For decades, economists and management theorists have been studying the principal-agent problem. It has nothing to do with who is the next big shot at William Morris or ICM. Rather, it concerns how diffusion of ownership at large companies leads to a divorce between stockholders (principals) and the CEOs and managers who work for them (agents). In modern corporate America, the board of directors is supposed to function as the conduit through which stockholders exercise control over management. But in the 1990s, the system frequently failed. Many directors at giant companies failed to act like owners or shareholder representatives. After all, their stock holdings are tiny, while they owe their positions (and hefty retainers) to management, especially the CEO.
And now for a gory example of the principal-agent problem in action, let us turn to General Motors. Last spring, billionaire investor Kirk Kerkorian began boosting his already significant stake in GM. Today, he controls nearly 10 percent of the company. Displeased with the restructuring plans in place, Kerkorian, who is the company's third-largest shareholder and has already lost several hundred million dollars because of the stock's decline, is trying to place an associate, Jerome York, on the board. Kerkorian isn't the only entity unhappy with GM's strategy and execution. It's safe to say no one is impressed with the management or board, what with GM's declining market share and wretched financial performance. On Monday, credit-rating agency Standard & Poor's ripped into GM. (Click here, and go to the Dec. 12 release.)
Given the crisis atmosphere, you would think GM might welcome to its board somebody like York, a former chief financial officer at Chrysler and IBM and a veteran of corporate turnarounds. And yet the board, which presided over a series of management missteps, is fighting Kerkorian. It is apparently trying to prevent one of the few people willing to make a huge financial bet on GM's future from gaining representation on the board. On Friday, Kerkorian and GM jointly announced that "they have not been able to reach a mutually satisfactory agreement for Jerome York to join the Board of Directors."
The failure to accommodate Kerkorian has encouraged critics to cast an eye on GM's board of directors. And the glare is uncomfortable. Unlike Kerkorian, the members of GM's board, who have continually ratified the decisions made by current management, have very little cash invested in the company. And unlike York, the board members have surprisingly little expertise on turning around troubled industrial companies.
Aside from CEO Richard Wagoner, the board includes 11 outsiders who are supposed to act as agents of shareholders. As with many boards, GM's board is half-stocked with retired CEOs. Some had stellar careers at publicly held companies, like John Bryan, the former CEO of Sara Lee, and Kent Kresa, who ran Northrop Grumman in the 1990s. A third retired head man, Philip Laskawy, was the CEO of Ernst & Young, which, along with all the other big accounting firms, didn't exactly cover itself in glory in the 1990s.
Some of the retired bosses have bigger issues. In the 1990s, board member Percy Barnevik, the former head of engineering company ABB, was seen as a European Jack Welch. But as Fortune noted, a mini-scandal over the disclosure of his pension "resulted in one of the most spectacular falls from grace in European business history." George MC Fisher, the retired chairman and CEO of Eastman Kodak, led the company as it failed to make the transition from film to digital and presided over the beginning of the stock's long slide. Eckhard Pfeiffer, the former CEO of Compaq, was cashiered in April 1999 after a series of disappointments. As James Surowiecki noted in Slate,Compaq founder Ben Rosen took out an ad in the New York Times charging that Pfeiffer "was ill-equipped to deal with 'a company on the frontier of change' and he was not 'a leader capable of managing at Internet speed.' "
The GM board also includes five active executives. There's Armando Codina, who runs a Florida real-estate firm. There are two women, Ellen Kullman, a rising star at DuPont, and Karen Katen, a big shot at Pfizer (she runs the main operating unit), and Merrill Lynch CEO Stan O'Neal. Erskine Bowles, the Clinton aide, textile industry executive, and new chancellor of the University of North Carolina, is the fifth. It's an impressive, diverse bunch. But of the five, only O'Neal is the CEO of a public company. He's also the only one who has direct experience in both auto manufacturing and finance—GM's two big problem areas. O'Neal worked at a GM plant in Georgia after graduating from high school, attended the General Motors Institute, and began his corporate career in GM's treasurer's office. And he's the only one who has successfully turned around a large publicly held company.
If the directors have seemed complacent about GM's woes, it could be because they don't have that much invested in the company. According to GM's proxy statement, directors get paid a $200,000 annual retainer but must defer $140,000 of that total "in restricted units of Common Stock." (They also get the use of GM cars.) Within five years of joining the board, directors are "required to own stock and/or deferred RSUs [restricted stock units] equal in value to five times the annual retainer." According to a chart on Page 12 of the proxy, the nonemployee directors collectively owned about 49,000 shares of common stock plus about 148,000 deferred stock units. Add in the holdings of top officers, and "all directors & officer of the corporation as a group own 617,262 shares," plus 970,682 deferred stock units.
At current prices, the common shares of GM's directors and officers are worth about $13.9 million, or about one-tenth of 1 percent of GM's market value. Kerkorian's stake is 100 times larger than theirs. It's no wonder the directors don't share the same sense of urgency as the octogenarian Kerkorian. And it's no wonder they're reluctant to welcome somebody to the board who would demand drastic action quickly. If GM's stock continues to slide, it will seriously damage Kerkorian's net worth. In the boardroom, however, the only thing that will be damaged are some large egos.