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E-MailSimon Wong is a Partner at Governance for Owners, an Adjunct Professor of Law at the Northwestern University School of Law, and a Visiting Fellow at the London School of Economics and Political Science.
The global financial crisis has prompted debate once again on how to improve the effectiveness of the board of directors at listed companies. Despite considerable reforms over the past two decades, boards – particularly at financial institutions – have been criticized recently for failing to properly guide strategy, oversee risk management, structure executive pay, manage succession planning, and carry out other essential tasks.
This article argues that the lack of attention to behavioral and functional considerations – such as director mindset, board operating context, and evolving human dynamics – has hampered the board’s effectiveness.
To reach their potential, the article recommends that – alongside establishing core building blocks such as appropriate board size, well-functioning committees, proficient company secretarial support, and professionally-administered board evaluation – boards and their members focus on the following:
1. Think like an owner
Boards are vital stewards, responsible for ensuring the long-term viability and health of firms under their charge for the benefit of current and future owners. As such, it is important that they adopt an ownership mindset. However, many outside directors are passive participants who do not believe it is their role to challenge management beyond asking a few questions at board meetings.
Contrast this with how the chairman of a family-owned construction firm describes the role of board directors in well-governed family enterprises: “Directors with an ownership mindset – whether from the family or outside – have passion for the company, look long-term, and take personal (as distinguished from legal) responsibility for the firm. They will spend time to understand things they don’t know and not pass the buck to others. They will stand their ground when it is called for. Ultimately, the success of the company over the long-term matters to them at a deep, personal level.”
An ownership mindset can be instilled by, among other things, recruiting directors who exhibit energy, a proactive attitude, and an independent mind, involving them meaningfully in substantive board work, strengthening their emotional bonds to the company, and employing long-term financial tools.
2. Know their companies
For a board to add value, individual directors must possess a strong understanding of the company and its industry. However, getting outside directors to be functional is challenging in practice.
A key issue is that the global trend of populating boards with “independent” directors means many board members begin their tenures with a shallow understanding of their firms. Additionally, the information that boards receive is often of poor quality and, at many companies, there is an excessive focus on passive learning through perusing written materials and attending lectures and presentations. Lastly, given the complexity of some industries – such as financial services, global mining, and pharmaceutical – there may be a limit to which outside directors can acquire deep knowledge solely through service on the board.
Boards can build in-depth knowledge and expertise by, among other things, emphasizing interactive, experiential modes of information acquisition, inviting “dissenting” opinions from the outside, and ensuring that a meaningful proportion of non-executive directors possess sector expertise.
3. Be prepared to “roll up their sleeves”
There is broad acceptance that listed company boards should operate on the basis of “noses in, fingers out.” However, to properly discharge their stewardship responsibilities, boards must engage intensively in such critical areas as strategy development and risk management. On matters where management faces severe conflicts of interest, such as CEO succession planning and executive remuneration, boards must “roll up their sleeves” and drive the work. Worryingly, board stewardship of these areas is frequently weak.
Given the unpredictability of CEO tenure and the long lead time needed to develop CEO-caliber leaders, boards must pay close attention to succession planning at all times. Their leadership is particularly important in smaller companies where, due to limited growth prospects, a talented chief executive is likely to be lured away by a larger company at a future point in time.
On setting executive pay, while the board must delegate day-to-day work to the human resources department and pay consultants, it needs to take charge of the overall process, starting with the selection of remuneration advisers. Crucially, compensation committee members must understand the key drivers of the business and the competitive landscape so that the right metrics and targets will be used to measure and reward management’s contribution to company performance.
To ensure active board involvement does not lead to micro-management and other inappropriate interference, the board must be led by a chairman who does not harbor ambitions to be the CEO and is genuinely content to play a behind-the-scenes role.
4. Take charge of their priorities
The board’s responsibilities have broadened over the years, including following the global financial crisis. As most boards still meet only 8-10 times a year, they need to prioritize their activities and manage their time efficiently.
Because the board and management may not always hold the same view on the priority issues that the board should address – for example, regarding the firm’s long-term strategic direction, approach to achieving growth, and succession planning and leadership development – boards should annually decide their top priorities rather than depend solely on management to determine their agenda. Given that boards, compared to management, are less able to rely on operational, financial, and share price metrics to gauge their performance, doing so will also provide them with a clear yardstick to evaluate how well they are fulfilling their responsibilities.
Operationally, boards should limit the time spent on routine and “backward-looking” matters and ensure they are not rushed on important decisions.
5. Hire a collaborative CEO
Boards are highly reliant on management to provide them with information on the company. In recent years, there have been high-profile incidents of CEOs failing to inform or involve their boards on critical developments, such as merger discussions. Such breaches of trust have often led to the CEO’s ouster.
Fortunately, executives are increasingly conscious of the importance of keeping their boards fully informed. Nevertheless, given the risk that they can be manipulated by management, boards must ensure a collaborative CEO is in place.
This can be accomplished by looking for collaborative traits when selecting a new CEO, incorporating collaboration with the board into the CEO’s job description, and providing regular feedback. In turn, boards can enhance management’s willingness to cooperate by demonstrating an ability to add value and not micro-managing the executive team.
6. Protect their authority and independence
To be effective, the board must possess adequate authority and independence from management. Board authority, however, ebbs and flows. Sometimes, such as when it cedes the chairman’s role to the CEO, the board consciously reduces its authority. In other cases, authority recedes gradually and without notice, until it is too late. Similarly, although directors are loath to admit it, independence of mind is likely to erode over time.
Boards can take a number of steps to protect their authority and independence. First, boards should ensure that the chairman and CEO positions are occupied by different individuals. Second, boards need to be on top of succession planning and leadership development so that CEOs will not be able to hold them hostage with unreasonable demands, whether on pay or additional authority.
Third, boards should pay attention to the relative status of people in the boardroom. In particular, boards should ensure that the statures of non-executive directors are equal to or greater than the CEO’s and comparable to each other. Lastly, boards should put in place term limits for directors and the CEO to ensure new perspectives come into the boardroom and the board remains sufficiently detached from management.
The full article is available here.
