Introduction
For those of us who have devoted our lives to leading businesses, the events of the last two years have been shattering - challenging our visions of business' role in and contribution to society. There can be no doubt that the wrong-doing of certain business leaders, from improper accounting to outright criminal acts, has shattered our ideals about the noble purposes of capitalism. Many more good leaders found themselves abandoning their core values, caught in the vortex of a system driven by short-term gains and outright greed, that led to a steady decline or even the long-term demise of their companies.

We find ourselves in the worst corporate crisis since the Great Depression. In its wake this crisis has left behind abandoned customers, cynical employees, angry investors, and a general public that has lost confidence in business leaders.

Ironically, Enron and Arthur Andersen did the business world a great service. The depth of their misconduct awakened us to the reality that business was on the wrong track, worshiping the wrong idols, and headed for self-destruction. Like the proverbial frog that dies when temperatures are gradually increased, but immediately jumps out when tossed into a boiling pot of water, it took this kind of shock therapy for us to realize that something is sorely missing in many of our corporations. What is it? Sound governance and ethical, values-based leadership.

What began as a few executives charged with violating the law morphed into issues of corporate governance and the failure of our governance systems. As we understand the issues at a deeper level, we realize that the missing ingredients in corporations are authentic leaders committed to building enduring organizations.

In response to this crisis, most of our corporate leaders have remained silent. A year ago when the crisis broke out, several CEOs told me, "We don't dare to speak out, for fear they will come after us next." Only a few CEOs, such as Henry Paulson of Goldman Sachs and Henry McKinnell of Pfizer, have been willing to condemn these practices publicly, recognizing the larger issue is one of public trust in the capitalist system. Paulson's acts were doubly courageous, as he risked not only criticism from his peers but his customers as well.

Thus, we created a leadership vacuum, leaving the field to the politicians, regulators, and lawmakers to step in and attempt to correct the abuses and shortcomings of our governance systems. They passed new laws and new regulations to prevent future abuses and send the so-called crooks off to jail. In effect, the new laws simply codified the "best practices" of our best governed corporations, practices such as separation of governance from management, a majority of independent directors, executive sessions of the board and so on. And in some instances we converted the signatures on SEC documents to a potentially criminal event.

While I have been an advocate of these new laws and regulations, they alone will not correct the multiplicity of problems we face to regain the credibility of our corporations and the confidence of our investors. Simply stated, you cannot legislate integrity, stewardship, or good governance.

At this stage, we don't need new laws. We need new leadership of our boards and in the CEO's chair.

Unless a new generation of leaders steps forth to run our boards and our corporations, we will simply find ourselves going through the motions to respond to the new requirements of Sarbanes-Oxley and the New York Stock Exchange listing requirements, but nothing fundamentally will change about the way we do business. And several years from now, we will find ourselves back in this crisis once again.

Our system of capitalism is built on trust – trust that corporate leaders and boards of directors will be good stewards of their resources, providing investors with a fair return. There can be no doubt that many leaders have violated that trust. As a result, investors lost confidence and withdrew from the market. In the process, many people got hurt, not just the perpetrators.

In the midst of the current crisis, we must ask ourselves, where have all the leaders gone? Where are today's versions of James Burke of Johnson & Johnson, Walter Wriston of Citicorp, John Whitehead of Goldman Sachs, and David Packard of Hewlett-Packard? These people not only built great enterprises but were statesmen in the business community and leaders in addressing societal issues as well.

Let's look deeper into these two issues, governance and leadership, to see what is required to get back on track.

The Transformation of Corporate Governance
Many well-meaning board members have forgotten that they are ultimately responsible for the corporation. They have a fiduciary duty to ensure its preservation and proper governance. If the corporation gets in deep trouble, they are responsible, not the CEO. "Not knowing what was going on" is not an adequate excuse for failure. Nor is being overpowered or misled by a chair and CEO who runs the board like a dictator.

In the 1970s Kenneth Dayton, then chairman of Dayton-Hudson (now known as Target) established a remarkable set of governance principles that enabled the company to flourish in spite of takeover attempts, CEO changes, and severe economic downturns. Dayton wrote a treatise called "Governance is Governance" that clearly delineated the board's role from that of management, and set forth the principles for maintaining a strong, independent board. Dayton 's principles included a lead director as vice chair of the board, a substantial majority of independent directors, a governance committee, regular executive sessions of the board, extended board meetings to review strategy, evaluation and compensation of its chairman and CEO separately in those roles, term limits for directors, and evaluation of board performance.

If more corporate boards had incorporated Dayton 's ideas into their governance practices, we might have avoided the governance scandals of 2002. Instead, most of these ideas have been adopted in new laws and regulations such as the Sarbanes-Oxley Act, SEC regulations, and NYSE listing standards.

As a result, every corporate board is taking its "new" responsibilities very seriously and attempting to comply fully with the added regulations. This is necessary, but compliance alone will not prevent future board failures. What is required is for boards to transform themselves from within, with a dedication to excellent governance. This dedication is fully apparent on the boards on which I have served most recently - Medtronic, Target, Novartis, and Goldman Sachs - and I believe on many other boards.

A recent study by Harvard Business School Professor Paul Gompers found that there is a strong, quantifiable correlation between excellence in corporate governance and excellent corporate performance. On the other hand, no correlation was found between individual governance processes and corporate performance. Instead, the difference was board leadership and board chemistry. Gompers also found that poor corporate governance is a symptom of a poor corporate culture. Gompers points out that, in spite of their "so-called" governance processes, Enron, WorldCom, Tyco and many other of the flawed boards caught up in the recent scandals had abandoned any semblance of board democracy for board dictatorship by the CEO.

It is hard to respect the leader of any institution – government, business, or education – that does not practice good governance. Good governance provides the appropriate balance of power for management, but should not in any way compete with or replace management's responsibilities. Governance is governance, not management! If ever there was a need for corporate leaders to advocate and practice sound governance, now is the time. If they don't, our system of capitalism may be at risk.

At the present time we are witnessing a transformation in board governance, a sea change in the balance of power between boards of directors and management. The question is, "Will it last?" Will the changes result in a permanent alteration of corporate governance, with directors finally accepting that they are ultimately responsible for the corporation? Or will boards simply go through the motions of complying with Sarbanes-Oxley and the new regulations, but not change anything internally in terms of the power balance between the board and the CEO? As I see it, the worst case would be boards going through a "box ticking" exercise to adhere to the new rules, the economy and stock market recovering from their current malaise, and a return to "business as usual" inside the boardroom.

In spite of the new laws and regs, we continue to hear calls from governance experts for further reforms. At this stage we don't need to keep tinkering with the laws and regulations governing our corporations. We need to make the reforms work and use them to transform our boards from within. Further regulations will only trigger a defensive response from boards, resulting in external compliance but no essential change in the internal functioning of the board.

Stepping Up: Challenges For Boards of Directors
 If boards are really serious about transforming their roles, they will step up – at a minimum – to the following challenges:

1. Taking charge of the process of CEO evaluation and selection. They will select and evaluate CEOs for their character and values, not their image and power. They will choose builders and visionaries, not gamesmen who principal ability is manipulating the numbers to keep the earnings and stock price up. And they will look less at CEOs' external power and more at their moral fiber and inner toughness.

They will ensure that solid succession processes exist, providing for continuity in management and on the board. And recognize that the necessity of looking outside for prospective CEOs is a sign of failure on the board's part to provide for internal succession. This may hurt the CEO executive search business, but it will be a great boon to corporate continuity and performance.

2. Enabling their leaders to avoid the quarterly earnings trap . This means moving away from stock price as a measure of performance. This means returning to old fashioned, tried and true measures like cash flow, return on investment, and compound growth in earnings over a five-year period. This will require them to support their leaders if and when the near-term stock price is hurt by responsible actions to build lasting value for the long-term.

3. Compensation committees revamping rewards for management . First, they must recognize that excessive CEO compensation is one of the root causes of seduction of CEOs to focus on the near-term and abandon the long-term health of the enterprise. The recent incidents at Xerox and Glaxo-Smith-Kline are vivid reminders of what regulators and shareholders are prepared to do if boards don't do their jobs. We should be paying CEOs only for the creation of long-term equity in the enterprise.

Although there are many advocates of eliminating stock options, I believe they are still a very good compensation vehicle IF a) we recognize their value when it is realized, and b) we extend the holding period for the stock to five to ten years, or one year after the CEO has left office.

Compensation committees also need to hire their own consultants, using a separate budget, rather than using consultants engaged by management. They should insist that the consultants help them escape the survey trap where every board thinks its CEO should be paid above the average. Instead, CEOs, like everyone else, should be paid in relation to what they are worth to their enterprise. These actions will require a lot of courage on the part of compensation committees, but no less can be expected or demanded from them.

4. Acknowledging that new kinds of board members are required to build healthy, diverse boards. They should seek out directors who recognize that they are ultimately responsible for the preservation of the company, are dedicated to it, and prepared to put in the time and emotional energy to work with management to build a great corporation.

5. Recognizing that an engaged board and a healthy tension between the CEO and the board are important to improved corporate performance. To achieve that, boards need to focus on building a strong chemistry inside the boardroom and on fostering an open, intense dialogue with their CEOs. Quality CEOs, like the ones I have worked with, will welcome and value strong boards helping them do their jobs better.

These five points, while crucial to a fully functioning board, are not exactly original ideas. Most of them were advocated by Ken Dayton and others twenty-five years ago. So why don't boards behave this way?

Board Leadership
I believe the answer comes down to leadership, leadership of the board and leadership of management. We have already demonstrated that for governance and management to be separated, which they must be, requires different type of leadership. This is true even if one person holds the positions of board chair and CEO.

In order for board governance to function effectively and democratically, the board needs to recognize a leader among its independent directors. Whether this person is given the title of board chair, vice chair, chair of corporate governance, or presiding director is far less important than having a strong, independent leader in this role who can organize the independent directors and insure both the separation of governance from management and provide for the supervision of the CEO.

To expect CEOs to perform this role is totally unrealistic, no matter how skilled leaders they are. If one of the board's most important role is selecting, evaluating and supervising CEOs, then it is impossible for CEOs to supervise themselves.

I have seen this “lead director” structure work very effectively on all the boards on which I have served most recently. The Target and Novartis boards have a vice chair in this role, and both individuals are highly at it. On the Goldman Sachs and Medtronic boards the lead director is the chair of the corporate governance committee. The individuals who serve in these positions are also highly effective at ensuring the separation of governance from management.

Although American CEOs have a very strong preference for the combined title of chair and CEO, the European approach of separating these positions into two people, which is legally mandated in a number of countries, can and does work well. A good example is British Petroleum. I have served as CEO under an independent chair and also as chair without being CEO, and know that it can work well. In contrast to many European colleagues, however, I do not believe the formal separation is a panacea. We have seen in the cases of British Telecom and ASEA-Brown Boveri that split roles can be quite destructive if the right relationships do not exist between the two top people.

Board Chemistry
However, there are two final requirements for effective governance of our companies. The first is that elusive phrase, “board chemistry.” The board members need to function effectively as a unit. The critical variable, in my opinion, is whether the board operates like a democracy or a dictatorship.

In a board dictatorship, such as we saw at Enron, Tyco, and Worldcom, the CEO calls all the shots for the board as board members defer to his judgment. Governance and management become blended together as one: so-called independent board members hesitate to challenge the powerful CEO for fear of overstepping their bounds into the realm of management and being put down. In a democratic board the chair actively solicits the inputs of all board members, not so much to gain their approval, but as a way to make better decisions and build a better company.

Unlike executive teams, boards don't go “off site” for the sole purpose of building their relationships. If boards only meet for five or six half days a year, it is extremely difficult to build chemistry, especially for newer board members. Boards have turnover as old members depart and new members sign on; meanwhile, the CEO is the one remaining constant. Yet board chemistry tends not to change very much at all unless there is a wholesale turnover of the board as there was at IBM when Lou Gerstner arrived or, more recently at Tyco, when Ed Breen took charge of a failing enterprise. I have even witnessed the same person behaving very differently from one board to the next.

A key vehicle for building board chemistry are executive sessions run by the lead director. I have witnessed on numerous occasions just how much the discussion changes when the board goes into executive session. It becomes very candid and open, and quickly moves to the deeper issues that are concerning board members. A key is for the lead director to communicate the essence of the discussion back to the CEO and, if necessary, have a follow up session with him to continue the dialogue.

Effective board chemistry can be built through annual off-site visits. These can take the form of a visit to an important company location, or an extended session to discuss strategy. These sessions take more of the directors' time, but it is precisely that time that enables board members to build trust and closer relationships. Some try to achieve this with board dinners, but that alone is insufficient to build board chemistry.

Leadership of the CEO
Finally, we turn to the role of the CEO in building board governance. As found in the HBS study I discussed earlier, board governance will inevitably deteriorate if the chair & CEO is permitted to become too powerful and more as a dictator to the board than as the democratic leader of the group. To address this issue, we need to look at the kinds of people we are choosing as CEOs and how they are motivated.

If CEOs are chosen primarily for their image, power, and ability to manipulate numbers to met earnings targets, and compensated for getting the stock price up, then boards shouldn't be surprised when CEOs behave like they are solely responsible and all the focus is short-term. Yet this is precisely the profile that many boards give executive search firms when internal succession processes fail and they are forced to go outside for a charismatic CEO. If we select people principally for their charisma and their ability to drive up their short-term stock price instead of their character, and shower them with inordinate rewards, why should we be surprised when they turn out to lack integrity?

In the 1990s many companies lost sight of the imperative of selecting ethical leaders that create healthy corporations for the long-term. The lessons of building great companies like 3M, Coca-Cola, Pfizer, Johnson & Johnson, Target, and P&G were lost in the rush to get the stock price up. We forgot that those of us fortunate enough to lead great companies are but the stewards of legacies we inherited from past leaders and the servants of our stakeholders.

What kind of leaders do we need to build our corporations in the 21st century? We do not need powerful, charismatic leader to drive up near-term stock prices in search of personal gain. Instead, we need authentic leaders , people of the highest integrity, committed to building enduring organizations. We need leaders who have a deep sense of purpose and are true to their core values. We need leaders with the courage to build their companies to meet the needs of all their stakeholders, and who recognize the importance of their service to society.

The good news is that a new generation of authentic corporate leaders is already emerging to lead in an authentic manner. People like Sam Palmisano at IBM, Jeff Immelt at GE, Hank McKinnell at Pfizer, Jim McNerney at 3M, Art Collins at Medtronic, and A. G. Lafley at P&G are bringing a new sense of openness, authenticity, and focus on stakeholders to building their companies for the long term. Although this group needs time to prove the merits of their new approaches and their sustainability, there are many encouraging signs.

I believe we are on the verge of a new generation of authentic leaders prepared to step forward to build enduring, authentic companies. In the end they will create far more lasting value for all their stakeholders. They may not be as glamorous or as charismatic as their predecessors, or devote as much of their time to meeting with security analysts and appearing on CNBC, but their results will be far better in the long-term.

I feel so passionately about the need for this new kind of leader that I have written a book on this subject. It is called “Authentic Leadership,” and will be published by Jossey-Bass in early August. Its subtitle is “Rediscovering the Secrets of Creating Lasting Value.” I hope you will appreciate its clarion call for authentic leaders to run our companies.

Conclusion
I recognize that meeting all the ideas I have laid out in the past half hour represents a real challenge for you as board members and as corporate CEOs. But nothing less can be expected or required if we are restore trust in our corporations and their leaders, a trust that is essential for the capitalistic system to function effectively.

The bottom line is that good governance is required not only to restore our corporations but to create lasting value in them. By committing ourselves – board members and CEOs alike - to restoring our corporations, we can rebuild and sustain the growth in their value and, at the same time, restore business leadership to its noble calling of serving society through our system of capitalism.