Corporate boards face a new set of issues, say three voices of experience.

Changing economic, social and political forces compel corporate directors to rethink their roles. In addition to the traditional concern for financial performance, boards face increasing pressures to monitor corporate "behavior," or "conduct," terms referring to a broad range of ethical, social, and environmental issues. Against the background of these pressures, the traditional definition of a director’s responsibilities is probably too narrow.

Charles M. Denny, Jr., retired CEO and Chairman of ADC Telecommunications, Inc., posed three questions for members of the National Association of Corporate Directors at an October 1993 meeting:

1. Are directors "auditors" or "policy makers?"

2. If boards and directors set policy, is corporate behavior an appropriate subject for policy making? Should directors concern themselves with issues such as pollution, fair treatment of employees, ethics, bribery, health and safety, or whether suppliers violate company standards of behavior? Is the culture of the organization a board concern? Should the board ensure that the company’s compensation system is structured so employee behavior is driven in ways consistent with values approved by the board?

3. If these are legitimate policy concerns for boards, who will implement policy, how will standards be determined, and who will monitor compliance? Where does "governance" end and management begin?

Summing up. Denny asked: "Do boards of directors have a role in assuring corporate behavior that acknowledges a company’s responsibilities to all of its constituencies?" His own answer to the question was unequivocal: "I would argue that never has there been a time in our country’s history when corporate involvement in the social issues of the day has been more urgent. Business has a pre-eminent role to play in shaping society for the better - if it chooses to exercise that role. The most significant factor in a business"s long-term prosperity is the health of the markets in which it works and lives."

Mr. Denny’s discussion wasn’t just about corporate social responsibility. That’s not new. What is new and is increasingly on the agenda for directors is their own responsibility, in the board room, for corporate ethics, organizational culture, compliance with the law, and social issues and initiatives.

Changing Context For Governance

The context for corporate governance in America, and indeed around the world, has changed dramatically in the last 20 years. Business is under greater scrutiny by governments, by shareholders, by the media, and by the public. Witness the changed norms of corporate behavior in Italy and Japan. Issues that lightly touched business are now challenging management and directors daily.

The scope and depth of change is evident in many areas, but we would cite seven.

• Increasing investor expectations.  Today’s investor is far more likely to hold directors accountable for a company’s financial performance. A 1992 Fortune article, "DIRECT0RS, WAKE UP!," was one signal. Major institutional investors, notably pension funds like the California Public Employees Retirement System (CalPERS) and Teachers Insurance and Annuity, Association-College Retirement Equities Fund (TIAA-CREF), exert direct pressure on boards to solve financial problems. CalPERS prepares an annual hit list of poor performers and expects directors to improve results. 
  
  Sponsors of endowment, pension, and profit sharing funds typically have set performance goals for their money managers and are, often with sophisticated techniques, monitoring performance at least quarterly. Even the small independent investor has heightened awareness of market performance.
  
  Numerous organizations have outlined expectations, principles, and standards for effective corporate governance. CalPERS, TIAA-CREF, the Treadway Commission, the American Law Institute (ALI), and the National Association of Corporate Directors, among others, have focused on the role of and standards for boards, committees, and directors. Directors, they argue, should be more independent of management, better informed, and vigilant in exercising their oversight responsibilities on behalf of investors.

• Government policy.  The past two decades witnessed a dramatic expansion of laws and regulations constraining corporate behavior related to environmental compliance, employment, health and safety, etc. That intrusion brought with it demands that directors and officers be held accountable for their company’s compliance with laws and regulations. The Foreign and Corrupt Practices Act is an early example. More recently, the U.S. federal sentencing guidelines for organizational defendants make it imperative that companies develop effective compliance policies and monitoring systems.
  
  Those serving on bank boards have felt strong pressure from the Office of the Comptroller of Currency and other regulators.

• Shifting public attitudes and expectations.  Controversy and scandal, coupled with a lingering recession, have shaped public attitudes toward business. Levels of executive compensation, the pay gap between workers and executives, recurrent downsizing, environmental disasters such as the Exxon Valdez, and scandal on the scale of the savings and loan debacle have engendered public cynicism and anger. Of course, government does not escape the public’s ire, but demands for government reform have often been accompanied by demands for laws, regulations, and enforcement efforts that compel business to behave to publicly set standards.

• Heightened risk and liability.  Once almost honorary and above the fray, being a director today carries substantial risks as liability suits have mounted. In a society prone I to litigate, the cost of real defense can be astounding. Many small and start-up companies find the cost of adequate insurance for directors prohibitive and indemnification provisions in their articles of incorporation or bylaws inadequate. Anecdotes about arduous director searches abound as more individuals decline to serve as directors due to the financial risk from liability suits.

• Rising concern for stakeholders.  The American Law Institute describes the objective of the corporation as "the conduct of business activities with a view to enhancing corporate profit and shareholder gain...." This obligation to shareholders is in tension with board obligations to other stakeholder groups. Directors’ consideration of the interests of multiple stakeholders is gaining ground, as indicated by three developments.
  
  First, the furor triggered by hostile takeovers in the 1980s led to changes in the laws of more than 30 states giving directors, for the first time, the explicit right to consider the interests of other stakeholders in making decisions related to acquisitions. While geared to takeover situations, the legal language is broad and may give directors greater latitude.
  
  Second, major business and investor institutions have adopted statements on corporate governance that explicitly recognize and endorse the stakeholder approach. CalPERS, TIAA-CREF, the A-LI, and the Business Roundtable are examples. Their language clearly permits directors to act on stakeholder and social responsibility issues.
  
  Third, research shows that directors themselves attach high importance to a variety of corporate stakeholders - customers, government, employees, communities, and society - in addition to shareholders.
  
  These conflicting obligations to shareholders and to stakeholders, says the lead author of this article writing in the October 1994 issue of Business Ethics Quarterly, are a paradox "best left to the judgment of directors who are experienced enough in both private and public life to understand it - and wise enough to manage it."

• Advent of social investing.  Investors and mutual funds characterizing themselves as socially responsible are a relatively new phenomenon. Such investors channel capital to companies perceived to be socially responsible and to exhibit business practices consistent with the investor's values. One 1994 guide listed 35 such mutual funds. At least one major employee pension fund has created a "social choice fund" for its members. 
  
  While total assets in social investment funds are small, the funds do exert influence and provide a choice and voice for investors. For example, in 1993 the United States Trust Company, which invests roughly half its fund based on social criteria, stopped investing in Gannett because of the company’s poor relations with its labor union. The existence of such funds indicates that substantial numbers of investors wish to interject conscience into their investment choices even though the result may be diminished financial returns. 
  
  Of equal or greater importance, a wide range of institutional investors, not just those characterized as focused primarily on social issues, have embraced social responsibility policies and standards. A recent Conference Board survey of 200 US companies reported that 21percent of their institutional investors gave weight in their decisions to "social concerns." In particular, public pension funds may have statutory or regulatory obligations to consider particular social issues in their selection of securities. 
  
  Issues raised by investors included: product liability, environment and pollution, employment practices (with respect to women, minorities, and sexual orientation), compensation, and local economic development. The Conference Board report notes two instances where investors demanded that corporate directors adopt nondiscriminatory employment policies and provide reports on the composition and status of its workforce.  
  
  TIAA-CREF, an example notable due to its size and influence, operates a "social responsibility committee" within its board of directors. The pension fund adopted a formal policy statement on social responsibility that covers the environment, equal opportunity, open communication with various stakeholders, employee training and development, the common good of communities, and a prohibition on exploitation of nonshareholder constituencies.

• Ethical dilemmas and global competition.  The increasing global span of operations even for relatively small companies raises profound ethical dilemmas. Cultures differ markedly in treatment of women and ethnic, racial, and religious minorities. Routine business practices and standards vary dramatically. Products banned in one country may be unregulated in another. 
  
  Management and directors are forced to make hard choices, balancing conflicting values and economic objectives across diverse cultures, and often these choices invite public debate and scrutiny. Apartheid in South Africa and "the troubles" in Northern Ireland triggered years of debate about the proper course for companies and investors. Nestle’s sale of infant formula in the Third World set off highly publicized international boycotts.
  
  Although businesses usually line up against government proposals to impose a human-rights test in foreign trade policy, sensitivity to the issue is evident in corporate decisions. Levi Strauss elected not to buy jeans from China because of that country’s disregard for human rights. Home Depot cut off suppliers indulging in exploitative labor practices, and Procter and Gamble discontinued a line of fruit juice concentrate shortly after the media exposed cases of worker exploitation by sub-contractors. In a related vein, Medtronic fired an international manager for making improper payments. Issues are ever-present.

Implications for Directors

Certainly the changes outlined above are complex, and their long-term, cumulative impact is difficult to predict. However, three themes are clearly discernible. First is the pervasive demand that directors do more to ensure that profits and shareholder values rise in keeping with market expectations. Second is the continuing expansion of the role of government in setting standards and demanding compliance from business. Third is the increasing acceptance of the idea that business should respond to multiple stakeholders, not only investors, and in so doing tackle serious ethical, social, environmental, economic and even political issues.

Information describing how boards have responded to this evolving context for governance is fragmented, but some examples exist.

• Monsanto has a board "corporate social responsibility committee" which met six times in 1993. The committee reviews and monitors the company’s performance as it affects employees, communities, customers, and the environment and recommends policies for consideration when appropriate.

• Pentair created a "public policy committee" of the board to oversee environmental, regulators, and health and safety interests.

• Medtronic’s directors conduct an annual survey of approximately 15 percent of the company’s 10,000 employees for compliance with the company’s code of conduct. The survey is reviewed by the company’s independent auditors who report their findings to the audit committee of the board.

• Dayton Hudson policy charges its board: "to assure that we act in the best interests not only of our shareholders - but also of our customers, our employees and the communities where we do business."

Next Steps

In this environment, when change is continual, we need to better understand what works and what doesn’t because the barriers to change are formidable. In the search for new models and approaches to governing corporations, boards must take account of obstacles, notably these five:

• Tradition. While much has changed in the operation and structure of companies, less change has transpired in the operation and structure of some boards. Traditions of board culture and behavior are tough to change. Organizations tend to stick with what they know the tested models of the past.

• Challenges of leadership. Acceptance of social responsibility and stakeholder management is by no means universal. Milton Friedman’s "the business of business is business" argument is old but vigorously invoked. An article in The Economists worried: "making bosses accountable to many stakeholders might make them accountable to none, as there would be no clear yardstick for judging performance..." Leadership in the face of such skepticism is vital if boards are to define an effective role.

• Complexity of information. Systematic information describing how issues of ethics, organizational culture, or society get onto board agendas and how boards are responding does not exist, and anecdotes are not enough. A nationwide survey of board composition and structure by a major accounting firm makes no mention of such issues and focuses solely on traditional board committees. Boards must learn what has been tried, what works or doesn’t, and what new ideas or models for boards hold promise in dealing with these new issues and responsibilities.

• Lack of evaluation. Self-evaluation by boards and directors is rare and "a relatively new concept," according to a 1994 report by the National Association of Corporate Directors. The NACD report includes a sample board evaluation form. As investors, the public and government strive to make companies more accountable, evaluation of board performance will become increasingly important. However, at present boards have little knowledge or experience of how to do it.

• Scarcity of time. Directors have a limited amount of time to devote to their duties. Existing board responsibilities can be demanding. Adding new duties for ethics, stakeholder issues or social responsibility requires developing methods that are feasible, efficient, and productive. Directors have little time, or patience, for "lofty demands" that promise little or no outcome for the company.

Clearly no end is in sight to debates of whether directors and boards should involve themselves with ethical, social, or stakeholder issues. Debate notwithstanding, for those who believe the important question is not whether but how, there is important work to be done.

The Minnesota Center for Corporate Responsibility (MCCR), which is funded by 135 companies, is working on two fronts to assist directors and boards in redefining roles and responsibilities.

First, the Center’s approach, developed by senior business executives, is articulated forcefully in "The Minnesota Principles: Toward an Ethical Basis for Global Business." That document in turn provided the basis for an international code of business conduct titled "Principles for Business" developed by the Caux Round Table, a group of senior international business leaders meeting annually in Caux, Switzerland. Efforts are now underway to present the Principles to appropriate forums in the United States, the United Nations, and governments, businesses, and associations worldwide.

Second, as a key element of its strategic plan, the Center is pursuing a research agenda to determine how boards can be organized and operated to address ethical, social, and cultural issues. This initiative reflects the belief of business executives like Charles Denny, Jr. who serve on MCCR’s board that "thoughtful leadership of corporate directors in setting and monitoring policy covering ethical business conduct and stakeholder relationships is vital."

No Permanent Victory

Thanks to the collapse of communism, capitalism is currently enjoying a respite from radical criticism. It would be tempting - but foolhardy - under such conditions to presume a permanent victory. Efficiency and material abundance, the twin goals of capitalism, are ultimately insufficient grounds for social survival. How we treat one another in the pursuit of those goals is the final test of success for ourselves, for our companies, and for the system itself in meeting this challenge, boards of directors can and must play a decisive role.

About the Authors

Thomas E. Holloran, is a professor of management in the Graduate School of Business at the University of St. 7homas. He serves on the boards of seven corporations and chairs the Bush Foundation. Previously, he was chairman of the board and CEO of InterRegional Financial Group, Inc., president of Medtronic, Inc., and a practicing attorney. He holds B.S. and JD. degrees from the University of Minnesota.

Robert W. MacGregor is president of MCCR. Previously he was president of the Greater Kansas City Chamber of Commerce, president of Chicago United, and vice president and executive director of the Dayton Hudson Foundation. He holds a B.S. from Macalester College and a M.D. Princeton Theological Seminary.

David H. Rodbourne is a consultant and research associate with MCCR. Mr. Rodbourne has been program director for a public policy conference center and issues adviser for public radio. He holds a B.A. from St. Lawrence University and has pursued graduate studies at the Humphrey Institute of Public Affairs.

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