01 Feb 1997

Ban the Butterfly Rule for Corporate Directors

by Joseph Hinsey IV


You're only as good as your job title? Apparently so, if you're the director of a major company. A corporate governance precept currently in vogue calls for outside directors to offer to resign if they change (or lose) their jobs. Chrysler, for example, requires outside directors who lose or change their jobs to offer to resign, and Dayton Hudson Corp. insists that outside directors resign if they change jobs.

The General Motors Board of Directors Corporate Governance Guidelines assert that "individual Directors who change the responsibility they held when they were elected to the Board should submit a letter of resignation to the Board." These GM guidelines have gained considerable acclaim, and many other public corporations have followed their lead.

In its recently released report on "Director Professionalism," the National Association of Corporate Directors" Blue Ribbon Commission has provided strong endorsement: "Boards should require that all directors submit a resignation as a matter of course upon retirement, a change in employer, or other significant change in their professional roles and responsibilities."

The question is, why? If the theory is that the loss of prestige associated with the loss of position renders the director no longer qualified to serve, the message to the outside world is that board membership is geared to the position, not the person. Stated another way, the apparent objective is to have a board stocked with celebrities, and if the director loses his or her brilliant colors - turns from a butterfly into a moth - then he or she no longer measures up. This view of the director's role creates a terrible perception for the public. Beyond that, it is the antithesis of enlightened corporate governance.

There are, of course, legitimate reasons that trigger a director's resignation. Section 8 of the Clayton Act, for example, prohibits a person from serving as a director or officer of competitors (to avoid possible antitrust complications). A new job may preempt time and attention to such a degree that an individual can no longer fulfill the obligations of board membership. Accepting a position in the public sector will typically necessitate stepping down from private sector responsibilities to avoid conflicts of interest. And it is possible that health problems or other personal concerns, which may have led to a director's change of responsibilities or job termination, will call for board withdrawal as well.

These are all important considerations that should be left to a responsible board to evaluate on a case-by-case basis - without being bound by the inference of lost effectiveness that the mandated resignation rule suggests. And mechanisms exist to handle such contingencies both efficiently and effectively. Depending on the facts and circumstances, for instance, a job change could lead to a decision not to renominate an incumbent director. In a case of greater urgency, a consensus on the part of fellow board members that a director should step down would almost always prompt a quick resignation.

Aside from board withdrawal for the reasons described, acceptance of the "volunteered" resignation prescribed by the job-change rule almost never occurs. And with good reason. As stated in the American Bar Association"s Corporate Director's Guidebook, the basic attributes for board service eligibility are common sense, practical wisdom, and informed judgment. Add to these baseline qualities the skills and experience acquired during the course of one's career. These abilities do not suddenly disappear or become impaired when a director moves to a new career position or ceases to be a top executive.

Be it in theory or practice, the "butterfly rule" makes no sense as a precept of corporate governance. It is a bad idea that doesn't fly - and that doesn't deserve a following in Corporate America.

Joseph Hinsey IV is the H. Douglas Weaver Professor of Business Law at HBS. A condensed version of this article appeared in the December 15, 1996 New York Times.


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