Should the roles of Chairman and Chief Executive be split? We compare the US and UK Models

11/06/2008

One of the main principles of the UK's Combined Code on Corporate Governance is that there should be a clear division of responsibilities at the head of a company between the running of the board and the executive responsibility for the running of the company's business. The Combined Code clearly states "no one individual should have unfettered powers of decision".

The Cadbury Report, published in 1992 with its groundbreaking Code of Best Practice, introduced the notion that the roles of chairman and chief executive officer should be kept separate and that corporate power should not be concentrated in the hands of one individual alone and in an increasingly complex business environment, should be shared. The 2003 Higgs Report and subsequent Combined Code sanctioned the separation of roles and, several years on, it is now rare, particularly with listed companies, to find one individual holding the post of both chairman and chief executive. This is in stark contrast to the US where the predominant view is that splitting the roles of the chairman and chief executive officer does not improve the performance of the company.

There is a belief amongst some that US governance is on the cusp of change, with some US companies embracing the notion. The majority however, still reject such division of power. Shareholder activists have recently been calling for reform and investors in various top-tier companies are crying out for change. Notably, certain shareholders of global giant ExxonMobil, led by members of the Rockefeller family, recently proposed that the combined role be split. The proposal was motioned at the company's annual meeting held in May but was defeated. Allegedly, forty per cent of ExxonMobil shareholders had supported the resolution in 2007. The supporting statement stated "symptomatic of the dangers inherent in both positions being vested in one individual are a lack of responsiveness and arbitrariness." The board, on the other hand, recommended that shareholders vote against such a proposal, strongly believing "that there is NO single best organisational model that would be most effective in all circumstances."

It may be useful to outline the pros and cons for each model to get a full understanding of the reasons behind each system.

UK practice

The view in the UK is that splitting the roles of the chairman and executive officer results in a clear demarcation between the purpose of the board and the responsibilities of the executive officer. This separation allows the chairman to run the board independently in a fair and impartial way in contrast to a situation where the executive officer could more usually manage the board to further his own agenda to the possible detriment of shareholder interests. Thus allowing the chairman to run the board ensures that shareholder interests are not prejudiced whilst alleviating the vast day-to-day responsibilities that an executive officer has in today's marketplace.

It is also thought that, the UK position enhances the relationship between the chairman and the executive officer. Provided that responsibilities and powers are clearly delineated such a partnership can provide the structure for valuable advice to be passed between the two as well as building a strong foundation of trust in the running of the company.

An important role of the chairman is his independence from the executive officer, allowing the chairman to evaluate the performance of the executive officer in a dispassionate manner and if necessary, remove him if it is viewed by the board to be in the best interests of the business and the shareholders. Furthermore, the chairman can facilitate the board's choice of a successor during the term of the current executive officer. This division of the roles allows the chairman necessary time to manage the board properly (with most chairmen operating with a wealth of experience), respond to shareholder communications, liaise with directors as well as undertake any official commitments. This normally requires a commitment of anything from one to three days per week.

Of course, a chairman will not always be beyond reproach in his own responsibilities and the UK model envisages a senior independent director (SID) stepping in if confidence is lost in the chairman. The SID has two further responsibilities, firstly, to chair a meeting of the non-executive directors in the absence of the chairman at least once a year and to carry out evaluations of the chairman's performance. In most cases, his presence will be inconspicuous and his role will only come into play where the chairman is seen to be failing in his duties.

The belief in the UK model lies in the division of the responsibilities between the executive officer and the chairman, as it allows each to utilise his independent strengths for the benefit of the company. Shareholder return is prioritised in this way as the executive officer is focused on the company's business performance and profitability, leaving board governance issues to be handled by the chairman.

The US position

There are many factors contributing to the school of thought in the US that the roles of executive officer and chairman should not be separated. Amongst these factors is the fact that there is no evidence of profitability associated with splitting the roles; in fact there is evidence in the US to suggest that not separating the roles is beneficial.

An additional factor is the belief that separating the roles will not further any effectiveness in corporate governance beyond the current position nor is there (as previously mentioned) any evidence of economic gain to warrant the splitting of the roles.

When comparing companies in the US to companies in countries which require the roles to be split, a 2004 survey showed smaller shareholder returns for non-US companies. Such evidence reinforces the view that there is no need to introduce the split and until there is economic evidence in support of the model, it is unlikely to take hold in the US. There are however non-financial factors that lend themselves to the US position.

Serious occurrences of corporate wrongdoing account for less than 3% in the Standard & Poor 500 companies and as such do not support requiring the remaining 97% to overhaul their leadership structure that is, for the vast majority, working well. The large proportion of US companies who are operating honestly are a testament to the executive officers and while a temporary split of the role may be warranted in companies in a crisis situation, for example, there does not seem to be a pressing need in the US to enforce such fundamental change to a company's leadership structure.

Besides, US companies have found many other ways to improve corporate governance without splitting the roles of chairman and executive officer. Most notably:

• Boardrooms are subject to more checks and balances with approximately 80% of directors being completely independent of management.
• Board members are now usually selected by a nominations committee and not unilaterally by the executive officer.
• Boards often hold executive sessions following board meetings without the executive officer present to discuss the effectiveness of the executive officer as well as any other concerns.
• Appointing a lead director has proven to be an excellent tool in enhancing corporate governance whilst still vesting the title of chairman and the responsibilities that go with it in the executive officer.

Not only does a lead director assist with the running of the board, but his interaction with the board makes independent board members more accountable for the boardroom process, which in turn results in more productive professional relationships between independent directors and management. It is the balance between the lead director acting in the interests of the majority of the board and the executive officer's power of management that is so effective.

Although some may argue that the number of US boards implementing the separation is on the rise, the chairman in most instances of separation was the former executive officer which creates the alarming issue of a lack of independence in the chairman. This is not a substantive shift towards the UK position at all, simply a formal change in structure allowing the same executive to maintain control of the board.

Cultural differences between the two countries also play a part; US executives tend to retire earlier than their UK counterparts and the role of chairman in the UK is seen as being the pinnacle of a business career. Needless to say, this is not the case in the US and advocates of the splitting of the role underestimate such cultural differences.

Therefore, whilst some boards in the US are making the shift towards separating the roles of the chairman and executive officer, this is not necessarily in the best interests of US companies at large. Where the leadership structure is providing effective governance, enjoys the confidence of the board and is securing the interests of shareholders, there is no need to make such changes to that structure.

Rather, US boards should focus on adopting and developing new practices of governance that work within the existing model rather than seeking to dismantle a time-proven structure until evidence arises to show that it is time to do so.

Contact: ritapadam@city-law.net

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