The Changing Of The Board


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The Changing Of The Board

  1. 1. No. 1, 2009 Board of Director Series: The Changing of the Board Boards In Crisis: Part One Failures in governance contributed significantly to the global disruption of markets and economies in 2008. We need to rethink and reshape corporate boards in order to improve their ability to oversee organizations that operate in complex and competitive business ecosystems. The first priority for boards is to refocus on shareholder value and restore shareholder trust. Boyden global executive search And John Levy of Board Advisory 1
  2. 2. Board of Director Series — No. 1, 2009 The Changing of the Board Table of Contents Introduction to The Changing of the Board I Corporate Boards in Crisis II A Brief History: Fighting for the Soul of the Board III Shareholders Get Engaged IV Transforming Boards for Competitive Advantage Boyden’s Board of Director Series Acknowledgements and Sources About Boyden About John Levy and Board Advisory 2
  3. 3. Board of Director Series — No. 1, 2009 The Changing of the Board Boards In Crisis: Part One Introduction The Changing of the Board is a series of the goal is to ensure boards act as trusted four papers about the challenge of finding agents on behalf of shareholders. CEOs and new directors for organizations that oper- company insiders often want to retain control ate in today’s increasingly complex business of board agendas and board membership in environment. These papers explore the chal- order to minimize opposition to their man- lenge of practicing corporate oversight and agement decisions. Research suggests that governance in a world of change. It is an is- companies do, in fact, become more profit- sue of critical importance to the many clients able and achieve higher stock prices when Boyden serves around the world. their boards are more independent and less controlled by internal management. Making boards (and those they serve) more successful has become a priority for all who Shareholders were the big losers in the re- participate in today’s global markets. That cent market collapse – inspiring them to be- includes shareholders, stakeholders, corp- come more engaged in company affairs. The orations, and customers – and the capital SEC recently voted to propose a comprehen- markets as well. The four papers that sive series of rule amendments to constitute The Changing of the Board facilitate the rights of shareholders to nomi- offer fresh insight on how to construct nate directors to run against company-select- boards that work. The series begins with a ed slates. This is another step in reducing the concise overview of why boards fail. It conflicts of interest which often undermine explains the meaning and value of board the commitment and effectiveness of boards independence. And it describes the strate- in overseeing company management. New gies needed to move boards from focusing research indicates that hybrid boards – com- on compliance to creating competitive bining shareholder-supported directors with advantage. management-aligned directors – are more successful in improving company results and Boards in Crisis, the first paper in the series, increasing shareholder value than traditional focuses on corporate boards: past, present, CEO-controlled boards. and future. Years of reform have improved the capability and performance of boards. Some boards, like that of Costco, have But not enough. The recent global crisis – proven very successful in proactively steering and especially a failure of boards to manage their companies toward continuing success. risk and compensation in financial services – Much progress has been made in moving indicates a need for deeper and more from ceremonial boards to working boards. thoughtful changes in the practice of corpo- The next challenge is to develop strategies rate oversight and governance. This first pa- to move boards beyond mere compliance per explores the reasons, both historical and to providing new levels of value. The board contemporary, why shareholder interests of Costco, for example, is clearly an equal have not received the attention they require. partner with internal management, and the results have been excellent. Leading thinkers Today the “fight for the soul of the board” such as Ram Charan, author of the acclaimed continues as many shareholders seek more books Boards that Work and Boards that independent boards, often asking that the Deliver, believe that building a great board positions of CEO and Chairman be separated. may be the next big corporate advantage – While both legislation (Sarbanes-Oxley) and and one of the few competitive advantages regulation (requirements of NASDAQ and the that may be sustainable over many years. National Association of Security Dealers) now mandate that “independent” directors fill Corporate boards must do a better job of key board positions, those directors may still delivering on the now centuries-old promise see themselves as led by the CEO and his to protect and increase shareholder value. A team. From the shareholder’s point of view, primary goal is building honest collaborative 3
  4. 4. Board of Director Series — No. 1, 2009 The Changing of the Board relationships with internal managers, includ- Tipping points were passed. The dominos ing occasionally temperamental CEOs; so began to fall. they can work together to find better ways to successfully navigate the accelerating First, the large financial enterprises that were complexity of twenty-first Century business the foundations of the economy began to tot- environments. ter then fail. As those institutions failed, other interdependent corporations collapsed. The Former Secretary of Labor Robert Reich demise of companies, one after another, cap- makes our future shockingly clear in his new sized whole sectors. Whole economies were book Supercapitalism. The global market- affected. The domino effect quickly crossed place will only become more competitive, national boundaries. more complex, and more unforgiving. Com- panies no longer have time to waste on any Soon we found ourselves in a world of pain. activity that will not improve products or gen- erate profits. The underlying causes and ultimate effects of these events will be studied for years. But I. Corporate Boards In Crisis there is no denying that too few corporate boards were prepared to deal decisively with What happened to our companies and our critical events of this size, speed, and com- world between January of 2008 and today? plexity. Too many CEOs and boards were late in recognizing and mitigating risks. The simplest way to comprehend the eco- nomic meltdown of 2008 is to view it as a For most of us, governance is invisible until “Boards own a large share of domino effect that occured on a global scale. it fails. The scope of the failure tells us the the responsibility for the good governance and management of scope of the change required to prevent companies. It’s time they step up Instantaneous global communication, busi- similar failures in the future. and do a better job of that” ness complexity and hyper-competition all Dinesh Mirchandani, Managing Director, Boyden India came together to drive unrealistic business Few are comfortable with fundamental expectations, models, and strategies. Those, change. But no one wants to see another in turn, generated unintended and out-of- year like 2008. control consequences. • A continuing market emphasis on On the surface, governance appears simple. short-term profitability distracted many Boards are responsible for overseeing com- companies from focusing on long-term pany compliance, strategy, execution, and sustainability. results. Many believe the buck stops with the board when companies falter and sharehold- • A need to deliver on projections of short- ers suffer. term profitability helped create a global market for financial derivatives. (Warren Beneath that apparently simple surface, how- Buffet warned markets early in 2003 that ever, lurk historical issues that have made it derivatives were “financial products of more difficult for directors to do their jobs. mass destruction.”) Boards have been held responsible for cor- “Too often boards have not porate governance, for oversight of manage- represented shareholders. And • Supposedly sophisticated risk manage- directors have waited too long to ment and business operations, and financial push back when they have doubts ment systems failed to identify and results, but too often directors were not about management decisions” mitigate the potential downside of what Sarah Stewart, Principal, given the access, tools, and support required. appeared to be a booming market. Boyden Pittsburgh Until 2002 (and the passage of Sarbanes- • Business ethics were deemed irrelevant Oxley) boards were not truly empowered to and pushed aside in many companies. access the information they needed to do their job. By 2008 many boards had still not • Control systems (governing institutions, changed culture and practice enough to uti- regulators, and corporate boards of di- lize their new powers. rectors) were gradually eroded, compro- mised, and eventually overwhelmed. 4
  5. 5. Board of Director Series — No. 1, 2009 The Changing of the Board The SEC, in announcing recent proposals to be encouraged to become more diligent in strengthen shareholder participation in board carrying out their duties. Changing regula- elections, noted that the economic crisis tions will not change results unless boards “has led many to question whether boards and directors change their behavior as well. of directors are truly being held accountable for the decisions that they make; whether “You need to be capable of deep, mature boards are exercising appropriate oversight thought and the persistence of action to in- of management; whether boards are appro- fluence change as a board member,” says priately focused on shareholder interests; Dinesh Mirchandani, Managing Director of and whether boards need to be held more Boyden India. “This is a responsibility that responsible for their decisions regarding such falls squarely on the next generation of issues as compensation structures and risk board members.” But who will identify management.” and recruit that next generation? How long should boards wait to make changes? And Not everybody is critical of everything that what are the most urgent concerns? happens in the boardroom. “Boards have generally done a better job than people give “The most critical role for boards now is to them credit for. One of the major problems restore trust,” says John Levy. “That is what is that the expectations of stakeholders are we need to do. We need to get that fixed.” often unrealistic,” states John F. Levy, CEO of Board Advisory, a member of the board of directors of five public companies, and a II. A Brief History: Fighting for the frequent author and speaker of boards and Soul of the Board corporate governance. While some commen- tators and shareholders believe that directors Ideally, CEOs and independent directors are responsible for company results regard- should be working together to restore trust less of what is happening in the business by improving shareholder value. Sometimes environment, many professionals who work they do. More often they do not. For decades with boards say the public has unrealistic there has been a battle over who controls the expectations of what directors can accom- board, who sets board agendas. In too many plish. “The role of the director is not well cases, that battle has been between the CEO understood. It doesn’t matter how intelligent, and the shareholders. dedicated or competent they are,” says Levy. “No director can be everywhere and Corporate investment structures were intro- do everything within a company. Board mem- duced four hundred years ago to facilitate bers are not ‘supermanagers.’ Their role is long-term investment in enterprises with oversight, not management.” substantial capital needs. The first such entity was the Dutch East India Company. Everyone wants boards to be better. And In exchange for providing long-term capital, many boards are better. Directors have been investors received partial ownership in the working longer hours than ever before. Many form of “shares” which could be sold when boards are now more persistent in asking they wanted to cash out. Investors thus questions and demanding answers. But, became “shareholders.” Later legislation as the financial events of 2008 continue to provided corporations with separate identity remind us, boards simply have not been and rights in perpetuity. This model proved better enough. highly successful in attracting capital and in driving the growth of businesses over the That is why institutions responsible for main- next few centuries. taining regulatory guidelines for corporate boards of directors must rethink and refine Initially, directors were shareholders elected frameworks for governance in order to by their peers to oversee the investment. ensure corporate boards are properly staffed The practice of selecting well-known mem- and fully resourced. In addition, boards must bers of the business community to be fair 5
  6. 6. Board of Director Series — No. 1, 2009 The Changing of the Board third-party observers was introduced shortly rubber stamping are rapidly coming to an end thereafter. Professor Robert Tricker, the au- as independent directors begin to flex their thor of Corporate Governance – Principles, muscles and adopt best practices in corpo- Policies and Practices published by Oxford rate governance.” in 2009, says their role was to assure share- holders that investments were properly uti- Sarah Stewart, a Principal with Boyden Pitts- lized, so shareholders would trust companies burgh, and an expert in governance issues, with their money. In practice, however, direc- agrees. “Not many CEOs have the confi- tors were appointed by senior management dence to come to a board without having all and so rarely disagreed with them. Being a the answers in place. But that’s what it really director paid well for duties that were largely takes. It’s critical to bring the board in earlier. ceremonial. It’s an act of courage for a CEO to do that. But that’s the only effective way to involve a The genius of the board system is that it es- board in strategy and also get the benefit of tablished third-party governance in order to the directors’ collective experience.” override the self-interest of management and individual shareholders in favor of assuring Boyden’s Mirchandani believes the problem safety and fairness to all shareholders. With- exists in India as well. “Board members here out such oversight, capital markets could have too often functioned as ‘yes-men’ of the not exist. But there is a fundamentally unre- Chairman, CEO or promoter. Satyam [a lead- solved issue in the system: “The Principal- ing Indian outsourcing company that for years Agent Problem.” The principal (in our case signficantly inflated its earnings and assets] is the shareholder) depends on payment to the a clear example of that.” agent (for this purpose the director and the board) to motivate the agent to perform the The Chairmen’s Forum, an influential group of activity desired by the principal. more than 50 current and former board chair- men, recently endorsed a new report which The difficulty is the principal (shareholder) suggests that separating the roles of CEO lacks sufficient knowledge of what will mo- and Chairman of the Board is essential to tivate the agent (the director and the board) “restoring market trust in the enterprise.” to perform the required service (watching Published by Yale’s Millstein Center for out for and growing shareholder value). Corporate Governance and Performance, Equally difficult for the principal is that while “Chairing the Board” says independent the agent knows what the agent has done, board chairs are the best way to compel often there is not enough information for the CEOs to focus on shareholder issues and principal to understand if the activity was to curb senior management conflicts of actually performed and if so, how well. The interest. The report emphasizes that Principal-Agent problem continues to be “managing the board is a separate and a fundamental issue for shareholders and time-intensive responsibility.” boards. The realistic shareholder entertains a healthy suspicion that their interests are not In the UK the number of CEOs chairing the being protected. board has been reduced to only 5% of FTSE 350 companies. A study in Canada showed Amazingly, virtually no one paid much atten- two-thirds of public companies were already tion to boards of directors until 1971 when using independent board chairmen by 2003. Harvard Professor Myles L. Mace published According to “Chairing the Board” the Directors: Myth and Reality. This classic US has been slower to take this key step study revealed directors did not, in fact, es- towards reforming boards. BusinessWeek tablish the policies of the firm, rarely chose recently identified 16 percent of US boards the CEO, rubber-stamped compensation as having truly independent chairmen in decisions, and were not inclined to ask tough 2008. The magazine said many non-executive questions. Tom Flannery, Managing Direc- chairs were actually either ex-CEOs of the tor of Boyden Pittsburgh says, “The days of company or otherwise related to internal 6
  7. 7. Board of Director Series — No. 1, 2009 The Changing of the Board management, and thus might lack full inde- by company insiders. The new regulations pendence. require sponsoring shareholders to own a not-insignificant share of company stock, but Boyden’s Stewart emphasizes that “whoever they will add another way to move boards controls the board agenda controls the board. to have more independence. It is interesting Boards have been and must be more vocal to note that a study that tracked the perfor- about what it is they want to work on.” mance of 120 hybrid boards (boards which mix independent directors with traditional directors selected and supported by com- III. Shareholders Get Enraged pany management) formed between 2005 and Engaged and 2008 demonstrated that hybrid boards of directors are able to increase share values Millions of shareholders suffered signifi- faster than traditional boards. cant losses in the 2008 meltdown of world markets. Some lost as much as half of the previous value of their equities. Enraged IV. Transforming Boards for shareholders can and do become engaged Competitive Advantage shareholders. Shareholder activism existed long before the events of 2008, but recent “Every board is different,” emphasizes Boy- events have caused activists to assert more den’s Stewart. “That’s because every com- independent control over boards. pany is different.” But it is clear that fixing board problems is on everybody’s agenda. Shareholder advocates believe the best way A recent McKinsey Quarterly report on the to assure that boards focus on protecting state of the corporate board indicates boards shareholder value is to put directors in place are becoming more active, engaged, and who are committed to doing just that. Board striving to make significant efforts to reform. fights are expensive and hard to win, but Boards surveyed by McKinsey are review- shareholders have had enough victories in ing current company performance, risk, and the past to allow researchers to measure financials. They are approving strategy. And how shareholder-focused boards perform. they are tracking progress against strategy. Studies indicate shareholders fare significant- Directors who say they want more time to ly better when boards become independent focus on strategy, are directors who are enough to make shareholder interests their becoming increasingly ambitious about pro- most important priority. viding more value to companies. They also would like to spend more time developing tal- “Corporate Governance and Equity ent for succession planning. Prices,” a study by Gompers, Ishii and Met- rick, showed that firms with stronger share- Independent directors complain of being holder rights (associated with independent frustrated by an inability to obtain a broader boards) were more profitable and had higher range of information. Too often, they are not stock valuations. Firms where boards and allowed to seek information from employees policies were controlled by CEOs tended to lower in the company hierarchy. Theoretically be less profitable and had lower stock valua- independent directors have a right to ques- tions. This appeared to be because CEO-con- tion any employee, but sometimes senior trolled boards tended to be more expansive, management discourages direct contact. making more corporate acquisitions and hav- The question is how can boards do a good ing higher capital expenditures. job of oversight without access to all crucial information? Recent SEC proposals to strengthen share- holder participation in board elections should Ram Charan described the path boards follow make it easier for shareholder-sponsored di- in evolving from simply being competent to rectors to run against director slates chosen 7
  8. 8. Board of Director Series — No. 1, 2009 The Changing of the Board providing high value services for companies. petitors. An evolved board is positioned to He says the initial changing of the board in- help do just that. volved moving it from ceremonial status to “liberated” status where it could play a more Overcoming the historical issues, empower- significant role in governance. Sarbanes-Ox- ing boards and working through conflicts with ley assured boards would now have access CEOs all require significant and sincere ef- to information, but relationships between fort. Many organizations aren’t willing to de- board and management are often negotiated vote the effort. The events of 2008 revealed and formal. In these circumstances, board too often companies lack boards able to governance is done mainly through compli- make a difference when times got tough. But ance activities. boards that are able to evolve to a higher lev- el of play, boards with directors who are able New opportunities are created as boards to establish respectful collaboration and a enter a third phase Charan terms “progres- level of trust with the C-Suite will themselves sive.” This is characterized by increasing become a significant competitive advantage dialogue and trust between independent for their companies. directors and senior management. Charan says self-assessment processes are used As the recent McKinsey survey shows, many to work though performance and partnering directors are hungry for the challenge. They issues. Transparency begins to improve as are absolutely prepared for the changing of information now tends to be made available the board. in more useful forms. Directors are thus able to learn how the business really runs. They finally have enough information to have more relevant discussions with management. Boyden’s Board of Director Series Though CEOs may not admit it, says Joseph This Boyden paper Boards in Crisis is the Daniel McCool, author of the recent book first of a sequence of four on The Changing Deciding Who Leads, CEOs can use all the of the Board. help they can get. “I think there are a lot of global companies that cannot be led by one Better Directors for Better Boards, the person alone. The CEO role has become too next in this series focuses on the chang- complex, too global, and too demanding for ing world of the board director. Traditionally individuals. Individual executives need to board membership was largely a well-paying have the courage and honesty to acknowl- ceremonial job reserved for friends of man- edge they can’t do it all.” Today’s manage- agement. Since legislation and listing regula- ment is in great need of board perspective, tions introduced in 2002 and 2003, directors experience and balance in order to determine are expected to do real work. Most have how to continually improve strategies and additional responsibilities including serving operations. on board committees, like auditing or com- pensation. As pressure (and sometimes bad Virtually all companies now struggle to catch publicity) increases, many board members up to the growing complexity, speed, and choose to leave boards early. This paper in- globalization of business. As boards and cludes a special interview with “Director X,” CEOs are active partners more often, the an experienced board member serving as a potential for new value and new ways to cre- Director of two high profile companies, who ate competitive advantage increases. Reich provides a surprising and unique look at what points out that most components in business really takes place in the boardroom in a crisis. value chains are now rapidly commoditized. Director X describes how the responsibilities Markets are becoming level playing fields, of directors changed, including the bad and resulting in extreme levels of hyper-compe- the good, and what shifted the day Sarbanes- tition between companies desperate to find Oxley became law. ways to differentiate themselves from com- 8
  9. 9. Board of Director Series — No. 1, 2009 The Changing of the Board Boards recognize that in the future they will Boards Get Real is the fourth and final paper need different kinds of board members than in Boyden’s series. It explores the new ability those who served in the past. Gone are the of boards to obtain independent resources. “feel good” celebrity directors. In the future, Boards may be still be hesitant to use them, boards will increasingly require experienced but for the first time in history, boards directors with solid knowledge of relevant finally have significant opportunity to practice business domains — and companies will the oversight that has long been promised. seek candidates who are tech-savvy, and Something as simple as assuring accurate re- have expertise in new areas such as risk porting of quarterly results has been surpris- management and business continuity. As ingly difficult. There is also the ever-present more directors resign early, there will be a temptation to over-state business results in growing shortage of qualified candidates. In order to trigger bonuses. Nearly 1200 public addition, it may be even more difficult to find companies in 2005 had to restate business new directors if director liability is increased. results (as opposed to 270 public companies What this means is that “The War for Talent” five years earlier). Nothing compromises the has finally come to the board room. Compa- trust of capital markets and shareholders nies will increasingly rely on retained search more quickly than inaccurate reporting of to find directors capable of helping a board business results, but board members them- become a competitive advantage. selves lack time to assure accurate reporting. The third paper in the series is Why Eth- Few members of the public are aware that ics Are Not Optional. The work of a board boards have direct responsibility for prevent- member always begins with a deep under- ing, discovering, and investigating significant standing of the unique duties of directors, fraud associated with company employees, both legal and ethical. The board is responsi- agents, or customers. Until 2002 and the ble for understanding, defining, and maintain- passage of the Sarbanes-Oxley legislation (as ing ethical frameworks to guide all employ- well as additional requirements established ees and agents of the company, as well as by stock exchanges), boards of directors circumscribing company business practice. lacked sufficient resources to accomplish Creating an ethical “tone at the top” turns this. Passage of the much-criticized legisla- out to be one of the most important duties of tion is considered by many experts to be directors. Leading by example is the most ef- the most successful act of empowering US fective way to assure an ethical organization. corporate boards in the history of corporate governance. Sarbanes-Oxley gave boards the History has shown what can happen when a legal responsibility to assure business infor- board like the Enron board (then considered mation was correct and business operations one of the best boards in America) sets eth- legal. But it also allowed boards the right to ics aside whenever senior executives ask. An retain outside auditors and other resources to interview with John F. Levy, CEO of Board report directly to the board. Advisory, who often consults for compro- mised companies and troubled boards, de- The question remains why, if boards now scribes how returning to ethical frameworks have sufficient external support to provide enables companies to restore shareholder real oversight, did so many prove ineffective trust. Levy, a participant in authoring “The in the financial crisis of 2008? It appears “the Changing of the Board” series, empha- changing of the board” will require more than sizes that the value of rebuilding customer legislation and regulation. Companies, boards trust and company reputation will always far and individual directors must all be willing exceed the cost and effort of doing so. It is to make the commitments and changes clear that good ethics is good business. required to protect shareholders and capital markets. 9
  10. 10. Board of Director Series — No. 1, 2009 The Changing of the Board Acknowledgements and Sources BACK TO THE DRAWING BOARD by Colin B. Carter and Jay W. Lorsch, Harvard Business School Press, Boston, 2004 BOARDS AT WORK: How Corporate Boards Create Competitive Advantage by Ram Charan, Jossey-Bass, San Francisco, 1998 BOARDS THAT DELIVER: Advancing Corporate Governance from Compliance to Competitive Advantage by Ram Charan, Jossey-Bass, San Francisco, 2005 CHAIRING THE BOARD: The Case for Independent Leadership in Corporate America, Millstein Center for Corporate Governance and Performance, Yale School of Management, New Haven, 2009 CORPORATE GOVERNANCE AND EQUITY PRICES, by Paul Gompers, Joy L. Ishii, and Andrew Metrick, Quarterly Journal of Economics, Vol. 118, No. 1, pp. 107-155, February 2003. CORPORATE GOVERNANCE: Principles, Policies and Practicies by Bob Tricker, Oxford University Press, New York, 2009 CORPORATE GOVERNANCE WEBSITE. DIRECTORS: MYTH AND REALITY by Myles L. Mace, Harvard Business School Press, Boston, 1971 and 1986. (Out of print.) HARVARD BUSINESS REVIEW ON CORPORATE GOVERNANCE, including article “Redrawing the Line Between the Board and the CEO.” Harvard Business School Press, Boston, 2000 SEC Votes to Propose Rule Amendments to Facilitate Rights of Shareholders to Nominate Directors, SEC press release. SUPERCAPITALISM by Robert Reich, Random House, New York, 2007 10
  11. 11. Board of Director Series — No. 1, 2009 The Changing of the Board About Boyden Boyden is a global leader in the executive search industry with more than 70 offices in over 40 countries. Founded in 1946, Boyden specializes in high level executive search, interim management and human capital consulting across a broad spectrum of industries. For more information, please visit About John Levy and Board Advisory John F. Levy is Chief Executive Officer and principal consultant for Board Advisory, a consulting firm that assists public companies, or companies aspiring to be public, with corporate governance, corporate compliance, ethics, financial reporting, and financial strategies. Mr. Levy has 30 years of progressive financial, accounting and business experience, including having served as Chief Finan- cial Officer of both public and private companies. As a frequent speaker on the roles and responsibilities of board members and audit committee members, Mr. Levy has authored “Focus on Corporate Ethics: Legal and Ethical Responsibilities of Board Members,” a course on the ethical and legal responsibilities of board members initially pre- sented to various state accounting societies. For additional Information about Board Advisory and John Levy, visit Special thanks are due to communications firm Margolis & Company for its perspective and support, particularly Dan Margolis and Sheldon Renan. Boyden Working Papers on Leadership is a new series of publications on innovative thinking and best practices for corporate leadership today. These working papers provide a foundation for discussion internally and externally, with multiple views of leadership that include sector-specific and global perspectives. Boyden Working Papers may be quoted or republished through internal or external channels. For further information, please contact Gray Hollett, Vice President, Global Marketing at Boyden — 11