Paraphrased from Mark Wiseman and Dominic Barton’s article in Harvard Business Journal May 2015 with additional commentary from Rob Andrews
Says Mark Wiseman, Boards simply aren’t working. It’s been more than a decade since the first wave of post-Enron regulatory reforms, and despite a host of guidelines from independent watchdogs such as the International Corporate Governance Network, most boards aren’t delivering on their core mission: providing strong oversight and strategic support for management’s efforts to create long-term value. This isn’t just Mark’s opinion. According to McKinsey, directors also believe boards are falling short.
A mere 34% of the 772 directors surveyed by McKinsey in 2013 agreed that the boards on which they served fully comprehended their companies’ strategies. Only 22% said their boards were completely aware of how their firms created value, and just 16% claimed that their boards had a strong understanding of the dynamics of their firms’ industries.
16%: The percentage of directors who say the boards they serve on understand the dynamics of their firms’ industries.
Those are shocking results. Clearly, the answer is not to impose yet another round of good-governance box-checking and hoop-jumping. The lack of improvement that approach has produced speaks for itself.
A good first step might be to help everyone firmly grasp what a director’s “fiduciary duty” is. Most legal codes stress two core aspects of it: loyalty (placing the company’s interests ahead of one’s own) and prudence (applying proper care, skill, and diligence to business decisions). Nothing suggests that the role of a loyal and prudent director is to pressure management to maximize short-term shareholder value to the exclusion of any other interest. On the contrary, the logical implication is that he or she should help the company thrive for years into the future.
If directors can keep the totality of their fiduciary duty firmly in mind, big changes in the boardroom would follow. They would spend more time on partnering with management to enable cultures of peak performance. They would spend time discussing disruptive innovations that could lead to new goods, services, markets, and business models; what it takes to capture value-creation opportunities with a big upside over the long term; and shutting or selling operations that no longer fit. And they will spend less time talking about meeting next quarter’s earnings expectations, complying with regulations (although that, of course, must be done), and avoiding lawsuits.
Selecting the Right People
From 2010 to 2013, the number of interventions by activist shareholders increased an astonishing 88%. The whole activist industry exists because public boards are often seen as inadequately equipped to meet shareholder interests.” Consider one more damning data point: Only 14% of 692 directors and C-suite executives surveyed by McKinsey in September 2014 picked “a reputation for independent thinking” as one of the main criteria that public company boards consider when appointing new directors.
In addition, public company boards—unlike general partners in the private equity world or successful family-owned companies—often do not think enough about attracting the right business expertise. Having a diversity of perspectives and proven experience in building relevant businesses, as well as deep functional knowledge, is critical.
That is indeed a problem. Former IBM CEO Lou Gerstner recently observed that the willingness to tackle outmoded orthodoxies decisively is crucial to sustained value creation. “In anything other than a protected industry, longevity is the capacity to change, not to stay with what you’ve got,” he said. Companies that last 100 years are never truly the same company, he noted. “They’ve changed 25 times or 5 times or 4 times over that 100 years.”
Remaking boards in this fashion is standard counsel these days. But if you truly get the importance of thinking and acting long-term, you’ll do whatever it takes to attract these people. Klaus Kleinfeld, the CEO of Alcoa, told us that he deliberately seeks directors who have substantial real-life experience, have worked through difficult times, and also have a strong feel for the kind of long-cycle investment-and-return rhythms that apply to his industry.
22%: The percentage of directors who say their boards know how their firms create value.
To ensure that it can see around corners, Mars, the privately held food-and-drink powerhouse, has created a five-member advisory group of external experts to complement its three family board members. Each adviser is an expert on a specific driver of company value, from demographic health concerns to food safety regulations, and regularly addresses how trends in these areas may affect the firm’s strategy and priorities with the board and senior executives. For executives serious about creating long-term value, injecting more of these kinds of informed perspectives into the conversation at public company boards is not optional; it’s imperative.
Spending Quality Time on Strategy
Most governance experts would agree that public company directors need to put in more days on the job and devote more time to understanding and shaping strategy. Some recommendations get quite specific. Robert C. Pozen, a senior lecturer at Harvard Business School and the former chairman of MFS Investment Management, says that directors of large, complex firms should spend at least two days a month, or 24 days a year, on board responsibilities, in addition to attending regular board meetings. Others suggest that the appropriate number is as many as 54 days a year, the standard for directors of companies owned by private equity firms, according to a McKinsey study in the United Kingdom. The notion of regular group outings for directors—holding board meetings in, say, retail stores or new R&D facilities, or asking members to tag along on sales calls—is also now in vogue.
Boards also need to do more to develop and communicate non-financial metrics that will help guide strategy, especially when income statements don’t capture the emerging story. The board of Tullow Oil, a multinational oil- and gas exploration company headquartered in the United Kingdom, does this well. To measure the company’s performance, it uses a balanced scorecard of financial and nonfinancial objectives—which include progress in carrying out key development activities; implementing capital spending plans; achieving environmental, health, and safety goals; and maintaining a healthy, well-funded balance sheet.
Strategy is the fundamental challenge of the organization, and it should engage the entire board.” That collective effort is critical to ensuring the right long-term debates and decisions.
Engaging with Long-Term Investors
Boards can and should be far more active in facilitating a dialogue with major long-term shareholders. Certainly, many investors would welcome such engagement. BlackRock, the world’s largest asset manager (with more than $4.5 trillion in holdings), already strives for what CEO Larry Fink calls “robust, ongoing communication” with both management and the board at many companies it holds stakes in. “That doesn’t mean that we want to tell companies what to do,” Fink told us. “We do, however, want to make sure there is a high-quality board and management team in place, and that we have ready access” in order to serve both the long-term interests of the company and “the long-term interests of our clients.”
Happily, this is an idea whose time appears to be coming. Organizations like Shareholder-Director Exchange, a group that includes BlackRock and State Street, have been working to ensure that public companies disclose how their directors interact with shareholders and have been compiling best practices for, among other things, preparing board members for such conversations. That trend underscores long-term investors’ growing interest in learning from and exchanging ideas with smart, engaged directors. Currently, however, too much of this dialogue focuses on investor pressures to have a “say on pay” and similar single-minded governance issues. The more powerful discussions occur when companies strive to communicate their strategies for longer-term growth and their key metrics for it.
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