Should Board Governance Change?

Originally published December 2014

This article, which is an excerpt from a forthcoming book on board governance co-authored by Michael Dennis Graham of Grahall, LLC and Nancy May of BoardBench Companies, LLC is reprinted with permission from the November/December issue of PSX: The Exchange for People Strategy, an eMagazine that brings you cutting edge views and perspectives on all things related to people strategy

Our experience has taught us that a board can have a significant impact on an organization far beyond its governance decisions. So, if board members are selected and elected without considering what they bring in terms of knowledge, experience, and credibility, they could be doing more than just a disservice to the organization and its shareholders.

For those of you interested in the subject, take a little time and search the Internet on the following keywords: CEO plus management success, turnarounds, major product or service introductions, and pay. Then try the same keywords using board of director and compare the results. You will probably start to see a pattern where newspaper stories about CEOs vs. board members is something like 100 to 1. Most of the stories that come up in either of these searches relates to CEO pay (and how boards are required to oversee it), their removal, or something they said publicly that upset a large constituency, among other “newsworthy” topics. Mention of the board of directors often deals with proxy challenges. Is the lack of media attention towards boards due to their being so effective and successful that they don’t warrant much scrutiny? If that’s your take, based on your own experience, congratulations. You may, however, not be seeing the whole picture.

Accountability: In the press, boards and CEOs are typically bombarded with blame and derision. But those that operate well rarely get the attention and respect they deserve for the success of the businesses they oversee. Then again, the press doesn’t believe “good” stories are interesting to their readers, and won’t attract more readers and advertising revenue. Yet again, when a company flounders, boards are rarely held accountable — unless they keep screwing up (i.e. J.C. Penny, HP, and others). Instead, the CEO takes the heat. However, many CEOs and directors continue to receive respectable pay packages, glamour (even after taking a fall), deflected blame (the buck stops here. . . or does it?), notoriety, etc. Don’t you find this odd?

After all, boards are charged with hiring the right CEO, approving strategy, seeing over the horizon, challenging business assumptions, and determining how CEOs are rewarded (or not), for their success. If the business strategies work, the CEO should get credit for execution, but the Board should get credit for its foresightedness (not just for hiring the right guy). If business strategies fail, then the CEO should carry the blame for poor choice of strategy or implementation and the Board for failure to appropriately examine and oversee the plans (not just the blame for overpaying the CEO). How often does that happen, though?

Board governance deserves deeper scrutiny, and more attention and focus on the part of investors, stakeholders, legislators, CEOs and the boards themselves. However, if they are not getting respect, boards have to do and show more to earn it, in particular by creating correctly structured board governance that will help to sustain the organization’s success.

Sadly… the approaches to board governance and pay have not changed remarkably.

Practices and Pay: Roles, responsibilities, regulation, and scrutiny of boards, have changed over time. Sadly though, the approaches to board governance and pay have not changed remarkably. Here is our key message: board governance practices need to be situational, in that situations vary among companies and industries, and also change over time.

Simply put, the mostly dated approaches used by most boards today to govern their organization do not work. In fact, they may be deleterious to their success. The framework that boards use to determine their level of involvement (contribution) is to do what they did at the last place where they were directors. And, if you always do what you always did, you’ll always get what you’ve always gotten ― at most.

The fact that the “Great Recession,” and legislative and regulatory changes are NOT making it easier or safer to serve as a director, is no excuse for ignoring the obvious: times have changed and board governance must change to meet new demands. Over time board roles and responsibilities must change as the organization evolves.

Boards should have different governance models based on each board’s role and responsibilities. Boards (and their individual directors) should also have different rewards structures that are aligned with their roles and responsibilities.
In corporations, ownership and control are intended to be separate like church and state, if you will, of corporate politics. The organization’s board is expected to oversee and direct the organization’s business affairs, protecting stakeholders (i.e. shareholders, debt holders, employees, customers, etc.). The board at its “50,000 foot” level examines the organization’s business strategy and its execution with the singular intent of ethically and logically sustaining and growing the business to the ultimate benefit of the organization and its shareholders. Shareholders, if they don’t like the board, can theoretically “vote them off the island.” Or at least that is how it is supposed to work.

The CEO should report to the board and the board should oversee the CEO’s activities and compensation. But, like the fox watching the hen house, the CEO is often also the Chairman of the Board.

Large corporations are highly complex entities. Even those with a fairly monolithic business structure become complex when they are large. So, in the case of a large, diversified organization, complexity grows exponentially. It’s no wonder that boards can and do miss a beat. Sadly, there are examples of where this has resulted in tragic outcomes.

Take everyone’s favorite – Enron where there was collusion, combined with dishonest and unscrupulous behaviors on the part of “C-Level” officers. Worse, there was also a serious failure on the part of the board to comprehend the issues before they became a calamity. A special investigating committee of Enron’s board in February, 2002 found that the board of directors failed in its oversight duties with serious consequences for Enron, its employees, and its many stakeholders. Further, the board underestimated the severity of the conflict and overestimated the degree to which management controls and procedures could contain the problem. (1)

No kidding, we all know what happened next!

The Enron disaster was a wake up call to boards, investors, and legislators who finally asked the important question: “Who is watching the hen house after all?” Unfortunately, even with this backdrop of contingency planning, vigilance, and focus, we still didn’t prevent the later fall of AIG, General Motors, Lehman Brothers, Freddie Mac, Fannie Mae and others, after Enron. What does it take to make permanent changes that really fix problems? We have some ideas. With passion, conviction, and experience, we share our thoughts on board governance and compensation, and how these can work together to make corporations more effective, efficient, and ethically sustainable.

Historically boards have been given neither their fair share of credit for triumphs, nor blames for fiascos. We believe a change will come in that philosophy. Contrarians may argue that directors are already held accountable for blunders with personal liability. But is that true? Board members can, theoretically, be held personally liable for an organization’s poor operations. In reality, according to an article in The New York Times Deal Book, directors “…have about the same chance of being held liable for their poor management of a public firm as they have of being struck by lightning… since management of an organization is largely regulated by state law.” In the 16 years from 1990 to 2006, a study found only nine cases where directors were held personally liable for securities fraud. Three of those cases were Enron, WorldCom, and Tyco. (2)

The Reality of the Current Board Governance

Ideally, an organization should have a situational and dynamic board comprised of individuals with the appropriate experience and skills to shape and enhance the organization’s value through each stage of the industry cycle, using its unique business strategy. Unfortunately, for many organizations, especially those which have changed dramatically in size, sophistication, complexity, and business stage, boards (along with their governance models and rewards structures) haven’t always kept pace.

Many boards today are still quite entrenched, with selection and election processes far from “democratic” or even constructive. Many new (and existing) board members are some form of “insider,” either an organization executive or someone known well by the current board or management. Seldom are there strong competing candidates (or diversified candidates for that matter). As a result, the “election” is essentially won before any votes are cast. Too often, a director’s removal is a condition of age (with “mandatory” retirement most often at age 72, and inching up) rather than on knowledge, experience, contribution or performance. Often, for organizations in a turnaround situation, the board is comprised of the same people who got the organization into the mess in the first place ― or close friends and colleagues.

Our experience has taught us that a board can have a significant impact on an organization far beyond its governance decisions. So, if board members are selected and elected without considering what they bring in terms of knowledge, experience, and credibility, they could be doing more than just a disservice to the organization and its shareholders.

Board Development and Assessment

If you don’t know where you are, how can you know where you are going? Boards need to assess themselves against the current and future needs of the organization they are governing. They need to do this meaningfully at regular intervals, and particularly when economic or business strategy changes occur that may drive the organization in a new direction. When board seats become available, candidates should be sought who can help it address the organization’s specific and long-view business issues, not just broad issues in general.

Unfortunately, most boards do not effectively self-evaluate (which, itself, is probably minimally sufficient), often enough, nor well, primarily because they are fearful of the consequences, have neither the framework, the tools, or in many cases the willingness to take time to do so properly. Investing the time and effort, though, contributes greatly to the organization’s overall value.

Summary

This may seem like common sense, but creating and managing a board of directors is not a science (yet) and is largely a word of mouth exercise executed much like the skilled trades or guilds of past centuries. Although there are many director education platforms, there is really no particular formal training required for the position. Board members are trained by sitting on their own organization’s board of directors, watching and imitating the more experienced board members. Oftentimes, having sufficient time and experience, they may be asked to join other boards where they proceed to instruct the less experienced board members in what they have been taught. Thus, mistakes and misconceptions get perpetuated.

References

1) Powers, William C. Jr, Raymond S. Troubh, and Herbert S. Winokur, Jr. “Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corporation.” 1 February 2002
2) Davidoff, Stephen. “Despite Worries Serving at the Top Carries Little Risk.” New York Times Deal Book, 7 June 2011, Available on line at <http://dealbook.nytimes.com/2011/06/07/despite-worries-serving-at-the-top-carries-little-risk/>