Wall Street must learn from the boss's downfall

Merrill Lynch's CEO wasn't the only issue. Governance matters, too.

Stan O'Neal's rise, and now even his fall, as CEO of Merrill Lynch show how far corporate America has come on race. But the O'Neal saga also reveals how far we still need to go in the governance of our corporations.

Mr. O'Neal came up the hard way as a young man, without the benefit of family wealth or connections. He made it from the General Motors Institute (now Kettering University) to Harvard Business School, and then up the fast track on Wall Street, based on his financial acumen, focus, and commitment to excellence. He became a protégé of David Komansky, his predecessor in the top job at Merrill, then displayed sharp elbows in accelerating the passing of the baton and orchestrating a purge that brought in a top team loyal to him. He also left his imprint on the board of directors – though it was the same board that ultimately forced him out.

When O'Neal became Merrill's CEO in late 2002, it was major news that he was the first African-American to head a top Wall Street investment banking firm. What is striking about recent reporting on his travails is that the corporate community and the media no longer appear to consider his race particularly noteworthy. It's in this sense that even his firing last week is an important marker of progress in US race relations.

Far less comforting is what this episode reveals about the enduring challenges in the governance of US corporations:

Risk management. One of the clear messages of the multibillion-dollar asset writedown debacles at Merrill, Citigroup, Bear Stearns, and other firms, is that these firms' quantitative wizards have still not mastered how to manage risk, not by a long shot. While this failure lies in the first instance with these firms' executives – Citigroup's Charles Prince has now joined O'Neal among the fallen CEOs – and not their boards, the latter are responsible for oversight of everything that potentially threatens the franchise, including poor risk management.

Separation of powers. The line between governance (the board's province) and executive leadership (management's province) remains blurry, Sarbanes-Oxley and the stock-exchange reforms notwithstanding. It's been reported that one of the precipitants of O'Neal's downfall – though undoubtedly a very distant second to the staggering $8 billion asset write-down – was the revelation of his preliminary discussions about a possible merger with North Carolina-based Wachovia Corporation, without prior board approval or even notice.

O'Neal is not the first CEO to have incurred the wrath of his board for perceived unauthorized freelancing. Indeed, the recurring nature of this scenario suggests that a shared understanding of the legitimate scope of a CEO's authority vis-à-vis that of the board is lacking in many US corporations.

Performance reviews. Boards sometimes have a shockingly poor grasp of the quality and performance of their companies' leaders. It is difficult to understand how a properly evaluated leader could have been honored, as O'Neal was, with a $46 million performance-based payout as recently as 2006, then be out of a job for incompetence in 2007. The most plausible explanation is that the question of whether a company has a good or poor leader remains disturbingly nebulous for boards. A "star CEO" seems to be, regrettably, more a social construction of the media and company PR efforts than a knowable reality – except, perhaps, with the benefit of hindsight.

Executive compensation. Various rationales for eight-figure CEO pay are commonly bandied about. The most compelling of them is that there is wide variation in CEO talent. The better CEO candidates understand their value in the free marketplace and demand that they be paid accordingly; boards can either pay up or settle for inferior talent. But this rationale presumes that a board can distinguish between a truly stellar CEO, and someone who has merely ridden a wave of favorable conditions.

It is welcome news that American boards increasingly look beyond race when considering whom to hire as CEO. As to evaluating the job the leader is doing, and how best to pay him or her, much work remains.

Andy Zelleke is a lecturer in public policy at Harvard University's Kennedy School of Government and codirector of its Center for Public Leadership.