Monday April 21, 2014

Refuting (At Least) 5 Myths of Governance

From the fundamental job of boards (it’s not to represent shareholders) to making decisions the right way rather than making the right decision.

I take governance very seriously, having spent 32 years in the field (ouch! I’m old!), so when it came time to write my blog, it was more like a block (as in writer’s block). Today, in desperation, the NACD “Blogmeister” gave me a simple assignment: name Five Governance Myths.

Where to begin? There are hundreds of them—and we at NACD spend much of our time dispelling them. Our main tool for setting the record straight is our set of Key Agreed Principles, reflecting a consensus of managers, shareholders and directors.

So, what are some of the myths, why do they matter, and how can directors overcome them through action?

Governance Myth Number 1: The fundamental purpose of the board is to represent the desires of shareholders.

This “agency theory” is close, but no cigar. The truth is that the board is there to build the long-term value and sustainability of the corporation on behalf of shareholders and all stakeholders. Believing the agency theory myth causes problems because it cuts other constituents (for example, rank-and-file employees) out of the picture.

Action step for directors: When requesting reports from management, ask for long-term financial projections and constituency impact statements (with proper disclaimers, of course).

Governance Myth Number 2: The main job of the board is to monitor management.

There goes that agency theory again. This isn’t even close, and frankly, it’s insulting (makes it sound like all CEOs and CFOs are crooks). The main job of the board is to select and develop a CEO, who will in turn select and develop a management team that will in turn select talent that can create and market worthwhile products and services. Believing the monitoring myth creates headaches because it puts everybody on the defensive and impairs productivity.

Action step for directors: Work with senior management and the head of human resources to develop and implement a CEO succession plan that empowers managers to be the best they can be.

Governance Myth Number 3: The main purpose of a board or committee meeting is to hear, discuss and vote on proposals from management.

This is fine for Civics 101, but the real world delivers more board value. If your company is using directors in this way, it is wasting a powerful resource. When a company has a fully engaged board, not all ideas come from management; sometimes they come from the board. There are times when instead of giving a long proposal to the board, management is better off making a very short proposal and then asking a question: What do you think? The board meeting then becomes a living proposal. (Indeed, this was exactly how we came up with our Key Agreed Principles mentioned above!)  The idea that directors are there only as a sounding board deprives a company of board brainpower.

Action step for directors: Insist that the meeting agendas have short timeframes for presentations and long timeframes for discussion.

Governance Myth Number 4: When considering management proposals, directors only know what senior management tells them.

The fancy name for this is “information asymmetry.”  It’s a problem but hardly a universal law. Directors receive information from many sources—including from the results of their own research, and reports from the consultants they are empowered to hire. Under Sarbanes-Oxley Act Section 301, “Each audit committee shall have the authority to engage independent counsel and other advisers as it determines necessary to carry out its duties,” and “each issuer shall provide for appropriate funding  … to any advisers employed by the audit committee under paragraph (5).”

Also, remember that audit committees receive direct reports from the internal audit function, which may or may not be part of senior management, and hotlines bring the information connection down to the shop floor. Most governance guidelines specifically permit board members to make and receive direct contact with any employee, as long as they inform the CEO of any non-routine contact. Believing otherwise impedes communication.

Action step for directors: Learn as much as you can about the companies you serve, from as many sources as you can. Rob Galford’s recent post on this subject is a good place to start.

Governance Myth Number 5. When it comes to governance, process is everything.

This is a half-myth, because it’s almost true, but it still misses the mark. To be sure, it is much more important for the board to make a decision the right way than to make the right decision. This is the basic idea behind the judicial concept called the Business Judgment Rule, and it was the great lesson of the 2005 Disney case decided by the Delaware Chancery Court as well. But the problem with believing in this half-myth is that if directors believe process is everything, they may start focusing too much on the mechanics of decision making and avoid making any decisions based on their own experience and intuition, which can sometimes transcend procedures:

Action step for directors: Go through all the proper steps—but don’t get so hung up in process that you miss a chance to make a good decision.

Comments on “Refuting (At Least) 5 Myths of Governance”

  • Ralph Ward says:

    I’m not so sure on some of these, Alex.

    No. 1 strikes me more as an excuse for bloated, drifting management strategy — telling the shareholders that cuts, restructuring or selling the company would “harm the stakeholders.” The old General Motors was a stakeholder company (the “stakeholder” being UAW employees), and there the approach just delayed collapse and made it more massive.

    Myth #2 may be a myth, but board monitoring of management and operations is precisely what SOX, subsequent laws, and the new corporate reform bill enforce with a vengeance. Agreed, it leads to “check box” governance, but if it keeps directors out of court, it’s a hard myth to buck.

    This also addresses myth #5. Considering what a lousy job most boards make of “process” (good agendas, mechanics, meetings, info, etc.) the last thing we want to do is dismiss it as a “myth” that gets in the way of good governance.

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