Research

When the cure is worse than the disease: the HP debacle

In early 2005, Hewlett-Packard's board of directors was embroiled in controversy. Board discord anonymously spilled into the media, and an effort commenced to find and plug the leaks of board deliberations. The probe has erupted into scandal, indictments and congressional hearings. Experts at the W. P. Carey School of Business say the HP saga is rich with lessons about corporate governance and ethics.

2006-10-11

In early 2005, Hewlett-Packard was in the doldrums. The future of the world's top technology solutions provider depended on new direction, but the board of directors was embroiled in controversy over which way to go and over the performance of soon-to-depart CEO Carly Fiorina, who had led the company through a fierce shareholder proxy fight. Board discord anonymously spilled into the media.

And so, an effort commenced — even before Fiorina's departure — to find and plug the leaks of board deliberations. The probe has erupted into scandal, indictments and congressional hearings where 10 people involved in the investigations declined to testify for fear of incriminating themselves.

Experts at the W. P. Carey School of Business say the HP episode is rich with lessons about corporate governance and ethics. But the underlying strength of the company, they add, has so far endured the storm of scandal.

Scenes from HP's film noire

In 2005, board chair Patricia Dunn contacted Security Outsourcing Solutions, a private investigating firm out of Massachusetts, to probe the board of directors. But it was a January 23, 2006, CNET story about the board's strategic deliberations at a management retreat, based on information from an anonymous board source, that especially riled her. In May 2006, board member Thomas Perkins resigned, citing "questionable ethics and the dubious legality" of the leak probe brought about by Dunn.

In his resignation letter, he said his phone records had been hacked. Revelations followed of surveillance and "pretexting" — investigators falsely identifying themselves to obtain private and personal information on board members, HP employees and business journalists.

By September 2006, it became clear that investigations code-named Project Kona I and Kona II had gone too far — without her knowledge, Dunn says. On September 12, George Keyworth resigned from the HP board after 20 years of service. Perkins and Keyworth had ties going back to HP founders Bill Hewlett and David Packard. After initially resisting pressure to resign, Keyworth gave in but issued this statement: "I acknowledge that I was a source for a CNET article that appeared in January 2006.

I was frequently asked by HP corporate communications officials to speak with reporters — both on the record and on background — in an effort to provide the perspective of a longstanding board member with continuity over much of the company's history. My comments were always praised by senior company officials as helpful to the company — which has always been my intention."

Dunn, after first saying she would resign as board chair, finally resigned from the board altogether. Also gone from the HP fold are chief counsel Ann Baskins, global investigations chief Anthony Gentilucci and chief ethics officer Kevin Hunsaker.

On October 5, California Attorney General Bill Lockyer filed criminal complaints against Dunn, Hunsaker, Boston-area private investigator Ronald DeLia, Matthew DePante, manager of Action Research Group of Melbourne, Florida, and Bryan Wagner of Littleton, Colorado, who worked for DePante. All five face four charges: conspiracy, obtaining confidential information from a public utility under false pretenses, unauthorized acquisition of computer data, identity theft and conspiracy to commit each of those crimes.

Conspiracy carries a maximum penalty of one year in prison and a $25,000 fine. Each of the other three charges carries a maximum penalty of three years in prison and a fine of $10,000. The probe scandal has overshadowed the fact that HP had largely adjusted to new leadership, had adapted to an ever-changing market and had regained its footing under new CEO Mark Hurd, who now also is the board chairman.

The very survival of Hurd, under whose leadership HP stock rose from about $20 a share up to the mid-30s, has been subject to speculation. Hurd has stated that a leaks probe was appropriate but that the techniques used in it were wrong and that he did not know about them.

But, although HP stock took a minor (6 percent) tumble to $34.52 a share September 22 as the leaks-probe scandal dominated front pages and airwaves worldwide, the stock climbed steadily into the high 30s in late September and early October. On the day the criminal complaints were filed, HP stock hit $38.08, its high so far this year.

What to make of the mess? Providing their views below are management Professors Albert A. Cannella Jr. and Robert E. Hoskisson, legal and ethical studies Professor Marianne M. Jennings, and Robert E. Mittelstaedt, dean of the W. P. Carey School of Business.

K@WPC: Was HP board member George Keyworth's leak, which resulted in CNET News.com's January 23, 2006, story, "HP outlines long-term strategy," harmful to the company? Did it warrant an investigation at all?

Cannella: To me, the leak itself wasn't terribly important competitively. I'm not at all sure that it should have warranted an investigation. It should have resulted in a stern reminder to those who attended the retreat that what went on there was private and should remain that way. What is surprising about the leak, to me, is the breadth and specifics of the information leaked.

Keyworth revealed a lot of information, some very specific information, and some of the information could have been troublesome competitively. For example, the increase in direct sales could cause problems with HP's distributors, and this is hardly the way to begin "moving away from Intel processors." I don't think the leak itself was terrible, but it certainly suggested that HP has a significant problem in keeping information private. I'm quite surprised that a director would do such a thing.

Hoskisson: After reading the story, I would conclude that it could be somewhat to very harmful to the company to have this story told before its time. First, a switch to an online approach from a retail strategy has the effect of undermining your relationships with retailers, which are the bases of your current success. It also provides more knowledge to a competitor such as Dell that provides them advanced knowledge of what you are doing.

For instance, if a certain retailer is dropped, perhaps Dell could pick up this business by putting online kiosks in the stores that no longer have HP products. At the very least, it is very embarrassing to have this signaled before the company is ready to go public with its strategy. Perhaps they would never go public with their strategic intent. For instance, what if they change their mind later and choose to go a different direction?

This type of leak can be very damaging also to trust between the board and the top management team, and result in the board being less informed about things that they need to know about to provide effective board oversight of major strategic decisions. If boards only get to evaluate financial performance after the strategy is executed, what happens is that top managers tend to be more conservative than need be compared to when the board is a full party to the strategic approach and sharing the risk as well.

Jennings: The initial harm rested with the breach of fiduciary duty by Keyworth as a director. Anything a director of a publicly traded company does affects share value and market cap. He was releasing information that had not been vetted or voted upon by the board, and the board has the responsibility for governance, including the release of information. This is serious legal business — directors have inside information and spreading that around affects markets and share movement. One director acting unilaterally in this manner is dangerous and irresponsible.

The second harm was the resulting atmosphere of distrust and mistrust that descended upon the boardroom, with a chilling effect on real debate and meaningful interaction among the board members. Boards need candid discussions and the fear that the discussions would be leaked clams folks up, even for purposes of playing the devil's advocate, because they have no way of controlling how the debate or their comments are portrayed by the anonymous leaker.

Having said all of this — the skullduggery with the pretexting trumped any damage Keyworth would have done with his shenanigans. The silly investigation was a symptom of the problems, not the problem. These folks were so egotistical and at odds with each other that they felt justified in doing whatever it takes to trump one another. One can hardly say any of this conduct was in the best interests of the shareholders.

Mittelstaedt: Regardless of whether Keyworth's leak was harmful, it is a very, very serious issue in my mind when a board member starts talking to outsiders about anything. It indicates a serious problem in board governance, specifically that there is infighting, lack of agreement on direction and perhaps petty politics. None of these are helpful to governance or in the interests of shareholders.

If a board member has a legal issue he should go to legal authorities. If he or she has a difference of opinion it should be aired with the board and if he or she loses a vote and/or the confidence of other board members, that information is not appropriate for outside consumption. All it does is undermine the company. With rare exceptions, I do believe board members should not speak or presume to speak for the company or the board to outsiders.

This dysfunctional board goes back a few years. When Carly Fiorina first proposed acquiring Compaq the board immediately became divided over the strategic wisdom of the move. Walter Hewlett, Bill Hewlett's son, went public with his frustration and began a proxy fight to defeat the merger. Hewlett lost as the merger was approved by a very small margin. He had also engaged in some leaking of his own to the press following a board retreat. After he lost the proxy fight, the board did not renominate him, so the son of a founder and a major shareholder left the board.

K@WPC: Assuming that Keyworth's comments to reporters should have been agreed upon by the board, wasn't it incumbent upon Dunn to get such board clearance before launching her ill-fated leak probe?

Cannella: My assumption is that she didn't know who the leak was coming from. That is why she started down this path. I don't see how she could have gotten board approval to find out which of those who would presumably "approve" her actions was the source. In her case, launching the probe wasn't a problem so much as the way she implemented it.

Hoskisson: This is a two-edged sword. [Getting clearance] would seem to be the right approach ethically; however, it would compromise the reason to do the leak investigation. If you get the board's approval, would this not leak to the leaker that you are on a serious hunt and that they are on notice and will try to cover their tracks? It may be better to get legal council to make sure that your approach is appropriate.

Jennings: Yes — this was classic sandbox (as in childhood) behavior. Those in the sandbox cannot see the silliness of the internal fight because they are too close to the moral box they are in to analyze it objectively. The rules of the sandbox became a game of "gotcha," rather than one of solving the board's and company's issues.

There is little question that the board was dysfunctional, but such a disconnect cannot be solved by splintering, warring egos, and snooping. This was poor form and poor judgment all around. Ironically, Dunn exhibited the classic iconic behavior that the board faulted Fiorina for — someone challenged her authority and approach to issues, and she retaliated with a childish response.

Mittelstaedt: It should have been discussed with the whole board, but as I understand it the whole board agreed that the leak needed to be investigated, although she may not have discussed how that would be done. It is a sad commentary when a board has a member who cannot be trusted. While there were laws broken here, let's not lose sight of the fact that Keyworth violated his fiduciary obligations to look after the interests of the company and its shareholders. What he did was not in the company's interests.

K@WPC: Granted that there existed discord — and breaches of loyalty, confidentiality and fiduciary responsibility — on the board. How should this kind of situation be dealt with ethically so that the nastiness and intrigue do not escalate into other kinds of dishonorable behavior?

Cannella: In the past, I would have simply said "what discord?" Breaches of loyalty and confidentiality are unheard of. Breaches of fiduciary responsibility have typically been described as endemic to boards where the watched are in charge of selecting the watchers. Of course, I always used to believe that public accounting firms were honest in their auditing practices — what was I thinking? I don't know that I've ever heard of this kind of leak from a board. I'm sure it has happened, but I haven't heard of it.

So, in my view, Dunn was on untested ground whatever she decided to do. I think that a good "talking to" would have sufficed — excoriate the entire board. She had justification. The directors would likely have turned in the leak themselves and her action (or their responses) would almost certainly have plugged it. There is tremendous pressure to support each other and avoid acts like this among directors.

Hoskisson: This is a tough question. I would suggest that board training and team building might be an approach that would help, to build more trusting relationships and establish what the ethical ground rules are before having too much interaction. However, this is often impractical, given the schedules and work agendas of most executives who serve on multiple boards. Certainly, getting some 3rd party involvement in the process would be helpful. Often with discord, it can't be solved internally due to the distrust.

Jennings: It can never be solved with offshoot meetings, which is what occurred here. In this case, the board needed to talk about the elephant in the room. There were two critical issues about which they disagreed: The poor performance of the company. The management style of Carly Fiorina. Hitting those issues head-on was necessary. The leak problem would have solved itself once they confronted the issues. This board needed some outside help to deal with the increasingly higher communications hurdles.

The chair, CEO or other board member can request outside expertise or, in some cases, mediation to bring the parties together in cases of real differences and testy issues. With their splintered groups, the HP board only perpetuated the division and ensured more leaks would be forthcoming. Being right becomes more important than working to solve the problem — an outsider can offer the perspective that was lacking.

Mittelstaedt: If it can be proven — which is the hard part — the board should censure the offending member. Remember that under the bylaws of most corporations he cannot be "dismissed" by the board. If he does not choose to resign when pressured he can sit there until the next election when the board will presumably not renominate him and he will thus not be reelected by the shareholders.

The missing pieces have to do with constructing a board that has a shared commitment to a reasonable governance process. This does not mean that every person agrees with the strategy or other important decisions, but it does mean that board members respect one another and conduct business in a civilized way. The "personality" of a board is more important than outsiders may realize.

The most dangerous thing you can do is to purposely design a board with opposing factions. It almost never helps. Look at the cases in this country where we have union representatives on boards. A board is not a place for open hostility and conflict. When that is the environment, the shareholder, the strategy and the company will suffer.

K@WPC: Are you surprised at the minimal effect this has had on H-P stock?

Cannella: It is probably evidence that investors don't trust the board anyway, and assume that it is fairly impotent! I smiled when I wrote this, but there's truth in the statement. I also think investors see this as separate from the core capabilities of the company.

Hoskisson: I am not. It has not materially affected the operation of the business. However, if Hurd is fired over an ethical lapse, then you can expect to see the stock price go down. He has had a very significant effect since Fiorina left, given the restructuring that he has done.

Jennings: A little — they caught a dysfunctional board before it did something really dumb, but the company is doing well and shareholders are shareholders — perhaps that says something about shareholder values. But, shareholders are missing something important here with this scenario. Leaving ethics out of it all for just a moment — you really did have inept leadership here and that should worry shareholders going forward. The leak and investigation may well prove to be the least of the company's and board's problems.

Hurd faces a real challenge in going forward in everything from credibility, to board communication, to company strategy. Fiorina emerges as the sane presence who got the company where it is today, and this board ousted her. Her forthcoming book may bring the shareholder reaction. One more thought that is frightening is that perhaps the market has become immune — nothing fazes it!

Mittelstaedt: No. For all the pronouncements by so-called "governance experts" what the market cares about most is performance. If the company is performing well the market will not trash the stock because of bad governance, nor will poor performance be rewarded with the presence of good governance. Some activists would have you believe that governance affects stock price — it does not unless the board itself is stealing. Performance and future expectations about performance are what drives stock price.

Bottom Line

• Although board members should have proper authorization before talking to the media, the Hewlett-Packard leaks investigation was an overreaction.
• When tensions arise on a board of directors, problems should be recognized and actively dealt with through proper channels.
• Mark Hurd most likely will survive the scandal because stock value has risen since he became CEO in early 2005.
• HP's core operations and the value of its stock remain intact.

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