More directors should be responsible for bad decisions

Let your imagination run: Out of the blue, the phone rings and you’re asked to join the board of directors of a major U.S. corporation. Sure, you say, I’m honored.

A few months later, you’re sitting at a big table with the other directors and the head of the board’s compensation committee says the company should lend the chief executive $400 million.

What would you do?

a) Say, “Gee, that’s an awful lot. Why should we? How much do other CEOs get? If we don’t lend it, will he quit? If he quits, do we care? Can we make the loan depend on whether he does a good job? Let’s offer less and see what happens.”

b) Keep your mouth shut and vote yes.

Anyone who agrees to be a corporate director ought to be able to come up with a few common-sense questions like those in answer “a.”

But staying mum and going along is not at all unusual. Many of the corporate scandals of the past few years were abetted by do-nothing directors.

One of the most egregious cases was the $11 billion accounting fraud from 1999 to 2002 at WorldCom, the telecommunications giant now called MCI.

This month, 10 former directors agreed to pay $18 million out of their own pockets to settle a lawsuit brought by shareholders who thought the directors deliberately looked the other way as executives cooked the books. Yes, the board also lent CEO Bernard Ebbers $400 million.

While lawsuits against directors are fairly common, it is extremely rare for directors to be required to pay up themselves. Usually, the company or the directors’ insurance policies cover legal costs, penalties and settlement payments. In this case, the plaintiffs demanded personal liability, though insurers also will kick in $36 million.

No defense

Defenders of the traditional system were quick to warn that such demands, if they became common, would discourage good people from serving on corporate boards, thus undermining the interests of shareholders, whom directors are supposed to represent.

Nonsense.

For starters, not many candidates are needed. The National Association of Corporate Directors has about 15,500 members, representing most of corporate America. Surely a country of nearly 300 million can come up with that many smart, honest people willing to ask tough questions.

The real problem is that the system is not designed to find that kind of candidate. Often, it’s the CEO who recruits the directors.

Or candidates are recommended by other directors.

Or they’re furnished by headhunters who are beholden to the executives that hire them.

This incestuous system bars candidates likely to rock the boat.

Sure, shareholders get to vote for directors. But the ballot typically has only one candidate per opening, and the candidates are those recommended by the board itself. A rotten board is not likely to nominate gadflies.

Power to the people

The best solution would be to make it easier for shareholders to nominate competing candidates. The Securities and Exchange Commission has been considering such a proposal, but that effort, modest as it is, has run into such intense opposition from business groups that the SEC has postponed a vote in lieu of more study.

So for now, the best prospects for cleaning up corporate boardrooms are found in the courts, with regulators and shareholders going after irresponsible, incompetent and corrupt directors.

The WorldCom settlement was good news as a rare effort to make directors personally accountable.

But it was not as good as it could have been. The $18 million in payments is designed to equal 20 percent of the directors’ net worth. In other words, a director worth $9 million would pay $1.8 million. Anyone left with $7.2 million ought to get by pretty well.

And the bite is not really as big as it seems. The net-worth calculation did not include the individual’s residences — note the plural — nor the value of retirement accounts or certain other assets held jointly with a spouse. For some of these folks, 20 percent of “net worth” may be a drop in the bucket.

To be really effective, a financial penalty has to really hurt, and that isn’t the case here.

By failing — or refusing — to ask obvious questions, the WorldCom directors allowed the biggest corporate collapse in U.S. history, costing investors billions of dollars and putting tens of thousands of company employees out of work.

These directors should share that level of pain. We can only hope the WorldCom settlement starts a trend — and that penalties will get tougher.