An independent board might have promoted ethical compliance and turned the culture around.

How is it that a global media company can withstand a phone-hacking scandal that led to 43 employees being arrested, the loss of several top executives due to firings or resignations, and the shameful closing of a profitable 168-year old publication, the News of the World, without going under? And how can the organization’s journalistic credibility be irreparably damaged and it suffer an estimated $1 billion loss to its bottom line (including legal fees) a year after the scandal, but its CEO and every member of its board of directors remain solidly in place?

Welcome to the world of Rupert Murdoch and News Corp, where acting in the best interests of shareholders can, at times, seem to defy logic. In spite of the negative publicity from being hauled in to testify about the scandal before parliament and being vilified by his colleagues in the press, Murdoch has managed to keep from tripping over the line that leaders walk which separates outright corruption from cunning courageousness.

None of the pressure exerted on Murdoch has moved him to step down. He has denied any involvement or knowledge of the wiretapping and other illegal activities that invaded the personal lives of over 5,700 people including celebrities, politicians, families of soldiers killed in Iraq and Afghanistan, victims of the July 7, 2005 terrorist attacks in London, and members of the royal family.

In a letter to shareholders contained in News Corp’s 2011 annual report, CEO Murdoch emphasized the positives: revenues rose 2 percent to $33.4 billion, while News Corp’s Wall Street Journal was still number one in circulation in the US and Fox Broadcasting was thriving. He acknowledged that the company had suffered a ‘major black eye. The behavior carried out by some employees of the News of the World is unacceptable and does not represent who we are as a company. It went against everything that I stand for,’ the letter read. Murdoch also said closing the News of the World  ‘was the right thing to do’.

But has the News Corp board done the right thing in standing by Murdoch? Governance experts disagree, but the long-term affects on the company will ultimately tell the story.

The board weighs in

After the persistent lawbreaking came to light, Thomas Perkins, one of News Corp’s independent directors, said the board had cleared Murdoch of any wrongdoing, according to the Guardian. Perkins said the nefarious activities were perpetuated by ‘bad people at very low levels of the organization’. Moreover, the board reinforced its view of Murdoch as its leader and saw no reason to replace him.

Though Murdoch only owns 12 percent of News Corp stock, he controls 40 percent of the company’s voting shares, and therefore has tremendous influence on the selection of its directors. Included on the board are Murdoch’s three children, four News Corp top executives (including COO Chase Carey, CFO David DeVoe and executive vice president Joel Klein) and several directors who have financial dealings with the company.

In essence, Murdoch wields the power to control who’s on the board and who stays there. ‘You either accede to his power or find another board to work at,’ says Robert Monks, founder of ISS.

Analyzing Murdoch’s relationships with his board members emphasizes this point – as parent, employer or business partner, he has leverage over almost the entire board. ‘The board members who are supposed to be independent are not truly independent,’ notes Lucy Marcus, CEO of Marcus Venture Consulting and professor of leadership and governance at IE Business School in London. Marcus questions whether the board is living up to its mandate to supervise the company. Healthy boardrooms consist of ‘people around the table who ask hard questions, are willing to have creative disagreements, and challenge the strategy and actions of the organization,’ she says.

Sydney Finkelstein, a management professor at Dartmouth University’s Tuck School, says that rather than seizing control andaddressing the issue of rampant misconduct across several of the company’s properties, the board has left it to Murdoch to fix the problem. ‘The board isn’t separate from management when it comes to News Corp,’ Finkelstein states.

An independent board can help address any misconduct and restore the company’s reputation. Finkelstein says the board needs to act in an independent way and separate itself from management to investigate improprieties and offer solutions if News Corp is going to cleanse itself of the lawbreaking culture that afflicts it. In fact, failing to address or rectify News Corp’s corrupt culture puts the company and its shareholders at risk.

When investors see an out-of-touch CEO who doesn’t respond to scandals and rampant wrongdoing, it raises a series of red flags, notes Finkelstein. ‘Even though most of the core businesses at News Corp are doing great, the risk factor is much higher because you don’t know what the limit on unethical behavior is, even to this day,’ he says.

A history of bad governance

The corporate governance problems created by News Corp’s board precede the phone-hacking scandal by at least a decade, explains Michael Pryce-Jones, senior policy analyst at CtW Investment Group, associated with Change to Win, which invests pension funds for 5.5 million union members. Over the last 10 years News Corp has invested in a series of failed acquisitions, including buying Myspace for $580 million in 2005 and then unloading it for $35 million to Specific Media in 2011.

Pryce-Jones also questions the board’s decision to acquire Shine Group, a media company led by Elizabeth Murdoch, Rupert’s daughter, for $673 million in 2011. In addition, the phone-hacking scandal led to the nullification of News Corp’s bid to acquire a controlling interest in British Sky Broadcasting (BSkyB), which would have been its most strategic investment in years, Pryce-Jones says.

‘We’ve had 10 years of failing to meet the cost of capital and equity, and costly corporate write-downs,’ Pryce-Jones says. Poor corporate governance has been weighing down the stock price, restricting its valuation.

Pryce-Jones suggests that additional governance problems persist because News Corp is run like a ‘multi-billion-dollar family business. Family members keep getting appointed and getting senior positions.’ Skilled leaders like Peter Chernin, the former president and COO of News Corp who resigned in 2009 to form his own media company, left because they faced a glass ceiling as a result of the fact that their last name isn’t Murdoch. Moreover, this lack of ethics is infused into the News Corp culture and may lead the company down a path of destruction in the future if it isn’t rectified. By changing nothing in the wake of the scandal, News Corp has sent the message that ‘the way to get ahead is to do whatever it takes to accomplish one’s goals,’ Finkelstein says.

What changes are needed?

What can the board do to restore morale and ensure productivity in the year to come? Finkelstein says the board needs to appoint an independent committee, made up of individuals who are not employees of News Corp and do not conduct business with it, to investigate the ethics scandal. The board must also communicate with the company’s senior executives and map out a new ethical program so misconduct doesn’t reoccur. Pryce-Jones says an independent board should be formed to examine whether the dual stock structure makes sense and to determine what price shareholders are paying for it.

Were the board independent, it would have started an all-out campaign on ethical compliance to turn the culture around, says Charles Elson, director of the University of Delaware’s Weinberg Center for Corporate Governance, (pictured left). ‘It would start at the top and create a persistent drumbeat through the corporation about meeting legal and ethical standards,’ he explains. ‘They’d make compliance the watchword of the culture.’ An independent board would likely have replaced the CEO and cleaned house before embarking on this culture change project.

Finkelstein suggests that one gesture which might encourage the board to change is for a board member to resign. ‘A departure might be a shock to the system,’ he says. ‘It could be a shock that would trigger change.’

Finkelstein also says board members with a conscience must speak up. Setting a higher ethical standard for themselves might lift other members of the board.

Although many governance experts are calling for change, observers in the investment community aren’t as alarmed. When the scandal reached its apex in July 2011, New Corp’s stock plummeted to a low of $14 per share, says Michael Corty, a Morningstar equity analyst specializing in media companies. At the time, many investors were worried about the scandal’s long-term effect on the company.

However, Corty says the scandal has not dramatically affected News Corp’s core businesses – the damage was limited to its London-based newspapers. He sees the fundamentals of News Corp’s diversified holdings of TV stations, a film studio, and publishing and international assets as sound. ‘I see a good business trading at low multiples,’ Corty says. ‘I’m getting a good business at a good price.’ In fact, since the summer of 2011, News Corp’s stock has recovered nicely, rising 30 percent as of the start of May. Some would argue that the board has met its obligation to create shareholder value.

Corty also gives News Corp credit for grooming a possible successor. He notes that News Corp’s COO Chase Carey is playing a critical role in restoring investor confidence, and if something were to happen to CEO Murdoch, Carey could succeed him and establish a smooth transition to the top. That reassures investors.

It hasn’t reassured everyone, however. Monks says that even a year after the scandal hit, Murdoch ‘is at the moment in serious risk of destroying the franchise.’ He says UK regulators have been scrutinizing whether it’s in the best interests of the public to renew News Corp’s license to run BSkyB. If News Corp were to lose that license, it would suffer a major revenue loss – BSkyB generated $498 million or 18 percent of News Corp’s net income in 2011. Losing the UK license could also apply pressure on US regulators to take similar actions.

On the surface, it appears as if Murdoch’s deft political ploys and stock ownership have enabled him to avoid relinquishing power – and in the short term, that has worked for investors. But Monks says that in the long term, even Murdoch has been damaged. The empire he has amassed will likely not be passed on to the Murdoch children. ‘The family business is simply kaput,’ says Monks. If any of the unethical behavior is linked to News Corp’s other franchises, it certainly will be.