When is a CEO’s Illness Material?

There was an article in yesterday’s Wall Street Journal entitled “Investors Want Right to Know” which uses the recent announcement of Steve Job’s latest medical leave of absence to advance the argument that Boards of Directors need to disclose more about the health of their chief executive officer. I’ve written about Steve Job’s illness and the lack of disclosure surrounding it on a number of occasions before (see “The Weighty Issue at Apple”, Jan. 6, 2009 and “Maybe Things Were Not So Simple and Straightforward” Jan. 15, 2009) and I stick by what I wrote then. In short, this is a sensitive area where the privacy of an individual bumps up against the disclosure of material events.

Surprisingly, in light of the numerous other items executives must disclose, there is no SEC rule requiring that a company disclose or discuss the health of its CEO. On the other hand, there is no right to privacy under the federal disclosure laws and regulations, either. So what it boils down to, as it does in so many investor relations situations, is the materiality of the issue. If the fact that your CEO has a life threatening disease would be enough to create “a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision” then you had better disclose it.

There are probably two lines of inquiry a Board needs to think about in considering disclosure; the corporate side and the health side of the issue. Factors to consider on the corporate side in making such a disclosure would include:

• How irreplaceable is the CEO perceived to be? People such as Sam Walton of Wal-Mart and Steve Jobs of Apple score highly on this test. Less visible CEOs might not be considered as important to the future of the company, particularly if there is a well publicized succession plan in place and the CEO is nearing retirement age.
• How much is the company paying the CEO compared to everyone else on the proxy compensation list? One of the most visible measures of how much the Board of Directors thinks the CEO is worth is how much they are paying him compared to the other important executives. If he’s making several multiples of the compensation of the next person on the list, then the logical assumption is that the Board views him as almost irreplaceable.
• Does the company have a risk factor in their 10-K report that talks about how unique and important their CEO is to their future? Obviously it’s difficult to argue that a life threatening illness to the CEO is not material if your risk factors say he’s very important to your future. (Apple in fact did this, but it sure doesn’t look good.)
• What is the fact situation surrounding the CEO? Does he portray himself as the sole identity of the firm or does he showcase other executives in public appearances, relations to investors, suppliers and customers?

On the health side of the equation, not to put too fine a point on it, we can all agree that the death of a CEO would be material. So the question Boards must wrestle with is how incapacitating, short of death, must an illness be before a Board has an obligation to disclose. Some commentators have been calling for more regulation by the SEC in these cases, but I think that is likely to be difficult, as hard and fast rules when dealing with health issues can prove a very slippery slope.

All of this sounds good in theory and it would work, except for one thing: Boards usually choose not to disclose a CEO’s illness. I can understand this from a couple of perspectives: the need for privacy in a very stressful situation and the Board’s sense of loyalty to the CEO. Further, when you go through the type of analysis I’ve outlined above, you can often find reasons not to disclose. So investors need to understand, and I think most do, that disclosure in these situations will be slower and more guarded than in a typical corporate situation.

As for the situation at Apple, I have very little sympathy for those who are now crying for more disclosure. If, after all the publicity surrounding Steve Job’s illness during the previous two episodes, an investor hasn’t gotten comfortable with an Apple after Steve Jobs, then they have been asleep at the switch.