It is telling that for the second year in a row we have given top billing to a regulator. This year’s most influential person in the boardroom is U.S. President Barack Obama. (Last year, it was Congressman Barney Frank, chairman of the House Committee on Financial Services.) Obama and his team have moved quickly, in FDR fashion, to stabilize the markets, shore up the financial system, and inject stimulus into the economy. For now, these measures seem to be working. It is likely that Obama’s team of financial minds will set their sights on putting measures into place to discourage the malevolent behavior that led to crisis. Most executives and directors favor some form of common-sense reform. In fact, many CEOs, such as Goldman Sachs’ Lloyd Blankfein, have been proactive in calling for sensible reforms on executive pay practices and in other areas.

Finally, I want to thank you, our readers, for your input on the list through the numerous polls and online surveys we issued. The Directorship 100 is meant to begin the dialogue, not to end it. So, please join the discussion online at www.directorship.com/D100-2009.

If the job of finding great new directors is difficult, so is the job of sitting on a board, especially for the first time. Here is some common-sense advice for new directors. First, and most importantly, remember that directors direct and managements manage.

Why Serve?
Understand why you choose to serve and embrace it. In earlier times, directors often served for prestige, compensation, and fellowship, and their performance rarely was challenged. Those halcyon days are gone. You now must consider reputational risk, substantially expanded (and often last-minute) time commitments—perhaps at little per-diem pay—and a more formal environment (which can impinge on candid strategic focus). Do due diligence on the company and its industry, as you will be judged in the court of public opinion—and perhaps even in the courthouse. You’ll need courage, good business instincts, and the rare ability to judge others accurately.

Directors must exercise due care in decision making and need, as much as possible, to ensure that the information they receive is accurate, complete, timely, and verifiable.

Reliance on Outside Advisors
As a matter of corporate law, directors are generally entitled to rely on advice from outside advisors, including compensation consultants. Directors should exercise care in selecting experts and shouldn’t hesitate to question those experts as much as necessary.

We recommend that the following be adopted as standard best practice for directors:
1. Audit Committees should meet regularly with supervisory partners of their firm’s auditors, not just the audit partner, and should require that the auditors disclose conflicts and disagreements about accounting matters and the consequences thereof. Auditors already disclose conflicts with management and “opinion-shopping”, but directors need to understand the “close calls” that accountants are making.

2. Compensation Committees should focus more on actual performance and on compensation expected under different scenarios, and less on consultants’ standard pitches on comparables.  Rewards for performance must be based on realistic goals, taking into account the environment and the factors management controls. In general, paying annual bonuses for performance only relative to an earnings budget should be avoided (because management controls the budget) and relative to peers’ stock performance equally (because management doesn’t control either its own or peers’ stock prices). Further, mark-to-market accounting of financial investments, determination of pension liabilities, and other key P&L components can be manipulated to affect reported profits and compensation. True operating cash flow, and performance relative to competitors, while also not perfect, are worth considering as performance measures. Proper use of deferred payouts tied to actual realizations will go a long way towards realigning managements’ and stockholders’ interests.

3. Boards should receive regular presentations from outside counsel about important trends and cases in corporate law, especially those affecting their duties and their liability. In addition, directors should be assured on a regular basis that each of their primary law firms has brought forward any legal or ethical concerns.

Board Oversight
It goes without saying that boards should focus on economic and financial scenarios covering the full gamut of assumptions. In the current environment, liquidity is a key concern. At other times, expansion or strategic transactions may play a larger role.

Management will always control the flow of information, and even deeply engaged boards will be on the losing end of an asymmetry of knowledge. But directors must exercise due care in decision making and need, as much as possible, to ensure that the information they receive is accurate, complete, timely, and verifiable.
We offer the following suggestions to mitigate, at least partially, the inherent disadvantage directors face due to this asymmetry.

First, ensure that management provides access to, and explanations about, competitors’ performance. Detailed understanding of relative competitive assessment of revenue growth, operating margin, employee turnover, customer satisfaction, and pricing policies will be far more useful than reiteration of historical financials or unsupported projections. Rating agencies face conflicts and their work cannot always be relied on (in any case, ratings often lag reality), and securities research can be superficial and dominated by management or employers. Spend time finding out how the firm is really doing.

Second, create and exploit opportunities to engage informally with employees at all levels of the organization. Plant managers, sales staff, and human resource middle managers, for example, will have a less edited view of how the business is going than you will hear at board meetings.

Third, make sure senior management regularly reinforces the responsibility, under a code of conduct or ethics policy, for every employee to notify an outside board member, anonymously or not, of any planned or known misconduct, whether financial fraud, Foreign Corrupt Practices Act payments, improper behavior, or other improper actions. The purpose of this “honor code” is to give directors more eyes and ears.

Fourth, make sure Board meetings include enough time for the independent directors to reflect in executive session on the reports they have received and to raise questions for later follow-up.

It is important for directors to have a good working relationship with management, and, at the same time, one that permits directors to exercise their responsibilities. This relationship best can be described as one with “healthy tension.” Directors and management need to understand that asking probing questions is not done out of suspicion: Sometimes judgments of senior management are just wrong, and directors must press their questions, no matter how uncomfortable this becomes.

Knowing Good from Bad
There is no perfect system for identifying a CEO who lacks honesty, integrity, or capacity. Just as a board needs to know the physical health of top officers, however, it also should (subject to reasonable limits on privacy) understand their financial health, and, as much as possible, their values. Financial circumstances, especially excess leverage, sometimes force desperate people to take improper steps.

One tip after years of experience: In addition to probing executives’ financial health, if a CEO regularly requests less compensation than his/her compensation committee would have awarded, that CEO is less likely to get the company into trouble via excessive risk taking or fraud.

Good luck to all new board members, and, remember, selecting a good CEO and helping him or her achieve the goals set by the board is one of your most important jobs.

Herbert S. Winokur is managing general partner of Capricorn Holdings and has been a director of numerous public companies.

Bob Pozen, chairman of MFS Investment Management and former vice chair of Fidelity, suggested that what’s needed is a re-examination of board structure in the aftermath of the financial crisis. “Some of the most distinguished people serving on boards–take Citigroup, for example–didn’t have a clue about what was going to happen” He suggested that most bank boards are simply too large and that corporations should be monitored by “the smallest board necessary.”

Fawcett, now chairman of Pensions First Group and Guardian Media Group, which publishes the Guardian and Observer newspapers in the U.K., and a director of State Street Corp., pointed out issues tend to get lost when a board has upwards of 17 or 18 members. What’s needed, she suggested, is “diversity of thought and experience. That’s diversity with a small ‘d.’ Those [financial] institutions whose boards were diverse tended to fair better because of the wide body of expertise.”

Pozen also questioned the wisdom of mandatory retirement for directors, calling it “wrong.” Directors age 60 and older  have both the experience and the time needed to devote to board service.

Noting that “two out of three deals fail,” a director in the audience asked what the board’s role should be after a merger or acquisition?  Ruettgers, who served as chairman of EMC, a data storage company that grew largely by aggressively pursuing an M&A strategy, said the board set up a separate acquisitions committee to review some smaller deals that didn’t need to rise up to the full board level. The board’s role, too, Ruettgers suggested is to compel management to put together a process for integration that can be monitored.

Governance reform, whether legislated or mandated by the Securities and Exchange Commission, looms large. Say on pay, proxy access, broker vote, and the separation of the chairman and CEO role are all up for debate. Drawing from her U.K. experience where “almost nothing is legislated,” Fawcett noted that these issues are addressed on a “comply or explain basis.” Posen predicted that hedge funds would become more active users of these procedural changes. “This opens the door to activist shareholders,” he said.

All business executives and board members would do well to consider the odds against Lincoln and how forcefully he inspires, while reprimanding, his general:

Lincoln’s Message to George B. McClellan
April 9, 1862:

Washington, April 9, 1862

Major General McClellan.

My dear Sir,

Your dispatches complaining that you are not properly sustained, while they do not offend me, do pain me very much.

Blencker’s Division was withdrawn from you before you left here; and you knew the pressure under which I did it, and, as I thought, acquiesced in it — certainly not without reluctance.

After you left, I ascertained that less than twenty thousand unorganized men, without a single field battery, were all you designed to be left for the defense of Washington, and Manassas Junction; and part of this even, was to go to Gen. Hooker’s old position. Gen. Banks’ corps, once designed for Manassas Junction, was diverted, and tied up on the line of Winchester and Strausburg, and could not leave it without again exposing the upper Potomac, and the Baltimore and Ohio Railroad. This presented, (or would present, when McDowell and Sumner should be gone) a great temptation to the enemy to turn back from the Rappahanock, and sack Washington. My explicit order that Washington should, by the judgment of all the commanders of Army corps, be left entirely secure, had been neglected. It was precisely this that drove me to detain McDowell.

I do not forget that I was satisfied with your arrangement to leave Banks at Mannassas junction; but when that arrangement was broken up, and nothing was substituted for it, of course I was not satisfied. I was constrained to substitute something for it myself. And now allow me to ask “Do you really think I should permit the line from Richmond, via Mannassas Junction, to this city to be entirely open, except what resistance could be presented by less than twenty thousand unorganized troops?” This is a question which the country will not allow me to evade.

There is a curious mystery about the number of the troops now with you. When I telegraphed you on the 6th. saying you had over a hundred thousand with you, I had just obtained from the Secretary of War, a statement, taken as he said, from your own returns, making 108,000 then with you, and en route to you. You now say you will have but 85,000, when all en route to you shall have reached you. How can the discrepancy of 23,000 be accounted for?

As to Gen. Wool’s command, I understand it is doing for you precisely what a like number of your own would have to do, if that command was away.

I suppose the whole force which has gone forward for you, is with you by this time; and if so, I think it is the precise time for you to strike a blow. By delay the enemy will relatively gain upon you — that is, he will gain faster, by fortifications and reinforcements, than you can by reinforcements alone.

And once more let me tell you, it is indispensable to you that you strike a blow. I am powerless to help this. You will do me the justice to remember I always insisted, that going down the Bay in search of a field, instead of fighting at or near Mannassas, was only shifting, and not surmounting, a difficulty — that we would find the same enemy, and the same, or equal, entrenchments, at either place. The country will not fail to note — is now noting — that the present hesitation to move upon an entrenched enemy, is but the story of Manassas repeated.

I beg to assure you that I have never written you, or spoken to you, in greater kindness of feeling than now, nor with a fuller purpose to sustain you, so far as in my most anxious judgment, I consistently can. But you must act.

Yours very truly,
A. Lincoln

The good news is that by using basic office tools (e.g. email, documents) people are executing these unstructured processes and the work is getting done. The bad news is that the business has no visibility into these processes–either during execution or upon completion; no IT support for control, management and tracking of these process; and no way to measure the effectiveness of these processes. This is becoming a critical business issue since these human processes are not just on the periphery of the business, but are the heart of the business and run the gamut from strategic planning processes to compliance tracking to audits. For many companies, the way they handle unstructured processes is the key differentiator between their execution capabilities, and those of their competitors.

Until now, most companies have focused their process management efforts on the larger, structured processes like Customer Relationship Management (CRM) and Enterprise Resource Planning (ERP). As the system for managing these structured processed have been implemented, both companies and analysts are coming to the realization that focusing on their structured processes isn’t enough; they need to start paying attention to their unstructured processes. Ignoring these unstructured processes is expensive and risky. For example, an overlooked email causing a missed government regulation deadline that leads to fines and sanctions; an inefficient investigation of a customer fraud report causing unneeded additional expense and an unhappy customer; and an incomplete audit because of missed communication or an audit with unimplemented findings that fell between the cracks.

It is no mystery why this happens. Email and documents are the preferred tools for running such processes – just take a look at your own email inbox. For most of us it contains some spam, personal items, one-off correspondence and a number of ongoing business processes that you actively participate in, or need to know about. The email chain of these “long running” business processes are scattered throughout your inbox and the inboxes of other participants, making them easy to overlook, hard to manage and almost impossible to audit. Some may have critical actions that you need to take, while others are on hold while some aspect is being handled by others. Some of the processes you own, while in others you are just a participant. Multiply your own experience by the number of “knowledge workers” in your organization and you get a feel for the scope of the problem.

Until your business has visibility into these unstructured processes, you really aren’t managing most of your business processes. If these processes should be tracked for compliance reasons, or are part of some larger compliance process, then this lack of visibility and auditability can cause real issues. For example, think of your businesses regulatory and compliance processes. These are people intensive processes which are kicked off as a result of an external regulation. Think of how many emails and documents are generated by these processes–does your business really know how compliance procedures are being executed? Or, where each of the currently running compliance processes stand? Since these processes tend to be ad-hoc and changing on a case-by-case basis, people tend to use ad-hoc methods (e.g. documents and email) to deal with them. But, since they entail some type of penalty, if not completed on time, the business needs the ability to track and monitor the process. Enabling the monitoring and tracking of unstructured processes also enables a system-of-record for these processes and their execution–an invaluable asset if issues arise and an audit trail is needed. Sarbanes Oxley compliance and Health, Safety, Environment processes are examples of unstructured processes that fall into this category.

Managing unstructured processes related to compliance, can be a valuable way to lower your company’s risk. As opposed to structured solutions to compliance which require new applications for each regulatory requirement, managing unstructured processes is a good catch-all solution for compliance requirements. Managing unstructured processes brings with it visibility and accountability which didn’t exist before, and allows management the ability to take charge of all processes that have compliance requirements, without the need for a specific tool for every regulation, or additional compliance related staffing. It can also provide a system of record for process execution, which can be used for compliance or performance optimization purposes.

Another type of related process is internal audits. Internal audits of various organizational processes and the adherence to corporate guidelines generate a lot of back-and-forth and negotiations before findings are published. In most cases, email and spreadsheets are the preferred tools for handling internal audit processes–making tracking and control very difficult, if not impossible, and provide no visibility into the process. The ability to track and monitor these negotiations can ensure that the audit process stays on track and on target. Once the findings are accepted and published, tracking related processes that were kicked-off to address the findings ensures that nothing falls between the cracks. This type of visibility and tracking can be especially valuable to board committees such as the audit committee, enabling them to track the status of various audit-related activities company wide.

A completely different type of unstructured process is decision tracking. For example, take the minutes of a board of directors meeting. High-level decisions are taken which need to be translated to execution. These decisions should kick off a set of unstructured processes with the goal of implementing those decisions. The problem is that there is no real way to track how the implementation is progressing, since each decision can generate tens of related human processes. How many times has your company made decisions that dissipate and never get implemented since there was no way to track and monitor the progress made? Being able to track and monitor the human processes surrounding decision implementation allows monitoring and follow up to ensure decisions are implemented.

Managing unstructured processes can have another benefit–they can be an “early warning system” of changes in the business and customer environment. Most companies have structured processes management tools for basic process like CRM and ERP. These tools handle the standard process flows very well, but they all have a mechanism (usually email) for initiating an unstructured, human process to handle exceptions to the structured process, or to handle escalations outside the scope of the normal process flow. Tracking these “exception” processes can be very valuable since they can provide an “early warning systems” of changes in the business and customer environment–that isn’t visible through any other system.

Let’s say you are convinced that managing your businesses ad-hoc, unstructured processes is beneficial both from a bottom line perspective and risk mitigation perspective. So how do you get started? What can you do tomorrow?

The first step is to start paying attention to the unstructured processes in your organization. Once you start looking, you will see them everywhere. The next step is to get management and IT on board. Choose a domain that will have quick benefit from managing their unstructured processes. Audits can be a good place to start, for example. Together with IT, have them start looking into tools for managing these unstructured processes. Vendors are starting to provide tools to support unstructured, human processes and companies need to start adopting these tools. The process tools that are fastest to implement allow workers to continue to use the work environment they know and are familiar with (i.e. email and documents), but enhance those tools so that they have a process focus, provide a process execution system of record and allow for the tracking and management of unstructured processes.

In short, every business runs on unstructured, human processes. These processes are the human side of business processes. They consist of gathering information, collaborating and negotiating with others, and making decisions, all which are fundamentally human activities. These processes are pervasive, including about 60 percent to 80 percent of all businesses processes – ignoring these processes is costing you money, and increasing your risk. The time has come for directors and executive management to be proactive at getting their companies to manage their unstructured processes as way towards operational excellence and lowered risk.

Jacob Ukelson is CTO of ActionBase, a company that provides Human Process Management Solutions that enable businesses to manage their business critical processes.

A core responsibility of the board is to engage with management in the development of an effective corporate strategy. After all, corporations are managed “under the direction” of boards, according to most state corporate laws—and therefore the board is ultimately accountable for the quality of the company’s management, including any strategic plans made and pursued by management.

As fiduciaries, directors have a duty to protect the corporation against threats to its long-term viability. To be sure, the level of direction provided by a board varies from company to company. Directors can be strategic assets to the corporation in a number of ways: by serving as a sounding board for management; providing performance-enhancing ideas; and offering constructive skepticism. Most importantly, the board can be a source of strategically relevant competencies.

As boards anticipate regulations to come from the new presidential administration, focus on the more intangible aspects of governance, such as strategy, will likely be redirected toward concrete compliance-oriented tasks. In surveys conducted for more than 15 years, NACD has found that director interest in strategy rises and falls in negative correlation to regulatory change affecting boardrooms. Following any period of regulatory reform, interest in strategy tends to wane while interest in compliance rises.

Directors should stay focused on strategy. Principle VII of NACD’s Key Agreed Principles provides the necessary guidance to create governance structures that enhance a board’s ability to maintain this focus. Sustaining and enhancing the value of a company through a well-conceived plan is vitally important. Even the best leaders can fail if they are fulfilling a bad or poorly implemented plan. Boards can veto poor strategic choices and make sure that management’s plans, well implemented, enable the organization to fulfill its highest potential for the benefit of all.

Current Guidance

Existing guidance on the board’s engagement in strategy has been issued by commissions of directors and governance experts, notably in the Report of the NACD Blue Ribbon Commission on the Role of the Board in Corporate Strategy (issued in 2000 and updated in 2006). We’ll review this universal guidance for engagement and then identify new challenges that boards must address quickly in the current environment.

The nature and extent of the board’s involvement in strategy will depend on the particular circumstances of the company and the industry in which it is operating. While the board can—and in some cases should—use a committee of the board or an advisory board to analyze specific aspects of a proposed strategy, the full board should be engaged in the evolution of the strategy.

The board should be a strategic asset—directors should individually and collectively seek to go beyond mere compliance and add value to the corporation. In general, directors can be effectively engaged in strategy by:

• Providing advice, counsel, and perspective;
• Challenging the underlying assumptions of management;
• Establishing high, realistic standards;
• Identifying additional opportunities and risks associated with the strategies under discussion;
• and Supporting the CEO during challenging periods of strategic implementation.

Corporate strategy is an ongoing process requiring oversight. Management brings vision while boards bring perspective. Management chooses a direction while the board, based on members’ diverse viewpoints, asks: Why? How? What if? As such, boards should be constructively engaged with management on an ongoing basis to support the appropriate development, execution, and modification of the company’s strategy.

Development

To take full advantage of their respective strengths, management and the board can jointly establish the process that the company will use to develop its strategy, including an understanding of the roles of both management and the board.

There is not always a “bright line” between management’s role and the board’s role, and involvement may vary. The role of management, ideally, is to engage the board in the strategic discussion and ultimately obtain board approval. The role of the board is to evaluate the strategy and challenge underlying assumptions. The board can serve best by providing strategic thinking and enhancement, rather than suggesting specific tactics. It is important to bear in mind these distinct roles so that the board does not usurp management’s role or fail to fulfill its own.

Companies can benefit from establishing clear yet flexible procedures whereby management and the board can exchange ideas through constructive interaction. This will help management develop a sound strategy, and help the board ensure the use of appropriate measurement criteria and benchmarks. It will also ensure that both management and the board fully understand and support the long-term direction the company will take. This “team-oriented” or cooperative approach can also foster a higherquality dialogue between management and the board, and enable management to make use of the expertise and experience of board members.

Evaluation and Monitoring

Once a strategy is approved, the role of the board is to provide ongoing evaluation of the strategy by monitoring implementation and encouraging changes, as events require. Therefore, to participate effectively in the strategic process, directors must thoroughly understand the assumptions and analysis upon which the strategy is based. Management should regularly update the board on the implementation and execution of the strategy. Directors should be prepared to ask incisive questions—anticipating, rather than reacting to, issues of major concern.

The board should ensure that management demonstrates commitment to the strategy, allocates adequate resources to its fulfillment, has a professional and financial stake in its execution, and adequately reports on its progress. The board should additionally monitor execution of the strategy against milestones. On an ongoing basis, the board must be willing and able to recognize whether or not the company has a winning strategy—and, if it does not, must be ready to urge corrective actions. The board should ensure that management makes modifications to the strategy as necessary.

Linking Strategy and Leadership

There is a strong tie between leadership ability and corporate performance. The board must ensure that the CEO has a clear understanding of the corporation’s strategic vision and has concrete ideas on how to implement that vision.

Moreover, the board needs to understand that leadership competencies are not all the same and industry dynamics are constantly changing. The strategic skills that senior managers possess must align with the future strategic challenges they will face. The board should establish achievable executive compensation objectives that reflect the company’s strategy, and define and communicate clear metrics and criteria for CEO evaluation that are tied to long-term strategic goals.

Future Challenges

Directors will always be challenged with finding a winning combination of strategy and risk for their companies. As boards grapple with the current complexities of strategy, the NACD believes the following issues will confront them.

Information is essential but it must be actionable. In strategic planning, the right information can help an organization successfully navigate its way through the marketplace. Directors are generally satisfied with the reliability of information contained in reports they receive from management, but the presentation of that information is often difficult to digest. Management’s main job is to bring the right information to the table. Directors, on the other hand, must then help management determine how the company will act in response to the information over the short, medium, and long term.

Greater Board Engagement

Typically, management develops a strategy with input from the board. In fact, according to the NACD Survey, slightly more than half of companies follow this model, while about 16 percent of boards work collaboratively with management in developing the strategy. Boards and management should consider earlier and greater collaboration when creating, refining, or (in rare cases) overhauling a strategy.

Directors must increase dialogue with management by asking the questions they want answered, rather than receiving information management wants to provide. Finding the right questions to challenge management’s conclusions is a director’s most difficult yet most valuable responsibility. As such, directors can ask management to limit their use of presentations in the boardroom and request unscripted time with the CEO for a free exchange of ideas.

Aligning Board Composition with Strategy

Companies have always tried to recruit accomplished professionals to sit on their boards, but sometimes directors’ backgrounds bore little connection to the company’s strategy. Today, enlightened boards are seeking directors with particular skill sets and expertise to complement their strategic goals. All boards can benefit from continually reviewing and evaluating the board’s size and membership mix to ensure a close fit with the strategic direction of the company.

Directors can develop a matrix of skills and expertise that the board requires in order to identify the leadership needs of the corporation, work with leaders to develop an appropriate strategy, and offer needed perspectives and advice in key areas. For example, a company looking to expand into international markets would seek directors who have business experience in those markets to ensure that the board can appropriately oversee the strategic plans and underlying risks of those plans.

Aligning Goals

The problem of short-termism has been well-established by a variety of studies and commissions, including, most recently, the Aspen Principles (Long-Term Value Creation: Guiding Principles for Corporations and Investors). The Aspen Principles, supported by the NACD, state that companies and investors should recognize that firms have multiple constituencies and many types of investors, and they should seek to balance these interests in accordance with their influence on the corporation’s long-term success.

Generally, companies should not seek short-term profit at the cost of long-term value. To avoid this, boards can develop forward-looking strategic metrics of corporate health. At the same time, boards can emphasize the need to achieve long-term goals while retaining benchmark reviews for the shortand medium-term goals as well.

Conclusion

Corporate performance depends upon corporate strategy. The board’s role in overseeing strategy is crucial. While a number of best practices have emerged, defining appropriate strategic engagement is still among the biggest challenges for boards. Improvement of corporate performance will require board members to become more actively engaged in the process of strategy creation. Directors must begin by requesting both time and information from management.

Boards must request unscripted time with management to probe the assertions and direction of the strategic plan. To foster this dialogue, boards need relevant and concise information—a current snapshot of performance. Improvement will also come from within the board itself. Careful selection of directors with relevant past experiences will enhance the board’s professional skills matrix. Most importantly, boards must have a steady hand to guide the company to long-term success.

Educating directors is vitally important to board success. NACD will deliver the findings in this white paper to boards directly through educational initiatives such as our Director Professionalism Courses and our Board Advisory Services, with the essential goal of empowering directors to act in the face of changing business, economic, and governance conditions.

The NACD White Paper Series I and Key Agreed Principles are not meant to prescribe a specific course of action; they point toward a direction—one that only the board, with management, can choose. The time to make that choice is now. Directors are leading the way to help restore confidence in the corporate governance of U.S. companies through the Director Challenge campaign. To obtain the Principles and White Papers, along with discussion tools for exploring them in your own boardroom, visit www.nacdonline.org/directorchallenge.

#1: Improve Cost Discipline: Reduce COGS and Capital Use, Not G&A Spending

Sometimes, the most effective strategies appear at first to be counterintuitive. For example, it’s natural to seek cost discipline by attacking the close-in and relatively fixed area of General and Administrative (G&A) expenses. While organizations should attack G&A to get rid of the fat, if they focus only on G&A then they risk cutting beyond the fat to “muscle and bone.” In fact, G&A cuts can actually make a company less efficient by shifting direct costs to indirect costs (e.g., automated work becomes manual). Moreover, unlike operational improvements, cuts to overhead often prove unsustainable. Most importantly, companies focused only on cutting G&A risk are missing out on the far greater cost-reduction opportunity that exists in Cost of Goods Sold (COGS).

Making cuts in COGS enables companies to achieve lasting operational efficiencies. CEB finds that not only do cost leaders focus on COGS, they actually maintain higher levels of G&A than their peers, leveraging selective G&A investments to reduce the cost of ongoing operations. This enables companies to create a far stronger long-term cost position.

Incorporate capital costs into SKU reduction efforts.After years of relentless focus on sourcing and operational efficiency, the next generation of COGS reductions will come from eliminating unprofitable products. How do you optimize the cost-benefit? The answer is to look beyond conventional approaches to measuring individual SKU profitability. Many companies fail to include the cost of capital in their calculations of SKU profitability—usually because traditional cost-accounting systems do not measure capital costs. As a result, economically unprofitable SKU’s (which earn less profit than the cost associated with funding them) are systematically retained. This phenomenon becomes increasingly important as capital costs rise due to tight credit markets. The best companies make a point of including capital costs in their assessment of SKU profitability, calculating and subtracting the marginal cost of funding from SKU profitability.

#2: Protect Growth Initiatives: Elevate, Consolidate, and Protect Innovation Funding

Name and protect explicit growth bets in the capital budget.
The complement to cutting the right costs is protecting critical growthinvestments. The current economic crisis sees companies planning forincreased costs and reduced investment dollars for 2009 by activelycutting capital expenditures across the board-—especially targetingcapital projects that can be deferred. Yet, CEB finds that the bestcompanies carefully protect their key growth bets from short-termfinancial pressures. They segment their budgets with targets for bothexplicit cost savings and growth projects. They then drive both bysacrificing those pockets of “business as usual” spending that haveless strategic value.

Incorporate concrete innovation targets into performance expectations and reporting, even amidst belt-tightening.
Herd mentality and high anxiety have public companies largely managingto short-term investor expectations. But in 2009, the best companieswill manage to the interests of long-term investors. They will committo a few concrete innovation projects and allow business owners todecide how best to achieve them. This strategy puts tough trade-offswhere they should be—in the hands of business owners—and encouragesthem to consider efficient sources of innovation that can yield higherROI. It also brings to light those executives who can best managescarce innovation resources during a period of belt tightening. CEBresearch shows that the best companies realize these goals in twoprimary ways:

• Cascade Innovation Targets into Multiple Functions
  Simply put, the best companies spread the responsibility for innovationaround. In addition to cost and budget levers, companies can hittop-line innovation targets by motivating fresh thinking not justwithin R&D, but across other functions that can also contribute togrowth (e.g., Marketing, Procurement, and Information Technology).
• Create Central “Growth Guardians”
  Instead of dispersing oversight for emerging growth platforms, the bestcompanies will assign accountability and authority for critical,explicitly named, emerging business opportunities. These guardians willaggregate some investments to preserve big growth bets.

#3: Leverage Financial Strengths: Reenvision Your value Chain as a Capital and Pricing Chain

Foster innovations that target the shifting financial strength of customers and suppliers.
Meetingcustomers’ needs is fundamental to growing your margins in both goodtimes and bad. The best companies understand how the economic crisis isshifting customer needs and values, and are transforming theirofferings through product and service innovations to address what’smost important to their customers now. Currently, that includes helpingthem reduce costs and free up cash. Consider these ways to capturesustainable margins:

• “Bite-Size” OffersConsumers in developed countries have long paid more up front forproducts in bulk (e.g., laundry detergent), saving on unit costs overtime. In contrast, consumers in developing countries buy these productsin the single-use sizes they can afford. Benefit from the coming shiftas consumers in developed countries seek lower up-front costs, payingmore per unit to buy less at one time—even if they buy the same amountacross the year.
• Terms of Purchase Inthe airline industry after 9/11, winning suppliers found innovativeways to help their customers continue to buy from them. For example, GECapital provided liquidity to airlines by purchasing their planes andleasing them back. Look to your relative financial strengths to freecash for customers.

On the supplier side, youcan use healthy balance sheets to create win-win deal terms in returnfor better prices or guaranteed availability of critical supply. Lookfor opportunities across your value chain by bringing differentsupplier-facing functions to the table to understand how today’sfinancial conditions are impacting critical suppliers. With this fullpicture, companies can position themselves at a distinct advantage withcritical suppliers.

#4: Exploit Risk Opportunities: Embrace, Don’t Eradicate, the Right Risk Exposures

Harmonize executive risk tolerances and pursue those you are uniquely positioned to manage.
During the financial crisis, the possibilities you’re able to see andseize will be shaped by your unique risk exposure and capabilities.Perspectives on risk differ not only among companies, but betweenexecutives within an organization. Especially in times of financialuncertainty, the best companies harmonize these divergent views—not tosuppress diverse viewpoints, but to create a common decision-makingframework. For example, an executive team that aligns Sales and Financeto use its strong cash position to drop price and increase market sharecan move more decisively than an executive team where Sales and Financeare at odds.

The best companies view their partners up anddown their value chains (i.e., suppliers and customers) as part of an“extended enterprise. This holistic perspective enables them toevaluate the interconnected risks across their value chains, graspingthe complete risk picture better and faster than competitors. Forexample, companies with an extended enterprise view have the ability toidentify vendor viability and business partner risks that mightotherwise go unseen. Consequently, they’re able to determine the mosteffective methods for managing these risks either by narrowing ordiversifying partners.

Evaluate your contract portfolios with an eye toward renegotiating past (and changing future) contract terms.
What made sense a few months ago may no longer be in your bestinterest. Against the backdrop of changing financial conditions,companies need to identify and renegotiate the contractual obligationsthat they (or other parties) may not be able to meet. Examine theseagreements literally: covenants that might have been waived oroverlooked in the past may very well be enforced now. For example, theinability to raise capital or maintain certain credit ratings maytrigger debt covenants and require additional expenditures, dependingon your financial condition and outstanding credit exposure. The bestcompanies will reevaluate both recent and pending contracts to findpotential cost reduction and upside opportunities.

Robustly manage fraud risks by identifying and punishing incidents of misconduct early in the down cycle.
In bad times, the risk of bad behavior also rises. As employees andeven customers experience heightened pressure to “hit the numbers,”companies’ risk exposure increases on all fronts. In response, you mustcarefully assess fraud risk across the organization, identifyingemerging hot spots. (For example, business units that face significantjob cuts or are likely to underperform in the next 6–12 months.) It isalso likely that insider trading will rise in tandem with major shiftsin strategy, industry consolidation, and rapid leadership changes. Yourbest protection is to police your own organization more proactively—communicating the company’s position on noncompliance, implementing a“no-tolerance” policy for compliance failures, and providing employeeswith real-life examples and guidance to demonstrate your commitment tocompliance and ethics in any environment.

#5: Make Critical Talent Plays: Use Today’s Crisis to Court and Cultivate Tomorrow’s Winners

Seize the opportunity to close critical skill gaps with “not-in-play” talent. It’sonly the beginning of the buyers’ market for talent. The economiccrisis will create a once-in-a-generation opportunity to deepen yourtalent bench.

And it’s not just a matter of combingthrough the talent flooding the labor market. One of today’s primarylessons is to take your time, and be picky. Even as job losses infinancial services and other talent-centric industries are freeing uplong-scarce talent, more is sure to come. While many companies aretaking the opportunity to aggressively replace their ownunderperformers, the best companies are being more strategic. They areprioritizing critical skills first and are still focusing primarily ontalented professionals who are not actively looking for a new job. Intimes of uncertainty, great passive talent is much more likely to bereceptive to a job opportunity that offers them a more compellingposition or future. The best companies also bear in mind that thereverse is true—other employers are eyeing their top performers—andtake measures to better engage and retain their most valuable people.

Reward relative outperformance (even if you must court the wrath of executive-pay watchdogs).
When planning for 2009, companies must resist what will surely becrushing pressure to slash pay for executive high performers. Greatexecutives get paid a lot because the difference in financial resultsdelivered by “average” and “great” is enormous. The company thatunilaterally cuts executive pay will more likely get the former ratherthan the latter. That said, the best companies will rethink goldenparachutes and other window-dressing that is out of alignment withshareholder interests. The bottom line: set pay to market, but designpackages to reward outperformance.

• Managegovernance concerns by removing authority for executive compensationplan design (to the extent possible) from the senior executive team andinside directors.
• Pay for long-term shareholderinterests, over-weighting ROIC, EPS, and total shareholder returnrelative to other metrics (ROA, margins, etc.).
• Determineexecutive pay on a relative basis compared to an industry peer group,comparing not only total pay, but each component (e.g., bonus, options,long-term incentive plans).
• Avoid monkey business withoptions—evergreen options, “reloading,” and resetting strike prices.They aren’t necessary and they raise eyebrows.
• Makepay transparent—shareholders shouldn’t need to scour a proxy statementwith a magnifying glass to understand how executives are paid.

Use the economic crisis to sharpen the acumen of future executives.
All executive teams will be called upon in 2009 to make critical, insome cases “bet-the-company,” decisions. The best will find structuredways to enfranchise and develop high-potential managers by activelyengaging them in addressing issues presented by the economic crisis.The crisis-management experience that this cadre gains now will pay offfor decades.

]]> http://www.directorship.com/five-imperatives-for-2009/feed/ 1 http://www.directorship.com/where-to-draw-the-line/ http://www.directorship.com/where-to-draw-the-line/#comments Thu, 01 Jan 1970 00:00:00 +0000 Joseph McCafferty http://www.directorship.com/?p=3282

It’s a given that it is the management’s role to run the operations of the company and the board’s role to oversee and advise management in fulfilling those duties. In most cases the lines are very clear.

Recent events in the financial sector and the rising importance of the role of the board over the last several years, though, have raised some important questions about the line of demarcation signaling where the job of corporate director begins and ends. Exactly how involved should the board be in providing corporate direction? Does the board overstep its bounds by providing strategic advice? Will expectations of boards become higher given recent events in the financial sector?

The answer to that last question is easy: You bet! Allegations from some that boards of financial companies were asleep at the switch are certain to change the way boards view their job. And the implications of the financial crisis on boards resonate out far beyond the paneled boardrooms high atop the financial district of lower Manhattan. Boards of every stripe are reevaluating how they fulfill their responsibilities and just what those responsibilities are.

Mainly, boards are asking themselves, if we are going to share in the blame when the corporate strategy fails, do we need to get more involved in setting that strategy? Many directors are reluctantly coming to the conclusion that they do. That’s not to say that the board is now responsible for setting the strategy. No one would argue that it is. But oversight is not a completely passive function. The word has always implied that action is necessary when the monitor doesn’t like what he or she sees. In the aftermath of the financial crises, board members will be more likely to increase their vigilance and take action when appropriate.

It is a subtle shift in the view of where the job of director begins and ends, but nonetheless and important one. It ups the ante for corporate directors. It could also require some shifts in the skills necessary for the job. Knowledge of strategy—always of high importance—is now a must. Directors will need a keen insight into how managers are performing so they can intervene before major problems arise. That raised awareness will also require deeper industry knowledge, understanding of risk, more visibility in the business, and more time sifting through the details.

Most boards are up to the task, but it could require adding more technical expertise and specific skills to the board.

“Strategy took a back seat over the past few years as boards grappled with volatile markets, shareholder pressure, and regulations, but directors recognize the need to focus on the longer-term as indicated by their top-three issues to be addressed,” says NACD president and CEO Ken Daly. And now the bad news: While strategic planning, corporate performance, and CEO succession are chief concerns among respondents, they are also the areas in which directors identify themselves as being least effective.

Another survey bolsters these findings. CEOs cite excellence in execution as their top concern out of 121 other possibilities on The Conference Board’s annual “CEO Challenge,” a survey of 769 global chief executives. “CEOs around the world are realizing that strong execution is a critical factor in driving profits and revenues,” says Jonathan Spector, president and CEO of The Conference Board. Sustained and steady top-line growth ranks second, followed by consistent execution of strategy by top management. Profit growth and finding qualified managerial talent rank fourth and fifth.

Too Aligned?

While most will agree that alignment of the concerns of boards and those of CEOs is a good sign, some say they are too aligned. A separate study of high-net-worth investors and financial advisers, released around the same time as the NACD survey, reports that a great majority of both groups believe boards still operate in the interests of management, rather than shareholders. The study, conducted by advisory firm FTI Consulting, shows that 61 percent of financial advisers and 64 percent of high-net-worth investors feel that boards are too beholden to management. Moreover, five years after the passage of Sarbanes-Oxley, which was intended to improve the accuracy and reliability of corporate disclosures in part by mandating director independence, these highly influential groups perceive SOX to have had a limited effect on improving corporate governance. Only 13 percent of financial advisers and 12 percent of wealthy investors feel that governance practices have improved “a great deal,” while 45 percent of advisers and 43 percent of investors think that post-SOX practices have improved “a moderate amount.” Investors and advisers also correlate effective governance with reputation and ascribe significant shareholder value to it.

The perception by investors and financial advisers that boards may be operating in the interest of management represents a significant enterprise risk, FTI notes in its summary of the results. To ignore the connection between the perception of a company’s corporate governance practices and its overall reputation, an FTI analyst concludes, “can be a serious omission.”

“Although boards are putting heavy emphasis on corporate strategy.” –Kenneth Daly, NACD

Perhaps the problem is one of communication, since boards admit they don’t communicate well with shareholders. Only a third of the respondents think their boards communicate “very effectively” with shareholders, according to the NACD study. The data shows less than half of the directors surveyed describe their relationship with shareholders as “highly satisfactory.” “Although boards are putting heavy emphasis on corporate strategy,” Daly continued, “shareholders may not be aware of that emphasis.”

Directors’ opinions about their relationship with investors show little year-to-year change even though the number of proxy contests has increased. In 2007, there were 42 proxy contests among the companies analyzed in the proxy database, compared to 27 in 2006 and 17 in 2005. Despite this increase, board directors’ views of their strengths in investor relations remain largely unchanged. In 2007, nearly 52 percent describe their board’s relationship with long-term investors as satisfactory and nearly 44 percent report a satisfactory relationship with individual investors.

More Majority Voting
Most boards identify the problem with shareholder communications and are working to fix it. At least these are the findings of yet another survey, one by the Business Roundtable. Its Survey of Corporate Governance Practices found an increase in the number of independent directors serving on boards. The number of CEOs who report that their boards are at least 80 percent independent increased from 87 percent to 90 percent. It also finds a “significant rise” in the number of companies that have adopted majority voting for directors. The figure jumped from levels too low to report to 82 percent in just two years.

“The results from this CEO survey demonstrate the importance of governance in leading a successful company through independent boards, performance-based compensation, and smart business practices,” said Anne Mulcahy, chairman and CEO of Xerox Corp. and chairman of the Business Roundtable Corporate Governance Task Force, in a statement.

Moreover, the Business Roundtable, an association of CEOs from the largest publicly held American companies, finds that 38 percent of their boards report meeting with shareholders in the last year. Formal efforts to meet with large shareholders on governance practices have been announced by at least two major companies, Pfizer and Home Depot.

The NACD survey reveals other areas where directors give themselves rather low marks. Consistent with its 2006 survey, respondents rate CEO compensation as either “too high” (35.7 percent) or “somewhat high” (41.6 percent). The top reasons for this apparent overpayment, according to respondents, is the absence of performance objectives, lack of strong negotiation by the compensation committee, and the granting of equity awards that have little connection to future corporate performance.

While the time commitment is still great for directors, the trend line sloped down, if slightly. The survey shows that the average number of hours for directors on board- and committee-related activities decreased to 207.4 hours in 2007 versus 209.7 hours in 2006.

Other highlights: More than half—56.3 percent versus 52.7 percent last year—report having a CEO succession plan; fully 96 percent report they conduct CEO performance reviews and 99 percent of them say such reviews occur annually; and nearly 100 percent say their boards provide D&O insurance, with 83.3 percent reporting that their policies are reviewed annually.

Areas where board oversight is more active include competitive analysis, information security, social responsibility, constituent relations (including employees, customers, creditors and suppliers), marketing, and philanthropic giving. The Public Company Governance Survey conducted by the NACD includes responses of 791 directors and is supplemented by data culled from the proxy statements of 5,000 publicly traded companies by RiskMetrics Group.

Buffett: “It takes twenty years to build a reputation and five minutes to ruin it.”

Shakespeare: “Who steals my purse steals trash…but he that filches from me my good name robs me of that which not enriches him and makes me poor indeed.”

Both the bard and the sage share an understanding of the value of reputation and the need to do everything possible to guard against damage to it. Those of us who have spent our lives in newsrooms and have dealt with scores of corporations in crisis have long been amazed that most executives caught in a media storm reflexively curl up and wish upon a star that the whole thing will just go away. That wish is rarely granted. Especially when 24-hour cable news will latch onto a story and gnaw it like a dog with a bone until a better one comes along.

As reporters, we worked the phones on many crisis stories and know that attempting to stifle, mislead, or ignore the media is a recipe for public relations disaster. Ask anyone at Hewlett-Packard, where “spygate” rocked the board of directors and toppled the company’s chairman, Patricia C. Dunn.

Given the warp speed of the Internet and the “Ready, Fire, Fire a few more times, Aim” standards of some journalists and many bloggers, the best policy for corporations is to get the fullest possible version of the facts out as quickly and as transparently as possible.

Buffett: “It takes twenty years to build a reputation and five minutes to ruin it.” 

The Gold Standard of Crisis Management

Our conviction stems from what we learned from the granddaddy of all corporate reputation crises, the Tylenol affair. It is one of the first nationwide cases where management won praise for handling the threat with immediacy and transparency. Twenty-five years ago this fall, a demented murderer bought bottles of Extra Strength Tylenol, substituted cyanide pills for the popular painkiller, resealed the bottles, and put them on the shelves of half a dozen drugstores in the Chicago area where they were bought by unsuspecting customers. Seven innocent people died.

That was back in 1982, long before the explosion in the number of media outlets. Network newscasts had 50 million daily viewers, twice their audience today and the first night all three led their broadcasts with the Tylenol story.

Owned by corporate giant Johnson & Johnson, Tylenol had a 37 percent market share and accounted for 19 percent of the company’s profit. J&J Chairman James Burke, moving swiftly and decisively, managed to save not only the product, which seemed doomed at the time, but also his company’s reputation. He did so in what has become a textbook case of crisis communication. Acting with what seemed like astonishing speed at that time, he developed a strategy resting on two pillars: protect the public—which he did by getting Tylenol off the shelves fast—and fully communicate what he was doing through the media.

A survey found that within a week, 90 percent of the public had heard about the cyanide killer. Tylenol wasn’t returned to the nation’s pharmacies until new tamper-proof bottles and seals had been developed. The Tylenol response in 1982 is still a classic because even back then Chairman Burke and his Tylenol team realized they didn’t have time to wait for all the facts before jumping out in front of the story. If they had, they’d still be waiting because the cyanide killer was never caught.

Fast forward to this October’s crisis affecting children’s cold medicines. As if following Burke’s playbook, the products were immediately withdrawn from drugstore shelves, while its corporate owner bought full-page ads headlined “Your child’s safety is our number one priority.” The names of two of the medicines? Concentrated Tylenol Infants’ Drops Plus Cold and Concentrated Tylenol Infants’ Drops Plus Cold & Cough. Thanks to adroit handling by Tylenol’s present owner, McNeil-PPC, the fever passed quickly; it was a one-day story.

Corporate crises come in many forms. Think TJX and the 45 million credit-card numbers they allowed to escape from their computer system into the hands of thieves. Consider the New England Patriots, the most successful NFL team of the decade, discovered videotaping the signals of opposing coaches, or toy maker Mattel, whose Chinese suppliers were using lead-based paint on the toys they sell to kids.

The Compensation Trap

Corporate reputation crises do not only emerge after spectacular product recalls or instances of compromised personal information. For many companies there is a ticking time bomb in the rich executive compensation stories journalists extract from SEC filings and Yahoo finance. Any politician with a populist streak seems able to find a company to turn into a personal piñata. Even President George W. Bush joined the chorus when in October he told a Wall Street Journal interviewer, “Do I think some of the salaries are excessive at the top? I do…It’s a role of boards of directors to be very transparent with shareholders about these different [pay] packages.”

With CEO pay quickly becoming a popular news peg, every director is just a phone call away from stepping into a news media crossfire that can come from any direction and at any time in the 24-hour news cycle.

To board members, the media world has become frighteningly more complex. No more is a corporate reputation at the mercy of just the three networks, top newspapers, and wire services with their cadres of trained journalists. Today, anyone with a computer and a blog has a megaphone with the potential to reach as many people as Dan Rather reached on the CBS Evening News 25 years ago when he reported the Tylenol story. One estimate of the number of blogs worldwide: 100 million. And there are few bloggers troubled by the ethical standards of mainstream journalism, or who honor the maxim, “Get it first but first get it right.”

So what’s a director to do when faced with a crisis in the age of The Drudge Report, TMZ.com, and Entertainment Tonight? The first manifestation of the nasties could be a driveway stakeout. Recall Kenneth Starr at the height of the Monica frenzy caught by television cameras as he put out the trash. How about being confronted by an aggrieved customer with the skill to set up a vituperative website as media columnist Bob Garfield recently did. Not one for subtlety, Garfield calls it ComcastMustDie.com.

Follow the Coast Guard

There are scores of public relations agencies and web-based gurus who deal in crisis communications. Their advice is usually the same as what the U.S. Coast Guard gives its sailors: Semper Paratus, Always Ready, or the Boy Scout’s motto, “Be Prepared.” It’s good advice and we agree it’s imperative to have a plan prepared well in advance, with key people briefed on what’s in the plan. It ought to be dusted off and reviewed every few months; one top media-savvy person should be designated as the main contact, and that person or a back-up should be available at all times. All employees should also be warned to refer every inquiry to this person. Add an easily updated website where company statements can be put up quickly, and have a company blog, preferably written by the CEO, where he or she can quickly and informally explain the company’s position to inquiring journalists as well as to the blogosphere.

PR guru Larry Weber worries about old school PR types and gray haired executives jumping into this new world without proper training. In his new book, Marketing to the Social Web, he writes: “Now is the time [for companies] to arrange extensive training for managers, bloggers, corporate communicators, human resource professionals, web strategists, and others who will be engaging in social web activities.”

The corporate world is not alone. Duke University faces a multimillion-dollar lawsuit after its clumsy handling of three lacrosse players falsely accused of raping a stripper hired to perform at an off-campus party. Duke found itself embarrassed on the front pages of the nation’s newspapers, answering questions on 60 Minutes, and serving as fodder for cable talking heads.

And yet Duke had a standing plan in place and was more than ready, or so administrators believed, to respond to any predicament that came its way. One of three spokesmen for the institution was senior vice president John Burness, who found himself dealing with the frenetic 24/7 news environment for well over a year. “It was very difficult, complicated by blogs dealing in misinformation. Mainstream media jumped on them and made it even more difficult,” he says.

The wise director recognizes another maxim of crisis management: When crisis occurs, the media demands facts; when all the facts are not known, they will take what facts they have at hand. By the time the full story is out, the journalists and bloggers are onto another story somewhere else.

Is There a Lawyer in the House?

Putting too much control of communications in the hands of lawyers, whom many executives turn to in a crisis, is a common reputation-management mistake. Lawyers generally fear communication and their advice is often to remain mute, go dark, and generally avoid any situation in which you are faced with the media. That was the case at Duke. Lawyers advised the president not to talk to the families of the players falsely accused and now that communication failure is a flash point in the lawsuit those families have brought against the university.

Lawyers are trained to carefully root out the facts, organize them, and present them in dry but logical fashion. Journalists root out facts too, but they are not paid by the hour; they are paid to meet deadlines and the next deadline is always looming. The possibility of an ill-prepared director or corporate spokesman appearing in a derisive posting on YouTube or as a laugh line on The Daily Show is now just seconds away.

Ed Fouhy has held management positions at CBS News, NBC News, ABC News and the Pew Charitable Trusts. Morton Dean was a network TV anchor and correspondent for CBS and ABC. They are cofounders of M.E. Communications Partners, which provides media training and communications advice to C-level executives.

Companies today can onlydream about investors willing togive them such latitude. Instead,many often feel hostage to WallStreet’s drumbeat for ever-higherquarterly earnings. The debateover long-term managerial focusand what companies shouldreport to their shareholders haswelled up again in recent years,after the meltdown of many companiesprompted widespreadreaction to what many see asexcessive pressure on executivesto deliver consistent results, evenat the expense of longer-termperformance.

The concerns have produced agrowing outcry for change. Initially,the calls came from pensionfunds and other institutionalinvestors that invest heavily inindex funds. More recently, businessgroups have joined thedebate, with recent statementsagainst short-termism comingfrom the U.S. Chamber of Commerceand the Business RoundtableInstitute for CorporateEthics, among others.

The Aspen Principles

The most ambitious campaignhas been mounted by the AspenInstitute, an independent leadershipthink tank. Last summer, afour-year effort culminated in theso-called Aspen Principles, a documenttitled “Long-term ValueCreation: Guiding Principles forCorporations and Investors.” Onereason the paper took so long todraw up is that the principles representa consensus view of groupsfrom both of these camps, includingthe Business Roundtable,Office Depot, PepsiCo, Pfizer,and Xerox on the company side,and investors such as the AFLCIO,the California PublicEmployees’ Retirement System(CalPERS), and the Council ofInstitutional Investors (CII).

The principles represent aremarkable achievement, givenhow these groups square offagainst each other on issues rangingfrom proxy access to executivecompensation. Despite themeeting of the minds, the AspenPrinciples remain a work inprogress. They call on companiesand investors to use long-termmetrics on a range of behavior,from corporate operations to executivepay. But while the groupcame out clearly against themuch-criticized practice of quarterlyearnings guidance, it didn’tgive a clear and detailed descriptionof what the alternative metricsshould look like. It’s now taking upthat task, as well as searching forways to draw in more companies,says Judith Samuelson, executive director ofthe Aspen Institute’s Business and SocietyProgram. The group started the follow-upeffort in December.

A key hurdle is defining exactly what theproblem is, which can be difficult to pindown even after all these years of complaints.There does seem to be someconvincing evidence that a short-term perspectivecan drive inferior corporateperformance. For example, a recent studyby REL consultants of Atlanta found thatthe 1,000 largest U.S. companies employeda variety of short-term tactics toboost their collective working capital by$100 billion in the last quarter of 2006—only to see all those gains erased whenworking capital plunged by a total of $122billion in the first quarter of 2007. RELfound similar patterns in 2004 and 2005.The study identified five common practicescompanies used to pump up theiryear-end numbers, including product discounting,delaying payment to suppliers,accelerating the collection of bills due,halting inventory purchases, and runningat full capacity to reduce overheads.

Since executive compensation typicallyis tied to corporate performance in variousways, critics argue that such manipulationstems from misaligned pay incentives thatprompt widespread earnings manipulation.“It is clear that year-end gamesmanship isakin to binge dieting, where an unreal andunsustainable illusion of beauty is createdfor the purpose of meeting the expectationsof others,” REL’s report concludes.

 _________________________________________________________________________

The Aspen Principles 

• Companies stop providing quarterly earnings guidance to analysts
• Corporate boards communicate with long-term oriented investors on senior executive compensation
• Senior executives hold stock rewards beyond their tenure
• Senior executives are banned from hedging the risk of long-term oriented stock options
• “Clawbacks” are used to recoup comp later proven undeserved

Earnings Misguidance

However, the evidence gets somewhatmurkier when it comes to quarterly earningsthemselves. The practice of issuingearnings forecasts began in the early 1980s,a few years after a 1978 decision by theSecurities and Exchange Commission toallow companies to issue forward-lookingprojections, provided they were accompaniedby appropriate cautionary language.Quarterly forecasting became commonplaceby the 1990s, leading to all the gamesmanshipduring the late-decade tech boomin which day traders would punish stocksthat missed the consensus forecast. In thewake of the tech-market crash, the SEChelped put a lid on some of the excesses byrequiring companies to give guidance andother material information to all investorssimultaneously (Regulation Fair Disclosureor RegFD).

Some companies then began to ditch thequarterly earnings practice. Gillette wasamong the first, in 2001, when it followedthe advice of board member WarrenBuffett, whose own Berkshire Hathawayhad never indulged in the quarterly game tobegin with. Coca-Cola, where Buffet alsosat on the board, followed suit the next year,as did Intel. McDonald’s did so in 2003.

What’s unclear in all the debate is justhow much the pressure to deliver quarterlyresults drives short-termism. Some criticsthink that companies which drop suchguidance just want an excuse to cover upmanagement failures. For example,Gillette’s move came after the razor companymissed its own earnings targets seventimes and took a hit to its stock price eachtime.

Some evidence for such a skeptical viewcame in a study last year by University ofFlorida professor Joel Houston and twoothers. The companies that drop quarterlyearnings guidance, they found, tend to beunderperformers. Their analysis, whichlooked at 222 companies that stopped guidancebetween 2002 and 2005, also foundthat investors got less forward-looking informationfrom these companies afterward.What’s more, the lack of guidance led toincreased volatility, presumably becauseinvestors had less information. Since volatilitycan attract short-term traders looking fora quick buck, it’s not at all clear that doingaway with the short-term guideposts frees upthese companies to focus on the long term.

In fact, the study found some counterintuitiveindications that the reverse mayhave happened. For one thing, those thatdropped quarterly guidance didn’t subsequentlyincrease their capital investmentsor research and development budgets—anunsettling finding in light of the argumentthat such long-term planning often is sacrificedwhen companies operate quarter toquarter. In addition, Houston and his colleaguesfound that nearly a third of companiesthat dropped guidance started rightup again later on. “Taken together, our evidenceindicates that guidance stoppers aretroubled firms, not role models for mitigatingmanagerial myopia by ceasing quarterlyguidance,” the authors conclude.

While the question of quarterly guidancemay not yet be settled, both corporate andinvestor groups agree that an emphasis onshort-term results has led many U.S. companiesastray in recent decades. What’s lessclear is whether they can come to an agreementabout what it means to focus corporatestrategy on the long term.

“Strategy took a back seat over the past few years as boards grappled with volatile markets, shareholder pressure, and regulations, but directors recognize the need to focus on the longer-term as indicated by their top-three issues to be addressed,” says NACD president and CEO Ken Daly. And now the bad news: While strategic planning, corporate performance, and CEO succession are chief concerns among respondents, they are also the areas in which directors identify themselves as being least effective.

Another survey bolsters these findings. CEOs cite excellence in execution as their top concern out of 121 other possibilities on The Conference Board’s annual “CEO Challenge,” a survey of 769 global chief executives. “CEOs around the world are realizing that strong execution is a critical factor in driving profits and revenues,” says Jonathan Spector, president and CEO of The Conference Board. Sustained and steady top-line growth ranks second, followed by consistent execution of strategy by top management. Profit growth and finding qualified managerial talent rank fourth and fifth.

Too Aligned?

While most will agree that alignment of the concerns of boards and those of CEOs is a good sign, some say they are too aligned. A separate study of high-net-worth investors and financial advisers, released around the same time as the NACD survey, reports that a great majority of both groups believe boards still operate in the interests of management, rather than shareholders. The study, conducted by advisory firm FTI Consulting, shows that 61 percent of financial advisers and 64 percent of high-net-worth investors feel that boards are too beholden to management. Moreover, five years after the passage of Sarbanes-Oxley, which was intended to improve the accuracy and reliability of corporate disclosures in part by mandating director independence, these highly influential groups perceive SOX to have had a limited effect on improving corporate governance. Only 13 percent of financial advisers and 12 percent of wealthy investors feel that governance practices have improved “a great deal,” while 45 percent of advisers and 43 percent of investors think that post-SOX practices have improved “a moderate amount.” Investors and advisers also correlate effective governance with reputation and ascribe significant shareholder value to it.

The perception by investors and financial advisers that boards may be operating in the interest of management represents a significant enterprise risk, FTI notes in its summary of the results. To ignore the connection between the perception of a company’s corporate governance practices and its overall reputation, an FTI analyst concludes, “can be a serious omission.”

“Although boards are putting heavy emphasis on corporate strategy.” –Kenneth Daly, NACD

Perhaps the problem is one of communication, since boards admit they don’t communicate well with shareholders. Only a third of the respondents think their boards communicate “very effectively” with shareholders, according to the NACD study. The data shows less than half of the directors surveyed describe their relationship with shareholders as “highly satisfactory.” “Although boards are putting heavy emphasis on corporate strategy,” Daly continued, “shareholders may not be aware of that emphasis.”

Directors’ opinions about their relationship with investors show little year-to-year change even though the number of proxy contests has increased. In 2007, there were 42 proxy contests among the companies analyzed in the proxy database, compared to 27 in 2006 and 17 in 2005. Despite this increase, board directors’ views of their strengths in investor relations remain largely unchanged. In 2007, nearly 52 percent describe their board’s relationship with long-term investors as satisfactory and nearly 44 percent report a satisfactory relationship with individual investors.

More Majority Voting
Most boards identify the problem with shareholder communications and are working to fix it. At least these are the findings of yet another survey, one by the Business Roundtable. Its Survey of Corporate Governance Practices found an increase in the number of independent directors serving on boards. The number of CEOs who report that their boards are at least 80 percent independent increased from 87 percent to 90 percent. It also finds a “significant rise” in the number of companies that have adopted majority voting for directors. The figure jumped from levels too low to report to 82 percent in just two years.

“The results from this CEO survey demonstrate the importance of governance in leading a successful company through independent boards, performance-based compensation, and smart business practices,” said Anne Mulcahy, chairman and CEO of Xerox Corp. and chairman of the Business Roundtable Corporate Governance Task Force, in a statement.

Moreover, the Business Roundtable, an association of CEOs from the largest publicly held American companies, finds that 38 percent of their boards report meeting with shareholders in the last year. Formal efforts to meet with large shareholders on governance practices have been announced by at least two major companies, Pfizer and Home Depot.

The NACD survey reveals other areas where directors give themselves rather low marks. Consistent with its 2006 survey, respondents rate CEO compensation as either “too high” (35.7 percent) or “somewhat high” (41.6 percent). The top reasons for this apparent overpayment, according to respondents, is the absence of performance objectives, lack of strong negotiation by the compensation committee, and the granting of equity awards that have little connection to future corporate performance.

While the time commitment is still great for directors, the trend line sloped down, if slightly. The survey shows that the average number of hours for directors on board- and committee-related activities decreased to 207.4 hours in 2007 versus 209.7 hours in 2006.

Other highlights: More than half—56.3 percent versus 52.7 percent last year—report having a CEO succession plan; fully 96 percent report they conduct CEO performance reviews and 99 percent of them say such reviews occur annually; and nearly 100 percent say their boards provide D&O insurance, with 83.3 percent reporting that their policies are reviewed annually.

Areas where board oversight is more active include competitive analysis, information security, social responsibility, constituent relations (including employees, customers, creditors and suppliers), marketing, and philanthropic giving. The Public Company Governance Survey conducted by the NACD includes responses of 791 directors and is supplemented by data culled from the proxy statements of 5,000 publicly traded companies by RiskMetrics Group.

Nasdaq recently launched some products and services aimed at board members. How is that going?

One of the most popular laments is that it’s more difficult now than ever to recruit qualified board members. Through the years, we’ve been involved in informal ways to place directors with companies. Our board recruitment tool is bringing a technology platform to make this a more efficient process. It’s a natural corollary that we have relationships with directors as part of the listing process.

We also just launched Directors’ Desk, which we acquired earlier this year. As a sitting company CEO, I personally understand how hard it is to get the board book out on a timely basis. When you’re involved in substantial M&A activity, at times it seems almost like an insurmountable task. With the Directors’ Desk product, you can update the information simultaneously and you can be reading this information in an hour or two before the board meeting. We think this is a clear step forward and a real step out of the dark ages for directors.

What is the ideal company that lists on Nasdaq?

Our fundamental value proposition is that our market structure provides a more efficient trading methodology for investors, and that efficient trading technology results in lower cost of capital and greater liquidity. As you look at the exchanges around the planet, Nasdaq has the highest liquidity per market capitalization. We’re proud of that. It’s a result of the structures we’ve put in place to have an open and fair electronic platform where we do not grant privileges to the few.

Would you say that the “where-to-list” decision is no longer a function of the size of the company?

Completely. We have some of the largest companies on the planet. Obviously, when you have a $280-billion market-cap company, one that just passed the $200-billion threshold, and a large number over $100 billion, you can see the market addresses all different levels of market caps. In a real sense, our market-structure advantage is more pronounced with larger companies because our market allows trading without intermediaries being involved.

You recently completed the separation of NASD (now renamed FINRA). Apart from the removal of some appearance of conflict, what has that meant to you?

The NASD separation allowed us to get our own license and complete the process of becoming a public company. It really set us on the proper path with respect to conflict. Now the Financial Industry Regulatory Authority is a vendor of regulator services to us. Obviously, we demand the best from them and that relationship is definitely working in a new and improved way.

With the battle for the London Stock Exchange behind you, what are your plans globally?

Regarding international expansion, we’ve clearly made a decision with regard to how we’re going to play up the European part of our strategy with the proposed transaction with OMX, which we expect to close in the first half of the first quarter. OMX will allow us to bring our particular abilities to play in the Nordic region where we think we can increase the liquidity of the marketplace, and it gives us the proper platform to launch a Pan-European effort in the competitive world that will exist after an EU regulatory change.

There’s been a contention that regulation here in the United States has hindered the listing of foreign companies. Do you agree?

We have done well getting foreign companies to list on Nasdaq, most notably in the last couple of years from China. Sometime between now and the end of the year, China will surpass Israel as our largest market outside of the United States. We currently have 72 listings from China. There are a lot of organizations that choose to avoid our regulatory structure and I would say this: the basic principals of SOX have been valid, but the implementation of those principals has been flawed. Going forward, the SEC and the PCAOB need to make that implementation for listing companies more straightforward.

We hear from private-equity firms that it’s easier to be a privately traded company. I’m going to guess that you would disagree with that?

It’s interesting to me that many private-equity portfolio companies maintain SOX compliance, so it’s not regulation that they’re trying to avoid by going private, because these private-equity firms have to think about how they are going to exit. And they know they have to be SOX-compliant to exit, so that’s not a valid reason.

And a major exit strategy of private equity is still the IPO, so I guess you have a love/hate relationship with those guys.

It’s been described as our recycling service, which may or may not be true. We work very closely with private equity and I think we have positive relationships with them. Any time you are the end goal, it tends to be a positive relationship.

New independence rules make it more difficult for public company boards to have members with significant M&A experience. Do you think that’s a problem?

Yes, I do. We at Nasdaq have two private-equity investors in our company and they both have representatives on our board. As we have gone through discussions about M&A and have done a number of deals, their input has been invaluable. Obviously, you have bankers who will give you advice and bankers will generally tell you whether it’s worthwhile, but you always have the thought in the back of your mind that they’re paid for successful transactions, rather than pure advice. Having that M&A experience on our board is very valuable, so I think boards in general have lost something there.

Give us a snapshot of some of the major trends you see happening in your corner of the capital markets.

Three years from now, there will be more exchange or exchange-type organizations, rather than fewer. In most of the markets, exchanges have operated as essential whole-market monopolies. The regulatory change is coming soon; it’s creating an environment where competition can develop very much like what we have here in the United States.

As the rules changed here, we at Nasdaq were able to gain a tremendous amount of market share in the trading of stocks that are listed on NYSE. Today, if you look at the floor of the exchange, they process under 40 percent of their volume. Nasdaq does 38-percent volume by itself on stocks listed on NYSE. We see that same opportunity in other parts of the world, and we see that we aren’t the only ones to recognize it.

AIG and Greenberg, 82 years old,have been dueling ever since his departure. The two sides have lawsuits pendingagainst each other relating to stewardship of the company. The Journal reportsthat investors are jittery. AIG shares fell more than eight percent in middaytrading one day last month, before largely bouncing back. Much of theirnervousness stems from potential exposure to the subprime mortgage market. AIGis scheduled to report third-quarter earnings tomorrow.

Greenberg made his statements in a 13D filing to the Securities and Exchange Commission last week. Such a filing doesn’t commit a filer to a specific action.

The Changing Role ofthe COO finds that the need for, and the definition of, a COO is determinedby the relationship between the role and that of the CEO, including theirrespective personalities and the needs of the particularbusiness.  A risk assessment of the CEO “goingit alone” and internal talent management considerations are also used to determine the role of the COO.Some have said that the COO position is evolving from the number two spot in acompany to a leadership “on demand” role that changes focus with changing businessstrategy.

What’s more, the report finds that companies, in order togrow more quickly in an increasingly competitive business world, are becomingflatter, with the CEO now going directly to the heads of lines of the businessfor answers. 

“The scope and intensity of leadership demands today callfor a team approach at the top,” said Fr. Robert J. Kramer, principalresearcher at The Conference Board, and author of the report, in astatement.  “Some companies are decidingthat the composition of that corporate leadership team need not include a COO.Others are changing the duties for which a COO is responsible.”

The report is based on in-depth interviews with executivesfrom companies that represent diverse industries and a literature review.  Those executives surveyed include heads ofhuman resources, regional heads, COOs, CEOs, heads of business units, and headsof company research.

]]> http://www.directorship.com/coos-dont-just-fade-away/feed/ 0 http://www.directorship.com/childrens-place-engages-lehman-to-review-strategic-alternatives/ http://www.directorship.com/childrens-place-engages-lehman-to-review-strategic-alternatives/#comments Thu, 01 Jan 1970 00:00:00 +0000 Joseph McCafferty http://www.directorship.com/?p=2731 The board of directors at Children’s Place Retail Stores,Inc. today announced that it has recently engaged Lehman Brothers to act as itsfinancial advisor for a review of the company’s strategic alternatives toimprove operations and enhance shareholder value. 

The board and management team are assessing a variety ofoptions to improve business and the company’s competitive position, which mayinclude possible organizational and operational improvements, capitalization,or other transactions.

The clothing retailer has been islocked in a boardroom tussle over the ouster of Ezra Dabah, who resigned as CEOin September but remains on the board. He claims that a small group of the board engaged in a “power play” to oust him.

The board has yet to set a specific timeline for thecompletion of the review, and there is no assurance that the review processwill result in any changes to the company’s current organizational oroperational structure, or lead to any transaction in particular. 

“The board of directors and management team are focused onstrengthening the organization and positioning the company to take advantage oflong-term opportunities through its Children’s Place and Disney Store brands,”Children’s Place interim CEO Chuck Crovitz said in a statement.  “We believe it is in the best interest of thecompany, our shareholders, and employees to initiate a comprehensive review ofstrategic alternatives for the business and to evaluate a variety of differentoptions for enhancing shareholder value.”

The 2007 NACD Public Company Governance survey, now in its secondyear, was released this weekend, and received reports from 791 individuals,63.2 percent of which serve as outside directors, 33.7 percent of which serveon two or more public company boards, and 8.6 percent of which are CEOs orpresidents.

“The Survey report presents the responses of hundreds of ourmembers regarding their board practices, as well as additional data gleanedfrom over 5,000 proxy statements by our friends and colleagues at RiskMetricsGroup,” — Ken Daly, NACD President and CEO

“The Survey report presents the responses of hundreds of ourmembers regarding their board practices, as well as additional data gleanedfrom over 5,000 proxy statements by our friends and colleagues at RiskMetricsGroup,” said NACD President and CEO Ken Daly on the survey.

Among other highlights, the study also found that strategicplanning is the number one issue for the survey’s respondents, followed closelyby corporate performance and CEO succession. What’s more, the average number of full-board meetings decreasedslightly from 6.4 to 5.8 per year, respondents found.

The suit, filed against the J.C. Flowers &Co.-led group, is asking the buyers to complete the $25 billion deal, or pay $900 millionfor breaking the agreement.  After SallieMae’s request Friday, the group is arguing that business conditions in theindustry have withered since the deal was formulated last spring.  As a result, the group said it has the rightto void or renegotiate the agreement.

In its requestfor an edepited trial, Sallie Mae said the deal essentiallygave control over the company’s day-to-day operations to the buyers group, andthe company’s executives have said their limited decision making and input hasmade the business harder to run, as a result.

According to the Journal, J.C. Flowers is planning to file alawsuit in Delaware,the article said, that would ask the courts for a declaration that the lawrepresents a material adverse event, and holds ground for tossing the deal out.

While the case may take months to get gong, either companycan walk away from the deal if it isn’t completed by February 15.

Still, Drucker, often called the father of modern management, knew that the board should actively participate in the strategic agenda of the company. In helping it fulfill this vital role, Drucker’s primary tools were a set of well-directed questions and thought-provoking suggestions—the kind of tools for which he is famous. As Drucker correctly predicted, this role of constructive adversary of top management is increasingly critical in the “Lego World.” Legos were a favorite analogy for Drucker to demonstrate how the pieces of a company—its people, products, ideas, and physical assets—fit together and connected and interconnected to build out the two-dimensional proposition of “what products at what price?”

Serving more than seven decades as our leading observer and strategic adviser to business—and as the author of 39 books on management—Drucker, who died in 2005 at age 95, developed a unique perspective on the healthy balance between preservation and change. His theories still revolutionize the way companies operate in the age of the Internet, changing demographics, and the knowledge worker (a term Drucker coined).

The timelessness of Drucker’s thinking continues to amaze even his newest readers. Nobody knew how to capitalize on the past and make way for the future like Drucker. His writings are all about business as an innovative agent of change; he provided solid, practical advice on how to succeed with start-ups as well as with established companies. Should a business stick to what it knows best, or should it take a risk and make a foray into a different area? His laser-like, penetrating questions helped management and the board see their challenges in a new perspective and arrive at innovative answers to strategic dilemmas. Here are some of Drucker’s thoughts, questions, and the cases he referenced as he took on the art of boardroom strategy.

Location, Location, Location

John Bachman, the retired managing partner of the financial services firm Edward Jones, remembers how Drucker got into a contentious discussion with Ted Jones, the chairman of the board. The discussion began with Drucker asking Jones, “How do you decide where you put your offices?” Jones, being clever, said, “Well we do it like the baseball player, Wee Willie Keeler. We hit ‘em where they ain’t.” He went on to explain that they targeted cities where there were no competitors and Edward Jones would be the only game in town. Drucker, pushing him, asked, “Why would you do that?” Jones responded, “Because we do better.” Drucker asked how much better and suggested that they look at the facts. When they did, they found that Edward Jones did 25 percent better where there were competitors. Jones had parsed the market geographically and had defined the customer as the rurally located American with no alternative access to the stock market. After some persistent challenging by Drucker, Edward Jones came to see that its customers were actually people who wanted personal service and relatively low-risk investments, regardless of location. Drucker’s questions fundamentally changed the board’s understanding of the Edward Jones customer and hence, the company’s value proposition.

Early Warnings to DEC About Tsunami

In a 1985 letter to a member of the board of Digital Equipment, Drucker asked if they had thought about the assumptions the business was built upon: “I have a strong feeling that the company—and indeed every other second-tier computer company in the United Statess—has to rethink its basic business assumptions and strategies. I have the distinct impression that the basic rules of the game have changed. First, that the Japanese have decided to adopt IBM as the standard has simply made IBM the standard. The basic strategy of a company like DEC…was to offer an alternative to IBM and thereby [try to] prevent the establishment of one standard in which a DEC would not have a separate identity but would be another IBM-compatible supplier. When the Japanese decided…to adopt IBM as their standard, they…made obsolete the basic assumptions of the smaller American computer companies…But perhaps more serious is…that the entry of the three Japanese companies on the world market has freed IBM from all restraints…Up until a year or two ago IBM very carefully nurtured enough competition to avoid accusations of being a monopoly. It seems to me dangerous to depend on mistakes made by the big competitors especially if the competitor’s pockets are so deep that they can write off a mistake without much pain. What does this mean, assuming my reasoning is correct, for DEC? Can they maintain a traditional strategy or is it time to think through the basic assumptions on which their business rests? Do let me know what you think of my questions.”

The DEC board chose not to question the assumptions underlying the company’s “traditional strategy” despite new external realities. DEC was acquired by Compaq in 1998 after years of poor results.

How P&G Lost Its Way

In 2001, during a period of performance decline at Procter & Gamble, Drucker was asked by the board to review a position paper that was meant to address this decline, which had preceded a broad slow down in the U.S. economy. Drucker followed up his review with a letter to the board:

“In a consumer boom you actually lost market share in some of your most important brands. There are three plausible explanations:

“Incompetent people can be dismissed out of hand. The same people, who today do not produce results, performed magnificently only yesterday.

“The basic assumptions and strategies on which the business operates no longer fit reality. P&G is already re-thinking its basic theory of business, adapting it, changing it, re-focusing it.

“The knowledge, the competence, and drive of performing people are misdirected or inadequately utilized.

“Your position paper is concerned primarily with explanation number three. Your paper argues that traditionally P&G has focused on optimizing its market capital–brands–and has treated the information, knowledge, and passion of people as an ‘input,’ that is, the traditional economist’s ‘labor’ and a ‘cost.’

“It makes no sense, however, to look for an explanation of P&G’s recent malperformance in faulty or inadequate utilization of the intellectual capital. There has never…been a company that has done a better job than P&G in developing people, putting them where the results are, and making high performers out of them. Rather, it may be precisely the very perfection of the P&G system that has become a straightjacket and tends to imprison the individual’s knowledge in the silo of a specialty, a brand, or a market segment, rather than allow it to become a company asset. That approach is, so to speak, a ‘planned economy.’ Worse, it does not utilize the individual’s motivation and passion, the ‘fire in the belly.’ As in any planned economy, performance standards are minimums below which the individual is not allowed to fall. The exceptional performer does so despite them rather than because of them. And he or she is thus also encouraged by the system to keep his or her information and knowledge to themselves rather than contribute them to the company.”

Under the leadership of then P&G CEO A.G. Lafley, who worked closely with Drucker, P&G effectively turned itself around by listening to the exact prescription Drucker advised—it abandoned its rigidity and enabled everyone to recognize the consumer as the ultimate boss.

If Only GM Had Listened

Beginning in 1939, Drucker and Alfred Sloane, then CEO and chairman of the board of General Motors, had a running disagreement. Sloan believed that management was a science. He saw General Motors’ success as a result of the company’s ability to optimize its distinctive economies of scale, manage the flow of money and investments, and provide an expansive dealer network that encouraged trade-ins while selling new cars. Drucker, on the other hand, believed that management was a practice and that the practitioner’s job was to continually challenge the theory and bounds to redefine the “what,” not the “how.”

By failing to reassess its “what,” today’s GM is a sickly shadow of the robust corporation that Sloan built and that thrived for 70 years. Its market share in the United States exceeded 55 percent through 1960. Today, it is less than half of that. In 1980, GM was still the most sought after company to work for by college engineers, according to MIT’s placement office. Today, it is not even in the top ten.

What happened? Customers’ values changed to reflect major shifts in society, taste, and culture. Americans wanted convenience, safety, fuel efficiency, and commuting comfort. Rather than listening and connecting with these values, GM invested in quick fixes and patches—solutions built from their old way of doing business—while the company continued to decline.

Meanwhile, Toyota quietly adopted the Drucker approach, continuously redefining their approach to “what.” At the time, the idea of a Japanese auto running in NASCAR would have been unthinkable. Toyota passed GM last year as the number one automobile company in the world; it’s expected to become number one in the U.S. market this year.

In one of his last conversations, Drucker shared what his advice to the GM board would have been. He would have told them: “Lock yourselves up in a room and assume in two years that you will not make another car anything like the ones you make today.” Then, he would have asked them, “‘how can you use your strength, your position, and your scale to redefine the transportation industry?’ Are they asking those questions?”

The Art of the Boardroom

Anyone reading today’s headlines would conclude that boards need Drucker’s advice more than ever. They need his clarity and often his ethical guidance. To perform effectively, Drucker would say that a board should:

• Understand and embrace the board’s unique mission to be a constructive adversary, even towards the CEO and his or her executive team.
• Guard the ability to have a truly external and longer-term perspective, one that, for example, values innovation and the development of human capital.
• View social responsibility as a necessary, engrained characteristic of the organization. Directors should focus on activities that enhance their organization’s knowledge and abilities in production and marketing but they should also realize the wonderful opportunity to bring responsibility to an organization.
• Balance their role as overseers of the executive team with their critical role as a valuable “sounding board.”
• Challenge their own assumptions and biases—and check the date stamp on their frame of reference—that might otherwise preclude their effectiveness as directors.
• Help ensure thoughtful and sensible succession planning from one era of management to the next.
• Establish effective methods of reporting and communications up and down the organization.
• Conduct detailed self-performance monitoring and tracking evaluations with metrics tied to targeted results.

Elizabeth Haas Edersheim is author of The Definitive Drucker: Challenges for Tomorrow’s Executives—Final Advice from the Father of Modern Management. She is the founder of New York Consulting Partners and a former partner at McKinsey & Co.

Sidebar – P&G’s Lafley on Drucker: curiosity and humility were two of his greatest assets

As I’ve looked back on the conversations and countless hours spent reading Peter Drucker’s books and articles, I’ve thought about what made him so extraordinary. For me, it comes down to five things.

First and foremost, Peter’s basic rule was the importance of serving customers. “The purpose of a business is to create and serve a customer,” he said. Plain and simple. Second, Peter insisted on the practice of management. He had little patience for detached theory and abstract plans.

The third characteristic was his gift for reducing complexity to simplicity. His curiosity was insatiable, and he never stopped asking questions. The fourth defining Drucker strength was his focus on the responsibility of leaders. “The CEO,” he said, “is the link between the inside, where there are only costs, and the outside, which is where the results are.” For many reasons, businesses become inwardly focused. The CEO has primary responsibility for bringing the outside in, for ensuring that the organization understands the views of the market, current and potential customers, and competitors.

The fifth and most important of Peter’s many attributes was his humility. He treated everyone with deep respect. “Management is about human beings,” he wrote. “Its task is to make people capable of joint performance, to make their strengths effective, and their weaknesses irrelevant.”

- From the forward of The Definitive Drucker: Challenges for Tomorrow’s Executives—Final Advice from the Father of Modern Management.

As a result, the majority of boardrooms have not fully examined the impact to their companies and industries that could result from shifting demographics. There are some exceptions, such as those businesses more closely tied to immigrant labor, and some that are ahead of the curve, such as Coca-Cola, Cox Communications, McDonald’s, and Toyota. But the vast majority have largely ignored the issue. The demographic forecast calls for significant downsizing of population in the Northeast and Midwest and an opposite trend in the South and the Southwest, where the projected growth of the Hispanic population and a migration of the labor force is expected to double.

Business decision makers in and out of the boardroom should be aware of the narrowing window in which to formulate how they will grapple with the changing face of America. It raises strategic issues on several fronts, such as changing consumer market opportunities and the impact on regional economic growth; and on the organizational side, executive recruitment and workplace policies. As the first wave of baby boomers near retirement, corporate officers and their directors will no longer be able to ignore the social and economic impact of immigration—legal and illegal.

Like they did with the green movement and the aging workforce, corporate leaders need to formulate a strategy around the patterns of immigration that are known and predictable. Just as some corporations have embraced eco-friendly initiatives to open new markets, cut energy costs, and improve the quality of life for their employees and communities, once embraced, immigration may present as many solutions and opportunities as challenges.

Our True Demographic Threat

The long-predicted retirement of the baby boomers is about to turn our economic world upside down. These 76 million Americans, born between 1946 and 1964, will begin to retire in the coming years and into the decades of the 2010s and 2020s. Although many say they will continue to work after retirement, we can expect their economic contributions to be sharply reduced.

The enormity of the impact can be seen in the ratio of those people ages 65 and older to workers between ages 25 and 64. After decades of stability, that ratio is projected to grow by 30 percent from 2010 to 2020 and by an additional 29 percent from 2020 to 2030. Because of our earlier decades of reduced birth rates, there are simply not enough younger people in the workforce. In the next decade alone, America’s businesses and taxpayers will face a tremendous jolt. How are we to cover the retirement expenses and health care of so many more seniors? The unpleasant options—all likely needed—are cutting benefits, raising taxes, and incurring greater debt. As an offsetting factor, the need to exercise those options would be reduced somewhat if we could find ways to boost the number of workers or their average incomes.

The practical effect on businesses and government agencies is that labor-force growth is expected to plunge near zero between 2015 and 2020, according to the Bureau of Labor Statistics. That is the average trend for the nation, but in some states and in many industries, net losses in the workforce can be expected. In the coming decades, employers will face a major scramble to find replacements for their retiring workers. Among their strategies will be to delay retirements, bring back workers part time, resort to hiring from the ranks of the marginally qualified, and offer relocation assistance for recruits from states with deeper work forces.

The growing immigrant population is part of the solution to baby boomer retirements and already accounts for more than half of the workforce growth in the nation. But these immigrant workers cannot all be imported in a rush. Their preparation for our workforce requires time for training and adjustment, a process already underway.

Public attitudes toward immigration revolve around more than just workforce numbers. Also included is a package of beliefs about assimilation and economic viability. Many fear that immigration is accelerating and increasing without limit, thus producing a rapidly growing population of unassimilated foreigners. As a result, many unfavorable trends are worsening, the story goes, with dire consequences for the future: English is losing its status as the nation’s language, and in places like Miami and Los Angeles, Spanish has become dominant, at least in many neighborhoods. It is feared that a great many of these newcomers are incapable of ever joining the middle class. Others believe that with immigrants spreading throughout America, more places will lose their traditional English orientation, and poverty will grow, placing even greater pressure on already over-burdened taxpayers.

Some of these beliefs about immigration have been true in the past, but they exaggerate the trends and lead to damaging myths. In fact, new evidence despels some of the myths and shows that many of the true trends are already shifting. First, the rate of immigration is no longer accelerating as drama-tically as it has in the past. According to most experts, the flow of newcomers has leveled off and is slowly declining, a trend expected to continue for the next decade or more. The fear of unlimited expansion is simply untrue.

Second, Spanish usage has become predominant in some areas, but that is due to the clustering of newcomers born south of the border. With their accelerated arrival, Spanish increased. Now the flow is stabilizing and experts tend to agree that the children of these immigrants will be fluent and reliant on English.

Third, the pace of their economic mobility is astounding, as best exemplified by the rate of home ownership among Latinos. Few can afford to buy homes when they first arrive, but after more than 20 years of residence in the United States, fully 54 percent of Latino immigrants have purchased homes, not far from the national average of 68 percent. The concentration of recent arrivals created an illusion of growing poverty that does not describe the future. Immigrant parents can acquire useful workplace training, but they are not as likely to go back to school for advanced degrees. The need to replace skilled retiring baby boomers, the most highly educated generation in U.S. history, requires renewed efforts to raise education levels among our immigrant and minority youth. The importance of this goal has long been recognized, but Americans have yet to fully embrace it.

It counts now. The coming workforce collapse will require that we encourage more citizens to become better-trained workers. Young adults need to become middle-class taxpayers because the wellbeing of the rapidly growing number of seniors, expected to live longer than any previous generation, will depend on younger people’s ability to pay taxes to fund programs such as Social Security and Medicaid. And there is one additional benefit that will, quite literally, hit close to home. With so many baby boomers retiring, a great many will be selling the homes that they have invested in. The growing senior ratio also indicates a relative surplus of home sellers compared to the number of potential home buyers.

If the younger generation is under-educated and earns a lower income, how likely is it that seniors will receive offers to buy their homes at reasonable prices? Latinos are becoming a growing presence in the housing market—Spanish surnames account for 4 of the top 10 most common names among buyers nationwide—and the numbers are increasing. However, Latino home buyers, hampered by lower education and lower income, generally offer only three-quarters of the price of the average house sold. The good news is that higher education can make a big difference to home sellers. When Latinos have a college education, they purchase homes that are about 60 percent more expensive than if they only have a high-school degree.

From the standpoint of business and organization executives, it is essential to raise the skill level in an otherwise diminished workforce. Those young people are in school today, and the nation’s well-being depends on their success.

Immigrants play a vital role in meeting the challenge of our needs for workforce replacements, new taxpayers, and fiscally fit home buyers. Rather than focus simply on the number of newcomers, we need to focus on the education and assimilation of immigrant residents and minority groups already living here today. Investment in the younger generation has never been more crucial to the continued prosperity of America.

Dowell Myers is the author of Immigrants and Boomers: Forging a New Social Contract for the Future of America (Russell Sage Foundation, 2007) and a professor in the School of Policy, Planning, and Development at the University of Southern California in Los Angeles.