Friday October 31, 2014
BOOK EXCERPT

Truly Effective Boards

An excerpt from Richard M. Steinberg’s Governance, Risk Management, and Compliance: It Can’t Happen to Us—Avoiding Corporate Disaster While Driving Success.

Richard M. Steinberg, founder and CEO of Steinberg Governance Advisors, is a former senior partner of PwC and the leader of its corporate governance advisory practice. This article is excerpted from his book, Governance, Risk Management, and Compliance: It Can’t Happen to Us—Avoiding Corporate Disaster While Driving Success. The key responsibilities originally appeared in Corporate Governance and the Board—What Works Best, a book Steinberg led development of while at PwC.

Richard Steinberg

It’s becoming increasingly clear that the landscape has changed—permanently. That means it won’t go back to the way it was. In other words, ensuring compliance with the letter and spirit of the new requirements will continue to require attention going forward. This is not a case of “done once and forget about it.” Sarbanes-Oxley, stock exchange listing requirements, SEC rules, Dodd-Frank and other rules and expectations of investors—especially institutional investors and other major shareholders—require ongoing diligence.

But experienced directors and senior executives recognize that the requirements, for the most part, deal with issues of form, not function. Yes, they are important because they’re now legal or regulatory mandates, and also can serve as enablers to effective board performance. But as noted, some boards that have always done these things still have not been very effective, while others had few of the now-mandated practices in place yet have been highly effective. What makes a board truly effective is something else entirely. Experienced directors—having spent a disproportionate amount of time on the new mandates that deal for the most part with additional disclosures to and empowering shareholders and imposing checks and balances on management—want to get back to the business of providing the chief executive and senior management team with value-added advice, counsel, and direction on critical issues facing the business.

So where is board attention needed? That will depend on each company, of course. But based on my experience, there are eight principal areas of responsibility where the value-add takes place, outlined here in high-level summary.

1. Strategy. Making sure the company gets strategy right is absolutely critical. Effective boards carefully analyze proposed strategy plans and management’s rationale for its recommendation. These directors bring experience and insight into the constructive debate, focusing on markets, competitors, risks, resources and interdependencies. It is of critical importance that resource allocation, business processes and senior executives’ buy-in all are positioned to drive successful strategy execution.

2. Risk management. The board must be comfortable that management is identifying and appropriately responding to risk, and that the board itself is apprised of the most significant risks facing the company. To reach this comfort level, effective boards ensure that management has in place an effective risk-management process, and the directors assess whether risks are undertaken and managed consistent with the established risk appetite.

3. Tone at the top. Management establishes the corporate culture, but effective boards ensure that the desired integrity and ethical values are present. Of course, that includes a robust code of conduct, a whistleblower channel, feedback protocols and related elements comprising a cohesive program, and also means the board must ensure the culture is driven not only by the words of management, but their actions as well.

4. Measuring and monitoring performance. The board must ensure that performance measures are linked to strategy, tactics and the real value drivers.

Metrics should balance financial performance with forward-looking, nonfinancial information. And performance awards should be aligned with company goals.

5. Transformational transactions. Directors must be truly comfortable with the business justifications for a proposed deal, whether it be a merger, acquisition, alliance partnership or joint venture. Effective directors critically evaluate management’s data, projections and assumptions—particularly when it comes to “synergy” and integration assumptions. The board should apply lessons learned from past transactions, and should have the courage to walk away from a bad deal.

6. Management evaluation, compensation, and succession planning. Effective boards and compensation committees, especially under the current governance spotlight, ensure that performance criteria and targets for management are linked to strategic goals and desired behavior. Compensation should be crafted to retain the best talent while paying for performance. The best boards don’t wait for signs of a departure before having succession plans in place.

7. External communications. Corporate boards— particularly their audit committees—continue to struggle to understand what entails “appropriate oversight” of financial reporting and related processes. Effective audit committees ensure they have requisite information from management and auditors, and the committee members gain sufficient understanding and insight and challenge critical judgments, resulting in the necessary comfort with the reliability of financial reports, internal control and related matters.

8. Board dynamics. This involves the ways in which the board itself operates. The most effective boards forge the right relationships, processes and constructive engagement to carry out the above responsibilities effectively.

Potential Pitfalls
For corporate boards to be well positioned to effectively carry out their responsibilities, directors must bring needed knowledge, skill and experience to the companies they oversee. We see boards of many companies do well, for instance, in selecting a CEO and senior management team, and making sure the right strategy is in place along with organizational, financial and human resources for effective implementation. But too many other boards have struggled to do the job, for any number of reasons.

One underlying cause is devoting insufficient time to dissecting and debating issues requiring the board’s attention. Being inside boardrooms, we see some directors operate on tight schedules, leaving them unable or unwilling to give needed time and attention to board matters—and they go through the motions without proper deliberation of risks, issues and events that drive company success or failure.

Board agendas typically are set far in advance of meetings, based on expected needs and historical patterns. Travel arrangements are made and directors schedule other commitments around the established board schedules. As such, a fixed amount of time is set aside for board business, with discussion time shoe-horned into the predetermined schedule. Of course, in times of crisis directors’ commitments expand significantly, with other commitments adjusted accordingly. But too often the time set aside for board and committee meetings simply isn’t sufficient, especially in light of the current regulatory environment and stakeholders’ heightened expectations. Some boards find it useful to build cushions into meeting schedules to deal with matters requiring additional discussion, but this hasn’t become a common practice.

Exacerbating this circumstance is the fact that demands on directors’ time continue to increase, with data showing that total time devoted annually to board responsibilities has doubled in recent years to about 250 hours. Much of the additional expenditure is due to boards’ expanded monitoring duties emanating from compliance-related requirements. But while the time commitment has surged, attention to critical strategic and related matters that create or destroy shareholder value has not always kept pace.

My experience is that many if not most directors of public companies not only have the requisite expertise, attributes, and characteristics commensurate with their tremendous responsibilities, they also devote the time and energy needed to drive corporate success. They extend themselves as needed to guide, counsel, and when necessary direct the CEO and senior management team toward attaining established growth and return goals. But in truth some directors fall short.

Directors must delve deeply enough into significant issues. By accepting board seats, directors already have put their reputations on the line and accepted responsibility to carry out their fiduciary duties. It behooves every board member to work with sufficient diligence to see that the company succeeds.

With that said, let’s look at a number of pitfalls boards have fallen into. We’ll do this in David Letterman top-10 style, finishing with those most threatening to a company’s success. You’ll note that there’s a natural parallel to some of the eight keyboard responsibilities outlined earlier.

10. Falling prey to governance ratings. Boards are cognizant of scores disseminated by a number of organizations providing some sort of rating. And if the investor community sees these ratings as accurate indicators of future company performance, a good deal more attention will be paid. But such correlation has yet to be proved, and spending undue attention on ratings can be counterproductive. This is because criteria used are, with few exceptions, based on information obtained from publicly available data, rather than knowledge of what goes on inside the boardroom. Yes, some information garnered in the ratings process can in certain cases, as some suggest, serve as a window onto board effectiveness. But how well the board truly operates in carrying out its responsibilities to help grow share value is more important than driving up externally developed scores.

9. Looking at the wrong performance measures. Boards review data provided by management, and in many cases it’s the right information to examine. But when it’s not, performance too often deteriorates long before directors realize it’s too late to fix what needs to be fixed and value has been eroded. Historical financial and share price data are not enough. Measures must be aligned with the company’s strategy and be sufficiently forward looking— including key nonfinancial data—to enable realtime appraisal of how the company is really doing.

8. Insufficient discipline in director selection. Having the same directors sitting in the same board seats for a long time has its benefits, but can also have major shortcomings—board membership that might have been right for a company years ago could be wrong for today and, more importantly, for tomorrow. But haphazard selection of new directors won’t ensure the right mix—the process requires thoughtful needs analysis and skills matching. Directors will want to consider not only process in selecting new board members, but also to look around the boardroom and ask: Is this the group with which I want to work, and when necessary, go to war?

7. Preoccupation with potential liability. Boards and individual directors today are increasingly concerned with personal liability, and justifiably so. Marketplace expectations for directors have risen dramatically, to the point where it may be impossible to satisfy them all. And with the new and still untested federal requirements, our increasingly litigious society and limitations of many directors-and-officers insurance policies, directors should be concerned about liability. But attention must be paid to fundamental board responsibilities—making sure the company has the right strategy and implementation plan; relevant and aligned performance metrics; strategically and economically sound business partners; effective ethics, control and compliance programs; sound financial reporting; sensible and effectively motivational compensation programs; and the like. Frankly, if the board does its job well in carrying out its core responsibilities and the company is successful, there is little likelihood of being sued in the first place.

6. Blatantly ignoring institutional investors. Owners of significant amounts of a company’s stock increasingly want, and expect, to be heard, and boards disregarding these requests are asking for trouble. If the media get involved, the spotlight becomes bright and hot, creating headaches for the board and company that can be intense and long lasting. Boards certainly shouldn’t allow institutional investors to dictate what needs to be done, but allowing major shareowners to raise issues and offer input and suggestions—and ensuring any information provided complies with Reg. FD and other rules—enables those investors to participate in the governance process without voting with their feet.

5. Thinking you’re apprised of critical risks when you’re really told about problems. With all the talk about the importance of being risk-focused, many boards are informed of business issues after the “bad stuff” has already occurred, rather than of where the potential exists for things to go seriously wrong. You want to know—far in advance—where the dangers lie that can derail key initiatives and strategic objectives, and to make sure those risks are being identified early and properly managed.

4. Presuming top management knows what the critical risks are. For the board to have any reasonable chance of being informed by management of key risks facing the company, management itself needs to have processes in place to ensure it can identify newly emerging risks. As such, effective boards ensure the company has an effective risk management process where each level of management identifies, analyzes and manages risk, and communicates upward. Only through such a process and culture can the board be comfortable that the most critical risks and related actions are presented to the board in timely fashion.

3. Focusing too much on rules and not enough on other important responsibilities. A tremendous amount of attention is being given to new legal requirements, the exchanges and the SEC, and ensuring compliance with these requirements is essential. But as noted, those rules tend to deal with matters of form, structure and disclosure, and a board can follow every rule and still be ineffective. Yes, boards must carry out their responsibilities and act as an effective check and balance on management—a basic thrust behind the new rules and compliance requirements. But the board also must operate effectively as a unit, providing the needed advice, counsel and direction to management to grow share value.

2. Signing off on bad strategy. Many boards do the right thing, carefully assessing strategic plans— often at an offsite retreat—reviewing market, competitive and other relevant information before approving the company’s strategy. But too many boards don’t go deep enough. They don’t see management’s plan for implementation of the strategy and ensure that the plan is supported by the needed organizational structure, resource allocations and buy-in of key managers who truly will make it happen—or not.

1. Making bad decisions about the CEO. It’s fair to say that a board’s most important responsibility is choosing the right chief executive. But that can also be the most difficult decision to get right. It’s only after the fact that one truly knows whether the selection was good or bad. Some boards have waited too long to make a change, and some appear to have pulled the trigger too quickly. Boards that do the best jobs know their company, its needs, the environment in which it operates, and its culture and direction. They carefully identify criteria for the person needed to get the company to where it needs to be, cast a wide net internally (preferably with sound succession planning in advance) as well as externally, and—most important—they have the business acumen, instinct and judgment to select the right individual to lead the company. And then the board puts in place the right motivations and measures, and provides the right level of oversight— neither abdication nor micromanagement—to help and allow the CEO to do the job.

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