Independent Board Oversight: Lessons from HP

Note: Republished with permission of the author. Originally published on the Bloxham Voice as Independent Board Oversight, 4/10/2011. Copyright The Value Alliance.

Nominating and governance processes and independent board oversight: Do they really matter? If so, to whom?

In a Digest publication late last year, I wrote about an ISS policy survey that found investors, in all markets, ranked board independence as the most important governance topic.

Of course, there are a number of ways independence is important. One is the independence of board members (including independent mindedness). Another is effective independent board oversight. Paralleling these are independent processes to nominate directors.

In a January 28 article for, I wrote:

HP’s 2010 proxy explains that the nominating and governance committee, chaired by Lucille Salhany, is in charge of identifying board openings and candidates. The proxy also explains that the committee hires a professional search firm to help it perform these tasks… When HP puts out its next proxy filing, shareholders ought to closely examine how the company describes its [director] succession process and the chair’s role.

With 20-20 hindsight, this advice was not as broad as it should have been: I should have recommended clearly examining the press reports leading up to the annual meeting as well.

More fully, the disclosure in the 2010 proxy read:

The Nominating and Governance Committee uses a variety of methods for identifying and evaluating nominees for director. The Nominating and Governance Committee regularly assesses the appropriate size of the Board and whether any vacancies on the Board are expected due to retirement or otherwise. In the event that vacancies are anticipated, or otherwise arise, the Nominating and Governance Committee considers various potential candidates for director… HP engages a professional search firm on an ongoing basis to identify and assist the Nominating and Governance Committee in identifying, evaluating and conducting due diligence on potential director nominees. On September 17, 2009, the Board elected Mr. Andreessen as a director effective immediately. Mr. Andreessen was identified by the professional search firm.

Are board nominations’ processes an “Internal Policy”? Contrary to many press reports that characterized the HP nominations process as an “internal policy,” (just search on google for: hp internal policy nominations), the nominations process of any public company is not just any old internal policy. It matters in understanding the governance of the firm and how that operates. Clearly, SEC mandates spelling out the requirement to disclose board nominations processes elevate them  beyond mere policies to be changed on a whim. And the fact that some investors view nominations processes as material should, as well, make characterization of a board’s nominations process as a mere “internal policy” untenable.

Best practice on disclosure? That said, although changes to the nominations process may be considered material by some investors, companies can fail to disclose changes to the nominations process until the next proxy, generally with no fear of SEC action or liability.

Is that the best practice? No. The nominations process is a required disclosure. If the process changes, then hopefully the company is proud of the changes and will want to share them with the public. Even if they aren’t particularly proud of the changes, if they want to maintain good relations with a variety of stakeholders, letting them know when the changes have been made, rather than waiting until the next proxy is filed, would be the order of the day.

A board’s nominations process involves decisions on three dimensions: who should go, who should stay (with or without additional coaching) and who should come on to the board. All three are important.

Regarding the process at HP, there have been a number of disclosures. In addition to the proxy, news reports have formed a patchwork of information on the subject. Here are some of the highlights in HP’s own words. (Background: Leo Apotheker is the CEO of HP appointed effective November 1, 2010. Ray Lane is the Chair and a new board member effective November 1, 2010.)

In a January 20 interview on CNBC, Ray Lane, the newly appointed director and chair said that “we were fortunate enough to have four board members …who voluntarily said, ‘I would step back because I’ve served this board a long time and I’m willing to step off if that’s what’s required’ and it allowed us to go out and look at three or four or five board members to compliment what we need going forward.” (Two of the four directors who resigned had served since 2007.)

Regarding the new appointees, Lane said: “Most of these names were known to Leo [Leo Apotheker, the CEO of HP] or myself.  We have a lot of experience with these individuals. I don’t think we are doing anything new here or surprising because we’ve known these individuals so long.”  He also said that the number one priority on the agenda for the board is “to support Leo, to support Leo in forming his leadership, his strategy for the company, so right now to support Leo.”

Summary: Four Volunteered to leave, New members known to new CEO and Chair, Top Priority of Board: Support CEO.

Issues: Boards are there primarily to oversee rather than support CEO. (Both are important but oversight and independent judgment takes precedence.) Boards should strive for members independent of CEO, Chair and each other so that each may feel as free as possible to exercise independent judgment.

According to a January 21 Wall Street Journal article, “Lane said that the four departing board members volunteered to leave and that he ‘couldn’t single out someone who should go.’”

Summary: Four Volunteered to Leave, new Chair couldn’t pick.

In a January 26 Business Week interview, Lane stated the directors “are not there to support Leo or me…They are there to take independent decisions.”

Summary: Board not there to support CEO, there to take independent decisions

Good: Boards are there to take independent decisions.

In its proxy, filed on February 1, HP’s description of its board nominations process was changed from the prior year to include a role for the Chair and the use of an ad hoc committee which included the CEO. HP did not disclose the other members of the ad hoc committee in the proxy:

The Nominating and Governance Committee uses a variety of methods for identifying and evaluating nominees for director. The Nominating and Governance Committee, with the input of the Chairman, regularly assesses the appropriate size of the Board and whether any vacancies on the Board are expected due to retirement or otherwise. In the event that vacancies are anticipated, or otherwise arise, the Nominating and Governance Committee considers various potential candidates for director… HP engages a professional search firm on an ongoing basis to identify and assist the Nominating and Governance Committee in identifying, evaluating and conducting due diligence on potential director nominees. Two of the seven directors who joined the Board since the last annual meeting of stockholders, Mr. Apotheker and Mr. Lane, were identified by the professional search firm. The other five directors, Mr. Banerji, Mr. Reiner, Ms. Russo, Ms. Senequier and Ms. Whitman, were identified by an ad hoc committee of directors consisting of the Chief Executive Officer and three non-employee directors, which was formed in November 2010 to assist in the identification of new director candidates and to facilitate the process of evaluating those candidates as potential directors.

Summary: Chair now involved in work of nominating and governance committee although not a member. CEO on an ad hoç committee that identified and evaluated candidates.

Issues: A properly constituted nominating and governance committee should perform its chartered work with as much independence as possible. If the committee needs to be reconstituted, the full board should reconstitute it properly with independent members assigned to the job.

In a February 13 report in the San Jose Mercury News, “Lane stressed that Apotheker is responsible for developing and executing HP’s business strategy.” Lane said “the board’s top priority will be supporting Apotheker”… “in developing a strategy for HP to compete around the world.”  “He described a close working relationship with Apotheker, whom he has known since Lane hired Apotheker as an Oracle consultant in the 1990s” and described “his own role as an adviser to the CEO.” Of the board changes, he said: “This was my job. I have to take full responsibility for leading this,” “although he stressed that directors agreed unanimously to bring on a majority of new members.”

Summary: Board there to support CEO. Chair known the CEO for over 10 and up to 20 or more years. Chair sees self as adviser to CEO. Chair sees self as responsible for board changes.

Issues: Boards should be there primarily to oversee the CEO. Oversight takes precedence over support. A CEO and a Chair with close long standing ties create lack of independence and may cause an imbalance: the CEO may be more powerful with a close Chair ally enforcing his will on the board than a CEO without a separate Chair. The nominating and governance committee, not the Chair, should be responsible for board changes. Chair should be appointed to the nominating and governance committee if he is to have a share of the responsibility for nominations.

According to a March 10 Business Week article, “Apotheker was a member of an ad hoc committee, appointed by Lane, that recommended candidates who were later considered by the full board,” Lane said. “The new board members ‘aren’t buddies of Apotheker,’ … ‘I knew these people better than Leo.’”

Summary: Chair appointed the ad hoc committee on which the CEO sat which identified and evaluated candidates to the board. Chair knew the candidates better than the CEO did.

Issues: New board member, the Chair, set up a committee to conduct some of the nominations decisions – including identification and evaluation of candidates – and put the CEO on that committee. Chair recommended people he personally knew (as opposed to other candidates who would not have ties to CEO and board — and potentially other candidates who might have served the board as well if not better but were not identified because they were not known to them).

A report by the San Jose Mercury News on March 10 said that ISS had identified the members of the ad hoc committee and that ISS said the nominating committee had been involved:

According to an ISS report last week, HP told the advisory firm that the prospective new directors were identified by an ‘ad hoc’ committee consisting of Lane, Apotheker and longtime directors Larry Babbio and John Hammergren. HP said the candidates were then vetted by the formal nominating committee and approved by the full board… Charging that the nominating committee failed to carry out its proper role, ISS advised HP shareholders to vote against three committee members [of the nominating and governance committee] who are seeking re-election to the board: Sari Baldauf, G. Kennedy Thompson and Babbio… In response, HP defended its governance practices and says the firm known as ISS, or Institutional Shareholder Services, misinterpreted the process that led to the selection of five new directors in January.

Summary: The ad hoc committee was made up of the Chair, CEO and two long standing members. ISS did not recommend against the ad hoc committee members. Instead ISS recommended against the members of the nominating and governance committee.

The ISS advice did seem counter-intuitive.

Issues: If the long standing members of the nominating committee, Baldauf, Thompson and Babbio were removed from the board as ISS recommended, wouldn’t that likely give CEO Apotheker and Chair Lane even more input into who sat on the board going forward? How would that correct the issues with the nominations process at HP? Instead, it would likely compound the issues in terms of a board with an even larger majority well known to the Chair and CEO.

On March 20, Lane told the Financial Times “that he alone had interviewed his fellow directors and decided who should be asked to leave.” “I was the only one that knew whether this particular board member could work together with the rest or dwell on the past.” “The board unanimously gave me the authority to do what I needed to do.” Regarding the new nominees, he said, “We got some usable names from [Leo], but we only ended up taking one to the committee.”

Summary: Those who left were not volunteers – the Chair picked them out. The CEO only ended up with one of his new picks for the board.

Issues: How did the nominations process work in terms of who exited? Were those who left volunteers or did the Chair pick?

HP’s Corporate Governance Guidelines effective March 2011, in the “role of the board” section do not mention supporting the CEO as part of the role of the board or supporting the CEO on strategy.  The guidelines do mention oversight and policy guidance. “The Board”…“oversees management.” “The Board also oversees HP’s strategic and business planning process,” the guidelines state.  Issue: What is the role of the board at HP primarily? To support – or to oversee?

What did shareholders do with this hodge-podge of information? They voted in all members. According to the SEC filing Baldauf, Babbio and Thompson suffered the greatest no votes, while Lane’s no votes were the second to the lowest. (Shareholders also voted No on say on pay.)

Less than a week after the annual meeting, it was announced that one of the newly nominated directors, Meg Whitman, would be joining Ray Lane’s firm, Kleiner Perkins.

Issue: Why was the announcement made after the meeting? This even stronger relationship between a new nominee and the Chair would have been of interest to investors voting on board members.

It is now April and HP’s governance remains in the headlines with new issues being discussed. See Poor Judgment at HP? (Barrons) and HP’s response here. Who on the board voted on a recent acquisition seems to be an open issue.

Lessons for other firms?  Maybe shareholders won’t read the press or the proxy carefully. Even so, why not go above and beyond?

Independence and Nominations:  Take the independence of board members, the nominations process and of board oversight seriously. Discuss whether you feel comfortable having the process you use to nominate directors and perform the work of the board fully exposed. Once it passes the so called New York Times test, let shareholders know in plain, transparent English what the process is.

Disclosure: Disclose as much as you can before you are engaged in the process and before the proxy is issued. If not known beforehand, disclose fully at the time the proxy is issued.  Don’t wait to disclose important information until after the annual meeting.

Chair: Although separation can be beneficial, independence is important as well. Separation of the CEO and Chair positions is not the Holy Grail, especially if there are long standing ties between the two. Spell out the limits of the separate Chair’s position carefully and clearly. Do this before choosing the Chair. Consider the basis for choosing someone as Chair and whether it makes sense to choose a Chair who has not worked on the board before.

All Directors: Make sure all current and prospective members understand what the role of director is. This should be reflected in the Corporate Governance Guidelines of the board.

Why do all of the above even if shareholders don’t (seem to) care? Lack of trust in companies – and the capital markets – has a corrosive impact on the economy. Anything a board can do to enhance trust benefits everyone in the long run.  (Note: Italics have been added, particularly on longer passages for emphasis, in the interest of clarity.)

The Value Alliance and Corporate Governance Alliance, Eleanor Bloxham.Copyright 2011 The Value Alliance Company. All rights reserved.

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