The Year in Review: You Better Watch Out

David Ogilvy said that taking his company public in 1966 was the biggest mistake he ever made. The founder of Ogilvy & Mather argued that outside board members, with their responsibility to look out for the financial interests of shareholders, limited the strategic vision of agency CEOs in a young, quickly evolving business.

Of course, virtually every major marketing services holding company in the world ultimately repeated Ogilvy’s “mistake.” But in a post-Enron, post-WorldCom business environment, the corporate-governance challenge confronting Madison Avenue has been concerned not with the specter of cautious conservatism but with the complexities of bubble-driven growth. And the U.S. advertising industry has hit a global critical mass, reaching a point where the quality of corporate governance is every bit as essential to strategic success as creative work.

The threat of further litigation, legislation and regulation makes governance an uncomfortable subject for American chief executives and their boards to publicly discuss. However, there’s no escaping the fact that the same kind of corporate-governance issues facing a Tyco, a WorldCom or a General Electric increasingly occupy the time and attention of the ad sector’s boards of directors.

All summer long, Wall Street darling Omnicom was questioned over purported accounting malpractices described as analogous to Enron’s. Enron first got in trouble for its use of “special-purpose entities” that removed big liabilities from its balance sheet, away from shareholder attention. Omnicom used a special-purpose entity called Seneca to distance itself from its money-losing Internet holdings. As conglomerates like Tyco came under fire for aggressive acquisition strategies and even more aggressive accounting practices, skeptical financial journalists and analysts queried how companies like Omnicom and Interpublic Group accounted for revenue from acquisitions vs. organic growth. Not helping matters was the fact that now-defunct accounting firm Arthur Andersen worked for both WPP and Omnicom.

After the Omnicom meltdown, investors were hit with bombshell revelations from IPG, where earnings were restated because of multiple booking of revenue from a common client at European offices of company flagship McCann-Erickson. That Omnicom execs have been accused of being too clever in their financial maneuvering and IPG managers too inept in theirs underscores the complexities of oversight in globally dispersed holding companies.

Whether the resulting focus on board-level governance reflects a profound over reaction to current events or a fundamental shift in the way global organizations will be run is unclear. What is indisputable, how ever, is that boards and their directors will be held more accountable for shareholder interests. Scrutiny and transparency are the order of the day.

“I think [what’s happening now is] a reflection of the bear market and the recession,” observes WPP CEO Martin Sorrell. “But some aspects were called for, given recent excesses—some of which have been experienced before, in other boom times. The danger is that there may be situations where nonexecutive directors attempt to second-guess management. In the end, though, I think it is a question of balance.”

In February, IPG was the first to revamp its board by cutting four insiders. Omnicom followed in April, eliminating seven employees. (Omnicom, citing proposed New York Stock Exchange rules, claims that chairman Bruce Crawford, its former longtime CEO, is an outside director.) IPG now has just two insiders on its nine-person board and Omnicom one on its 10-person board. (WPP has 14 directors, three of whom are defined as insiders.) That move to reduce insiders is in line with the rest of corporate America in the wake of Enron. In August the NYSE and the Nasdaq proposed that listed companies have a majority of independent directors on their boards.

Of course, the essence of the renewed emphasis on corporate governance is that independent directors may need to second-guess top management. Management reports to the board—not the other way around.

“A board that has experience that is valuable to the CEO and the corporation, and balances those experiences of the CEO, is very proper,” says IPG CEO John Dooner. “It’s better governance when it’s more objective and interactive.”

While IPG struggled in 2002, WPP emerged from the year of shareholder discontent relatively unscathed. The reasons are intriguing and perhaps unique in marketing services: The company does not have the large U.S. institutional ownership of its American rivals. More important, WPP has benefited from a British business culture where issues of corporate governance and best practices have been outlined in authoritative standards like the 1992 Cadbury Report.

WPP’s American counterparts have begun to address these issues. “You’re seeing a change here in that board memberships are no longer an honorary position. It’s no longer an old-boy’s network,” says Tom Rosenwald, head of the marketing and consumer products practice of recruitment firm Directorship Search Group. “The audit committee is getting more attention than it ever has.”

No one doubts that independent board directors feel more free to criticize the boss. But as companies replace insiders, who possess operational insight, with financial types, some critics wonder whether near-term profits will take priority over broader initiatives.

“It’s important that boards not be dominated by people who are driven by the aspirations of the investment community. Financial performance will always emphasize short-term rather than long-term strategic objectives,” argues Bob Willott, editor of Marketing Services Finan cial Intelligence, in an explicit echo of Ogilvy. Willott is an accountant who co-founded Willott Kingston Smith, a London-based consultancy that advises on financial issues in the communications industry. “In boom times” he says, “the stock market is going to reward those who follow fashions for the quick buck, things like the dot-coms and fairly shallow ideas. You shouldn’t give [those outsiders] more stewardship than senior managers. I think the pendulum has swung too far.”

IPG’s board is heavily weighted toward members with financial backgrounds: Nearly half of its outside directors are from the financial world, and company CFO Sean Orr is also a director. Arguably, though, that could be a benefit given the fact that Dooner comes from the ad side of the business and lacks the number-crunching background of peers Sorrell of WPP and Omnicom CEO John Wren.

Unfortunately, even a reputation for financial expertise can lead to a crisis-driven redesign of governance and accountability. In recent years, Omnicom, for example, replaced IPG as the industry’s high flyer in terms of stock market multiples—so it was nothing short of astounding when, in June, the company’s share price went into free fall after a Wall Street Journal article questioned its accounting practices. However aggressive Omnicom was in its bookkeeping, there was never proof of illegal financial maneuvers. But that didn’t reassure the frayed nerves of investors in the post-Enron era or put off bloodthirsty short sellers. Omnicom’s stellar reputation became tarnished amid a revaluation of its debt ratings and mounting lawsuits triggered by the company’s drop in share price. (The stock has since recovered, now trading in the mid-to-high 60s, nearly double its 52-week low last June.)

Strikingly, much of the publicity surrounding the debacle was a direct result of a board-level disagreement. The WSJ piece was based largely on leaks of an embarrassing dispute between management and a disgruntled Omnicom board member, Robert Cal lander, who quit in protest. Omnicom CEO Wren declined interview requests.

More substantive than the accounting questions at Omnicom were the outright irregularities uncovered at the European operations of IPG agency McCann.

Back in June, questions about the role of board oversight—brought on by the departure of Omnicom’s dissident director—provoked a healthy public discussion of corporate-governance issues in an industry where holding companies have always opted for a low-profile existence in the shadow of their flashier operating brands. By year-end, those questions took on more urgency as it appeared IPG’s directors were assuming an increasingly activist role in the recruitment of a chief operating officer. If a board’s primary role is to hire and fire a company’s CEO, at what point does its involvement in more day-to-day management decisions turn into interference?

IPG board member Reg Brack says that while boards have become more involved, as is the case at IPG, “that doesn’t mean directors are micromanaging or running the company.” Good boards don’t do that, he says. “We have to have confidence in the CEO, or we have to get a new CEO,” adds Brack, who last week expressed board support for Dooner.

“John came in during a very difficult time. The market turned south,” notes Brack. “He inherited that climate and a bunch of complicated internal accounting problems that had nothing to do with clients or the performance of the business.” Dooner and the board have worked overtime to “put the house back in reasonably good order,” says Brack, crediting Dooner for leading the industry in securing more independent board members.

While the Sarbanes-Oxley Act, which became law in July, requires that directors sitting on audit committees be outsiders, at Omnicom and WPP—like IPG—that was already the case. Even so, the multiple booking of revenue at McCann, and financial woes at IPG sports-marketing unit Octagon, underscores the difficulty of identifying grass-roots accounting problems for those responsible at the top of holding companies.

“Because of their history of expansion through acquisition—holding companies acquired companies, agency networks ex panded geographically through acquisition—these businesses have become highly decentralized operations. The holding companies really hold their member agencies responsible for their books,” says Rosenwald.

Given the accountability now facing board members in a corporate America slammed by shareholder lawsuits, attracting well-qualified directors may become more difficult. In the marketing-services sector, it’s never been easy, given the potential for conflicts of interest with consumer marketers. Industry boards typically include a large number of retired executives and academics.

Like other IPG board members, presiding director Frank Borelli declined interview requests. (Omnicom directors similarly did not return calls.) In February, however, after the collapse of Enron, Borelli talked to CFO magazine about the unprecedented number of solicitations made to CFOs to fill board seats. To avoid unsuitable corporate affiliations, CFOs should apply the same kind of due diligence they use in evaluating acquisitions or personnel, he said.

According to Borelli, who chairs IPG’s audit committee in addition to the one at Express Scripts: “It’s just like hiring someone: You want to talk to all the third parties you can to check their references.”

Borelli, a former CFO at Marsh & McLennan, said that when assessing board invitations, he interviews a company’s outside auditor and analysts, as well as its general counsel. He studies management’s candor during conference calls and checks the limits and strengths of the company’s D&O (directors and officers) insurance policy. Since retiring in 2000, Borelli said, he had turned down invitations from three boards.

Technology guru Esther Dyson, chairwoman of EDventure Holdings, joined WPP’s board in 1999. She argues that it’s not just the expertise of board members that’s important, it’s their dynamic as a group.

“Seven wonderful people do not necessarily make a wonderful board. The issue is how well they interact,” she says. “It’s awkward, because you really want to rotate the outsiders on a board. Just when people are getting to know the company well, it may be time for one or two of them to leave.”

In contrast to the buddy system that’s been a time-honored tradition in American boardrooms, in the U.K. best practice is that board members come up for re-election every 30 months. In addition, U.K. companies typically appoint nonexecutive chairmen, unlike in the U.S, where the insider CEO often carries both titles. U.K. outsiders are intended to provide a counterbalance to a powerful CEO.

“U.K. accounting practices are probably tighter than in the U.S., so WPP has succeeded in corporate-governance issues where Omnicom and IPG have failed in the areas of internal controls and accounting practices,” says Neil Blackley, an analyst with Merrill Lynch Global Securities.

European companies such as Publicis and Havas have a different relationship with shareholders than U.S. concerns, with their banks exerting more direct control on corporate affairs.

American business is adopting its own ways of providing more outside control over top management, with companies like IPG appointing presiding directors. “The trend toward presiding directors—which is analogous to the British practice of non executive chairman—is a good idea, and I think we’ll see more companies hiring them,” contends Rich Kelly, an attorney at Mintz Levin Cohn Ferris Glovsky Popeo, which includes corporate governance in its areas of practice.

Adds Phil Geier, IPG’s former CEO: “You’re going to have more and more companies with a lead director who will be a board communicator to the CEO. It reassures shareholders that the board has involvement in the board agenda.”

Which brings us back to the questions surrounding IPG and its activist board. Does a stronger board make for a weaker CEO? Not necessarily, given the unique dynamics of the marketing-services industry.

“The board can fire the CEO, so you’d say they wield more power,” says Rick Kurnit, a partner at Frankfurt Garbus Kurnit Klein & Selz, who heads the firm’s advertising and marketing practice. “But the CEO has important client relationships and the ability to motivate key managers, so they have a lot of power as well. There are checks and balances at work here.”

There have always been checks and balances. What’s different now is that the balance of power in that dynamic is tilting away from the insiders and chief executives and toward the outside directors. Greater transparency and accountability supposedly assure that temptations to cheat will be minimized. Will this make marketing services a safer and more reliable investment for shareholders? That’s the undeniable goal.