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John Balkcom
Director
Aleris International Inc.

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

What are your views on the separation of the chairman and CEO positions? Should corporations seek this model as a matter of good corporate governance and board-level accountability?

Many years ago, the director of a major company characterized the role of an outside director as “nose in, fingers out.” Though perhaps unintentionally, the Sarbanes-Oxley Act (SOX) has induced directors to have both nose and fingers in matters that lie ambiguously near the border between governance and management. The location of that boundary is less clear than ever before, if it ever was clear at all.

On the matter of the combination of the roles of chairman and CEO, I find that no single solution applies equally well to all companies. Very often, governance solutions that make boards more effective are idiosyncratic to the company and its circumstances. So, I don’t hold the view that the separation of these two roles is universally good. While companies in the U.K. and Europe tend to advocate and to follow this practice more than U.S. firms, I’ve not seen the evidence that shows the separation of roles systematically creates greater value than their combination in a single incumbent.

Overall, I usually find it better not to separate the two positions of chairman and CEO. The two questions of separation and good governance, as you pose them, go to the issues of (a) the establishment of a distinct boundary between governance and management as venues for decision making, and (b) the unambiguous separation of powers between directors and managers as makers of critical decisions. On the surface, the application of the boundary and separation principles would seem to reinforce director independence and, therefore, the integrity of governance.

In the SOX era, however, separation could reduce the effectiveness of both governance and management. By observation of board and executive behavior over many years, I find that both the quality and the content of critical information somehow change when that information crosses an organizational boundary. We’ve all seen the obvious examples of a corporate initiative grossly misinterpreted in the operating divisions of a major company. The same potential for misunderstanding and misapplication exists even at the board level and particularly at the high-level border between governance and management.

Given the current primacy of SOX in matters of governance and shareholder relations, it’s best to have one person who is both a director and an executive (i.e., the chairman and CEO) participate in all board deliberations and personally carry the board’s decisions from the boardroom into the management venue for execution. While that could be accomplished by the CEO serving on the board but not as chairman, I prefer the same person have the responsibility for leading the charge in SOX compliance both among directors and among managers.

Yes, that means one person is simultaneously responsible both for decision management and for decision control (in the terms coined by Fama and Jensen). But the risks associated with this specific and limited conflation of powers can be countervailed by means of the lead director and by the assurance of adequate and timely flow of information from management to the board.

To illustrate the point about information, let me cite not a governance example but a management example. I recently had the privilege of attending (as a guest) the weekly Saturday morning associates’ meeting at Wal-Mart headquarters in Bentonville, Ark. Among the many unusual aspects of that meeting were a depth and intensity of performance data that I’ve never seen before in a management discussion of a business. Both on the walls of the meeting room and in the many brief presentations of those responsible for parts of the business, Wal-Mart colleagues shared and discussed with one another every aspect of top-line and bottom-line variance from plan -- where they were up, where down, and where flat. This intensity of data analysis and disclosure seemed to me to eliminate the excuse giving and arm waving that often show up in other management settings, and to make the discussion of expectations clear, efficient, and effective.

This benchmark of clarity and detail would stand many directors in good stead as they formulate the form and content of performance information they review at the board level. While a broader or higher level of information may be needed in the governance suite than in a meeting of associates, the SOX imperative (if I’m right) of “nose and fingers in” calls for more than the short list of gross, collective numbers that once sufficed for the oversight of directors.

How can the effectiveness of a nonexecutive chairman be enhanced?

My previous comments suggest that I don’t find the appointment of a nonexecutive chairman ideal, and I don’t in most cases. The question merits a response nonetheless. First, the effectiveness of the nonexecutive chairman depends on the board’s having a clear charter for the role, one that has been vetted and approved by the full board. That charter represents the chairman’s “deal” with the board in terms of his/her decision latitude as distinct from that of the board as a whole and especially as distinct from that of the CEO.

Most importantly, the charter needs to distinguish the chairman’s decision roles from those of the CEO so that the role of nonexecutive chairman does not weaken or disable the executive role of the CEO. Norman Augustine’s comments on this and related issues are most insightful (see his Directors & Boards articles, “Seeing Around Corners,” Fall 2002, and “How Leading a Role for the Lead Director?” in Winter 2004 -- the latter is summarized in the next section). The clarity of these decision roles and of their separation become critical in matters of succession planning for company leadership and in questions of “you bet the company” decisions such as major mergers or acquisitions.

Second, the nonexecutive chairman may need a cadre of current or former chairmen of other non-competing companies to serve as a sounding board. While directors often think of this need in the context of a new or young CEO’s participation in organizations such as the Young Presidents Organization, we might overlook the same need for the chairman who can benefit from candid, critical advice from others who have held similar roles. The problem with this notion is that we have so few former chairmen to serve this role. Perhaps the NACD could provide safe ground for discussions of the challenges and obstacles of the non-executive chairman.

Third, of course, the nonexecutive chairman needs regular meetings of the independent directors to help him or her distinguish those areas where the chair can most make a difference in the success of the company. In this case (anticipating your next question), the chairman fulfills the role of a lead or presiding director, and the chairmanship subsumes the responsibilities of the lead director. All of this presupposes the chairman has the ongoing and strong support of the other directors, and that the chairman recognizes that “support” may not always take the form of outright agreement.

What are the key roles of a lead director?

The etymology of “lead” and “director” quickly guides you to the notion of a leitmotif, an idea more commonly found in music but no less applicable to governance. In the milieu of Sarbanes-Oxley, a dominant, recurring theme of validity, timeliness, and integrity would serve a board well. So, I am strongly biased to think a lead director had better have expertise and experience akin to that of the “financial expert” serving on the audit committee. Such is the case at Aleris International, and I believe the presence of this expertise in our lead director enhances the value of that role to our board. It keeps the broadest notion of risk management continually in front of the board.

Again, Norman Augustine’s thinking on this question is astute. He cites in particular the work of presiding over meetings of independent directors, setting the board agenda with the CEO, serving as a point of contact for board members on issues they can’t readily address with the CEO, and directly facilitating a mutual understanding of critical matters between the board and the CEO.

The mix of these responsibilities may have different weights and emphases depending on the circumstances. For example, Russ Palmer as the new lead director at May Department Stores Co. likely has a very different role from his counterparts at many other companies. The central question is this: for what decisions and outcomes does the board want the lead director to be accountable? The best answer to the question may depend on the setting. The emphases differ among firms undergoing a turnaround versus those experiencing a leadership transition or those in a period of rapid growth and innovation.

New board data suggest we stand to learn a lot about the reality of this role in 2005. Spencer Stuart’s new Board Index indicates the prevalence of the lead or presiding director role jumped from 36% of the S&P 500 in 2003 to 84% in 2004. That represents an astonishing rate of change, and the jump likely stems, at least in part, from the greater sense of personal accountability the body of independent directors feel under Sarbanes-Oxley.

What key challenges to board leadership are we likely to encounter in the coming year?

Not to state the obvious, but first and foremost, we face the challenge of SOX – and financial literacy by itself is not sufficient to the task. The board is now asked to monitor in a particular way the accuracy, integrity, and timeliness of financial reporting. That means the directors preside over a chain of review and judgment extending from the governance level to the customer transaction level, and over the validity of the reported financial effects of transactions far removed from the boardroom.

This presiding responsibility puts the board at a cornerstone of a new set of relationships between and among directors, executives, auditors, process testers (including the internal auditor but often outside resources also hired to do part of the testing), the SEC, and even the PCAOB. In this network of developing relationships, moreover, the company is no longer the primary client of the auditor. The “lead client” seat is now taken by the SEC and the PCAOB. I’m not objecting to this turn of events, after the many frauds of the past few years, but these events and SOX have altered the auditor-client relationship such that the company paying the bills is very often along for a (bumpy) ride in the process of SOX.

Secondly, I agree with Pete Peterson’s observation that executive compensation remains the unacknowledged “elephant in the boudoir” (D&B e-Briefing, January 2005). The new challenge to the board and to its compensation committee lies in the sheer number of constituencies who want to have their say in the matter of executive pay. The number of new “standards” seems to multiply by the day, and each constituency wants its own standards heeded, without regard to the unique needs of any given firm. Deciding how much, to whom, and for what remains one of the most vexing board responsibilities.

Two other phenomena are also largely unacknowledged: first, more and more of the best candidates for director are no longer interested in the role, and second, many small cap firms are looking for ways to get acquired or to go private. Both phenomena stem in part from the unexpected risks and costs of SOA, and from the growing penalties of even inadvertent noncompliance with the new law.

I first heard a prominent CEO say he was cutting back on directorships almost 25 years ago. Now, both the time requirements and the risks are exponentially higher and in all likelihood well out of balance with the psychic and financial rewards to the role of director. In addition, while the principles of compliance with SOX are well articulated, the tasks of compliance remain largely unknown and subject to a difficult period of discovery by trial and error. No new director can come to these tasks with more than an incomplete understanding of their requirements.

So, directors and their companies face the challenge of both managing the process of compliance with SOX and appropriately controlling the seemingly uncontrollable costs. The costs have accelerated despite expressed Congressional intent not to expand the scope and cost of many audit tasks. In my conversations with the directors of other small cap companies, I’ve heard no estimate of less than $2 million for the annual cost of compliance with SOX Section 404 alone. For micro-cap companies, these and related costs probably render public ownership infeasible.

Dave Kuhlman, a former colleague of mine at Sibson Consulting, recently commented that one of the basic problems with SOX is the disconnect between what the shareholding public thinks auditors are doing (“tell me if this company is healthy”) and what the auditors are now saying (“this company followed the rules as nearly as we can tell”). The resolution of this mismatch of expectation with reality may have a lot to say in the evolution of public company response to the requirements of SOX.

John Balkcom served as a management consultant for 25 years, retiring in August 2000 from Sibson & Company. In the fall of 2000, he assumed the presidency of St. John's College in Santa Fe, N.M., where he served through the summer of 2003. In late fall 2003, he became a director of IMCO Recycling, where he was appointed chairman in April 2004 as the company negotiated a merger of equals with Commonwealth Industries. The merger closed on December 9, 2004, forming Aleris International Inc. (NYSE: ARS). For Aleris, he serves as a member of the audit committee and as chairman of the compensation committee.

Mr. Balkcom also teaches from time to time. This spring, he will co-lead seminars on the plays “Oedipus at Colonus” and “Antigone” for the Tecolote Group, a teacher development program hosted by St. John’s College in Santa Fe. In the spring quarter at Northwestern University, he will offer an undergraduate course in the Business Institutions Program (an undergraduate minor) entitled “Wal-Mart, Wealth, and Economic Justice,” in which his class will take an objective look at Wal-Mart in light of classical ethics and contemporary economic theory.