COMMENT Analysis

Corporate ethics: Moral hazards

By Richard Waters in San Francisco

Published: August 13 2010 22:57 | Last updated: August 13 2010 22:57

Personal expense: proved or not, sexual harassment allegations can cost CEOs such as Mark Hurd the board’s trust

Would a board of directors really force a highly regarded chief executive to quit over an unsubstantiated sexual harassment claim and a handful of dinners on the company dime? That, according to one version of events that has emerged in recent days, is what happened when Hewlett-Packard last week jettisoned Mark Hurd, its CEO of five years.

The loss of a man credited with reviving the fortunes of the world’s biggest computer-maker, and the cloud of uncertainty left hanging over the group as a result, has since wiped $13bn from its stock market value.

A full picture is hard to assemble from the partial facts that have emerged. But one thing is not in dispute: the saga has become an exemplar of a new, stricter approach to boardroom ethics. Depending on where you sit, it is evidence either of a well-intentioned system gone awry or that the most powerful corporate figures are no longer above the rules applied lower down the pecking order.

“If all you’re concerned about is an expense account, there are other sanctions,” says Professor John Coffee of Columbia Law School. “You could have taken away his bonus for the year. Most companies would not have treated a peccadillo with this severity, particularly when it inflicts such a penalty on shareholders.”

To others, though, the higher standards to which corporate bosses are being held are part of a broader shift affecting all of society. “Politicians and celebrities can’t get away with the things they used to,” says Nell Minow, doyenne of the US corporate governance movement. “Why should CEOs think they are any different?”

Complicating this picture is the fact that boards, while far more open than today about how they deal with ethical transgressions, still draw a veil over many of the facts. With enough to feed a scandal-hungry media, but too few to enable a complete understanding of whether justice has been served, the partial facts are used to support prejudices on both sides.

While he has not commented in detail, Mr Hurd said in a statement at the time he quit that there had been “instances in which I did not live up to the standards and principles of trust, respect and integrity that I have espoused at HP, and which have guided me throughout my career”. This, he added, would make it “difficult for me to continue as an effective leader at HP”. He received a severance package valued at nearly $40m.

“In the end, if it is just about expense reports, one has to question the board’s process,” says Prof David Yoffie of Harvard Business School. Echoing a widely held view, though, he adds: “I’m still not clear whether the real issue was [a reported] $20,000 [€15,600, £12,800] in inaccurate ex­pense reports or something greater.”

The case has highlighted three elements of personal conduct for which CEOs are being held far more accountable – though boards have struck different positions on how they deal with transgressions and with the all-important question of disclosure.

The first concerns claims of sexual harassment. This was the issue that touched off the events that led to Mr Hurd’s departure, following an allegation from Jodie Fisher, a one-time aspiring actress and former marketing consultant to HP. After its own investigation, the company said it had found no violation of its sexual harassment policy. Ms Fisher’s claim was settled privately for an undisclosed sum the day before the CEO’s exit was finalised, according to a person familiar with the matter.

Yet the very existence of the claim drove a wedge between the board and its chief, according to one person close to the situation. “Sexual harassment has been an explosive issue for 20 years,” says Prof Charles Elson of the University of Delaware. Most suits are settled out of court. But, as the charges are often hard to disprove, CEOs who have stood accused have found it hard to regain the full support of their boards, says Ms Minow.

When boards consider how to handle issues such as this, ad­vice from public relations ex­perts comes straight after that of lawyers, says a US corporate director who has sat on the boards of 10 companies. Protecting the image of a business is important at such times, this person adds.

But even if attention to appearances is essential, the impression that a board might have made a decision motivated by its PR value is liable to backfire – as HP’s board, which took its own external PR advice, has found.

Normally, companies seek to avoid the scandal that comes from disclosure of harassment claims even if they feel compelled to act. When Starwood Hotels forced Stephen Hilbert to step aside as CEO in 2007, the group said only that his “management style” had led to a loss of confidence in his leadership. It emerged later that the board’s action had been precipitated by the investigation arising from an allegation of sexual harassment, though Mr Hilbert denied the charge.

HP’s board took the opposite approach. Even though Ms Fisher’s claim had been settled and the company had decided there had been no violation of its policy, it chose to make the claim public when Mr Hurd’s departure was announced. To some, that points to an over-zealous interpretation of the new responsibilities on directors and a disregard for the reputation of its departing CEO.

The second issue highlighted by the case is growing intolerance of affairs or other inappropriate relationships involving bosses. HP said its CEO had had a “close personal relationship” with Ms Fisher that violated its code of conduct – even though Ms Fisher has said the two did not have sex.

US groups tend to take a stricter line than European counterparts on affairs involving corporate bosses, say boardroom experts. But the companies concerned invariably attribute their actions to a higher ethical justification than mere prudishness.

When Harry Stonecipher was forced to quit as Boeing CEO over an affair with an employee in 2005, it was not the fact of the affair itself that was behind the move, chairman Lew Platt claimed at the time. Rather, the circumstances showed “poor judgment” on the CEO’s part and “impaired his ability to lead going forward”, he said.

Few CEOs who conduct affairs are likely to escape a similar verdict when their personal behaviour is examined closely. If the situation involves subordinates, they are liable to open themselves to charges of abuse of authority, while if they involve business partners they raise questions of conflict of interest.

Trying to hide a relationship can itself lead to trouble – as Lord Browne discovered when he was forced to resign as BP CEO in 2007. He lied to a judge about where he had met a former lover, whose account of their relationship he was seeking to keep out of the media.

Expense account abuse and the misuse of company assets is the third issue that has been thrown into the spotlight this week. The misstatement of expenses is often a catch-all offence that boards use when they are looking for a way to discipline executives but find the real cause too difficult or messy to deal with, experts say.

“It’s like the way the government takes on the Mafia – that almost always ends up about tax evasion,” says the veteran US corporate director. “The board’s approach is almost always oblique – they’re never looking to tackle the issue head-on.”

HP, for its part, says its investigation into the allegation of sexual misconduct uncovered “numerous” ins­tances where its CEO had put personal costs on his expense account or misused corporate assets. Yet one person close to Mr Hurd says he had only about half a dozen dinners with Ms Fisher and that, if expenses were misstated, it may have been an error by his personal assistants. This did not appear to go far, however, towards ex- plaining the full amount of expenses in question, which one person close to the situation puts at up to $20,000.

In circumstances such as these, forcing a successful CEO to resign may be too severe a punishment, backfiring mainly on shareholders, according to more lenient observers.

But a more stringent view holds sway in many boardrooms following the financial and ethical scandals of recent years. External requirements – for instance, from governments re­quiring certain standards from groups they do business with – in some cases reinforce this discipline, says Ms Minow. If companies believe they can decide for themselves how strictly they deal with transgressions such as the misstatement of expenses, she adds, they are “completely ignorant about how we do business now”.

As tolerance of ethical failures re­cedes, however, it remains hard for the world to know what is really going on behind the boardroom door. The old approach – a bland statement that an executive is “leaving to spend more time with his family” – is often considered insufficient. But for legal and PR reasons, most companies still shrink from a full explanation of what has undermined their trust in a CEO.

The result in the HP case, says Gary Lutin, a US shareholder activist, is that the board was able to show off its probity and attention to disclosure, but shareholders were left none the wiser about what really went on.

In this new world of partial transparency, many directors must look longingly at the days when scandal could be swept under the rug. What they have to look forward to instead are more boardroom soap operas.

Hurd could receive $40m severance pay

By Richard Waters in San Francisco

Published: August 13 2010 23:03 | Last updated: August 13 2010 23:03

A loophole in Mark Hurd’s contract made it hard for Hewlett-Packard to dismiss him outright and added to pressure on the board to give him severance pay which could be worth nearly $40m despite his admission of ethical lapses, according to experts in boardroom practice.

The terms of the former HP chief executive’s employment did not lay out any specific circumstances in which the company would fire him “for cause”, which would have enabled it to avoid paying severance.

This contrasts with the contracts of most chief executives in the US, whose contracts usually lay out more detailed conditions on which they can be fired, including for breaches of a company’s ethical code of behaviour, said Nell Minow, a US corporate governance expert.

Mr Hurd resigned under pressure a week ago after admitting that he did not “live up to the standards and principles of trust, respect and integrity that I have espoused at HP”. The company said he had left by agreement with the board over expense violations and a “close personal relationship” with an external contractor that contravened its code of conduct.

Mr Hurd’s severance includes $12m in cash plus stock benefits. The value of the latter cannot yet be calculated, but the total package probably comes to about $40m, according to one person close to the situation. The Hurd pay-out has drawn criticism from governance experts and has already become a focus of the first shareholder lawsuit filed against HP over his departure.

“If it was really about Hurd submitting a misleading expense report, I’m sure they could have found a lawyer somewhere in America who thought that justified firing him without a dime of severance,” said Gary Lutin, a US shareholder activist. [See Note, above.]

HP’s board could have sought to fire Mr Hurd for cause even without a clear definition of circumstances in his contract, experts said. However, that would have made it far harder to defend any legal action from him later to recover his severance. “The squishier the definition, the harder it is to prove cause,” said Charles Elson, of the University of Delaware.

Even if Mr Hurd’s contract had not contained the loophole, HP would probably still have been unwilling to fire him over the ethical lapses he admitted to since it might have “led to a slugfest over the expenses”, Mr Elson said.