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Tuesday, August 17, 2010

More on HP

There has been a terrific discussion on The Conglomerate about HP's Code of Conduct and its newly deposed CEO, Mark Hurd (who reportedly walked away with a severance package of 12MM cash plus options that could bring the entire package up to about 40MM).  Gordon Smith notes that Joe Nocera has speculated that the Board may have had other reasons for firing Hurd, but used the current "crisis" as a pretext for getting rid of him.  Today's New York Times reports that Hurd was fired because the Board and company investigators were mystified by his lack of judgment (authorizing more than $75,000 in first-class perks for an HP contractor who would later sue him for sexual harassment), and his lack of transparency (reaching a late-night settlement with the accuser before the Board's investigators had a chance to speak to her). 

It seems to me that given these circumstances, the Board acted well within its business judgment. 

At some point, the directors undoubtedly said to themselves, "What else don't we know?" and ultimately concluded, "We don't trust this guy any more."  (We can assume that different directors had different baselines of trust.  What's relevant is that the tipping point had been passed for all of them).  Given HP's prior issues with "integrity" and a brewing FCPA investigation with the feds, it's hardly surprising that risk-averse directors decided that it was time for Hurd to go.

The only question that remains, then, is whether the Board should have given Hurd any severance.  Recall that Hurd "resigned," albeit with some very strong encouragement.  Had he been fired "for cause," he would not have received any severance, but his contract does not define "for cause."  (Even if it did, do you think it would include the exact conduct that occurred here?  Surely, one could always engage in a protracted fight over what happened, and whether what happened constituted "cause".)

So if I'm a board member, I'm probably wondering whether it's better to tell Hurd to go pound sand, and risk a protracted and potentially embarassing lawsuit with Hurd, or give Hurd a relatively moderate severance package (this isn't a Michael Ovitz-size debacle, no matter how you slice it) and risk criticism from the media and a lawsuit from my shareholders.  Assuming that the media storm will die down, I probably choose the latter.  After all, assuming I cross my t's and dot my i's, the business judgment rule protects my decision from judicial second-guessing, and Hurd's severance package is a drop in the bucket compared to the value of moving on from this scandal.

This episode nicely demonstrates the benefits and shortcomings of corporate compliance.  On one hand, seemingly small compliance issues can serve as a bellweather for deeper, more intractable issues.  $75,000 is not very much money to HP, and HP found no evidence of harassment, but Hurd's conduct was troubling enough to raise a number of red flags.  On the other hand, the episode shows us what compliance cannot do, which is prevent people from engaging in incredibly short-sided and even self-destructive behavior.  You can intone values of integrity; you can spend inordinate amounts of time drafting and revising a comprehensive Code of Conduct; you can spend thousands of dollars educating your employees on how and why they should stay out of trouble.  But corporations are like cities, and just as no amount of enforcement by the NYPD can prevent crimes ranging from traffic infractions to violent murder, so too is corporate compliance limited in what it can and cannot do.   

Posted by Miriam Baer on August 17, 2010 at 09:51 AM | Permalink

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Well, I appear to be outvoted and, in light of the eminence of the lawyer-scholars voting against me, outgunned as well. But I'm still not persuaded. In an effort to rebut the rumors of my obstinacy, let me explain briefly why.

Miriam is right to call me on my ill-chosen trope of the punishment fitting the crime. I never intended to suggest that it was the Board's job to punish Mark Hurd, and I fully agree that the Board's primary concern is to protect the company under the difficult circumstances that Hurd appears to have created.

I think we are also in general agreement that there are good arguments for a business judgment defense to a broad range of responses, including terminating for cause (no severance), terminating without cause (paying severance) or not terminating (but possibly imposing other discipline). So the legal question here (i.e. what can the Board do without likely liability to the company or its shareholders) is not really what is most interesting. I think this amounts to a point similar to Jeff's, that it is important to place law within the dynamics of human relationships.

Where I differ with my learned friends is on what the Board should have done as a matter of good corporate governance. While I share Miriam's concern about what I would call the "cult of CEO personality"--that is, the unshakeable view that one individual is so iconic and unique as to be fundamentally irreplaceable (possible exceptions being folks like Charles Schwab and Steve Jobs, though that really is a matter of degree) I categorically disagree with her suggestion at the opposite extreme that "CEOs are fungible." If we've learned anything about corporate governance, it is that management matters, and that management is in significant part personal. CEOs are no more fungible than law school deans or law professors, and I'm confident that neither Brooklyn nor Suffolk intends to stint on the exacting scrutiny they exercise in picking their new ones. What that means is that, unless some really important things have changed that we don't know about, it is a real, substantial and very costly loss to HP to remove Hurd.

That doesn't mean that it should never happen, but it does raise the question of when that cost is justified. So what should the Board do when confronted with what we are assuming was Hurd's lack of candor and bad judgment? I just don't agree that, for misbehavior of the kind we have been led to understand Hurd committed, you have to get rid of him and "move on" as Jeff suggests. There's going to be a hangover from this party no matter what--either a sex harassment suit which the pundits seem to think is a loser (I'm inclined to agree, and besides it appears to have been settled), or derivative suits and shareholder class actions, which are already being filed and which are going to seek to delve into what Hurd did and whether the Board handled it properly. Thus, unless these suits are terminated early (which they might be) the shovels are headed for the dirt no matter what.

In my view, you keep Hurd and discipline him. For example, you make him pay the cost of the sex harassment dispute, reimburse the improper expenses, and forfeit some comp. Maybe you add some company therapeutics (extra training for all managers, send Hurd to some counseling). You take steps so everyone, inside the company and outside, gets the message that this was wrong, is being condemned, and had real consequences. Then you keep your star manager, save $12 million in severance, and do the right thing all at once. As I said before, if thy right eye offend thee, there are better ways to cure the offense than plucking it out.

Maybe Hurd would not have agreed to such an arrangement. Maybe there was additional bad behavior that justified tossing him under the bus. Maybe Hurd had outstayed his usefulness, so the value to his continued tenure I am insisting be kept in the balance should be removed. But these decisions are ones of nuance, degree and presentation (witness the fact that at least three apparently knowledgeable and reasonable people differ on what to do). I think we all agree the Board likely has not incurred liability for itself or the company, but I continue to believe there were more effective decisions avaiable from a management, human, and public relations point of view than the one on which the Board seized.

Posted by: Bernie Burk | Aug 19, 2010 12:15:53 AM

Many thanks to both of you for the comments. Jeff, I particularly like your comment about "placing law as a discipline within the other dynamics of human relationships."

Bernie, here is where I disagree with your comments: You say that the "punishment" of Hurd may not have fit his "crime." But the job of the Board is not to mete out an acceptable amount of retribution; rather, it is to protect the company and ensure that the best persons are running the firm. Once it became clear that Hurd had fudged expense reports (and let's assume that there was sufficient evidence that the fudging was intentional), the Board had to come to the grips with two very serious optical problems. First, the company would risk alienating its own employees, who might otherwise reasonably conclude that two sets of rules apply to officers and rank-and-file employees. Second, and more important, the company would risk alienating federal prosecutors in the event the DOJ's FCPA investigation bore fruit. I agree that the second point can, in some instances, be problematic. There have been episodes (Bristol Myers Squibb for one) where it appeared that the company's Board was acting solely at the behest of the whims of the US Attorney (now governor of New Jersey). But nothing like that happened here.

If, as has been suggested in reporting, the Board genuinely believed that Hurd was not dealing with it in an above-board manner, then the Board had the right -- indeed, the responsibility -- to take quick action. (As I said in the post, the trickier question is whether you give the guy severance, but I can see the reasons for giving him some money and quickly getting past this).

One of the healthier aspects of this story is that it demonstrates the Board's belief that the company is more than one person. CEO's are (or at least should be) fungible. The minute a board starts acting like one man or woman is the only person who can run the company is the minute shareholders ought to sell their stock. HP may suffer a tough couple of months, but I'm betting that there are people out there who want and have the ability to run the company, but without Hurd's baggage.

Posted by: Miriam Baer | Aug 18, 2010 11:05:13 AM

Well, Bernie, thanks for calling me out. I thought Miriam's analysis was exactly right for legal, practical, and moral reasons. Legally, the case for not paying is a little stronger (on the facts that are in the public domain) than the facts underlying one of the issues in Brehm v. Eisner (the Disney case): the question whether the Disney board violated the business judgment rule in not firing Ovitz for cause, and then paying something less than the full amount to settle with him. Sanford Litvack, Disney's GC, told Eisner (as did outside counsel, apparently) that the obligation to pay was a "no-brainer." The difference here seems to be that Hurd may have done something arguably wrong, where Ovitz's primary sin was not getting along with Eisner.

I think Miriam is absolutely right as a practical matter. In a situation like this, you want to get the incumbent out, and move on. The last thing you want to do is squander resources and energy litigating (which will eat up most of the amount you paid in severance anyway).

Finally, I think Miriam is spot on as a matter of placing law as a discipline within the other dynamics of human relationships. There's a limit to what positive law, even the positive law created by private agreement between the parties, can address. I published an essay a few years back in Law, Culture, and the Humanities entitled "Freedom, Compulsion, Compliance, and Mystery: Reflections on the Duty Not to Enforce a Promise" that begins with a hypothetical much like the situation here. My point was precisely this one: that the situation points out the difference between positive law and morality because the moral issue isn't the Board's but the fired CEO's. When should you forego the benefits of a legal right because it's morally inappropriate to accept them? Almost all of our doctrine in contract law focuses on the rights of the promisee and the obligations of the promisor. But whence come the obligations of the promisee? My thesis is that they can only be moral.

Posted by: Jeff Lipshaw | Aug 18, 2010 2:32:55 AM

Miriam, With all respect, I wonder whether that really adds up.

Let's assume that the resignation-cum-termination was within the Board's business judgment. Why should the Board exercise its judgment that way? $75,000 in misdirected expenses vs. $12 million in severance plus the precipitous loss of someone universally regarded as one of the most effective CEOs walking on shoe leather, someone who is credited with restoring a devalued company's prestige and multiplying its stock price. Again, let's assume that Hurd was as foolish as the papers imply--that these were not just errors or oversights on his expense reports (even inexcusably negligent ones), but rather were conscious efforts to conceal expenses that shouldn't have been incurred on perks for a contractor with whom Hurd shouldn't have been trying to make time, especially on company time. Does the punishment fit the crime? The New York Times coverage keeps stressing the professional advice that the Board received in reaching its decision, but that was public relations advice, not corporate ethics or risk management advice. The sex harassment case was, by current estimation, a loser, and the derivative cases for the termination and severance are already being filed (literally--I saw one today in the local new filings service out here).

I don't mean to devalue institutional integrity--it's obviously an essential corporate value. Nor do I mean to suggest that the Board was not within its reasonable business judgment if it decided to preserve that value at the cost the company incurred. But if thy right eye offend thee, there may be better ways to cure the offense than plucking it out--and paying eight figures to do it.

Legally, the situation illustrates the difficulty of assessing business judgment when intangible values (visions of institutional integrity) are stacked up against ordinary tangible ones (a lot of money, not to mention the value of Hurd's leadership, whatever that may be). Practically, the situation screams to me that there's a lot we don't know, either about the dynamics of the decision (if there's little more to the picture than the papers have reported to date), or about what was really going on over there. The latter seems at least possible--already the Times today was tossing out hints about recent erratic or peremptory behavior on Hurd's part, suggesting the possibility that the Board had more before it than what we've heard about.

Jeff Lipshaw, if you've made it to the end of this, what would you have done if you were sitting in GC Holston's chair?

Posted by: Bernie Burk | Aug 17, 2010 11:27:20 PM

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