High Aspirations Governance: Two Examples

GFS and Governance

GFS had been around for almost ninety years when I met Paul and John Gordon in 1987. That was the year they decided to take steps to ensure quality governance, orderly management succession, and family control for generations into the future. It was not quite clear what those steps should be. Dave Gray and I helped the family identify and implement them.

GFS has been a remarkable story of growth and high performance in the ensuing twenty-five years. It has also been the story of a family dedicated to customers, employees, and service. The Gordon family practices servant leadership as a guiding principle in its stewardship of the company and expects the leaders of the company to do the same.

 

High Aspirations. The creation of governance arrangements for GFS was built on high aspirations for the company's future. Four stand out.

First, Paul and John wanted a governance structure that would enable the company to operate successfully for decades, even centuries, into the future—through multiple generational changes in family and management. They wanted, in other words, governance that would enable GFS to be a successful company in perpetuity.

We were acutely aware that few companies, public or private, achieve this goal. Corporate change and mortality statistics are sobering. Of the original companies in the Fortune 500 published in 1955, about 90 percent have disappeared from the list. This reflects the death of some companies, the absolute or relative decline of others, and the acquisition, merger, and loss of original identity of many. Few family businesses make it beyond two generations for a variety of reasons, including inadequate capital, scaling problems, failure to develop leaders, family desires for liquidity, estate taxes, and so on.

The stark reality of corporate mortality reminded us how important governance would be for GFS to have a chance to continue in perpetuity. Governance would have to anticipate and prevent or resolve all the issues that lead companies to lose control of their destinies, disappear, or die.

Second, Paul and John aspired for GFS to be a high-performing growth company. They wanted, somehow, to ensure the board would, every year, find the sweet spot between stretch goals and acceptable risk. This is a vital challenge for every board. Let me explain.

The board, as management's boss, must set goals, provide incentives, and monitor results to motivate high performance. Directors are also responsible for managing the enterprise's risk profile through project approvals and denials and balance sheet management. Deep financial strength is the best insurance policy against a company's becoming a mortality statistic. Excessive risk aversion leaves the organization lethargic and subject to decline and slow death (e.g., General Motors in the 1980s and 1990s). By contrast, extreme stretch goals and financial incentives can lead management to take excessive risks with crash-and-burn results (e.g., Lehman Brothers in the 2000s).

As entrepreneurial leaders of GFS, Paul and John managed this balance point personally. They constantly reinvested in the business by living modestly, thus minimizing their personal demands on company resources and enabling GFS to take prudent investment risks to expand and grow. Looking ahead to the time when the board would manage the balance point, they wanted to be sure the company became neither lazy and complacent nor excessively leveraged and risky.

Paul's and John's third aspiration was that GFS remain focused on food service and not be easily distracted by the siren song of unrelated diversification. They also preferred that the family resist the temptation to become passive investors. They understood that financial returns must be acceptable and the company would have to adopt and adapt to new technologies and circumstances. But the family had made its living for over ninety years in the food business, and they believed in its staying power. As Paul's wife, Dottie, liked to say, "It might be green beans or filet, depending on the times, but people will eat." Food service was not likely to become an obsolete industry.

Fourth, Paul and John made it clear that they wanted the company to have strong leadership. They understood the need for a board that expanded beyond the two of them and their sons in the business. But they had no appetite for management by committee. They emphasized the importance of a strong CEO. They also expressed the aspiration that GFS remain private, entrepreneurial, nimble, and intensely focused on customers and service even as it grew rapidly into a large and geographically far-flung enterprise.

Paul and John set high aspirations twenty-seven years ago as we wrestled with the task of creating modern governance arrangements. In summary, they sought

 

• a company that could survive in perpetuity;

• a high-performing growth company with stretch goals and acceptable risk;

• a company focused on food service; and

• a strongly led, entrepreneurial, service-oriented company.

 

Governance Structure and Philosophy. Dave Gray and I digested all this and, working closely with the Gordons, turned to the task of designing governance for GFS. We did homework on well-known and widely admired private companies, like Cargill and S.C. Johnson, that had survived beyond a couple of generations, grown, and performed well. But mainly, we thought deeply, envisioned the future through multiple generations of continued family control, tried ideas on each other, and gradually developed an approach.

Two main elements emerged: a two-tiered governance structure and a statement of philosophy from Paul and John to future generations of family and directors. I came to think of the structure and philosophy as hardware and software, the former comprising the what of great governance and the latter the how and the why.

The two-tiered structure was the result of long debates about the merits of a smaller versus larger board. By small, we meant no more than five people. Remember, just two people had governed the company for decades! The great attraction of a small board was that it could act decisively and move quickly. We also expected that fewer people would mean fewer politics. We figured out, in detail, how a five-person board could be appointed and operate in a way that maintained family control while ensuring a strong family or non-family CEO and bringing in at least one outsider (i.e., neither a family member nor company employee).

But as we thought about the governance requirements of a large and growing enterprise and the need to develop younger directors while retaining the wisdom of senior members of the board, having only five directors felt too limited. We considered creating a board of up to nine people but were concerned that control of the company might become cumbersome and politicized.

For a while, we were hung up on the horns of this dilemma. Then we arrived at a solution.

We decided that the governing body that would connect to the family and exercise control of the enterprise would be a five-person board of advisors. GFS would have a board of directors of up to nine members to directly oversee the company. To avoid duplication and confusion, we empowered the board of advisors to appoint themselves as the company's board of directors with the ability to appoint up to four additional directors. We sought the benefits of a small board to represent the family and control the company and a larger board to accommodate all of the talent required to govern.

The initial GFS board of advisors was composed of Paul and John plus Paul's eldest son, Dan, Dave Gray, and me. The board of directors was composed of these five plus Paul's and John's other two sons in the business, Jim and John Gordon Jr. Paul served as chairman and John as vice chairman of both boards. There were no committees; the board handled all matters.

In an exemplary act of leadership, Paul and John soon insisted that the five-person board of advisors be composed of their three sons, Dave Gray, and me (i.e., they gave up their positions as advisors). This membership of the board of advisors has remained unchanged for twenty-five years. We are preparing now for orderly succession during the next decade.

With regard to operating philosophy—the "software" of governance—Dave and I observed early on that Paul and John had strong views about business and life. Some had direct implications for governance and leadership, such as an attitude of stewardship about the company, a philosophy of servant leadership about the people, a very cautionary approach to debt, and a belief that the family should remain focused on the industry they knew. Other things were more personal, including their deep Christian faith, its guiding influence in their lives, and their desire to devote resources to spreading God's word around the world rather than living lavishly.

As Dave and I thought about the in perpetuity intention for GFS, it struck us that there would be future advisors and directors who would have no idea about the thinking of these entrepreneurial owners if we didn't capture and preserve it for future dissemination. With this in mind, we asked Paul and John to write a Letter of Wishes. The title was chosen carefully. The brothers wanted their thinking to be a guide and an inspiration, not a straitjacket or set of commandments. They understood that future advisors, directors, and family members would need freedom and flexibility to make sensible decisions for their times and situations.

The Letter of Wishes makes permanent Paul's and John's high aspirations. It is a profession of their Christian faith. It addresses their views about the purpose of the company, the perpetuation and growth of the business through future generations, the role of family in the business, and the structure, financing, and focus of the company.

EQR and Governance

When Sam Zell called me in 1993 about joining the board of EQR, he made it clear that the goal was to build a great public real estate company. As the board came together and began its work, we breathed life into the aspiration Sam had articulated and came to understand what it would mean for the company and its governance.

 

High Aspirations. Three things defined greatness for EQR.

• First, being a leader in creating the new, public real estate investment trust (REIT) industry. The industry had been tarnished two decades earlier by the failure of companies with too much debt and egregious related-parties transactions (deals that benefited company insiders at the expense of other shareholders). The industry needed a reset. The liquidity crunch experienced by private real estate companies in the early 1990s encouraged or forced many to go public and provided the reset opportunity. Sam was enthusiastic about what quality public companies could mean. For shareholders, he said, they would provide liquid real estate—attractive yields in the form of dividends and capital appreciation of real estate assets with the liquidity of public company stock. For the industry, public ownership held the promise of more rational capital allocation and a reduction of the boom-and-bust development cycle that had long plagued commercial real estate.

• Second, capitalizing on the unique window-of-opportunity in the early 1990s to acquire real estate assets at great prices. Distressed owners and the federal government were unloading an unprecedented amount of property on the market. Sam coined a mantra for the struggling commercial real estate industry in 1991: "Stay alive 'til '95!" Meanwhile, a new public REIT could build a once-in-a-lifetime portfolio of quality real estate assets at rock-bottom prices. There were two requirements: speed and capital. From the outset, being smart, decisive, and quick to act were EQR core competencies.

• Third, being a leader in value creation. This would require serving residents well, operating buildings efficiently, and buying and selling properties advantageously. Central to EQR's investment thesis was that strong demand and limited supply would drive earnings and value creation.

 

In these three ways—leading creation of a new industry, capitalizing on a unique window of opportunity, and creating value—Sam set high aspirations for EQR and its board from its birth as a public company in 1993.

 

Governance Structure and Philosophy. What were the implications for governance? In terms of people, EQR needed a board composed of individuals who could quickly develop mutual respect and trust and excellent teamwork because timely decision-making was of the essence. The board required a mix of real estate professionals and people with other skills such as finance and law. From the beginning, EQR had a majority of independent trustees. As board colleague Jim Harper told me at the time, Sam counted on EQR trustees to have real, not just technical, independence. "Joe," he said, "Sam is a force. He's smart and opinionated and no shrinking violet. He'll be counting on each of us to think independently and speak up."

Structurally, the board had a chairman (Zell) and CEO (Doug Crocker). From the outset, the board had three committees: executive, audit, and compensation. Speed combined with good judgment would require an executive committee of Sam, Doug, and independent trustees in whom the entire board had confidence to make transactional decisions between board meetings. The audit committee was charged with maintaining high credibility with capital markets. This required quality financial reporting and internal control. The compensation committee was charged with designing pay for performance (i.e., incentives for management to focus on value creation to benefit owners). The 1990s were a period of great ferment in corporate governance. Accordingly, the EQR board established a governance committee to ensure board practices in the best interests of the company's shareholders and stakeholders.

It was apparent from the outset that the EQR board would be fast company. Zell, Crocker, then-CFO (now CEO) David Neither-cut, and trustees like Errol Halperin, Sheli Rosenberg, and Jim Harper were among the smartest business people I've ever met. Over the years, I would tell trustee candidates, "You need to be quick on the uptake!" There has never been room for bureaucracy on the EQR board. Detail work is done in committees. The board focuses on the big picture (strategy, risk, acquisitions, and divestitures), financial matters (operating results and the balance sheet), and the leadership team, especially the CEO. Things move fast. But when a matter is not obvious or there are differences of view, Sam as chairman slows the action to get viewpoints aired, then pushes for decisiveness. This fast company process fits EQR's business situation (multiple windows of opportunity when the combination of scale and speed is a competitive advantage) and the people around the table.

There have been many chapters in EQR's history since 1993, including its governance. The board has been as small as nine people and as large as fifteen. The company's focus within a framework of strong value creation has shifted over time: from pell-mell acquisition in the early years, to operational effectiveness, to repositioning the portfolio from garden apartments across the United States to top-quality medium-and high-rise buildings in high barrier-to-entry markets on the east and west coasts. A strong balance sheet has always been a priority. The approach to development has been conservative. There have been only a few small missteps. For example, our adventures in the furniture rental business served to remind us what our core competence is and is not.

In line with Sam's high aspirations, EQR has been a leader over the last twenty-one years in creating a vibrant public REIT industry. Today, many investment advisors recommend that REITs be part of any well-diversified portfolio. EQR's value creation has been strong. Between the initial public offering in 1993 and the end of 2013, EQR's stock has quadrupled. REITs are required to distribute at least 90 percent of their taxable income to investors, so EQR has provided a steady stream of dividends to investors during two decades of paltry interest rates on bonds and savings accounts. As Sam predicted, the modern public REIT industry has made liquid real estate a reality for investors. EQR has helped lead the way.