Sarbox Sobers Directors Facing Rising Compliance Costs

A Directorship/RHR International survey of nearly 270 US board directors shows compliance sticker shock along with a need to push for greater change in governance practices.

In a recent survey of 266 board directors of US public companies conducted by Directorship Search Group and RHR International, board members reported that the current annualized direct cost of compliance with the new regulations represented by Sarbanes-Oxley and rules set forth by the SEC and securities exchanges represent an average out of pocket cost of $16 million — an increase of 77 percent over the prior year. The average cost estimated for a mid-size public company is nearly $5 million, but one outlier respondent at a large corporation put the total cost close to $1 billion.

Respondent's estimates may be low, as many directors remain unsure of the exact overall outlays that many suspect are much higher. Earlier this year, GE reported spending $30 million on the internal control requirements (section 404) resulting from Sarbanes-Oxley. Last May, AIG chairman and CEO Maurice "Hank" Greenberg indicated that the world's largest insurer was spending $300 million a year fulfilling the new requirements.

Almost two-thirds (64 percent) said they have changed the way they participate as a director in response to the new regulations. One change they report is in how the CEO is compensated. Two-thirds (66 percent) indicate that they plan to change either salary (33 percent) or salary relative to bonus (33 percent). Almost a fifth (19 percent) say they will change how shares are awarded and 12 percent indicated that stock option plans would be altered.

Curiously, directors say they are less influenced by investors, with 50 percent saying that investor groups have either none or little influence on their activities or decisions.

Most directors express a high degree of confidence in the judgment of their fellow directors, but only a third say the level of dissent at board meetings is high. High performance leadership groups need to have a significant measure of robust dialog about critical issues and dissent frequently enough to ensure meaningful alignment rather than shallow agreement. Boards of directors must work against the effects of group membership on their thinking and behavior. Though directors are talented and experienced, they are "no less subject to psychological forces than anyone else" observes Constance Dierickx, board services practice leader, RHR International. "The consequences of failing to create and maintain an atmosphere of vigorous dialog are vast. The capacity of a board to not only tolerate dissent, but make it an expected and productive part of the culture of the board is an important safeguard against undue influence by individuals as well as the phenomenon of groupthink."

Almost two-thirds report that their boards undertake evaluations of individual board members. The methods used range from "informal" and "self-evaluation" to 360-degree feedback. Informally, we understand from some directors that measuring board and director effectiveness is difficult for several reasons including difficulty defining the relevant elements of effectiveness in human terms and integratin the results of assessments in ways that are meaningful while being respectful.

Participants indicate that director meetings in executive session without the CEO occur in most companies. Four such sessions each year are average, with some directors reporting such meetings as often as every month. Oddly, more than 13 percent have no such meetings at all which given SEC requirements suggest a surprising degree of compliance foot-dragging.

Similarly, directors visit with company constituents (employees, suppliers, vendors, etc.) on average four times per year, with some making many more. Still, a fourth of all directors say they make none at all. The directors in this study who met more frequently without the CEO were also more likely to visit constituent groups. This could suggest that more independently directors act in one area, the more independently they are likely to act in another. Interestingly, the level of confidence directors have in the CEO bears no relationship to the number of meetings they have without the CEO. In contrast, directors who have "some concern" about other directors are more likely to visit other constituencies than those who are either mostly confident or are absolutely confident.

Directors who report that they are "very confident" in the senior management team, on average, visit constituencies four times a year. "We don't know if these visits coincide with board meetings," says RHR International's Dierickx, "if so, we wonder if they allow the type of candid interaction that we believe is most beneficial."

In contrast, directors who report "little" confidence in the senior team surrounding the CEO are twice as likely as those who report "some confidence" to visit with outside constituencies. Are they increasing activities after something has gone wrong? How long does it take to notice this? Why is this behavior more likely if they have concern about the senior team but not so if they report little confidence in the CEO?"

There are a number of possibilities that may explain such responses. Addressing concerns about either the CEO or about fellow directors is difficult as it sends a message of mistrust. There is often a strong, though implicit proscription against activities that signal such doubt. If directors are concerned about one another, visiting other constituencies may be a less direct, though useful way, to get more independent information. If they are concerned about the senior management team but are not getting good answers from the CEO, this may likewise be useful. The lack of relationship between concerns about the CEO and meetings without him or her is unclear. Most participants in this study expressed confidence in the CEO (95 percent indicating either "absolute" or "mostly") presenting a surprising uniformity in the survey responses.

In conducting this survey Directorship Search Group partnered with RHR International, a firm of consulting psychologists with offices in the US and Europe, who assist directors and executives to accelerate the development of executives and organizations and achieve improved performance.

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