Governing the House of the Mouse:
Corporate Governance at Disney from 1984-2006
CASE ASSIGNMENT
At the departure of Eisner, Chairman George Mitchell and new CEO Robert Iger are preparing to move the company forward. They have invited your consulting firm to meet with the new Board of Directors and discuss the situation at Disney. To familiarize yourself with the client, your first task is to prepare a background report which analyzes Disney's business environment and strategy.
1. What external forces and industry conditions have had an impact on Disney's performance over the years?
2. How did the internal organization and culture at Disney influence its performance?
3. How has Disney strategically responded to its competitive environment and internal capabilities?
You have been asked to present a five-minute overview of the root causes of Disney's governance issues. The content of this brief presentation should achieve the following goals.
4. Identify the causes and consequences of the Board of Directors' ineffectiveness.
5. Highlight other governance weaknesses that have made Disney vulnerable to managerial opportunism.
To be prepared for the ensuing discussion, you'll also need to be familiar with the following items.
6. How have governance mechanisms at Disney been used in the past, and what was their effect?
7. What unprecedented maneuvers were made by Disney stakeholders to overcome internal governance weaknesses?
During the discussion, you should be able to demonstrate an insightful look at Disney's situation, make recommendations for establishing effective governance practices, and support the need for governance mechanisms despite the appearance of performance success.
STRATEGIC MANAGEMENT INPUTS AND ACTIONS
1. What external forces and industry conditions have had an impact on Disney's performance over the years?
The prevalence of television viewing and at-home viewing devices has reduced movie attendance and ticket sales revenues dramatically over the years. Additional distribution channels, including cable and subscription-based services, have also increased competition for motion picture industry participants. To replace lost revenues and respond to industry changes, movie studios have shifted their primary focus from show quality and content to distribution, licensing, marketing, and merchandising arrangements. Seeking alternative sources of revenue and taking advantage of emerging technological opportunities, traditional studios have extended their reach more broadly into other forms of entertainment. Diversification and integration have not only helped participants survive the industry's transformation, but strategic actions by major industry players have caused some of the changes in the industry.
Disney's core business has always centered on its reputation as the premier producer of animated films. However, new competitors have emerged with the advent of digital technology. Pixar, in particular, is emerging as a highly profitable new giant of animation. DreamWorks has also released successful animated blockbusters and is becoming a potent rival for Disney.
2. How did the internal organization and culture at Disney influence its performance?
Despite the evolution of the American culture, Disney had essentially remained unchanged since the death of Walt Disney in 1966. Directors had been with the company for an extended time and were advanced in age, suggesting possible distance from the changing external environment. While tradition and culture within an organization can be a strength, a stagnant internal environment that is not responsive to industry changes can threaten the company's survival.
At the time Eisner joined Disney, poor stock performance, few movie releases, and an unsolicited takeover attempt were indicators of a struggling company whose independence was at risk. Failure to hire first class talent in film and television production was responsible for poor management and financial results.
The heart of the company remained Disney’s animated film unit, which again, could prove to be both an advantage and a limitation.
While the early 1980s saw rapid changes in the film industry, for Disney, it was a time of crisis. Defensive maneuvers resulted in deals that shuffled ownership interests and gave voice to new shareholders with enough power to exert influence in the company's decisions.
3. How has Disney strategically responded to its competitive environment and internal capabilities?
Prior to his departure, Miller had wisely begun making moves to develop entertainment content beyond animation, targeting a broader audience.
Bringing creative experience and Hollywood insight (and insiders) with him to Disney, Eisner is credited for revitalizing the company with a corporate strategy of related diversification. During his first decade at Disney, movie production remained at the heart of the company, with major animated films still contributing to success. The film business was reporting record operating profits and competing with even the biggest Hollywood studios. Once representing only 5% of income, films had grown to generate 40% of Disney's earnings.
Expanding its studios, hotel/resort operations, theme parks, and entertainment divisions, Disney achieved remarkable growth and transformation during a period of rapid industry change. Managing release windows, home video pricing, software development, and home viewing distribution was increasingly complex in this fast-cycle market.
Diversification and complexity increased further with the merger of Capital Cities/ABC with Disney, doubling the size of the company, making it the second largest entertainment company in the U.S. This merger of highly complimentary companies triggered an era of integration in the industry, combining studio libraries with broadcast and publishing distribution systems. The company combined film, television, artistic, production, distribution, and broadcast under a single studio entity, positioning Disney for substantial growth worldwide.
Disney also partnered with Pixar to finance and distribute films produced with new digital technology. Despite the unraveling of this Pixar relationship and Pixar's success at outperforming Disney animation films, Iger reiterates that animation is at the core of the Disney brand as he takes over the company. While Disney’s top managers focused on strategic operations, much outside attention focused on the company's governance system.
STRATEGIC MANAGEMENT IMPLEMENTATION -
CORPORATE GOVERNANCE
4. Identify the causes and consequences of the Board of Directors' ineffectiveness.
At the root of the company's governance issues is the ineffectiveness of Disney's Board of Directors. Its poor oversight is based on two primary causes: Eisner's success at maximizing shareholder value and Eisner's accumulation of power.
Eisner's Success
Eisner may have had a questionable management style and may have been difficult to work with, but one could not argue against his success. Eisner took decisive action at an underperforming company and showed immediate results. Under his direction, stock appreciated 1600% and revenues grew from $1.5 billion to over $30 billion. With this type of success, any board of directors is going to be reluctant to question the CEO. As Disney's revenues and stock price increased, so did the board's deference to his decisions and actions. The board, representing the principals of the company, relinquished additional managerial freedom as Eisner's achievements continued. Judgment was tempered by success in the stock market.
Eisner's Power
While building a successful record and board reliance, Eisner was also building an indisputable position of power. A look back at his actions gives the appearance of a calculated power play.
Outlined below is a comprehensive detailing of his power-building moves:
· One of Eisner's first steps at Disney was to approach the Bass Brothers to secure their support for long-term changes at the company. He received a five-year commitment from this large-block shareholder for his management team. (The Bass Brothers owned 24% of outstanding Disney shares at this time.)
· Eisner's role allowed him to influence the choice of new directors and eventually establish full control of the company. By placing allies on the Nominating and Governance Committee, he was able to assign directorships at will.
· As part of his power building, Eisner appointed directors with limited experience (such as Poitier and O'Donovan) and directors with personal connections to him (such as Van De Kamp) who would be more likely to approve of his actions and plans. Eisner’s desire to surround himself with "yes men" would result in collective kowtowing.
· He was able to bring in his personal attorney as a board member and the eventual head of the board's Compensation Committee.
· Upon the death of Wells, Eisner initially divided Wells’ responsibilities among Disney’s existing executives and assumed the position of president himself on an interim basis. Just weeks later, he decided to continue indefinitely in the position, arguing that this would provide more direct access to his management team.
· Katzenberg's departure left Eisner alone at the head of Disney. He did not act to fully develop a strong top management team beneath him. Instead, he appeared ready to eliminate anyone who could possibility step into his shoes or whose development could pose a threat to his authority or position.
· When Ovitz finally replaced Wells, he took responsibility for Disney's three operating divisions, but the legal and finance departments did not report to him. The structural arrangement resulted in a less powerful president, with Ovitz reporting to the CEO (Eisner) rather than to the board. In practice, he had far less discretion and authority than Wells had, and his role in the company was never fully defined or delegated by Eisner. Instead of shifting responsibilities to Ovitz, Eisner had actually increased his own level of involvement in making decisions that were to be under Ovitz’s purview. With Ovitz's limited discretion and Disney’s management philosophy, this placement was doomed.
· Sidestepping Disney's corporate by-laws and the board's role in hiring the President, Eisner and his attorney Russell (not corporate counsel Litvak) approached Ovitz and roughed out contract conditions and a compensation agreement over one weekend. Neither the Board of Directors nor the Compensation Committee was involved with the details of the deal or the analysis of its potential costs. Additionally, the move that finally removed Ovitz came directly from Eisner. Board involvement was highly limited. While Ovitz’s exit may have reduced internal turmoil, it also reduced Disney’s cash balance. The final cost for his fourteen months with Disney was approximately $140 million in cash and stock options.
· Through the issuance of stock options in his compensation package, Eisner's accumulated holdings in the company became significant. By 1995, Eisner held around two million shares of Disney stock, and his options were worth roughly $600 million. His 1997 employment contract guaranteed him access to 16 million shares, giving him more than 2% interest in the company based on 670 million outstanding shares reported in the 1997 Consolidated Statement of Shareholders' Equity.
· This ten-year contract solidified Eisner’s power and reduced the board's ability to force changes in management. Immediate vesting of all stock options and the cash value of future salaries and bonuses would cost Disney hundreds of millions of dollars and seriously impact the company's cash flow.
· Chiding Eisner for acting independently from the board oversight and for his failure to seek consent or authorization from the board, Chancellor Chandler adequately described Eisner's role in disabling the board's oversight ability:
· "By virtue of his Machiavellian (and imperial) nature as CEO, and his control over Ovitz's hiring in particular, Eisner to a large extent is responsible for the failings in process that infected and handicapped the board's decision making abilities. Eisner stacked his (and I intentionally write "his" as opposed to "the Company's") board of directors with friends and other acquaintances who, though not necessarily beholden to him in a legal sense, were certainly more willing to accede to his wishes and support him unconditionally than truly independent directors. . . As a general rule, a CEO has no obligation to continuously inform the board of his actions as CEO, or to receive prior authorization for those actions. Nevertheless, a reasonably prudent CEO (that is to say, a reasonably prudent CEO with a board willing to think for itself and assert itself against the CEO when necessary) would not have acted in as unilateral a manner as did Eisner when essentially committing the corporation to hire a second-in-command, appoint that person to the board, and provide him with one of the largest and richest employment contracts ever enjoyed by a non-CEO. I write, "essentially committing," because although I conclude that legally, Ovitz's hiring was not a "done deal" as of the [original labor agreement], it was clear to Eisner, Ovitz, and the directors who were informed, that as a practical matter, it certainly was a "done deal".
In the wake of Eisner's rise to power and amidst rumblings of investor discontent, another takeover threat emerged. Comcast made an unsolicited bid of $54 billion bid to purchase Disney. The proposal was intended to benefit shareholders by combining Disney’s content assets with Comcast’s distribution pipelines: a strategy of vertical integration. Despite the apparent strategic value to the two parties, Disney's ineffective board was in no position to evaluate the benefits to shareholders, and neither Eisner nor the board gave the bid any serious consideration.
5. Highlight other governance weaknesses that have made Disney vulnerable to managerial opportunism.
Succession Planning
The choice of top executives, especially CEOs, is a critical decision with important performance implications. Succession plans make the transition between CEOs easier, but they can be opposed by CEOs who fear diminished job security when a replacement is selected and developed to take over.
Not only did Eisner fail to develop a strong slate of managers, he avoided succession planning when the vulnerability of leadership at Disney was clearly demonstrated by the unexpected loss of Wells and Eisner's subsequent heart surgery. Fearful of relinquishing any of his control, he used the loss of key executives to prevent the accumulation of power beneath him rather than to promote new talent in the interests of the company. The ineffectiveness of the board is illustrated by its inability to force the issue of succession planning even as the Disney's vulnerability was so apparent and public.
CEO Duality
The practice of CEO duality ascribes to the stewardship theory that effectiveness is increased (and agency costs are decreased) when one person holds both the CEO and chairman of the board positions. At the time that Eisner was given these two titles, Wells was placed in the President and COO positions. A balance of power was maintained as both men reported directly to the board. When Wells passed, Eisner maneuvered for full control.