This is “What Defines the Best In-Class Boards?”, section 10.2 from the book Governing Corporations (v. 1.0).
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10.2 What Defines the Best In-Class Boards?
What makes for a good board? In Building High-Performance Boards, executive search consultants Heidrick & Struggles observe that a high-performance board governs by continually challenging—in a positive way—every significant aspect of the company’s operations: its business model, strategies, and underlying assumptions; its operating performance; and its leadership development. In doing so, a best in-class board should seek to create a culture of rigorous, relentless examination, and press for continuous improvement. This way it can set a “tone at the top” that reverberates throughout the organization—to employees, to customers, to shareholders, and to the communities served by the company. A best in-class board, therefore, is more than a roster of prominent names; it is a well-balanced team that leverages the diverse experiences, skills, and intellects of the directors to further the strategic objectives of the company. Members of such boards focus on the big picture yet know when to drill down on specifics; they have the fortitude to speak openly and candidly, and the humility to remember that they do not run the business. Thus, being a good director is both a skill and a mindset.
A recent study by Bird, Buchanan, and Rogers (2004) for Bain & Company concludes that truly effective boards concentrate on value growth and practice seven habits that build their effectiveness:
Effective boards own the strategy. Strong boards contribute to strategic thinking and feel a sense of ownership of the resulting strategy itself. The authors cite the case of Vodafone, where each year the board helps develop the agenda for a multi-day strategy retreat with senior executives. Each director contributes to the list of key strategic decisions that need to be made at the retreat. The event begins with a highly analytic overview of Vodafone’s markets and competitors, providing data that will inform those decisions. Instead of just including presentations by executives to the board, Vodafone’s process fosters debate on options, investments, and returns. When boards understand the issues at this depth and ask critical questions early on—Is the strategy bold enough? Is it achievable?—they can respond more quickly to opportunities such as major acquisitions when they arise. Decisions unfold faster. Vodafone’s swift consummation of the Mannesmann acquisition aptly demonstrates the value of such an approach.
Effective boards build the top team. As noted in earlier chapters, selecting, developing, and evaluating the top executive team are major board responsibilities. A truly effective board understands the significance of developing leaders to creating market value, and therefore has a strong incentive to get involved. Yet, Bain & Company’s analysis of 23 high-growth companies revealed that only a minority systematically try to develop new leadership through internal advancement.
Effective boards link reward to performance. Determining the right reward structure starts with how the company chooses to measure success—and how closely these measures are tied to the drivers of long-term value in the business, not with pay systems. Selecting the right approach is critical, because CEO compensationPay for services to a corporation’s CEO that is determined by the board of directors through the compensation committee. remains a controversial issue for many companies. Effective compensation schemes measure what matters and pay for performance, with a real downside for mediocre results. They also are simple and transparent and focus on sustained value creation, balancing short-term and long-term focus.
Effective boards focus on financial viability. As noted in earlier chapters, ensuring a company’s financial viability extends well beyond complying with the Sarbanes-Oxley Act and other applicable laws. It includes making other key financial decisions, such as choosing appropriate levels of debt and scrutinizing major investments and acquisition proposals. As Bird, Buchanan, and Rogers observe, worst practices can sometimes be instructive. They cite an investigation by former U.S. Attorney General Richard Thornburgh into WorldCom’s $11 billion in accounting irregularities that concluded that WorldCom’s directors were often kept in the dark, particularly in matters involving some of the company’s more than 60 acquisitions. The study also revealed that the company’s directors made little effort to monitor debt levels or the company’s ability to repay obligations; yet, they “rubber-stamped” proposals by WorldCom’s senior executives to increase borrowings.
Effective companies match risk with return. Most boards have a process in place for assessing and managing operational risk. Yet, as noted in Chapter 6 "Oversight, Compliance, and Risk Management" in the section on enterprise risk management, few boards understand the true risks inherent in their companies’ strategies. This is critical: Almost three quarters of major acquisitions destroy rather than create value, and 70% of diversification efforts away from the core business and into new markets fail. Furthermore, Bain & Company estimates that more than 40% of recent CEO departures not related to retirement can be attributed to a controversial or failed “adjacency” move. The message: Boards need to understand and accept the risks inherent in their strategy and recognize the implications for required risk-weighted returns.
Effective boards manage corporate reputation. Strong boards avoid the traps of “check-the-box” compliance and a short-term horizon; they target long-term value creation and ignore guidance by “analysts” and court investors who seek long-term value. Once a course is set, they focus on transparency and effective communication to enhance their reputation.
Effective boards manage themselves. An effective board chair sets the tone from the top and implements an effective governance model. Such a model (a) focuses the agenda on issues of performance and regularly reviews board effectiveness, (b) builds a team of directors with the right mix of skills and experience, and (c) is clear about the value a board can contribute, and (d) ensures that directors have ample opportunities to fulfill their roles.