Making Corporate Boards More Effective Professor Krishna Palepu Harvard Business School

“ A” Grade Board Members … “B” Grade Boards? Potential issues Role of directors Board information Board agenda Boardroom discussion dynamics Board leadership

Potential issues

Role of directors

Board information

Board agenda

Boardroom discussion dynamics

Board leadership

Key Board Functions Role: Protect the long-term interests of the corporation and external investors Oversight of Strategy CEO Appointment and Succession Planning Performance monitoring and Compensation Firm Management Oversight of financial reporting and legal compliance

Role: Protect the long-term interests of the corporation and external investors

Oversight of Strategy

CEO Appointment and Succession Planning

Performance monitoring and Compensation

Firm

Management

Oversight of financial reporting and legal compliance

New US Board Governance Requirements Focus: independent and empowered oversight and prevention of fraud Board independence Majority of independent directors Strict definition of independence Key board committees of independent directors Audit Committee – Financial expertise and oversight Compensation Committee – Compensation Disclosure and Analysis Nominating and governance committee – New director selection, and existing director evaluation Executive session of independent directors Auditor independence – appointment by audit committee, limit on consulting activities, partner rotation Internal controls audit (section 404 in the US) Management certification of financial statements

Focus: independent and empowered oversight and prevention of fraud

Board independence

Majority of independent directors

Strict definition of independence

Key board committees of independent directors

Audit Committee – Financial expertise and oversight

Compensation Committee – Compensation Disclosure and Analysis

Nominating and governance committee – New director selection, and existing director evaluation

Executive session of independent directors

Auditor independence – appointment by audit committee, limit on consulting activities, partner rotation

Internal controls audit (section 404 in the US)

Management certification of financial statements

Effective Board Practices Appropriate Board composition - right skills and capabilities Board size – large enough to staff committees, but not too large to prevent good discussions Board leadership – Chair/CEO, Lead director

Appropriate Board composition - right skills and capabilities

Board size – large enough to staff committees, but not too large to prevent good discussions

Board leadership – Chair/CEO, Lead director

Effective Board Practices (continued) Board information – streamlined information focusing on strategic performance metrics Board agenda – focus on key strategic issues and risks Time commitment – Board members’ ability and willingness to commit adequate time to prepare for and attend meetings Board meetings – adequate time allocation, and discussions that promote healthy debate Board retreats – annual retreats to focus on strategy and board evaluation

Board information – streamlined information focusing on strategic performance metrics

Board agenda – focus on key strategic issues and risks

Time commitment – Board members’ ability and willingness to commit adequate time to prepare for and attend meetings

Board meetings – adequate time allocation, and discussions that promote healthy debate

Board retreats – annual retreats to focus on strategy and board evaluation

McKinsey Study Survey of 824 US outside directors Two of the top three priorities – approving strategy and tracking progress against strategy … But Only 52% say they are satisfied with their access to strategic information

Survey of 824 US outside directors

Two of the top three priorities – approving strategy and tracking progress against strategy

… But

Only 52% say they are satisfied with their access to strategic information

A Potential Framework Focus Board’s agenda on key drivers of value and key risks that can derail the strategy (the 80-20 rule) Create a strategic board information system that allows tracking these key drivers on a regular basis

Focus Board’s agenda on key drivers of value and key risks that can derail the strategy (the 80-20 rule)

Create a strategic board information system that allows tracking these key drivers on a regular basis

A Framework For Boards (2) Focus on strategic drivers in approving strategic initiatives and resource allocation on-going performance evaluation and compensation oversight of financial reporting and disclosure

Focus on strategic drivers in

approving strategic initiatives and resource allocation

on-going performance evaluation and compensation

oversight of financial reporting and disclosure

Strategy: Five Key Questions What is the customer need we seek to satisfy? What is the competition? How do we differentiate ourselves? What are the key capabilities and processes to successfully differentiate? What are potential threats to our differentiation?

What is the customer need we seek to satisfy?

What is the competition?

How do we differentiate ourselves?

What are the key capabilities and processes to successfully differentiate?

What are potential threats to our differentiation?

Will our Strategy Create Value? Strategy Organizational Capabilities Business Processes Customer Value Shareholder Value

Two Key Questions on Execution Are we investing in the right capabilities and processes to execute our strategy? Do our customers experience the promised differentiation?

Are we investing in the right capabilities and processes to execute our strategy?

Do our customers experience the promised differentiation?

A Simple Strategic Board Information System “ One-pager” on strategy (for each business) “ One-pager” on customer metrics & related strategic initiatives during the year “ One-pager” on key process and capability metrics & related strategic initiatives during the year “ One-pager” on key competition and industry developments

“ One-pager” on strategy (for each business)

“ One-pager” on customer metrics & related strategic initiatives during the year

“ One-pager” on key process and capability metrics & related strategic initiatives during the year

“ One-pager” on key competition and industry developments

Strategic Agenda for Board Retreat Reaffirming the current strategy or discussing potential changes to it Discussing strategic initiatives for the year Shore up key capabilities related to our competitive advantage Expand into new geographies Enter new businesses M&A, partnerships

Reaffirming the current strategy or discussing potential changes to it

Discussing strategic initiatives for the year

Shore up key capabilities related to our competitive advantage

Expand into new geographies

Enter new businesses

M&A, partnerships

Strategic Agenda for Board meetings Tracking the progress of the strategic initiatives identified in the retreat Drilling deeper into one aspect in each meeting Customers Competition Key Capabilities and processes Key strategic business risks

Tracking the progress of the strategic initiatives identified in the retreat

Drilling deeper into one aspect in each meeting

Customers

Competition

Key Capabilities and processes

Key strategic business risks

Potential Pay-offs Focus limited Board time on what is strategically critical Add an external market focus to Board’s agenda Identify problems early on, so they can be discussed and corrected Linking Resource Allocation choices, Audit and Compensation committees’ work with the broader Board work

Focus limited Board time on what is strategically critical

Add an external market focus to Board’s agenda

Identify problems early on, so they can be discussed and corrected

Linking Resource Allocation choices, Audit and Compensation committees’ work with the broader Board work

Process Issues Initiating the process - board evaluation, board retreat, external facilitators as triggers Bringing the CEO/Management on board Articulating the role of management versus Board - avoiding micromanagement but performing the oversight role Role of the Board Leader in board information design, agenda setting, and board discussions

Initiating the process - board evaluation, board retreat, external facilitators as triggers

Bringing the CEO/Management on board

Articulating the role of management versus Board - avoiding micromanagement but performing the oversight role

Role of the Board Leader in board information design, agenda setting, and board discussions