Executives Drucker’s practices of effective executives

Columbia’s practices of effective CEOs

A. Gathering knowledge They asked, “What needs to be done?” They asked, “What is right for the enterprise?”

Shows enthusiasm for the work we do. They asked, “What is right for the enterprise?”

B. Converting knowledge into effective decisions They developed action plans. They took responsibility for decisions. They took responsibility for communicating. They were focused on opportunities rather than on problems.

Demonstrates perseverance in achieving goals Behaves consistently with own words and standards Is accessible and approachable for talking about issues or concerns Demonstrates calm and stamina under stressful circumstances

C. Ensuring the whole organization felt responsible and accountable They ran productive meetings. They thought and said “we” rather than “I.”

Effectively uses his/her network of relationships inside the organization Demonstrates respect for others

that included a set of practices of those CEOs. This study appeared in the article “What Effective CEOs Have Yet to Learn”4 and was prompted by Peter Drucker’s June 2004 article, “What Makes an Effective Executive.”5 As I read through his list, my thoughts immediately went to my work with the executives who had participated in Columbia Business School’s executive education programs. The practices that Drucker highlighted were very similar to the effective practices found within the Leadership Compass, which I had used with the participants of my program (table 4.1). What struck me, however, was that approaching the question of effectiveness in terms of this list of positives was only one side of the coin, and in my study I wanted to look at the flip side. The Drucker and Columbia practices tell us what effective executives most often have, but my study focused instead on the practices that effective executives lack. Boards should be on the lookout from the start for things that CEOs could be doing better—tough love thinking early about not just the hard metrics of the business but the soft metrics of a CEO’s leadership. From the group profile data of the CEOs in my study, I’ve identified six practices that were rated lowest—the six practices, that is, that many CEOs lacked. These are all soft metrics.

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Two of the lowest-rated practices were from the Leading the Organization segment under the category of “Leading Change”: r
Effectively creates dissatisfaction with the status quo in order to motivate change efforts. r
Effectively influences people who resist change.

Another two were also from the Leading the Organization segment, under the “Promoting Innovation and Strategic Thinking” and “Making Decisions” categories, respectively: r
Facilitates innovation by providing time and opportunity for reflection and brainstorming. r
Effectively delegates appropriate decision-making authority to others.

A single practice from the Leading as a Coach segment under the category of “Coaching and Motivating Others” was rated the lowest: r
Develops leadership skills of others.

The final behavior in the group of lowest-ranked practices was from the Leading as a Person segment under the category of “Openness and Self-Awareness”: r
Is willing to admit mistakes and change his/her mind.

The first four practices were rated the lowest by two or more of the reporting groups as well as the CEOs themselves. The last two practices (Develops leadership skills of others; Is willing to admit mistakes and change his/her mind) were not seen by the CEOs themselves as a weakness, but two or more of the other survey groups agreed on the low ratings of these practices for their CEOs.

Applying the Integrated Leadership Model

The board can address the lowest-ranked practices (gaps) within the context of the Integrated Leadership Model (ILM; see figure 3.7). As discussed in chapter 3, the ILM allows boards to assess where the business is on the “S” curve and, from there, to determine what agenda,

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practices, and leadership style are appropriate for their CEOs. Once the board has determined its organizational needs from its CEO, it should start to think about possible leadership gaps—lowest-ranked practices. My study offered six of the most common leadership practice gaps. The Leadership Compass, as well as other instruments, also gives rating tables that can help the board in its weighting of the practices. The table of lowest practice ratings is the most obvious but the table titled Practices Relative to Importance Ratings gives added weight. In an instrument created specifically by the board for its CEO, it would be assumed that all the practices are “important” or “very important” in the assessment of the CEO. In more generic instruments, some practices could be rated as less than important—“somewhat important” or below—and therefore less relevant. In the profile of CEOs that I studied, the lowest-rated practices were all rated as “important” or “very important” to the CEO’s success. Applying the ILM, a board can then examine these practice gaps in the context of its CEO’s leadership style. For example, each of the lowest-rated practices identified in my study can be positioned under the four leadership styles: DRIVER LEADERSHIP

r
Effectively creates dissatisfaction with the status quo in order to motivate change efforts r
Effectively influences people who resist change EXPRESSIVE LEADERSHIP

r
Facilitates innovation by providing time and opportunity for reflection and brainstorming AMIABLE LEADERSHIP

r
Effectively delegates appropriate decision-making authority to others r
Develops leadership skills of others ANALYTICAL LEADERSHIP

r
Is willing to admit mistakes and change his/her mind

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By combining the ILM with this list of lowest-rated practices, boards can identify the most likely leadership gaps for their CEO’s leadership style and they can discuss these gaps before they become a problem. Furthermore, because CEOs need to modify their leadership style to suit various business cycles, boards can keep these gaps in mind when asking their CEO to shift from one leadership style to another. These six lowest-ranking practices have been put together from my collected group data. Once a CEO has undergone personal assessment, the board can address any other personal leadership gaps as well as these common ones. So how can the board put this information about potential and actual leadership gaps into practice? Let’s assume that the group profile data of CEOs in my study is the individual profile data of your board’s CEO and that your business is in a downturn. You need a driver leadership style from your CEO, but first you need to address the leadership gaps that fall under the driver style. In a discussion with your CEO, a little tough love coaching might include the following recommendations: Gaps: Effectively creates dissatisfaction with the status quo in order to motivate change efforts. Effectively influences people who resist change. We believe that leadership is the management of change. If you agree, you need to be more cognizant of the importance of managing the downturn our business is experiencing. We understand that it is counterintuitive to “create dissatisfaction with the status quo,” but unless our people are dissatisfied with their current state there is little motivation for them to change. We are pleased that you have provided a vision of the future and a path to get there. We know these are critical elements to successful change but we need you to continually challenge the status quo or we risk not pulling out of this downturn. We feel we are at a point that a reinvention of our business must occur to avoid our ultimate collapse.

This exchange begins to confront the practice gaps that surfaced from the CEO assessment. It also includes some information culled from the scholarly literature on leadership competencies, emotional intelligence, and executive derailment. In addition, it draws from the practical experience of this author in conducting leadership development and coaching sessions with hundreds of executives on a global basis. This is one of the reasons that CEOs, with the support of their boards, have professional coaches working

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with them. Coaches have experience with many different types of leaders and can help solve a range of problems specific to the CEO. Now let’s assume that the business is no longer in a downturn but coming out of its trough. Following the ILM, you need an expressive leadership style from your CEO. You want your CEO to experiment with new things but you want to be assured that anything new is thought through before being implemented. Gap: Facilitates innovation by providing time and opportunity for reflection and brainstorming. First, we believe that if we are going to be able to compete against our peers we need to be learning faster than they are. As our CEO, you need to be as effective a learner as you are a leader. You need to be more deliberate in your learning to serve as a role model to others in our organization. You need to take the time to “reflect,” to learn from an analysis of our situation and develop alternatives before you “conclude” what our next move should be. We need you to work that stage of the learning cycle. We know there is a greater emphasis in our industry to “plan” and “act” to achieve short-term results but we feel that this limits the cultivation of our insight and innovation. We need you to maximize our organizational learning. It may be our only truly competitive advantage.

The learning cycle stages referenced in this exchange are based on the work of Peter Honey and Alan Mumford.6 I first worked with Mumford in 1996 when I was appointed the academic director of Columbia’s Executive Education program. He collaborated with us to design our methodology for executive learning, which employs the learning cycle. The learning cycle is based on the finding that “a learning style preference is inferred from the way individuals go about solving problems or behaving in meetings.”7 Thus a manager’s ordinary, day-to-day behavior is a great indicator of the way he or she thinks and learns. One of a number of tools used for helping CEOs gain self-awareness of how they learn is Honey and Mumford’s learning styles questionnaire. In addition to bringing in learning cycle data, this example confronts the expressive leader’s tendency to learn by doing. Although expressive leaders can be spontaneous, creative, and willing to experiment, they can also be wrong. The board should try to keep the expressive leader’s intuitive instincts in check by asking for more reflective thinking before action is taken.

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In this next scenario, your company is doing fine and your success is growing. Along with this success comes a strong belief about what works for the business. For this success to endure, you need to fortify your leadership bench and have your succession plan fully populated. You need an amiable leadership style from your CEO but there are some practice gaps in willingness to delegate and develop others. Gap: Effectively delegates appropriate decision-making authority to others. Develops leadership skills of others. We agree that we have to build a leadership team that will outlive us in order to assure the company’s continued success once we’ve retired. We need to develop the skills of other leaders and on-the-job training can’t be the only way we accomplish this goal. In that regard, we are concerned that you are not “effectively delegating appropriate decisionmaking authority to others.” We know that this can be difficult because delegating does not remove you from the ultimate responsibility, but it is important for others to be involved in decision-making processes and to develop leadership skills of their own. We want to emphasize that we don’t expect nor want you to “do it all.” You may prefer to have total control, but we feel that may hinder the development of our next generation of leaders. If you don’t “develop leadership skills of others,” we will consider it a failure of your leadership.

In this example, the board is confronted with the dilemma of telling its CEO that he or she needs to lead by preparing others to take over—to “build the bench” with a successor. This is a tricky subject because effective CEOs have a personal need to survive that is just as strong as their desire for their business to survive after they leave. With CEOs that are not amiable leaders by nature, this can be even more difficult to confront. Edward E. Lawler III, the author of Talent: Making People Your Competitive Advantage, asserts that CEOs can be dangerously out of touch with the people they lead, particularly when it comes to the issue of development.8 Good leaders will address this deficiency. As an example of a positive acknowledgment of this, Lawler points to a statement that Jeff Immelt, GE’s former chief executive, made in GE’s 2005 annual report about what CEOs need to be doing: “Developing and motivating people is the most important part of my job. I spend one-third of my time on people. We invest $1 billion annually in training to make them better. . . . I spend most of my time on the top 600 leaders in the company; this is how you create a culture. These people all get selected and paid by me.”9

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In the last case, the board instinctively knows that business is doing as well as it ever has but also knows what goes up must come down. The company may be close to reaching a point of inflection and the board and CEO must manage their risk. Therefore, the board needs an analytic CEO who will give it the “unvarnished truth” and make accurate assessments and decisions about the future of the company. In this case, your board needs to address the CEO’s unwillingness to admit possible mistakes or change its thinking because these factors may make the CEO reluctant to openly discuss risks with the board. Gap: Is willing to admit mistakes and change his/her mind. We have all been feeling pretty good lately about our performance. All the hard measures—ROA, ROI, and ROE—are strong. Our EPS has reached its highest point in our history. You’ve kept us on a steady path and you’ve gotten it right. But we want to emphasize that you also need to be clear with us about our risk and be “willing to admit mistakes and change your mind” if you think we’re not going in the right direction. We know that this upward trend can’t continue forever. We want you to objectively assess our risk and tell us where we could go wrong. If we can understand this early, we may be able to avoid a total failure in the future. The worst thing we can do is not be totally honest with each other about the state of the business. Now can we talk more about these “derivatives” that we’re trading?

I threw in that last line in because I presented a case study on the Lehman collapse to an Outstanding Directors Exchange (ODX) meeting in New York. Richard Fuld, Lehman Brothers’ CEO, was an analytical style leader who didn’t like admitting his mistakes, and this leadership gap should have been addressed by his board for his own good and that of the company. Assessing leadership styles and possible gaps, rather than looking only at the hard numbers, can help boards identify problems before they become crippling for the company.

Diagnostics: The Use of Soft Metrics

Today boards have many ways to measure and decide what is required of their CEOs in terms of the hard metrics of the business, but soft metrics, which are not measured as often, allow boards to understand how the CEO

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got to those hard metrics. Looking at soft metrics gives boards an opportunity to have a dialogue with their CEOs about building long-term strategic value. However, soft metrics are not a one-size-fits-all metric for a CEO. I recommend a more tailored set of hard and soft metrics that assess the agenda, practices, leadership style, and viability of the CEO in the context of where the business is in its life cycle. In other words, choose metrics that will diagnose what is needed for the business (the business cycle), and what’s required of the CEO’s leadership (agenda, practices, style). A closer look at the metrics used in determining the performance of Lehman’s CEO can help illustrate the importance of both hard and soft metrics. Richard Fuld had been chief executive officer of the company since 1993 and chairman of the board of directors since 1994. In March 2008, the board granted Fuld an award of more than $40 million in cash and stock for, as the proxy put it, “successfully navigating the difficult credit and mortgage market environments and maintaining the firm’s strong risk controls.” That proxy also commended Fuld for a 104 percent jump in Lehman’s stock price over the prior five years, notwithstanding a 15 percent drop in fiscal 2007. Fuld, the proxy says, cultivated “an employee-ownership culture that promotes long-term alignment with stockholder interests.”10 In contrast to that proxy statement, Bloomberg, in an article a couple of months after the Lehman collapse, chronicled the following account of the practices of Fuld’s leadership style: An intimidating figure—he played in international squash competitions when he was younger and is still fit—Fuld was known around the office as “the Gorilla.” His icy stare, people who worked at Lehman say, froze recipients with fear. No one wanted to tell Fuld something was wrong or to question how Lehman was run. . . . Management-committee meetings were conducted without discussion, attendees say. The same was true of executive-committee meetings presided over by Fuld. While reviewing budgets for 2007, one committee member questioned the performance of a unit, according to a person who was in the room. Fuld stared at him coldly, then broke the silence: “You’ve got some balls to say that, knowing how much I hate that topic.” As Fuld returned to studying the papers in front of him, Gregory continued dressing down the committee member for his impertinence. He also upbraided him after the meeting, demanding that any objections be brought to Gregory privately and not voiced in front of the committee. Word on

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proper comportment spread through the ranks. Fuld conducted an employee webcast every three months. He’d always end by asking if there were any questions. There rarely were. The problem with this authoritarian climate was that when Lehman began to sputter, Fuld was cut off from dissenting opinion. Woe to the messenger who came to the 31st floor bearing bad news. As cut off from information as Fuld may have been, it wasn’t as if he didn’t recognize the firm’s problems. In November 2004, more than two years before the bull market reached its peak, Fuld was telling people around him that low interest rates and cheap credit would create a bubble that could one day pop. “It’s paving the road with cheap tar,” he told colleagues in a meeting at the time. “When the weather changes, the pot-holes that were there will be deeper and uglier.”11

If members of the board had considered these practices or soft metrics, they might have better diagnosed the health of the organization under the Fuld leadership and not provided him with $40 million in cash and stock. Looking back at the practices that make for effective executives, the soft metrics that measure a leader’s style as either hierarchical-authoritarian or egalitarian-participatory would have been appropriate. I’ll offer more detail about how to make measurements like this in chapter 7, but by way of example, I would have included these leadership metrics in the assessment of Fuld’s effectiveness: r
Takes responsibility for communicating r
Is accessible and approachable for talking about issues or concerns r
Effectively uses his/her network of relationship inside the organization r
Thinks and says “we” rather than “I”

r
Demonstrates respect for others

By rewarding Fuld for only the hard metrics of the business, the board was not making a comprehensive assessment of the performance of the business under Fuld’s leadership. Sometimes what really matters in the diagnosis of a business is not the numbers but an assessment of the CEO’s agenda, practices, and style and its alignment with the needs of the business. In my Executive Leadership course, which I teach in the Columbia Business School’s Executive MBA program, the Lehman collapse and Fuld’s

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leadership was a hot topic. One of my students had contact with someone still on the inside of Lehman when the dysfunction of Fuld was occurring. The general assessment of Fuld’s leadership from this insider was that Fuld had become a captain of the industry by steering the company through more than one near-death experience in the past, and this created a disbelief that Lehman would ever go into bankruptcy on his watch. In the congressional hearing that followed Lehman’s collapse, however, Fuld acknowledged the destabilizing factors that began to appear in the last few months of his tenure. These included rumors, widening credit default swap spreads, naked short attacks, credit agency downgrades, a loss of confidence by clients and counterparties, and “strategic buyers sitting on the sidelines, waiting for an assisted deal.”12 Ironically, Fuld was applying not just hard metrics but soft metrics in the diagnosis of Lehman’s collapse. It is unknown if the Lehman board, Fuld’s boss, ever felt a lack of confidence in him. If it did, a little tough love could have gone a long way in leading him to admit his mistakes and change his mind about the way he was doing things around Lehman. This would have been a difficult assignment for the board’s Compensation and Benefits Committee, which evaluates the performance of the CEO, since Fuld was also the chairman of the board. However, since Fuld had continued to improve the hard metrics that he was rewarded for by this committee, it’s likely that measuring and rewarding the soft metrics could have led to an improvement in those as well. Measurements and rewards should be linked to the needs of the business on the business cycle, including the required agenda, practices, and leadership style of its CEO. If all these factors are being measured and rewarded, the metrics are right for a productive board-CEO partnership. If the board does not apply all these metrics in diagnosing the health of the business and its CEO’s performance, as was the case with Lehman and Fuld, a business and its leader can collapse. In hindsight, it is apparent that Lehman reached a peak on its business cycle but Fuld continued business as usual. He had his way of doing things and wasn’t about to change. Although an analytic style is generally what’s needed when the company is at its peak, Fuld’s analytical style was toxic for Lehman because he would not readily admit mistakes or change his mind. Under stress, he shifted to a “tell-assertive” style that left him ill equipped to lead and isolated in the crisis. It took a cataclysmic failure before he considered modifying his style to challenge the status quo and create change in the way things were being done at Lehman. Hard metrics could have diagnosed the poor health of the business but weren’t

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enough to get to the root cause of the illness. According to SeekingAlpha. com, investors should have been asking why Lehman had let its leverage ratio, or total assets divided by stockholders’ equity, climb to 30.71 to 1 in the market turmoil of November 2007 from 26.2 to 1 in the peaceful bull market of 2006.13 But I would add that some of the soft metrics that could have diagnosed the poor health of Fuld’s leadership style can be found in Drucker’s Practices of Effective Executive practices for “Ensuring the Whole Organization Felt Responsible and Accountable” and Columbia’s complementing practices for CEOs (see table 4.1). Specifically, the board could have been assessing whether Fuld thought and said “we” rather than “I” and whether he “demonstrated respect for others.” These intangible assets didn’t show up on Lehman’s balance sheet but they definitely showed up in its bankrupt leadership. The board needs to measure what it wants done and reward what it wants the CEO to continue to do, taking into account both hard and soft metrics. When the CEO’s leadership practices are directly linked to the organization’s needs and subsequently measured and rewarded, the metrics are correctly focused on what really matters in the board-CEO partnership.

CASE STUDY: DEMOULAS MARKET BASKET: A GOVERNANCE CHALLENGE By William M. Klepper ID#160405, Published on November 10, 2015

INDIVIDUAL, BUSINESS AND SOCIETY

Summer of 2014—Inevitable? In the summer of 2014, much of the American business press was focused on the activities swirling about the headquarters of Market Basket (the trade name for stores owned and operated by Demoulas Super Markets, Inc.) in the small town of Tewksbury, Massachusetts, just north of Boston. Decades of family resentment, accusations of unsavory business practices, and epic legal battles had come to a head for the large privately-held, family-owned grocery retailer. On June 23, 2014, the board of directors of Demoulas Super Markets (DSM) led by Arthur S. Demoulas (Arthur S.) opted not to re-elect its CEO, Arthur T. Demoulas (Arthur T.), its director of operations and vice president. The board further announced that the CEO position would be shared by former executives from Radio Shack and Albertsons. While the effective dismissal of a CEO was not headline grabbing, the subsequent effective shutdown of the chain drew national

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attention. Within weeks after Arthur T. was deposed, several of Market Basket’s key managers resigned, and several hundred employees protested outside one of the chain’s flagship stores. Wanting to ensure employee safety, the co-CEOs allowed the protest on company property. The labor action quickly expanded, with thousands of employees and customers demonstrating in front of the company’s headquarters and stores, all demanding the reinstatement of the CEO. A strike by corporate office workers and delivery truck drivers soon followed. It resulted in almost bare shelves in Market Basket stores and the loss of millions of dollars in revenue daily as customers shopped elsewhere. As the work action escalated, the board was reportedly reviewing offers to buy the company, including one from Arthur T. As the independent board members worked on multiple levels to try to stabilize the business and resolve the differences among the family shareholders, the governors of Massachusetts and New Hampshire urged a resolution for the 25,000 workers and two million customers impacted by the dispute.14 Yet both sides, distrustful of one another, remained entrenched in their positions, seemingly impervious to the entreaties of the governors. At least one serious bidder, Delhaize Group SA, was still believed to be in active discussion with the board to purchase the company. The Belgian company was parent of the local New England Hannaford chain and its stores were seen as complementary to those of Market Basket.15 However, before long, analysts began suggesting that the company was approaching the brink of collapse. Arthur T. then made a $1.5 billion offer on August 22 to purchase the 50.5 percent of the company owned by the other side of the family. A week later a deal was reached, and by December 12 it was completed.16 As the very public family battle over the business played out, many wondered what had gone so wrong and what lessons could be learned from the situation. Those focused on governance—especially of family-run businesses—believed that if there had been more effective governance structures at Market Basket at least some of the problems that ultimately drove the meltdown of the company might have been mitigated. Some Thoughts on Governance A substantial percentage of all businesses in the United States are family run; according to McKinsey & Co., a management consulting firm, one-third of the firms in the S&P 500 Index are “defined as family businesses.”17 Studies suggest that family businesses perform better than those that are publicly held, exhibiting stronger finances and enjoying higher levels of customer loyalty and public trust. However, the effective governance of a privately-held family-run business requires the coordination of decision making among three stakeholder

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Exhibit 1: Governance Structure of Family-Owned, Family-Controlled Businesses

)DPLO\ RIILFH

)DPLO\ DVVHPEO\

)DPLO\

%RDUGRI GLUHFWRUVDGYLVRU\ ERDUG

)DPLO\FRXQFLO

2ZQHUVKLS

$QQXDO VKDUHKROGHUV PHHWLQJ

7RS PDQDJHPHQW WHDP %XVLQHVV

Source: Ernesto J. Poza, Family Business, 3rd ed. (Mason, OH: South-Western Cengage Learning, 2010), 248.

groups: the family, the ownership, and the business (see exhibit 1). The role of each of these three groups is discussed below.18 As Ernesto Poza, a noted leader in the field of family business, explains, “family governance is a system of joint decision making, most often by a board of directors and a family council that govern its relationship with its enterprises and wealth.”19 The absence of an effective governance structure leaves the business vulnerable to a host of challenges, including nepotism, family conflict, and a lack of oversight. Nepotism can lead to a decline in the value of the business and of the family’s wealth. Family conflict can result in turf wars, which consume time and energy and make it difficult to move the business forward in a competitive environment. A lack of oversight (an issue in any enterprise) can lead to self-dealing and prioritization of one group of shareholders or family members over another. (See exhibit 2 for a more complete list of the vulnerabilities of a weak governance system.) Family Council As its name suggests, the family council is a body focused on the family and ownership matters related to it. The council meets at regularly-scheduled intervals to discuss family conflicts, the education of the next generation of owners, and other ownership issues. The discussion within the family council or its associated structures (such as the family office or family assembly) should remain focused on family issues and not devolve into a forum on the management of the business.

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Exhibit 2: Challenges to Family Governance

1. Nepotism 2. Loss of family identify and values 3. Family conflict 4. The belief that fair means equal 5. Current leader’s unwillingness to let go 6. Entitlement culture 7. Dilution of wealth 8. Erosion of the entrepreneurial culture 9. Insufficient professionalism and institutionalization of the family’s enterprises 10. Lack of transparency 11. Lack of oversight 12. Altruism 13. Confusion over what is a family issue, a management issue, and an ownership issue 14. Wanting to keep it all in the family Source: Ernesto J. Poza, Family Governance: How Leading Families Manage the Challenges of Wealth (Zurich, Switzerland: Credit Suisse Securities and Thunderbird School of Management, 2012), http://www.family-business.com/article1.pdf

Board of Directors In many ways, the responsibilities of the board of directors in a family-held business are similar to those in a publicly held company. Among other activities, the board reviews the financial performance of the firm, provides insight into the business’s strategy, and holds the CEO and senior management accountable for the firm’s performance. In the family business setting, where it is assumed that the owners have a vested interest in oversight, there is often more emphasis on advice and counsel than on monitoring. Generally speaking, boards of familyowned businesses are relatively small (with between five and nine members) and are composed of independent outsiders, such as peer CEOs, business school faculty, and/or professional service providers who can offer unbiased, objective views and a broad perspective. This is important because, as Poza notes, “in the absence of a board with truly independent outsiders, family members who do not fully understand the difference between owning and running a family company may conspire to meddle inappropriately.”20 Having long-time family friends and associates on the board is typically discouraged because they can be perceived as

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unable to challenge the CEO. Inclusion of family members as at-large representatives of the family, on the other hand, can help ensure that the board takes family preferences and strategies into consideration. Top Leadership Team As with public enterprises, the top leadership team reports to the board of directors. In general, people outside of the family are included on the team to provide a skill set that complements the family members’. The presence of outsiders also reassures family shareholders who are not active in the business that the leadership team is professional and objective. To be effective, the board and the CEO must define how they will work together and establish mutual expectations. As mentioned in chapter 1, this social contract is created when a board and its CEO evaluate and discuss what is necessary to “ensure their commitment to the welfare of the business”; for the social contract to be effective, “each party must be willing to place his/her authority under the direction of the supreme will—in this case the board-CEO partnership.” A key component of the contract is risk management. The CEO moves the business agenda forward, balancing the growth imperative and the attendant business risk concurrently, while the board approves the strategy with attention to the inherent level of risk. At times, it is incumbent on the board to be firm in dealing with the CEO and enforcing governance policies. The purpose of the legally-required annual shareholders meeting is to inform owners about the performance of the firm, review management, elect board members, appoint company auditors, and make updates to corporate bylaws. Only shareholders may attend the meeting; it is closed to their spouses and members of the extended family. Market Basket In the second decade of the new millennium, the grocery business was mature, highly competitive, and facing consolidation.21 In the United States, traditional supermarkets typically ranged from 20,000 to 60,000 sqare feet and carried an assortment of 15,000–60,000 SKUs. They were under increased pressure on one end from warehouse clubs and superstores such as Walmart, which had purchasing economies of scale, and from specialty and organic grocers such as Whole Foods on the other. In addition, retailers that had not previously been in the grocery segment were now edging into it; drug stores and other business were allocating more shelf space to food while dollar stores were beginning to carry frozen foods as well as canned goods. The grocery industry was a high-volume, low-margin business. Average store sales were about $300,000/week, with profit margins ranging from 1.5 percent

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to 3 percent. Effective cost management was critical; product and labor costs accounted for 70 percent to 75 percent and 10 percent to 12 percent of sales, respectively. Category management was essential for determining the optimal mix of product selection, assortment, promotion, and pricing. Information technology was increasingly important in successful grocery store chains. For example, point-of-sale scanners lowered labor costs and collected data that could be used for analysis of product assortment and associated shelf space. In 2014 Market Basket was the twenty-seventh-largest grocery retailer in the United States,22 operating seventy-three stores in New England. (See exhibit 3 for a list of the top thirty U.S. grocery retailers.) Increased competition had created a challenging market for several of the area’s supermarkets. In 2012 Johnnie’s Foodmaster, a sixty-five-year-old chain of ten stores, liquidated and transferred several leases to Whole Foods,23 while the second-largest chain in the area, Shaw’s/Star Market, went through several changes of ownership, store closings, and downsizing.24 While others faltered, Market Basket continued to thrive against the encroaching giants and big box discounters. It was the acknowledged lowprice supermarket for everyday shopping, with prices 15 percent to 20 percent lower than its traditional competitors and 10 percent lower than big box retailers. Purchases from grocery stores accounted for about half of the $8,066 that Boston-area families spent annually on food.25 The 20 percent price savings was significant and created a group of very loyal customers, and in 2014 Market Basket also offered a 4 percent loyalty discount on the cost of groceries. (See exhibit 4 for a summary of relative pricing at several grocers in Market Basket’s trading area.) Employee loyalty was also a driver of Market Basket’s success. In 2014 the company’s 25,000 nonunion employees (about 8,000 FTEs) started at $12/hour (which was above the minimum wage) and qualified employees received health care benefits and paid sick leave. Employees with more than 1,000 hours were eligible for the company’s profit-sharing plan. A significant percentage of Market Basket’s workforce started with the company and stayed for decades, bringing other family members into the business. While “store managers and truck drivers could retire with a nest egg of $1 million or more,”26 the vast majority of Market Basket were part-time workers. Industry observers suggested that this not only created loyal employees but also lowered training costs. 27 The Seeds of Discord? Market Basket’s roots lie in Lowell, Massachusetts, where a Greek immigrant couple, Athanasios (Arthur) and Efronsini Demoulas, opened a grocery store specializing in fresh lamb in 1917. The couple had six children and in the late 1930s,

Exhibit 3: Top 30 U.S. Food Retailers

Rank Company

Sales (000)

Number of supermarkets

1

WalMart Stores, Inc.

288,049,000

4,024

2

The Kroger Co.

108,500,000

2,625

3 4 5

AB Acquisition LLC Publix Super Markets Inc. Ahold USA Inc.

56,443,140 30,559,505 25,976,700

2,238 1,097 761

6 7 8 9 10 11 12 13 14 15 16

H-E-B Grocery Co. Delhaize America Inc. Meijer Inc. Wakefern Food Corp. Whole Foods Market Bi Lo Holdings LLC Trader Joe’s Co. Target Corp. Aldi Inc. Giant Eagle Inc. Supervalue Inc.

22,590,000 16,900,000 15,400,000 14,700,000 14,194,005 12,559,300 12,100,000 10,100,000 9,800,000 9,600,000 9,492,000

363 1,296 213 141 414 801 433 249 1,366 222 625

17 18 19 20 21 22

Hy-Vee Inc. Wegmans Food Markets Inc. Great Atlantic & Pacific Tea Co. WinCo Foods Inc. Defense Commissary Agency Save Market Supermarkets Inc.

8,700,000 7,200,000 6,300,000 6,100,000 4,800,000 4,300,000

235 85 301 98 185 218

23 24

Stater Bros. Markets Inc. Roundy’s Supermarkets Inc.

4,000,000 3,855,156

168 149

25 26 27 28

Ingles Markets Inc. Price Chopper /Golub Corp. Demoulas Market Basket Raley’s Supermarket

3,836,000 3,805,100 3,400,000 3,061,500

202 135 75 125

29 30

Weis Markets Inc. Smart & Final Inc.

2,800,000 2,668,900

163 299

Store names

Employees or FTEs

Walmart Superstores Walmart Neighborhood Market Harris Teeter, Ralphs, Kroger SW Safeway, Albertsons, Vons Publix, Publix Sabor Stop & Shop, Giant Lanover, Giant Carlisle H-E-B, H-E-B Plus Food Lion, Hannaford Meijer ShopRite, Price Rice Whole Foods Winn Dixie, Bi Lo, Harveys Trader Joe’s SuperTarget Aldi Food Store Giant Eagle, Market District Save-A-Lot, Shoppers Food Warehouse Hy-Vee Wegmans Pathmark, A&P, Waldbaums WinCo DECA Commissary Save Mart, Lucky Store, Save Mart, Food Maxx Stater Bros. Pick N Save, Mariano’s, Copps Ingles, Sav-Mor Foods Price Chopper Market Basket Raley’s, Nob Hill, Bel Air Market Weis Smart & Final, Smart & Final Extra

1,235,000.00

Source: “The Super 50 Food Retailers: Company Ranking,” Progressive Grocer, May 2015, 42, 44.

400,000.00 165,000.00 1,745,000.00 72,000.00 85,000.00 100,000.00 65,000.00 50,000.00 88,000.00 52,200.00 9,000.00 657,000.00 21,000.00 36,000.00 38,500.00 69,000.00 40,000.00 22,000.00 10,000.00 11,000.00 13,655.00 18,000.00 22,000.00 9,100.00 11,860.00 8,100.00 8,700.00 18,000.00 7,900.00

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Exhibit 4: Pricing in Greater Boston Supermarkets

DeMoulas Market Basket Hannaford Price Chopper Shaw’s (Salem) Shaw’s (Weymouth) Stop & Shop (Peabody) Stop & Shop (East Weymouth) Target Trader Joe’s Walmart Supercenter

Price comparison score using our standard market basket of items, including national brands, comparing similar items at Trader Joe’s

Price comparison score using our standard market basket of items, comparing similar items at all stores, regardless of brand

Price comparison score for meat only

Price comparison score for produce only

Variety— percent of items available, counting similar items at all stores

$81

$76

$77

$76

87 percent

$94 $95 $101 $106

$89 $90 $96 $102

$89 $97 $105 $113

$102 $94 $97 $112

91 percent 89 percent 93 percent 85 percent

$90

$85

$89

$87

94 percent

$103

$98

$98

$107

93 percent

$89 $93 $82

$85 $93 $78

$103 $102 $86

$98 $87 $73

69 percent 42 percent 81 percent

Note: Scores compare stores’ prices to the average prices found at surveyed Shaw’s and Stop & Shop stores. Source: “Supermarkets—Key Findings from Our Surveys,” Consumers’ CHECKBOOK, Fall 2013/Winter 2014, http://www.checkbook.org/interactive/spmkt/other/b/article.cfm.

with the store facing foreclosure, their youngest son, Telemachus (Mike), left school and began working full-time to help keep the business afloat. In 1954 they sold the business to Mike and his brother George. Within fifteen years, the two brothers had transformed the operation into a profitable chain of fifteen stores. In 1971 George died of a heart attack while vacationing in Greece, leaving Mike as the sole head of the supermarket chain. Because the brothers had made a personal agreement to provide for each other’s family in the event of death, Mike also took effective control of George’s assets.

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Over the following twenty years, Mike continued to oversee the growth of the Demoulas Market Basket chain. However, in 1990 George’s heirs—led by his son Arthur S.—filed suit against Mike, alleging that he had exploited their trust by selling all but 8 percent of George’s real estate and stock in Demoulas Super Markets, Inc. to members of his own family. While Mike contested that he had acted at the request of his sister-in-law and her children for access to cash, George’s children attested that they had signed documents that they were too young to understand, placing their trust in their uncle. The ensuing litigation became one of the most convoluted and intense struggles in Massachusetts legal history, rife with allegations of skullduggery, reports of physical altercations in court, and, ultimately, disbarment of some of the attorneys involved. Decisions were followed by years of appeals that made their way to the state’s Supreme Judicial Court. Prior to launching the litigation, Arthur S. had been active in the family supermarket business, as had his cousin Arthur T. (Mike’s son).28 At a young age, Arthur S. retrieved shopping carts at Market Basket. He continued to work in the stores through and after college, rising to the level of assistant produce director. As the litigation escalated, Mike sued for Arthur S.’s dismissal. The court ultimately suggested that Arthur S. take a paid leave instead.29 In 1994 Middlesex Superior Court Judge Maria Lopez ruled that Mike had defrauded George’s family out of nearly $500 million,30 and she ordered that 50.5 percent of stock ownership be transferred to them. She further awarded attorney fees and about $300 million in lost dividends.31 (See exhibit 5 for a list of the Market Basket shareholders.) The shares assigned to George’s son, Arthur S., and to other members of George’s family were referred to as Class A shares; those assigned to Mike’s son, Arthur T., and to other members of Mike’s family, were referred to as Class B shares. It was also ruled that each side of the family could appoint two members (Class A and Class B directors, respectively) of the sevenmember board of directors. The other three were to be chosen by a majority of the shareholders and were required to be “disinterested, independent directors who meet the standards for independence as published by the New York Stock Exchange.”32 In 1999, at the direction of a court order, Mike resigned as president in favor of William Marsden. Arthur T. Demoulas—CEO Although they owned a minority of shares, Arthur T. and other Class B shareholders remained in control of Market Basket in the early 2000s because Arthur S.’s brother’s widow, Rafaela Demoulas Evans (who controlled 5.5 percent of the shares in the company), sided with Arthur T.33 Over the course of the next five years, Arthur T. doubled the number of the company’s stores; revenues increased by $1 billion and profits continued to outpace those of Market Basket’s rivals, who were closing stores in the competitive region. (See exhibit 6 for an estimate

Exhibit 5: Market Basket Shareholders

Class A Shareholders—Heirs of George Demoulas, owning 50.5 percent of Demoulas Market Basket Arthur S. Demoulas Diana Merriam Demoulas Fotene Demoulas Evan Demoulas (deceased) Rafaela Evans (widow) Vanessa Demoulas (daughter) Class B Shareholders—Heirs of Telemachus (Mike) Demoulas, owning 49.5 percent of Demoulas Market Basket Arthur T. Demoulas Karen Pasquale Glorianne Farnham Frances Kettenbach Source: Bennie DiNardo, James Abundis, and Patrick Garvin, “Split Decisions at Market Basket,” Boston Globe, July 25, 2014, https://www.bostonglobe.com/2014/07/24/split -decisions-market-basket/gePggarMOky55aIdQ7VAaO/story.html.

Exhibit 6: Estimated Net Income, Demoulas Super Markets, Inc   





  



 







Source: Casey Ross, “Market Basket CEO Gets Reprieve,” Boston Globe, July 18, 2013, https://www.bostonglobe.com/2013/07/18/marketbasket/qKpk8JGaLsmUmLwJ0oItHL /story.html.

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of Demoulas Super Markets, Inc.’s net income.) Arthur T. also cemented his relationships with employees of the chain, where he himself had worked since 1974, right after finishing high school, though he did take time to attend Bentley College outside Boston. Though Arthur T. expanded store operations, his relationship with the board was fractious and combative.34 Board members felt excluded from access to company information and were at odds with the CEO over “spending decisions, real estate deals, and the company’s profit-sharing plan.”35 An ongoing point of contention was how much spending the CEO could commit on behalf of the company without board approval. One board member noted, “There can’t be, in any company of any size, absolute delegation of authority on transactions,”36 while another added, “To say the CEO has unfettered authority to do a $100 million deal . . . is not fulfilling our oversight duty as a board.”37 Arthur T.’s response was that he would agree to keep board members informed of his decisions but that a spending limit would interfere with his ability to do his job effectively. “I’m running this company in the best interest of this organization. I’m running this company with the philosophy, the very strong philosophy, that there’s only one boss in this company. There’s not two. There’s not five.”38 Dividend policy was an ongoing source of contention. Forbes noted that in a ten-year period from 2001–2011 Arthur S.’s ‘side’ received $425 million in dividends. In 2010 Arthur S. put forth a proposal that would payout an additional $425 million using $1.2 billion in debt financing.39 The board, then controlled by Arthur T., rejected the proposal. Real estate transactions were another source of serious disputes between the board and the CEO. As a matter of policy, Arthur T. used businesses owned by his side of the family to develop new stores in Massachusetts and New Hampshire. Citing concern over whether Arthur T. acted objectively in conducting the transactions, board members proposed that all real estate deals be approved by either the independent directors or by Arthur S.’s side. The proposal proved to be unworkable. Subsequently Arthur S. submitted a document alleging that deals that Arthur T. had arranged to develop Market Basket stores had paid out millions in excessive fees and inflated sales prices and that Arthur T.’s actions constituted grounds for his dismissal.40 As Forbes noted, the real estate dealings were not trivial: [Arthur T.] ran things in such a way as to enrich his entourage—and enrage his cousin. Between 2008 and 2013, when Artie was CEO, Market Basket spent $700 million on related-party transactions, say two people with knowledge of the company’s dealings. Half that amount was spent with Phoenix Foods, a food broker owned by Artie’s brother-in-law. The company spent an additional $350 million on construction and contracting businesses owned

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by two of his other brothers-in-law. Market Basket also did an estimated $200 million-plus in business with companies controlled by Artie’s wife, other family members, and friends.41 In 2011, the company, under Arthur T.’s direction, hired a retired judge to investigate potential wrongdoing by Arthur T. in the purchase of real estate for store development and in receiving the associated fees.42 While no malfeasance was established, the judge did find that Arthur T. and the board of directors had neglected their fiduciary duties by not looking into whether the company would have been better off if it had exercised its option to purchase at least one store instead of renting it from a company in which Arthur T. and his family owned a 55 percent stake. The issue remained a serious source of dispute between Arthur T. and Arthur S., with Arthur S. noting in a February 27, 2014 board meeting, “The board for a total of fifteen years never said ‘No’ to you. And all you did was behave the same way you did when your dad and you and everyone diverted opportunities, stole stock, okay, and took value away from certain shareholders of this family.”43 A Change in Allegiances While the Market Basket chain continued to perform well, the turbulent relationships between the two sides of the family and between the board and the CEO also continued to grow. A shift in the dynamics—and ultimately in the structure—of the board occurred in May of 2013, when Evans switched her allegiance to the Class A shareholders,44 effectively swinging the balance of power away from Arthur T. to Arthur S. Two months later, the board met for over twelve hours to consider the removal of Arthur T. For a number of reasons, there was no action on the motion that had been driven by the accusations that Arthur T. had “directed tens of millions of dollars to real estate businesses owned by his wife and brothers-in law”45 and mismanaged the employee profit-sharing plan. In September 2013, in a heated meeting of the CEO and board where the true independence of two of the independent directors was challenged, the board approved a $300 million dividend, over Arthur T.’s vehement objection. In response, he initiated a lawsuit accusing Arthur S. of manipulating the board so that a former Class A director became part of the independent group but continued to vote with the Class A group. The suit contended that this violated the original court order concerning the board’s composition.46 Nabil El-Hage, one of the independent board members, resigned the following month, citing the burden of the time commitment. El-Hage was a former Harvard Business School professor with experience in governance issues and had served as chairman of the Market Basket board’s governance committee. (See exhibit 7 for a summary of the members of the board of directors in 2014.)

Exhibit 7: Market Basket Board of Directors 2014

Independent Board Members Keith O. Cowan, Chair Cowan served as president of strategic planning and corporate initiatives at Sprint Nextel Corp. from 2007 to 2013, according to his LinkedIn profile. Prior to that, he spent a decade at BellSouth Corp., rising to the position of chief field operations officer. He received his law degree from the University of Virginia School of Law in 1982, and his bachelor’s degree from the University of North Carolina. Ronald G. Weiner Weiner is president and chairman of Perelson Weiner LLP, an accounting and consulting firm in New York City, according to the firm’s website. He earned a bachelor’s degree from Babson College and attended the New York University Graduate School of Business and Harvard Business School. He has served as a trustee of Babson College. Eric F. Gebaide Gebaide is managing director of Innovation Advisors in New York, a boutique investment banking firm that advises technology companies. According to the firm’s website, Gebaide practiced law in New York and Florida prior to joining Innovation Advisors, and founded an Internet startup, Everlink Corp. He earned an M.B.A. from Columbia Business School in 1996, according to his LinkedIn profile, a J.D. from University of Miami School of Law in 1986, and a bachelor’s degree from the University of Miami in 1983. He has served on the Demoulas board of directors since November 2013, and also serves as president of the Columbia University Alumni Club of Long Island. Note: In October 2013 former Harvard Business School professor Nabil El-Hage resigned his seat as an independent director indicating the position had grown too time consuming. He also resigned as a trustee of the employee profit-sharing plan. Members Affiliated with the George Demoulis (Arthur S.) Side of the Family: Arthur S. Demoulas Demoulas and his branch of the family have been feuding with his cousin, Arthur T. Demoulas, since 1971, when his father George died. George’s family assumed they would inherit George’s 50 percent stake in the family company. Arthur S. and his relatives took control of the board of directors in 2013 and in June 2014 ousted Arthur T. from his position as chief executive.

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Gerard J. Levins Levins is a tax attorney with his own practice, Levins Tax Law LLC, in Boston. On his website, Levins says he has 30 years of experience in representing clients before the IRS and resolving tax controversies and tax disputes. His LinkedIn profile says he earned his law degree from the Massachusetts School of Law in Andover, after receiving a master’s degree in taxation from Widener University in Chester, Pennsylvania, and a bachelor’s degree from Spring Garden College in Chestnut Hill, Pennsylvania. Members Affiliated with the Telemachus (Mike) Demoulis (Arthur T.) Side of the Family J. Terence Carleton Carleton has been a financial advisor at UBS Financial Services since 2009, according to his LinkedIn profile. Prior to that, he served as executive vice president of the Boston advertising firm of Hill, Holliday, Connors, Cosmopulos for 20 years. He received an M.B.A. from Suffolk University’s Sawyer School of Management and a B.S. from Bentley University. William J. Shea Shea, 66, is chairman of Lucid Inc., a medical device company that sells cellular imaging systems, according to the company’s most recent annual filing. Shea has 35 years of experience in the financial services industry. He spent 19 years with the accounting firm of Coopers & Lybrand, rising to vice chairman. From 1993 to 1998, he was vice chair and chief financial officer at BankBoston. He has served on the boards of Boston Children’s Hospital and Northeastern University. Source: Bennie DiNardo, “Meet the Market Basket Board of Directors,” Boston Globe, July 23, 2014, https://www.bostonglobe.com/business/2014/07/23/meet-market-basket -board-directors/0oHQYHuDEoBFkv6xbHO3XI/story.html.

The Company Becomes Derailed As 2014 dawned, the embattled Arthur T. announced that Market Basket would be providing a 4 percent discount to all its customers to thank them for their past loyalty, noting, “The customer needs the savings more than the company needs the extra profits.”47 The cost of the program was estimated at about half of the $300 million distribution approved in the fall of 2013 and about 70 percent of operating income.48 Through the winter of 2013 and the spring of 2014, the board and the CEO continued to clash on the appropriate level of board oversight over the actions of

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the CEO. Forbes reported that Arthur T. not only dismissed the board’s request for a business plan but also refused to share financial information with the board, forcing the directors to independently discover that while revenue was climbing, profitability was down and cash generated had fallen for five consecutive years.49 Then, on June 23, 2014, the board chose not to reelect Arthur T. as CEO. Within days, employees began to walk off their jobs and employee and customer boycotts effectively shut down the chain. In July, as the board and the interim CEO team scrambled to reestablish control of the situation, Arthur T. announced that his side of the family was willing to purchase the outstanding shares in the company from the other faction of the family. While the company took care not to lay off workers and inflame an already difficult situation, in late July the interim CEOs issued a statement that employees had to return to work by August 4. For some, the actions of the employees were another source of contention. Supporters of Arthur T. saw employee picketing and use of social media as an outpouring of support for a beleaguered CEO. Others speculated that employee actions were being indirectly orchestrated by Arthur T. as a lever to regain control of the company.50 (See exhibit 8 for a summary of the events from June 2013 to August 2014.) As the situation unfolded, the board’s independent members reached out and attempted to work with Arthur T. on a solution to stabilize the company, but they were rejected. For example, one proposal allowed Arthur T. and his management team to return to normalize operations while the independent members considered his offer to purchase the company. For his part, given the board’s stipulation that the interim CEOs remain in place, Arthur T. responded that the proposals were merely an attempt to stabilize the company while the independent board members considered selling the company to another bidder.51 In early August, the independent board members issued an open letter to employees:

statement of the independent directors of the demoulas board of directors: let’s get back to work “Twenty five thousand Associates and 2 million customers shouldn’t be held hostage for a business deal between shareholders. We need to get back to work, stock our shelves and allow customers to return to shop. Clearly, each side has sets of proposals to solve the impasse—there are enough proposed solutions out there to begin a serious negotiation. Business negotiations should not prevent our Associates from earning a living or our customers from buying groceries. It is wrong to hold everyone hostage to gain a negotiation advantage. Let’s end the hostage-taking and get together to work at finding common ground. We are ready to meet, anytime, anywhere,” said the Independent Directors.52

Exhibit 8: Timeline of Events, Market Basket, June 2013–August 2014 June 3, 2013: After years of back and forth, Judge Rya W. Zobel authorizes Arthur S’s side of the family to “seek full recovery of the plan for its $46m loss” [relative to the employee profit sharing plan]. The judge dismisses the part of [the] lawsuit filed against the board of the directors. June 2013: Rafaela Evans, who owns just over 4 percent of Market Basket shares, switches her allegiance from Arthur T. to Arthur S. September 2013: Judge Judith Fabricant allows Market Basket to proceed with a $300m distribution to shareholders despite objections from Arthur T. November 25, 2013: The board of directors begins a selection process for new investment advisors for the profit-sharing plan. April 2014: William Marsden, former trustee of the profit-sharing plan, pens a letter to the board asking for clarification as to why he was removed as the trustee of the profitsharing plan. June 23, 2014: Arthur T., William Marsden, and Joe Rockwell are fired by the board. June 26, 2014: Within days, seven executives quit their jobs with Market Basket to protest Arthur T.’s firing. July 15, 2014: Staff at the Tewksbury Market Basket demand that Arthur T. be rehired. July 21, 2014: Arthur T. releases first statement since being let go, asking that Market Basket reinstate the fired employees. July 23, 2014: Arthur T.’s side of the family announces that they are willing to buy the other half of the company from the Arthur S. faction of the family. July 25, 2014: While the board of directors meets to consider Arthur T.’s bid, protesters hold a third rally in Tewksbury. The board of directors announces it’s considering all bids for the company, including that from Arthur T. July 30, 2014: Market Basket’s new CEOs, Felicia Thornton and James Gooch, tell boycotting Market Basket workers that they need to return to work by Monday, August 4. August 3, 2014: Arthur T. issues a statement that he is ready to return to work immediately “in advance of the completion of the stock purchase” if his bid were to be accepted. In order to stabilize and begin to restore the business, he would bring back his full team, according to his spokesperson. August 8–12, 2014: The board of directors says that they have invited Arthur T. to rejoin the company, but not as a CEO. Arthur T. declines the offer. August 8–12, 2014: Arthur S. issues a statement noting that he is willing to sell to Arthur T.—and provide a loan on his own terms. He adds, however, that Arthur T.’s “conduct to date” undermines Market Basket. The three independent members of the Market Basket board of directors issue a statement asking workers and customers to come back. August 22, 2014: Shareholders reach a deal to sell the remaining 50.5 percent of shares to Arthur T. for an estimated $1.5 billion. December 12, 2014: Deal closes. Source: Adapted and supplemented from “A Timeline of the Market Basket Supermarket Family Feud,” Guardian, August 14, 2014, http://www.theguardian.com/money/ us-money-blog/2014/aug/14/timeline-market-basket-supermarket-arthur-family-feud.

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Days later, an agreement was reached for Arthur T. to purchase the outstanding shares from Arthur S.’s side of the family for an estimated $1.5 billion. By early September, Arthur T. had been reinstated at Market Basket, though the interim CEOs remained, pending the closure of the deal in December. In January 2015, free to select his own board, Arthur T. announced the retention of the two former board members from his side, the selection of two previous directors who had supported him, and the addition of three long-standing business associates, two of whom had been at Market Basket for over twenty years.53 Questions for Discussion 1. What are three critical family business challenges facing the company and/or the family? Suggest an approach for dealing with each. 2. What were the governance issues—regarding duty of loyalty, duty of care, and business judgment—at Market Basket? 3. How would you evaluate the actions of the board of directors? What other actions could they have taken? 4. What are your recommendations for Market Basket going forward? 5. What are the most important lessons you take from this case that apply to your future as an executive leader and/or board director? Conclusion In the Market Basket case study, the board looked outside the family for its CEO, which began the Demoulas family feud. The board took seriously their fiduciary responsibilities but did the family take seriously good governance? My assessment is that there never existed a commitment to shared values between the board and the CEO, a social contract. Had they been able to build those guiding principles, they may have been able to avoid the split board and its leadership chasm. In the The CEO’s Boss, I conclude with a recommendation if the decision is to look elsewhere for your next CEO: Develop your social contract. A board-CEO partnership cannot be sustained by good intentions alone; it must be defined by an explicit statement of the beliefs and behaviors that are essential for the general will of the organization. Boards should share a set of common commitments with their CEO: r
Commitment to values: a leadership credo that answers the question, “What do we stand for as an organization?” r
Commitment to the stakeholders: customers, employees, shareholders, band community. r
Commitment to risk assessment: a willingness to manage the company’s risk profile.

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r
Commitment to transparency: openness, communication, and accountability. r
Commitment to coaching: support the continuous improvement of their CEO’s performance. Eric Gebaide was the independent director of Demoulas Market Basket during its family feud. He has been a special guest in my Columbia EMBA Executive Leadership course to discuss my case study. His insider view of how the board confronted the executive leadership incapability of Arthur T. Demoulas is one of the key lessons to be learned from the case. The debate continues today now that the company was sold to Arthur T. He is left with his own capabilities to achieve a reasonable return on his investment. Whether he will apply the hard and soft metrics that the former board determined were essential in judging his executive capabilities to leading Market Basket is an open question.

Summary r
Measure what the board wants done and reward what it wants to be done repeatedly. r
A CEO’s leadership practices and behaviors are directly linked to the organization’s performance. r
Hard and soft metrics matter in the board-CEO partnership. r
A commitment to transparency, openness, and clear communication between the board and the CEO is essential to a productive partnership. r
Objective feedback is a gift from the board to its CEO.

5 How the Partnership Can Go Wrong: Take-Two Interactive

Culture: The way we do things around here.

Take-Two Interactive (TTWO) provides an informative example of a failed partnership between the CEO founder—a twenty-one-year-old genius—and the board. This case was brought to my attention by a fellow business professor at Columbia, David Beim, who developed it and handed it over to me for presentation at a series of Outstanding Directors Exchange (ODX) meetings in Chicago and San Francisco in 2007. More than just illustrating a failure in the partnership and social contract between a board and its CEO, the TTWO case study gives us an opportunity to examine the interdependence of business cycles and leadership agenda, practices, and styles. While presenting this case, I will discuss how the integrated leadership model (ILM), if applied with the appropriate level of tough love, could have helped a CEO-board partnership and business from going wrong.

The Gamer Generation

TTWO, a producer of video games for machines like Xbox and PlayStation, was a child of the dot-com era. Founded in 1993 by Ryan Brant,

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a twenty-one-year-old programmer, the company went public in 1997 and was a hot stock that increased in value through the rest of the decade and entered into the new millennium with an impressive set of performance numbers. Brant, a graduate of the University of Pennsylvania’s Wharton School of Business, was the CEO of the company from its inception. This case study will begin looking more closely at the partnership between Brant and his board through the lens of the ILM (see figure 3.7).

Leadership in the Beginning and Early Stages

Brant had been the CEO and a director of TTWO since he founded the company. He had two years of prior experience as COO of an illustrated book publisher. The CEO agenda for planning and launching a new business requires responding to a challenge and willingness to experiment. The combination of operating experience and creative ability gave Brant the right leadership practices and style for a start-up company. I have seen students with this driver/expressive behavioral profile in the entrepreneurial program at Columbia Graduate Business School and they are usually action oriented and spontaneously creative with a concomitant need to achieve results and gain approval. Sean Silverthorne sees this type of leadership behavior as particular to the gaming industry: Gamers approach the business world a bit more like a game. They see the different companies—and maybe the people they work with—as “players.” They’re way more competitive and are very passionate about “winning.” They are both more optimistic and more determined about solving any kind of problem you can imagine; they think there’s always going to be some combination of moves that will result in success. That drives them to be incredibly creative. They’re a bit suspicious of company leaders: The game world is not big on following hierarchy. Plus, they are very confident. Like entrepreneurs, they would rather rely on their own abilities to succeed or fail. They’re also more comfortable with risks, but aren’t reckless.1

The CEO looked right for this start-up company. Did the board? Here is the founding board’s membership as reported in TTWO’s 10K filing.

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FOUNDING BOARD Ryan A. Brant, CEO and director Mark E. Seremet, president, COO, and director Thomas Ptak, VP of Creative Development Barbara A. Ras, controller James W. Bartolomei Jr., VP Sales Oliver R. Grace Jr., director Neil S. Hirsch, director David P. Clark, director Kelly Sumner, director

This would appear to be a board that could work in partnership with its under-thirty CEO. Seremet and Ptak had both held leadership roles at similar companies, and Ras and Bartolomei had the financial expertise and experience to help the company get started. However, looking more closely at the “independence” of the directors on the board, there are some red flags. Clark was a cofounder of IMSI, a company acquired by TTWO, and Sumner entered into an employment agreement with Take-Two Interactive Software Europe Limited (TTE), a wholly owned subsidiary of TTWO. Because these external directors were primarily investors or vested in TTWO, the focus of the board’s partnership with Brant was based on short-term rewards rather than on long-term growth, and on satisfying immediate gratification rather than on sustained health. Brant needed more independent and unencumbered directors to serve as his coaches. This partnership required a social contract, a set of operating principles that would ensure TTWO’s long-term development. I would prescribe r
Commitment to values: a leadership credo that answers the question, “What do we stand for as an organization?” r
Commitment to the stakeholders: customers, employees, shareholders, and community r
Commitment to risk assessment: a willingness to manage the company’s risk profile r
Commitment to transparency: complete honesty in financial and nonfinancial matters r
Commitment to coaching: for continuous improvement

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Unfortunately, Brant never had a group of directors that could give him honest feedback on his performance, let alone agree on a set of operating principles. In addition, the executive compensation contract with the CEO included a bonus that was dependent on meeting First Call’s consensus estimate of EPS each quarter, and the contract with the CFO included a bonus dependent on the company increasing its net income each period.2 This reliance on these few hard metrics as indicators of success would contribute to the downfall of the TTWO board.

Changes in 1998 and 1999

In addition to the vested interest of the external directors, the board’s membership was constantly shifting. The first signs of change on the board become apparent with the first complete 10K published at the end of the 1999 fiscal year. Seremet, Ptak, Bartolomei, and Clark were no longer directors, and Sumner moved up the in the batting order to VP of international operations and director. There was a 50 percent turnover of external directors and three new chief administrative officers (CXOs) were added to the board lineup—COO, Anthony Williams; CFO, Larry Muller; and Barbara Ras assumed the role of chief accounting officer (CAO) and secretary. Robert Flug and Robert Alexander joined as new directors. Despite this constantly shifting board, Brant successfully led his company through its beginning and early growth stages, with a driver/expressive style required of the leader, but then TTWO began to move into the middle part of its business cycle. To ensure that the company continued to prosper, Brant needed to shift his leadership style to being more amiable and start enabling others for the business to endure. Instead, he relinquished the CEO role and thus we will never know if he could have modified his leadership agenda, practices, and style. Had Brant continued as CEO of TTWO as it began to move into its more mature stage of development, he and his board would have had to address his leadership capabilities and those of his management team. As it was, Brant remained in his daily operating role, with the title of chairman, and Kelly Sumner took over as CEO in 2000. Looking at the board for the fiscal year ending October 31, 2000, we find very few members from the board at the founding of the company: Ryan A. Brant, chairman and director Kelly Summer, CEO and director

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Paul Eibeler, president and director Anthony R. Williams, cochairman and director Larry Muller, COO and director James H. David, CFO and director Oliver R. Grace Jr., director Robert Flug, director Don Leeds, director

During Brant’s tenure as CEO, of the four external directors on the board, Grace was the only constant presence. The only thing consistent about the board was an annual turnover in external directors. For Brant to get any constructive feedback, he needed external directors who had seen the company through different stages in the business cycle and who had observed his leadership at each stage. As discussed in chapter 1, the reinvention of Tyco by Breen and Krol resulted from a strong partnership and a clear set of priorities. This partnership included a board of external directors with the expertise that could guide the company through its new beginning and early rise from the ashes of its previous CEO’s failed leadership—a practice that could have served Brant and TTWO well not only during its rise but at the launch of his start-up.

The First Signs of Trouble

Although the leadership metrics of this company looked troubling, the hard metrics of the business did not immediately indicate this. Financial performance had become the only rule for the success for Brant and his board, and the company’s numbers were only getting better. For the fiscal year 2000, TTWO reported a 26.5 percent net increase in sales and a 53 percent increase in net income. In the 10K for that year, the board attributed this to the expansion of our global publishing and distribution businesses, with substantially all of the increase attributable to internal growth.3 TTWO had acquired numerous small game manufacturers and planned to deliver high-profile game content for both PC and evolving console markets. This financial success translated into huge compensation packages for Brant and the CFO. Brant’s compensation increased 38 percent in his last year as CEO to just over $1 million, and he was granted 200,000

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additional options. As its chairman in 2001, his compensation was increased another 30 percent and he was granted just under 480,000 additional options. Right around this time, however, the dot-com bubble burst. Many internet-based companies that had grown rapidly in the 1990s had not applied standard business models, focusing instead on increasing market share at the expense of the bottom line. By 2001, it became clear that TTWO was having similar difficulties. In February of that year, the company alerted its investors that the Q2 and Q3 earnings would fall short, citing the fact that fewer new games were coming out the pipeline. The year only got worse. In the wake of 9/11, the company had to do a costly reworking of three of its new Xbox games. In addition, Grand Theft Auto, which had been one of TTWO’s top games for several years, became the focus of media attention as a contributor to the root causes of violence in the global society. As a result, Australia banned the third version of the game from distribution and the stock fell 31 percent. In October, the company’s troubles deepened when its accounting methods came into question by the SEC. TTWO was forced to restate the results for fiscal 2000, and the first three quarters of fiscal 2001. Analysts began to suspect that the company had been selling products to itself and then recording those sales as part of its revenues.4 NASDAQ halted trading in the company’s stock in February of 2002 while TTWO dealt with its restatements. Where was the board in the middle of all this dysfunction? In hindsight, it’s clear that the external directors should have asserted themselves at the first signs of accounting irregularities. However, too many of the board members were management cronies and incompetence was tolerated for too long. Rather than addressing the root problems that led to these accounting troubles—by, for instance, instituting a social contract to ensure a commitment to transparency and to the shareholders—the board flushed out some of its old members. Karl Winters replaced the CFO, Albert Pastino, and several others joined the board with the priority of overseeing the company’s adherence to its operating policies and practices. In 2003, Jeffery Lapin replaced Kelly Sumner as CEO, and Sumner remained on in a developmental role. Although all these changes strengthened the membership of the board and allowed it to address the gaps in the company’s leadership and performance, in the end they happened too late to keep the company from becoming dysfunctional.

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This dysfunction was not immediately apparent. Even in the midst of TTWO’s financial scrutiny, Grand Theft Auto 3 became the top video game in the country for four months and the stock went up 8 percent following the announcement of restated earnings. In the first quarter of fiscal year 2002, earnings were reported at $0.82 versus $0.25 the year before. By mid-2003, earnings were up 58 percent. The board must have thought it dodged a bullet. However, its reliance purely on hard metrics as indicators of the company’s strength and its failure to deal with the dishonesty of its leadership would come back to haunt it.

New York Times Exposé, May 12, 2003

It took the New York Times to pull together the story of the root cause of the failed CEO-board partnership and to show that despite intermittent success, something was fundamentally unsound about the company’s culture, the “way they did things” around TTWO. The article revealed, for instance, that Ryan Brant’s father, who had served prison time for tax evasion, was one of the first major investors in the company and was profiting from the real estate that the company leased from him. In 2001, he came under scrutiny for selling $1.86 million in shares, almost his entire holding, months before the trading halt.5 But it wasn’t only the family connections in TTWO that aroused suspicion. Both of the CEOs appointed after Brant came under fire in the article as well. Sumner, for instance, was the president of Gametek before coming to TTWO, a company that sold its British business and other assets to TTWO a few months before bankruptcy in 1997. And Lapin was on the board and audit committee of eUniverse, which was the subject of an SEC investigation after restating two quarters of earnings. This was exactly what Lapin had been hired to clean up at TTWO when he was hired. This exposé made it clear that the changes in the board in 2001 and 2002 could only serve as a short-term solution. This must have become clear to the company itself as well, because in June 2003 the president, Paul Eibeler, declared that management must focus on accounting irregularities and sales practices. When Brant and Lapin overruled him to press ahead with game development, Eibeler resigned. Nonetheless, the board initiated its own independent investigation of accounting even though Brant and Lapin insisted that this distracted management from operations. Some members

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of the board demanded the resignation of Brant and Lapin, whereas others feared a loss of creative talent and management continuity. The company was still successful enough to justify this fear; in October 2003, Grand Theft Auto San Andreas was released to huge acclaim. Sales for 2003 topped $1 billion, and the stock rose to an all-time high. However, in December 2003, a SEC Wells Notice reported its plan to file suit against TTWO, Brant, Lapin, and two former officers over accounting practices. The company announced that it would delay filing its 2003 report and restate five years of earnings.6 Finally, in March 2004, Brant resigned as chairman and director, although he remained as vice president in charge of publishing, a new post. Independent director Richard Roedel became chairman, and when Lapin resigned in April 2004, Roedel took that position, too. Paul Eibeler was brought back as president and vowed to clean up accounting. As a result, TTWO reported Q2 earnings that were far below expectations and cut estimates of 2004 sales and earnings. The stock fell to $28.

Shareholder Activism

Although by 2004 and into the 2005 fiscal year the shareholders might have thought the worst was behind them, in July 2005, a hacker published “mod” code for Grand Theft Auto San Andreas that revealed sexually explicit scenes buried in the game. Many retailers took the game off their shelves, and although TTWO stopped producing the game and said it would release a cleaned-up version, Walmart and Best Buy announced that they might not restock the game at all. Sales at TTWO fell by 63 percent in November 2005, and when the company revised its earnings estimate downward, the stock fell to $19. In early 2006, numerous new shareholder lawsuits based on a range of charges about business practices, including backdating of management stock options, resulted in an investigation by the board’s audit committee. The management stalled as the board sought an explanation of the issues, and the chair of the committee resigned, complaining that the board was kept in the dark by management and was not adequately independent. By June 2006, TTWO revealed it had received criminal grand jury subpoenas inquiring into a range of business practices. The stock fell to $10, and the SEC opened an investigation into the option backdating, which Brant plead

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guilty to in 2007. TTWO announced that five external directors had also received backdated options, including the former audit chair. These directors agreed to improper gains back to the company, and TTWO said it would take $42 million in charges relating to backdating. By March 2007, the TTWO board game was truly over. A consortium of investors holding 46 percent of the stock announced its intent to oust the board and top management of TTWO, and within a few weeks all but two of the directors were replaced. Upon the close of the 2007 fiscal year, Strauss Zelnick, the new chairman of TTWO, stated: Fiscal 2007 was a year of progress for Take-Two, capped by better-thanexpected bottom-line financial performance in the fourth quarter. The Company has benefited from initiatives to streamline operations and improve our cost structure, while continuing to expand our portfolio of powerful video game franchises. As a result of this progress, TakeTwo today is sharply focused on its core publishing business and is operating more productively and efficiently, while continuing to foster the extraordinary creative talent of our development teams. We are fully committed to building on this solid foundation to produce great entertainment and to enhance shareholder value.7

Hindsight: How the ILM Could Have Helped

It’s unclear, given the lack of transparency throughout the company, who was gaming whom at TTWO. If there ever was a case where tough love was needed between a CEO and the board, this is it. One of several root causes of the problem was that there was not a credible cadre of external directors serving on the board for an extended period of time. In addition, there was no evidence of a social contract to guide the company’s actions, nor was the board confronting the unethical behavior of its CEO and his management team. Given these conditions, what TTWO needed as it matured as a company was a CEO whose agenda was to build a management team and culture committed to ethical behavior, to all stakeholders, to risk assessment, to transparency, and to coaching for improved performance. An amiable leadership style could have helped build productive relationships and institute an ethical way of doing things around TTWO. When the market forces changed, as they always do, the board should have required an analytical

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leadership style that could bring greater insight to its strategic thinking and model the way for superior execution of its business plan. Absent this alignment of the agenda, practices, and styles in its CEO with the needs of the business, dysfunction was almost inevitable for TTWO. The situation at TTWO was unique in that the investor group that spearheaded the revolt controlled nearly half of the company’s shares. Also, Brant was the first chief executive to be convicted of backdating stock options. Still, as B. Espen Eckbo, the founding director of the Center for Corporate Governance at the Tuck School of Business at Dartmouth College, said, “The takeover sends a message to directors of other companies that their jobs are in jeopardy if they lose sight of their commitment to shareholders. . . . The pendulum is swinging in the U.S. toward more hiring and firing of directors—the board is being held to a higher standard as we go forward than ever before. Boards are literally being re-educated about what their jobs are.”8 The leadership failure at TTWO illustrates the need for tough love in the boardroom. Whether TTWO’s founder/father combination would have allowed for an open and honest partnership between the board and the CEO is truly suspect, but the lack of any kind of social contract or independence from external directors made failure almost inevitable. In the end, it took a revolt from outside to change the executive leadership and the board. David Beim had it right when he said, “The problem is corporate culture. This was a defiant, over-confident, under-experienced crowd with scant regard for social norms or legal niceties. Corporate cultures are incredibly difficult to change once embedded. It was beyond the power of the board to change.”9 Upon further reflection, I would offer that it was beyond the power of this board to change the TTWO culture because it helped create and reinforce it. If the board wanted a different culture, it needed to define its partnership with Brant through a social contract that embodied its credo and mandated ethical operating policies and practices. The external directors needed to assert their independence, thereby fulfilling their fiduciary role to the shareholders by diligently monitoring the performance of the CEO. They needed to: Know the CEO’s behavioral style and leadership practices. Know the organization’s needs (strategy, priorities, and gaps). Match the organization’s needs with the leadership that is required. Look first at the CEO and then the senior team to find the correct match. Look elsewhere if the correct match isn’t found.

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At TTWO, the board exercised tough love with its CEO too late, rendering it about as effective as not having exercised it at all. This case is a classic example of the tension between a creative genius and sound business practice—complementary leadership practices and styles that didn’t coexist in this boardroom. Boards are loath to lose what makes a creative business special, but they must not forget good management practices in the quest for originality. You can rely on driving independence and a disposition to experiment when starting up a business but as the business matures there is a need for more enabling leadership and proven business practices. During the fall of 2016, the Wells Fargo scandal was breaking in the news. The unethical and illegal practices within the bank raised the question as to where the board was in fulfilling its fiduciary responsibilities. Wells Fargo was in a governance crisis that resulted in the exiting of its CEO. Again, as in the case of TTWO, corporate culture was key and an absence of tough love in the boardroom motivated my writing of my Wells Fargo case study.

CASE STUDY: WELLS FARGO AND COMPANY: CORPORATE GOVERNANCE CRISIS By William M. Klepper ID#170413, Published on, June 9, 2017

Introduction We never take for granted the trust our customers have placed in us, and we understand the important role we play in helping grow the U.S. economy. John G. Stumpf, former chairman and CEO, Wells Fargo & Company, 2015 Annual Report The luxurious Sawgrass Marriott Golf Resort and Spa in Florida—where Wells Fargo & Company had just concluded its 2017 annual meeting—must have seemed an odd place to host what was anticipated to be the most contentious shareholder session in the bank’s 150-year history. On April 25, 2017, surrounded by PGA Tour golf courses and private villas, the meeting featured outbursts by angry shareholders, a ten-minute interruption to eject an activist, and a vote of nonconfidence by two large California pension funds. But despite the raucous crowd, all thirteen of Wells Fargo’s returning directors were reelected to the board,10 a result that was supported by Warren Buffett’s Berkshire Hathaway Inc.,

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its largest shareholder. The votes were by no means unanimous: support for some directors was as low as 53 percent; the chairman’s came in at 56 percent. Wells Fargo had been under heavy public scrutiny following news in September 2016 that it had paid a $185 million fine to settle allegations of fraudulent sales practices. For years, employees had been pushed to open fake accounts for customers without their approval. While John Stumpf, the bank’s chairman and CEO at the time, had tried to contain the scandal by assuring observers that the indiscretions were in the past, the board, admitting that the situation was deteriorating, began asserting control on September 18. A group of four independent directors met in Manhattan without Stumpf and hired Shearman & Sterling, a law firm, to investigate. The firm conducted 100 interviews and looked at 35 million documents. Stumpf was forced to forfeit millions in bonuses and salary, and he stepped down on October 12. Carrie Tolstedt, the former head of Wells Fargo’s Community Banking division who had pushed the division to open the accounts, faced wage clawbacks and was retroactively fired for cause. Lawmakers and shareholders, among others, demanded to know why the board had not acted sooner, given that at least one whistleblower had stepped forward as early as 2007 and that the Los Angeles press had conducted a public investigation in 2013. Predictably, Shearman & Sterling’s findings, made public on April 10, 2017, noted that “board members believe they were misinformed” by presentations that “minimized and understated problems at the Community Bank.”11 Now, with the entire slate reelected, the board could seize the chance to reset Wells Fargo’s strategic priorities. Yet observers wondered what impact the Wells Fargo board would make, given that almost nothing had changed. There had been very little turnover at the board level, with the average tenure of directors at nine years. Stumpf had been forced into retirement, but Tim Sloan, a twentyeight-year Wells Fargo veteran, had been installed as the new CEO. At the end of April 2017, it seemed that the challenge for Wells Fargo’s board of directors was to prove its critics wrong. A renewal in the bank’s corporate governance standards and practices seemed necessary. The question was what changes, if any, the board should and would make. Good Governance Practice12 As representatives of the shareholders, boards oversee the activities in a corporation. They are ultimately responsible for a CEO’s actions and they scrutinize the company’s strategic leadership and strategic management. Strategic leadership, by definition, defines the change an organization desires, whereas strategic management aligns the levers of the business system to achieve that change. A CEO once inserted into the business system will serve as either a catalyst or an Aimpediment to a board’s desired change. To understand if the CEO’s actions

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Exhibit 1: CEO Alignment Model

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Figure 5.1 

(Source: William M. Klepper, The CEO’s Boss: Tough Love in the Boardroom (New York: Columbia University Press: 2010).)

are aligned with the firm’s strategy, a board may look at the following four issues: structure, process, people, and culture (see exhibit 1). r
Structure: How would you align your activities as CEO to achieve the strategic objectives of the business? Does the current design of our organization provide the structure you would need to support our strategic intent? Are there any systems you feel are not aligned? r
Process: How would you improve the work flow throughout the organization? What do you feel are the knowledge, skills, and information requirements needed to improve our work processes? Do you feel that are our performance measures and indicators are aligned? r
People: Do you feel our employees possess the required competencies? Are there any changes you envision, and if so, how are those changes aligned with our employees’ expectations and motivations? r
Culture: How should we be doing things around here in support of our strategic intent? Are our norms and values aligned with yours, and if so how? If a strong partnership between the board and the CEO is to be developed, they need to have a social contract—a formal understanding of how to work together. This social contract is created when a board and its CEO evaluate and

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discuss what is necessary to “ensure their commitment to the welfare of the business.” For this to be effective, each party must place “his person and authority under the supreme direction of the general will—in this case, the board-CEO partnership.” As part of the social contract, a board must be able to support and to discipline its CEO, practicing “tough love” if necessary. As it receives and processes information from the CEO and the management team, the board needs to keep an eye on the “inflection points” in the life of a business, where transitions occur to and from the peaks of success. Ensuring that good governance is practiced means that the board needs to be vigilant. One way it can do this is by asking questions and by continually questioning the degree of alignment between the CEO’s actions and the organization’s needs. This five-item framework can help a board with this task: r
Know its CEO’s behavioral style and leadership practices. r
Know its organization’s needs—strategy, priorities, gaps. r
Match the organization’s needs with the leadership that is required. r
Look first at the CEO and then to the senior team to find the correct match. r
If the correct match isn’t found, look elsewhere. The U.S. Banking Sector In 2016, the U.S. banking industry earned net income of $171.3 billion, its highest since 2013, and achieved a return on equity of 9.3 percent.13 Five large banks14—JPMorgan Chase & Co., Bank of America Corp., Wells Fargo, Citigroup Inc., and US Bancorp—controlled nearly half of the $16.8 trillion in assets in 2016,15 compared to under 30 percent in 2003.16 Commercial banks earned interest income from the margin between their borrowing rate and their lending rate and fees on accounts and investment products. Typical businesses included community banking (consumer lending and private student loans); wholesale banking, which covered equipment lending; and wealth and investment management. Wells Fargo & Company The third largest bank in the United States after JPMorgan Chase and Bank of America, Wells Fargo was founded in 1852 in San Francisco. It had $1.8 trillion in assets and offered services such as checking and savings accounts, insurance, investment products, and loans to consumers and businesses. It employed more than 250,000 people and counted one out of every three American households as a customer.17 The bank was international, with offices in thirty-six countries.

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In spite of a low-interest-rate environment in the United States, Wells Fargo’s total income grew from $84.6 billion in 2013 to $87.2 billion in 2015, propelling it to the position of the world’s most valuable bank in July 2015. “Earning lifelong relationships, one customer at a time, is fundamental to achieving our vision,” said Stumpf in the bank’s 2015 annual report. “We never take for granted the trust our customers have placed in us, and we understand the important role we play in helping grow the U.S. economy.” In addition to the stated focus on customer relationships, Stumpf added that the bank valued its employees. He continued: We are a relationship company, but our relationships with customers are only as strong as our relationships with each other. Products and technology don’t fulfill the promises we make to our customers, our people do—people who are talented, motivated, and, I believe, more energized than our competitors.18 Next, Stumpf talked about Wells Fargo’s third goal of “earning relationships with our communities,” citing examples of how employees—“team members” according to Stumpf—volunteered their time and donated to not-for-profit causes. Last up Stumpf described a commitment to investors, or “earning relationships with our shareholders,” and talked about Wells Fargo’s market leading share, diversified revenue sources, “experienced management team and consistent culture.”19 (See exhibits 2 and 3.) It was also noted in the 2015 annual report that, as part of the bank’s succession planning, Tim Sloan, a twenty-eight-year veteran of the bank and previous head of its wholesale banking division, was promoted to president and chief operating officer on November 17, 2015.20 Wells Fargo’s momentum continued into the start of 2016 when, on January 16, 2016, it passed Citigroup to become the third-largest U.S. bank by assets—$1.79 trillion versus $1.73 trillion. The Wall Street Journal attributed this achievement to Wells Fargo’s “Main Street focus and an ability to dodge the regulatory headaches that have dogged much of the industry.”21 Yet not even a month later, in February 2016, Wells Fargo paid $1.2 billion to settle a mortgage lending suit by regulators accusing Wells Fargo of “reckless origination and underwriting” of government-backed loans. Wells Fargo was one of several large U.S. banks sued by the Federal Housing Administration; it was the last bank to come to a settlement with the regulator.22 Despite the fine, it was a much smaller settlement in September 2016—less than one-sixth the size of the mortgage deal—that drew the most attention.

Exhibit 2: Wells Fargo Culture

(Source: “Opportunities for Future Leaders: Our Culture,” Wells Fargo web site, http://myfuture.wf.com/culture, accessed June 9, 2017.)

Exhibit 3: John G. Stumpf, Chairman, President & CEO: The Vision & Values of Wells Fargo

Our vision Our vision is: “We want to satisfy our customers’ financial needs and help them succeed financially.” It is just as relevant today as when it was written more than 20 years ago. We didn’t know then that at only 84 characters, it would be succinct enough to tweet today! Our vision of financially successful customers is based on a simple premise: We believe customers across all business segments can be better served, and save time and money, if they bring their financial services to one trusted provider that knows them well, provides reliable guidance and advice, and can serve their full range of financial needs through a wide choice of products and services. Our journey toward this customer-centered vision has required hard work, persistence, and determination. We’ve made steady progress toward this goal. But we still have much to accomplish. For example, our own customers still give a significant amount of their financial business to our competitors. Our job—central to our vision—is to make it easy for them to bring more of their business to us so we can satisfy their financial needs. Our vision has nothing to do with transactions, selling products, or getting bigger for the sake of bigness. It’s about building lifelong relationships one customer at a time. Each of our customers defines “financial success” differently and very personally. Some want financial security and self-sufficiency. Others want to be disciplined about spending and saving so they can afford to buy a home, start or grow a business, save for education, or prepare for retirement. And some just want to be better informed about financial matters. Knowing what financial success means to each of our customers is the starting point for serving them well. The reason we wake up in the morning is to help our customers succeed financially and to satisfy their financial needs, and the result is that we make money. It’s never the other way around. Our time-tested vision will forever be what matters to Wells Fargo. We’ll never put the stagecoach ahead of the horses. Our values Our values should guide every conversation, decision, and interaction. Our values should anchor every product and service we provide and every channel we operate. If we can’t link what we do to one of our values, we should ask ourselves why we’re doing it. It’s that simple. All team members should know our values so well that if our policy manuals didn’t exist, we would still make decisions based on our common understanding of our culture and what we stand for. Corporate America is littered with the debris of companies that crafted lofty values on paper

but, when put to the test, failed to live by them. We believe in values lived, not phrases memorized. If we had to choose, we’d rather have a team member who lives by our values than one who just memorizes them. We have five primary values that are based on our vision and provide the foundation for everything we do: r
People as a competitive advantage r
Ethics r
What’s right for customers r
Diversity and inclusion r
Leadership People as a competitive advantage We value and support our team members as a competitive advantage. We strive to attract, develop, retain, and motivate the most talented, caring team members who work together as partners across businesses and functions. In hiring, we really don’t care how much people know until we know how much they care. We like to say that we hire for attitude and train for aptitude. We provide the tools and training that team members need to succeed in their work, and we want them to be responsible and accountable for their businesses and functions. We expect the best from our team members, and we thank them for their outstanding performance. We say “team members,” not “employees,” because our people are resources to be invested in, not expenses to be managed—and because teamwork is essential to our success in helping customers. Our culture is about plural pronouns—we, us, and ours—instead of I, me, and mine. The star of the team is the team; we win by playing “us” ball. We believe everyone on our team is important and deserves respect for who they are and how they can contribute to our work together. Products and technology don’t fulfill the promise behind a brand, people do—people who are talented, motivated, and more energized than our competitors. When our team members are in the right jobs, spending time on the right things, feeling good about their contributions, fully using their skills and learning new ones, leading well, and having fun, they’ll do what’s right for the customer. When they’re properly supported, rewarded, and encouraged, they’re even more satisfied with their jobs, providing even better service for our customers. This can generate happy, more loyal, and lifelong customers, which can lead to more revenue, greater profits, and a higher stock price. We want to be an employer of choice, a company that truly cares about people, where teamwork is valued and rewarded, where how the work gets done is just as important as getting the work done. We’re a relationship company, but our relationships with our customers are only as strong as our relationships with each other. We want to create an environment where team members feel

included, valued, and supported to do work that energizes them and where we are inspired to go further together—for one another, our customers, our communities, and our shareholders. We survey our team members regularly to determine how well we’re doing and to measure their level of engagement. Using those survey results, managers across the company work with their teams to develop specific action plans. In a company our size, jobs are always changing, going away, or being added to satisfy customer needs. A company has a responsibility to its stockholders and its customers to eliminate duplicate jobs and operate as efficiently as possible while also providing outstanding customer service. That doesn’t mean we have to lose good people and their experience, loyalty, and commitment. New jobs are being created virtually every day somewhere in Wells Fargo. We would like team members whose jobs have been eliminated to find positions elsewhere in the company. Our team members are our most important constituents because they’re the single most important influence on our customers. We want our team members to be our customers, too. Some people say loyalty to a company is a thing of the past. We don’t believe that. People naturally aspire to a larger purpose beyond themselves. They want to believe in their company and the good it can do. Don’t we all? We want every team member to be able to say, “I chose the right company. I’m valued. I’m rewarded. I’m recognized. We work hard, and we have fun, too. I can improve my professional skills and reach my career goals here. I enjoy my work.” Ethics We strive to be recognized by our stakeholders as setting the standard among the world’s great companies for integrity and principled performance. This is more than just doing the right thing. We also have to do it in the right way. Honesty, trust, and integrity are essential for meeting the highest standards of corporate governance. They’re not just the responsibility of our senior leaders and our board of directors. We’re all responsible. Our ethics are the sum of all the decisions each of us makes every day. If you want to find out how strong a company’s ethics are, don’t listen to what its people say. Watch what they do. This is even more important in our industry because everything we do is built on trust. It doesn’t happen with one transaction, in one day on the job, or in one quarter. It’s earned relationship by relationship. Our customers trust us as their financial resource. They trust our tellers to complete transactions accurately and promptly. They trust our bankers to provide them with products and services to meet their needs. They trust our financial advisors to give them sound advice. They trust our mortgage

consultants to manage their application process completely, accurately, and as quickly as possible. They trust our investment bankers to build financial models to analyze business trends, shape investment ideas, raise capital, and meet their strategic objectives. And they trust all of us to act as risk managers—to ask the right questions, protect their assets, and help them reach their goals. We have to earn that trust every day by behaving ethically; rewarding open, honest, two-way communication; and holding ourselves accountable for the decisions we make and the actions we take. We value what’s right for our customers in everything we do. We’re proud to compete in an industry that’s central to the growth of our local, national, and global economies—an industry where doing what’s right for customers and communities enables us to make a reasonable profit at the same time. Our customers are our friends. We treat them as our guests. We want them to be successful. We want them to feel as if they’re part of Wells Fargo—that we’re their company. We want to be approachable and caring, exceed their expectations, and invest in relationships that last a lifetime. One of our top priorities is protecting customers’ confidential data and information. Customers trust us to use that information to provide them with products and services that can save them time and money. They expect us to help guide them, help grow and protect their financial assets, and help them succeed financially. Our focus on customers is unwavering. That is how we have been doing business for more than 160 years and is the key to our future. Leadership We’re all called to be leaders. We all have the responsibility to be the link between the vision of Wells Fargo and our customers. This is not the exclusive domain of managers. We define leadership as the act of establishing, sharing, and communicating our vision, and as the art of motivating others to understand and embrace our vision. Leaders are accountable. They share the credit and shoulder the blame. They give others the responsibility and opportunity for success. Good leaders inspire teams to have confidence in their leadership; great leaders inspire team members to have confidence in themselves. We want all team members to be able to lead themselves, lead the team, and lead the business. When a customer needs an answer, we have to be able to respond quickly. That’s a competitive advantage. Leaders consider themselves equal partners in a team effort to achieve our vision. When the team needs help, leaders pitch in just like everyone else. Leaders are involved. They’re handson and available. They take personal ownership for a customer’s problem and don’t let go until that problem is solved. No one tells them to do it; they just do it.

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The best leaders are the best coaches. They don’t rely on authority or force of personality. They are confident in the inherent knowledge and talent of every team member. They believe our team members have the answer to every problem and see the potential in every opportunity. Leaders empower themselves and team members to develop ideas, test them, quantify the results, and then share the good ones with our other businesses and functions. Leaders connect to our vision. They share their passion and their discipline about how to make our vision come alive. Leaders inspire outstanding performance. How we behave as leaders is just as important as the results we get. Leaders care about their team members’ success, development plans, and professional dreams. Leaders learn from each other. That’s an advantage of being a big company. We share ideas and search for the best ones. We don’t resist a good idea simply because “it wasn’t invented here.” We’re always searching for the best way to do something and adopting it wherever it applies—to improve our service, keep customers and attract new ones, support communities, increase revenue, and manage expenses. It’s not the strongest or most intelligent companies that survive in our industry but those that best adapt to change and take full advantage of the knowledge and experience of the whole team. Source: John G. Stumpf, “The Vision and Values of Wells Fargo,” 2015, https://www08. wellsfargomedia.com/pdf/invest_relations/VisionandValues04.pdf.

There were fifteen members on Wells Fargo’s board of directors (see exhibit 4).23 According to the bank’s corporate governance guidelines, the board focused on these three tasks, among other things: “succession planning for the CEO and senior management; reviewing, monitoring and approving strategic plans and objectives; and ensuring processes are in place for maintaining the integrity and reputation of the Company and reinforcing a culture of ethics, compliance and risk management.”24 (See exhibit 5.) The Fake Accounts Scandal On September 8, 2016, it was revealed that Wells Fargo had paid $185 million in fines to federal banking regulators to settle a lawsuit accusing it of opening 1.5 million unauthorized bank accounts and approving 565,000 credit card applications. The lawsuit was initiated by Michael Feuer, the Los Angeles City Attorney, and the settlement involved Feuer’s office, the Office of the Comptroller of the Currency, and the Consumer Financial Protection Bureau. In total, Wells Fargo agreed to refund about $2.6 million in fees to customers. These practices

Exhibit 4: Wells Fargo Board of Directors as of April 26, 2017.

Timothy Sloan, 56 Director, President, CEO Since 2016 John S. Chen, 61 Independent Director Since 2006 Federico F. Pena, 70 Independent Director Since 2011 Donald M. James, 68 Independent Director Since 2009 Ronald L. Sargent Independent Director Since 2017

Susan G. Swenson, 68 Independent Director Since 1998 Enrique Hernandez, 61 Independent Director Since 2003 Suzanne M. Vautrinot, 57 Independent Director Since 2015 James H. Quigley, 65 Independent Director Since 2013 Stephen W Sanger, 70 Non-Executive Chairman of the Board Since 2003

Cynthia H. Milligan. 70 Independent Director Since 1992 John D. Baker, 68 Independent Director Since 2009 Lloyd H. Dean, 66 Independent Director Since 2005 Karen B. Peetz Independent Director Since 2017 Elizabeth Duke, 63 Non-Executive Vice Chairman of the Board Since 2015

*Elaine Chao (member since 2011) and Susan Engel (member since 1998) did not stand for reelection to Wells Fargo’s Board in April 2017. Chao had deferred stock options earned as a board member at Wells Fargo and stood to collect a total cash payout of between $1 million to $5 million, paid between July 2017 and 2021 (Lee Fang, “Wells Fargo to Pay Transportation Nominee Elaine Chao up to $5 Million Over Next Four Years,” The Intercept (blog), January 17, 2017, https://theintercept.com/2017/01/17/chao-trump-wellsfargo/).  

 

 

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(Source: “Wells Fargo & Co.: Insiders: Board of Directors,” Morningstar.com, http://insiders. morningstar.com/trading/board-of-directors.action?t=WFC®ion=usa&culture=en-US.)

Exhibit 5: Wells Fargo & Company—Corporate Governance Guidelines

° Succession Planning for the CEO and Senior Management r
The Chair of the HR Committee coordinates an evaluation by each of the non-management directors on the performance of the CEO and reports to the Board on the results of the evaluation in executive session without the CEO being present. The evaluation is based both on objective criteria, including various measure of financial and business performance, and subjective factors, and is used by the HR Committee in the course of its deliberations when considering the compensation of the CEO. The BoD also meets with the CEO annually in executive session to discuss the CEO’s performance appraisal. The HR Committee, with the full involvement of the Board, plans for the succession to the position of CEO. To assist the HR Committee and the Board, the CEO and management report to the HR Committee and the Board at least annually on succession planning (including plans in the event of an emergency) and management development. The CEO and management also provide the HR Committee and the Board with an assessment of persons considered potential successors to certain senior management positions at least once each year. ° Reviewing, monitoring, and approving strategic plans and objectives, etc.

r
The Board oversees management’s development of the Company’s strategic plans, and works with management in setting the schedule, format and agenda for Board strategy sessions so that there are sufficient time and materials to permit appropriate interaction between directors and management in reviewing and considering the Company’s strategy. ° Ensuring processes are in place for maintaining the integrity and reputation of the Company and reinforcing a culture of ethics, compliance and risk management

r
One of the Board’s key responsibilities is to ensure that the Company, through its management, maintains high ethical standards and effective policies and practices designed to protect the Company’s reputation, assets and business. The Board has adopted and promotes the Wells Fargo Code of Ethics and Business Conduct applicable to team members as well as directors Source: Wells Fargo & Company, “Corporate Governance Guidelines,” February 28, 2017.

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started in 2011 and 5,300 employees were fired as a result. “Unchecked incentives can lead to serious consumer harm, and that is what happened here,” said Richard Cordray, director of the Consumer Financial Protection Bureau.25 As part of the settlement, Wells Fargo did not admit any wrongdoing. It later emerged that Stumpf had sold $61 million of his Wells Fargo stock in the month leading up to the September 8 announcement.26 The allegations of a high-pressure sales culture would not have come as a surprise to Wells Fargo’s management team or its board of directors, given that the former had engineered the program—known by the slogan “Eight Is Great”—and the fact that the Los Angeles Times had written about the bank’s sales practices in December 2013. In fact, it later emerged that the fraudulent practices dated back to at least 2005, when Julie Tishkoff reported to the Human Resources department that she had seen employees forging signatures to create fake accounts. Tishkoff continued to complain for four years before she was fired in 2009.27 In 2007, a whistleblower even sent a letter directly to Stumpf (see exhibit 6), claiming that his allegations of illegal practices were deemed to be “harassment,” and he was subsequently removed from his workplace as a result. “Eight Is Great” referred to Stumpf ’s proud goal of achieving eight product sales to every Wells Fargo customer. To monitor progress towards this goal, as Rita Murillo, a Wells Fargo branch manager interviewed by the Los Angeles Times revealed, “Regional bosses required hourly conferences on her Florida branch’s progress toward daily quotas for opening accounts and selling customers extras such as overdraft protection. Employees who lagged behind had to stay late and work weekends to meet goals.”28 Employees falling short of the goals were threatened with dismissals. Murillo recalled: “We were constantly told we would end up working for McDonald’s. If we did not make the sales quotas . . . we had to stay for what felt like after-school detention, or report to a call session on Saturdays.”29 Employees were taught to artificially boost sales figures by opening duplicate accounts without customers’ knowledge. In some cases, bank employees cross-referenced a bank database to identify customers with pre-approved credit cards, and then proceeded to order the cards without first checking with the customers.30 Wells Fargo tellers were coached to apologize for the inconvenience, if any customers complained, and to blame “a computer glitch or say the card had been requested by someone with a similar name.”31 The account opening drives were monitored by daily and monthly “Motivator” reports that tracked progress towards sales goals.32 The pressure was felt at all levels, with promotions such as “Jump into January” encouraging employees to deliver lists of friends and family as potential targets. According to a CNBC report, “one branch manager had a teenage daughter with 24 accounts, an adult daughter with 18 accounts, a husband with 21 accounts, a brother with 14 accounts

Exhibit 6: Letter from Whistleblower—2007

September 13, 2007 John Stumpf Wells Fargo & Company 420 Montgomery St San Francisco CA 94301 Dear Sir, I sincerely regret the circumstances under which I am corresponding. Nine months ago, I reported unethical (and illegal) activity to Wells Fargo Regional Bank. Regional Bank Management informed the banker of my report, the banker immediately responded claiming my report to be harassment, upon which Regional bank demanded my immediate removal from the office for seven months to conduct an investigation. The activity reported directly violates established, written Wells Fargo policy and is conducted under fraudulent pretense for the sole and singular purpose of acquiring sales and bonus compensation, a direct violation of Wells Fargo’s Sales and Ethics policies. At no point has Wells Fargo Bank earned revenue or do our customers receive benefit from these activities. In Northern California’s Greater Bay Region the activity is widespread and so highly encouraged that it has become a normal sales practice. Left unchecked, the inevitable outcome shall be one of professional and reputational damage, consumer fraud and shareholder lawsuits, coupled by regulatory sanctions. All attempts to utilize traditional channels to report this information have been met with immediate and lasting retaliation and having exhausted all other options, I am forwarding this information directly to the audit committee as a final hope for internal resolution. I consider myself to be a loyal and devoted employee. I have been a team member since 1992, the last l2 consecutive years spent in one store. It is unconscionable to allow the routine deception and fraudulent exploitation of our clients, a belief which was ingrained upon me by Wells Fargo. At great personal cost, I also believed in the strident promises of professionalism, confidentiality, fair consideration and absolute protection against retaliation. Despite having been slandered, publicly discredited and effectively blacklisted, have remained loyal to Wells Fargo, taking only actions requisite to protecting my career. I have not engaged a lawyer to sue Wells Fargo, disclosed details to colleagues, to the media, to the public nor made a single demand. I have simply asked to be made whole.

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My intention to avoid litigation and public spectacle has seemingly been interpreted as weakness rather than a loyalty to Wells Fargo; what I have reported is accurate and public disclosure can only damage shareholder value and endanger the livelihoods of 150,000 team members. Inexorably, Regional Bank has drawn me down this path, without reason and complete fiat: “Employment is AtWill; staffing decisions are under the complete and arbitrary discretion of Regional Bank. We have not retaliated, you will not be reinstated. If OSHA determines we have retaliated, you will not be reinstated; you will never be allowed back in the same office, sue us if you disagree.” This is an imprudent position and clearly an attempt to escape individual accountability with inside the shield of a ‘flawless’ bureaucracy. To openly invite a lawsuit, prefaced by outside government investigation, wherein guilt is statutorily defined in absolutes rather than gradients even more imprudent, in that I have labored to remain open to any frank and candid discussion. I remain committed and loyal to Wells Fargo; I am not a traitor, I am not impetuous, I am not some hyper-malcontent. I want what is right, what is best and what is fair for Wells Fargo, for our customers and for myself. It is my hope that this information will be fairly evaluated without vested interest, concerned with protecting the integrity and values of Wells Fargo and its customers. Seemingly if our aims are identical, any differences which may have existed should no longer, and any remaining issues should be easily resolved, but the evidence thus far suggests this would be optimism to the point of foolishness. Sincerely, [Name withheld] Source: Contributed by: Matthew Egan, CNNMoney, https://www.documentcloud.org /documents/3143757-Wells-Fargo-Stumpf-Letter.html.

and a father with four accounts.”33 A regional president, in what seemed like a poor attempt to spark competition, had her district managers put on themed costumes and run ‘the gauntlet’ to a whiteboard where each manager would write down his or her sales figures.34 To meet their sales goals, employees were encouraged to target immigrants and infirm adults, or college students. “The analogy I use was that it was like lions hunting zebras,” said Kevin Pham, a former Wells Fargo employee in San Jose, California, who saw it happening at the branch where he worked. “They would look for the weakest, the ones that would put up the least resistance.”35

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Wells Fargo Responds to the Scandal On September 9, 2016, the bank took out a full-page advertisement in the Wall Street Journal and other major papers, stating that that “[we] truly regret and take full responsibility for any such instances and have refunded those customers who incurred fees. We have also made many improvements to make certain our ongoing focus is on helping you succeed financially.”36 It announced the end to sales goals for community bank products, to be phased out by January 2017. Stumpf made himself available for interviews and, in an interview with CNBC’s Jim Cramer, he stated: “To the extent we don’t get it right 100 percent of the time . . . I’m responsible, I’m accountable . . . We all feel when we fall short . . . we feel accountable and responsible.”37 To demonstrate that it was taking steps to correct the situation, Wells Fargo’s Chief Financial Officer, John Shrewsberry, noted that it was investing $50 million in monitoring activities, including having an external party conduct 15,000 mystery shopper visits and bulking up the bank’s oversight department. The bank also noted it had donated $281 million to nearly 15,000 not-forprofit corporations in 2016, to be seen as being a responsible corporate citizen. In an intervie, I noted: “The support of nonprofits in its served communities is admirable, but that alone would not make Wells Fargo a model corporate citizen.”38 U.S. lawmakers, including the Senate Banking Committee and later the House Financial Services Committee summoned Stumpf for hearings. Stumpf prepared by hiring a law firm for advice and participating in mock interrogation sessions called “murder boarding.”39 During his testimony in front of the Senate Banking Committee, Stumpf denied that the issues revealed cultural flaws at Wells Fargo. The negative publicity had an impact on Wells Fargo’s share price, exacerbating the fact that its business was already slowing. In May 2016, a UBS analyst was concerned about subprime risk in Wells Fargo’s auto loan portfolio and its consumer credit card portfolio. Wells Fargo was continuing to focus on “adding relationships and delivering operating leverage” in its retail—or community banking—business, which, in other words meant that it would continue to attract customers and cross-sell them products, growing revenues without opening up more branches.40 By September 2016, when news of the scandal broke, Wells Fargo had experienced the second largest decline among its peers in earnings expectations, a drop of 7.2 percent since the first quarter of 2016 (see exhibits 7 and 8). On September 18, 2016, as the situation seemed to be spiraling out of control, the board created a special committee, chaired by Stephen Sanger, Wells Fargo’s chairman, to investigate the sales practices issue. Three other independent

Exhibit 7: Major Banks Change in Earnings Expectations from Q1 2016 to Q3 2016  ²

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C = Citigroup, WFC = Wells Fargo, MTB = M&T Bank, KEY = KeyBank, BBT = BB&T Corporation, PNC = PNC Financial Services, BAC = Bank of America, USB = U.S. Bank, JPM = JPMorgan Chase, FITB = Fifth Third Bank, RF = Regions Financial Corp, CFG = CFG Group, STI = SunTrust Bank,

Source: FactSet. Brennan Hawken, David Eads, and Brent Dilts, “Wells Fargo & Company,” USB Global Research, September 14, 2016, page 6.

Exhibit 8: Wells Fargo and Key Competitors: Change in Share Price September 2013—July 2016 













                                                                             



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(Source: Case writers and https://ca.finance.yahoo.com/)

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directors were involved: Elizabeth Duke, Enrique Hernandez, and Donald James. The committee appointed Shearing & Sterling LLP to conduct an investigation. Stumpf, admitting that concessions had to be made, recommended that he forfeit equity compensation—awarded but unvested—of $41 million. His salary and bonus for 2016 were also taken away. By October 12, 2016, Stumpf concluded that he was becoming too much of a distraction and tendered his resignation. Tim Sloan was then appointed as CEO of Wells Fargo. Observers questioned why Wells Fargo would not bring in an outsider to renew the management team and the bank’s culture. “It’s very difficult for anyone within that organization to make a change,” I said. “The last thing they might sense is the water they’re swimming in.”41 In the months leading up to the shareholders’ meeting, the key event most observers were anticipating was the release of the “Sales Practices Investigation Report” by Shearing & Sterling. (An overview of the board report can be found in exhibit 9.) Made public on April 10, 2017, the report suggested that there were serious issues with Wells Fargo’s culture. It stated, among other things: r
“Even when challenged by their regional leaders, the senior leadership of the Community Bank failed to appreciate or accept that their sales goals were too high and becoming increasingly untenable.” r
“It was convenient instead to blame the problem of low quality and unauthorized accounts and other employee misconduct on individual wrongdoers.” r
“Effect was confused with cause. When Wells Fargo did identify misconduct, its solution generally was to terminate the offending employee without considering causes for the offending conduct or determining whether there were responsible individuals who, while they might not have directed the specific misconduct, contributed to the environment that increased the chances of its occurrence.”42 The report focused blame on two executives, Stumpf and Carrie Tolstedt, forcing them to return more money in compensation. In total, Wells Fargo recovered $183 million in executive compensation, with $69 million from Stumpf and $67 million from Tolstedt.43 Newly-installed CEO Sloan wasted no time, meeting with more than twenty key people such as Warren Buffett, Wells Fargo’s largest shareholder. In anticipation of the shareholders’ meeting, the board made changes to its risk, audit, human resources, and corporate responsibility committees.44 There was impetus for change as Wells Fargo’s stock price had underperformed its key peers since the scandal (See exhibit 10).

Exhibit 9: Wells Fargo Board Report—Overview—Released April 10, 2017

This is the report of the Independent Directors of the Board of Wells Fargo & Company on their investigation of sales practices at the Community Bank, conducted by a four-director Oversight Committee, assisted by independent counsel Shearman & Sterling LLP. The Independent Directors’ goals in conducting the investigation were to understand the root causes of improper sales practices in the Community Bank, to identify remedial actions so these issues can never be repeated and to rebuild the trust customers place in the bank. Shearman & Sterling conducted 100 interviews and searched across more than 35 million documents. Principal Findings The root cause of sales practice failures was the distortion of the Community Bank’s sales culture and performance management system, which, when combined with aggressive sales management, created pressure on employees to sell unwanted or unneeded products to customers and, in some cases, to open unauthorized accounts. Wells Fargo’s decentralized corporate structure gave too much autonomy to the Community Bank’s senior leadership, who were unwilling to change the sales model or even recognize it as the root cause of the problem. Community Bank leadership resisted and impeded outside scrutiny or oversight and, when forced to report, minimized the scale and nature of the problem. The former Chief Executive Officer, relying on Wells Fargo’s decades of success with cross-sell and positive customer and employee survey results, was too slow to investigate or critically challenge sales practices in the Community Bank. He also failed to appreciate the seriousness of the problem and the substantial reputational risk to Wells Fargo. Corporate control functions were constrained by the decentralized organizational structure and a culture of substantial deference to the business units. In addition, a transactional approach to problem-solving obscured their view of the broader context. As a result, they missed opportunities to analyze, size and escalate sales practice issues. Sales practices were not identified to the Board as a noteworthy risk until 2014. By early 2015, management reported that corrective action was working. Throughout 2015 and 2016, the Board was regularly engaged on the issue; however, management reports did not accurately convey the scope of the problem. The Board only learned that approximately 5,300 employees had been terminated for sales practices violations through the September 2016 settlements with the Los Angeles City Attorney, the OCC and the CFPB.

Reform and Accountability The Board has taken numerous actions and supported management steps to address these issues. Wells Fargo has replaced and reorganized the leadership of the Community Bank. It has also eliminated sales goals and reformed incentive compensation. Centralization of control functions is being accelerated. The Board has separated the role of the Chairman and the CEO, strengthened the charters of Board Committees and established regular reporting to the Board by the new Office of Ethics, Oversight and Integrity. As a result of the investigation, the Board has terminated for cause five senior executives of the Community Bank and has imposed forfeitures, clawbacks and compensation adjustments on senior leaders totaling more than $180 million. Source: Wells Fargo Investor Presentations, 2017, https://www08.wellsfargomedia.com/ assets/pdf/about/investor-relations/presentations/2017/board-report.pdf.

Exhibit 10: Wells Fargo and Key Competitors: Change in Share Price

September 2016–April 2017 









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On April 25, 2017, with the shareholders meeting over, all attention was focused on Wells Fargo’s board of directors as they looked to the future. The board could not help but note that while they were reelected, shareholder support was lowest for Sanger and directors on both the risk and corporate responsibility committees. “The board is now on notice that they need to become more activist and engaged. The acting out by Bruce Marks [the activist who was ejected from the meeting] is a catalyst to that. . . . This voice has got to be addressed.”45 “Wells Fargo shareholders today, I think, have sent a clear message of dissatisfaction,” noted Sanger. “The board has recognized this message.”46 Questions for Discussion 1. How should Stumpf have responded to media reports of unethical practices in his organization? 2. Where were there misalignments in the bank’s business levers—i.e., key gaps in structure, process, people, and culture? 3. What is a board’s role in avoiding and detecting unethical practices in an organization? Assuming the Wells Fargo board was aware of the bank’s business practices, what steps might they have taken to avoid them? Given that the board did not “ensure that the Company, through its management, maintains high ethical standards and effective policies and practices designed to protect the Company’s reputation, assets and business,” should they have been held accountable for the unethical behavior? As an independent board director, would you have accepted the resignation of Stumpf or fired him? Why? 4. As an independent board director, what selection criteria would you proffer for measuring the qualifications of Stumpf ’s replacement? 5. Faced with the bank’s eroding performance relative to its competitors, how can the board become more “activist” in the fulfillment of its fiduciary responsibilities to its shareholders? Conclusion In an interview with Reuters, I was asked to assess the Wells Fargo board’s decision making in its crisis. Beyond the obvious requirement of it holding its executive leadership to its core values, my guidance was that they look beyond the current bench to assume leadership in the company. It doesn’t take great insight to analyze the scamming behavior of its Retail Banking management and employees to determine that Wells Fargo has a performance gap between what it says and what it does. Its employees were competitive, but at the expense of its customers. These employees were routinely violating the code of ethics of the

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company. Its business conduct was not What’s right for customers. There was a failure of leadership from the CEO down to its Retail Banking personnel. My statement to Reuters was “It’s very difficult for anyone within that organization to make a change. The last thing they might sense is the water they’re swimming in.”47 The Wells Fargo board should have reaffirmed its stated values by first firing its CEO, then looking outside the company for new leadership, much like was required at TYCO—to rise from its ashes. During the summer of 2017, I have exchanged communications with Timothy Sloan, Wells Fargo’s new CEO. He clarified that the Retail Banking business was the area that needed a turnaround and he accepted that responsibility. Beyond the $185 million settlement with regulators and city officials, they had spent about $110 million in additional charges related to remedying Wells Fargo’s operations following the retail sales-practice scandal. He has supported my further study of the company’s rise from these ashes and will be providing a member of his operating committee to discuss the case and their progress in my Columbia EMBA Executive Leadership course in the fall. The Federal Reserve levied a final set of sanctions on Wells Fargo on February 2, 2018, which restricts the bank’s asset level to the 2017 amount, thus inhibiting its future growth. In addition, the bank’s board will replace four of its current directors. The bank is at a low point on its S-curve.

Summary r
In a battle between a new strategy and an old culture, the old culture wins. r
Board due diligence ought to confirm that doing things better or different than the competition, not illegal and unethical practices, is what brought them business success. r
Business school case studies can provide valuable lessons on why companies fail in the way they do things around there—old culture. r
Boards have a growing obligation with the executive management of the company to manage the risk of its enterprise. r
Not managing risk is a fiduciary failure by the board of its duty to care.

6 What Directors Need to Know Before Committing to a CEO

Alignment: The levers of the business system working in sync to achieve optimal output.

There are extraordinary circumstances under which it is difficult to conduct an impartial and thorough search for a CEO. At Coke, for instance, the sudden death of Roberto Goizueta forced the board to make a hasty decision about the successor, and it chose the second-in-command without much discussion. At Take-Two Interactive (TTWO) and JetBlue, on the other hand, the CEOs were also the founders of the companies. These circumstances did not allow for a deliberate approach to the process of committing to a new CEO. However, in ordinary circumstances, there are a few things boards should be sure of before they make any commitment. Most important, directors need to be certain that their choice is a result of congruence among their business strategy, the CEO’s leadership, and the levers of their business system. To help boards make their decision, I have developed a process that is based on my work with two former faculty members of Columbia Business School, Don Hambrick and Mike Tushman. Both men were wellestablished thinkers in strategy creation and implementation when I began teaching full-time in Columbia executive education programs in 1996. During my early years, working alongside them with our custom clients, I learned the power of using Hambrick and Fredrickson’s Strategy Diamond1 and Tushman’s Congruence Approach for managerial problem solving.2 Both of these processes can be applied to a model that helps answer the

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crucial question, “What do directors need to know before they commit to their CEO?”

CEO Alignment

I have developed a four-step process for determining if a prospective CEO aligns with the needs of a business: 1. A board needs to fully understand its own strategic context and intent—collectively, its strategy—before it can hope to engage productively in the process of selecting a CEO. Only then can the board move on to the next step. 2. Determine, given the company’s position, the agenda, practices, and style required of its CEO. 3. The board must assess the alignment of the levers of its business system (structure, process, people, culture) and identify any gaps, because these gaps will become the CEO’s strategic priorities. The final step occurs as a result of the first three steps. 4. Achieve a degree of congruence among the strategy, the CEO, and the business system (figure 6.1).

Let’s walk through my CEO alignment model in greater detail.

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Figure 6.1

CEO Alignment. (All Rights Reserved, William Klepper, 2008. Adapted from D. C. Hambrick and J. W. Fredrickson, “Are You Sure You Have a Strategy?” Academy of Management Executive 15, no. 4 (2001); M. Tushman and C. O’Reilly, Managerial Problem Solving: A Congruence Approach (Cambridge, MA: Harvard Business Publishing, 2007).)

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Step 1: Strategic Context and Intent

Underlying every strategy is a set of assumptions about the customers, the competitors, the company, and the environment in which the business is operating. For instance, a business might assume that its offerings respond to the hierarchy of needs of its customers, that it is doing things better than its competitors, or that it has a business model that allows it to make money at any particular point in its business cycle. However, the board must continually reassess the business’s competitive environment—including its industry, the economy, geopolitical dynamics, and so on—and adjust its assumptions accordingly. A “situation analysis” can help the board understand and reexamine its strategic context. When transitioning to a new CEO, the board must take the time to revisit the assumptions that underlie its strategy by completing this analysis. Rita McGrath and Willie Pietersen, both of Columbia Executive Education, offer processes for conducting a situation analysis. Again, I have used their methods successfully with them with clients including M&T Bank and Ericsson respectively. McGrath’s book Market Busters: 40 Strategic Moves That Drive Exceptional Business Growth (2005), written with Ian MacMillan, offers five strategic lenses through which companies can analyze their current business, and includes targeted ‘prospecting questions’ and corresponding tools to guide executives as they mine areas for growth opportunities.3 Willie Pietersen, in his Reinventing Strategy: Using Strategic Learning to Create and Sustain Breakthrough Performance (2002), emphasizes that the mission of strategy is to create and sustain an adaptive organization—one that continuously scans and makes sense of its changing environment, learns from its own actions, and modifies its strategies accordingly.4 His website offers even more detail on the questions that should be asked and answered in the situation analysis.5 Both of these methods can help boards analyze the assumptions underlying their business strategy. If their original assumptions no longer hold, the strategy needs an update before the board can define its criteria for success (the agenda, practices, and style) of its CEO. It is not uncommon for the situation analysis to be outsourced to a consultancy, and in this case it may be appropriate for the consultancy to charge for updating the firm’s work and reaffirming or modifying the conclusions it came to. Ideally, the board will be directly involved in the process of updating the strategy, with either its in-house executive team or outside consultancy, so as not to outsource its thinking. A board needs to fully understand

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its strategy to be able to credibly engage in a strategic discussion with a prospective CEO. Once the strategic context of a company has been validated, it is time for the board to take a hard look at the strategy itself and determine what’s missing. In figure 6.2, the Hambrick and Fredrickson strategy diamond offers a set of elements to help the board with this process. For our purposes, I am focusing on four of the five elements. The fifth element, economic logic, asks, “How will we obtain our returns?” Although the economics of the business is a key factor in determining the viability of the strategy, the board can defer that assessment to the CEO and management team. When the board understands the CEO’s concept for achieving the business objectives, it needs to be assured that the plan will result in greater satisfaction of its customers’ needs and superior profitability for the business.6 Eric Abrahamson, a fellow faculty member at Columbia Business School, adapted Hambrick and Fredrickson’s strategy diamond to include four elements for our work collaboratively with one of our executive education custom clients. We knew that the economies of this client’s business were tried and true and felt that the focus on the arenas, vehicles, advantages, and timing would allow them to think more strategically. We defined strategy as “the

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The Strategy Diamond. (Adapted by Abrahamson from D. C. Hambrick and J. W. Fredrickson, “Are You Sure You Have a Strategy?” Academy of Management Executive, 15, no. 4 (2001).

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central, integrated, externally oriented concept of how we plan to achieve our objectives,” and then presented the four key components of the strategy diamond (figure 6.2). In their article “Are You Sure You Have a Strategy?” Hambrick and Fredrickson used the example of IKEA to illustrate how these four elements can define the strategic intent of the business.7 Many of these elements can be gleaned from IKEA’s mission statement: “IKEA offers a wide range of well-designed, functional home furnishing products at prices so low that as many people as possible will be able to afford them.”8 It is a strategy that is obviously working, as the company’s sales at the writing of the first edition were up by 7 percent, to a total of 21.2 billion euros for the financial year 2008 and 36.3 billion euros at the close of FY 2017. Hambrick and Fredrickson mapped IKEA’s overall strategy using a strategy diamond (figure 6.3). (Note: the economic logic of IKEA is found in its economies of scale and efficiencies gained from replication.) Completing a strategy diamond will help the board revise and clarify company strategy and will allow it to determine what it needs from a CEO

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