Elevating Board Performance

Electronic copy available at: http://ssrn.com/abstract=1832234

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1 © 2011 Simon C.Y. Wong

Elevating board performance: The significance of director mindset, operating context, and other

behavioral and functional considerations

Simon C.Y. Wong Partner, Governance for Owners

Adjunct Professor of Law, Northwestern University School of Law Visiting Fellow, London School of Economics and Political Science

E-mail: [email protected]

Draft: 1 June 2011

Northwestern University School of Law Law & Economics Research Paper No. 11-12

This paper is available at SSRN: http://ssrn.com/abstract=1832234

Abstract

The global financial crisis has prompted debate once again on how to improve the effectiveness of the board of directors at listed companies. Despite considerable reforms over the past two decades, boards – particularly at financial institutions – have been criticized recently for failing to properly guide on strategy, oversee risk management, structure executive pay, manage succession planning, and carry out other essential tasks. This article argues that the lack of attention to behavioral and functional considerations – such as director mindset, board operating context, and evolving human dynamics – has hampered the board’s effectiveness. To reach their potential, the article recommends that – alongside establishing core building blocks such as appropriate board size, well-functioning committees, proficient company secretarial support, and professionally-administered board evaluation – boards and their members focus on the following:

• Think like an owner • Know their companies • Be prepared to “roll up their sleeves” • Take charge of their priorities • Hire a collaborative CEO • Protect their authority and independence

Keywords: Board of directors, mindset and behavior, board culture, independence and authority JEL Classifications: G34, M14


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Elevating board performance: The significance of director mindset, operating context, and other behavioral and

functional considerations

Simon C.Y. Wong

The global financial crisis has prompted debate once again on how to improve the

effectiveness of the board of directors at listed companies. In their investigations of the recent

economic meltdown, the Organisation for Economic Co-operation and Development, European

Commission, US Congress, and others found serious deficiencies in the way boards, particularly

at financial institutions, guided on strategy, oversaw risk management, structured executive pay,

managed succession planning, and carried out other essential tasks.1

What is most troubling is not that boards have failed per se but that their alleged

shortcomings have persisted despite the considerable board reforms pursued over the past two

decades.

What went wrong?

To be fair, boards have improved as a result of previous reforms. Today, they

increasingly consist of highly qualified individuals, operate more professionally, and undertake

substantive work. But reforms in the past focused principally on board structure, composition,

and processes. Much less attention has been paid to behavioral and functional considerations,

such as director mindset, board operating context, and evolving human dynamics.

1 See, for example, Organisation for Economic Co-operation and Development, “Corporate Governance and the Financial Crisis,” February 2010; European Commission, “Corporate Governance in Financial Institutions: Lessons to be drawn from the current financial crisis, best practices,” June 2010; David Walker, “A review of corporate governance in UK banks and other financial industry entities” (Walker Review), November 2009; and US Financial Crisis Inquiry Commission, “The Financial Crisis: Inquiry Report,” January 2011.


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Yet, examinations of board “failures” around the world, including at leading companies

renowned for their corporate governance arrangements, routinely point to deficiencies in these

areas – for instance, CEOs who increasingly dominated their boards, non-executive directors

who failed to fully grasp their companies’ fundamental performance drivers, and boards that

were insufficiently engaged in key activities and decisions, whether on strategy, executive

remuneration, or acquisitions.

In addition, the board’s effectiveness has been hampered by a few well-intentioned but

misguided moves – as reflected in best practice guidance and other commentaries – such as

emphasizing board independence over directors’ company and industry knowledge and setting

boundaries on board involvement that has constrained its ability to fulfill core responsibilities.

Considerable stakes involved

If the quality of board stewardship does not improve, the consequences are likely to be

severe. First, the board’s freedom to organize itself, set priorities, and keep sensitive matters

private may be at risk. In the UK, the government has inquired whether the remuneration

committee’s membership should be “widened” so that boards will be more sensitive to “pay and

employment conditions elsewhere” in the company.2 Last year, the European Commission

consulted publicly on whether boards of financial institutions should be required to approve new

financial products. 3 Reversing a long-standing policy, the US Securities and Exchange

2 UK Department for Business, Innovation and Skills, “A Long-Term Focus for Corporate Britain: A Call for Evidence,” October 2010. 3 European Commission (2010).

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Commission decided in 2009 to allow shareholders to submit resolutions to require boards to

disclose detailed succession planning processes.4

Second, shareholders, regulators, and others may be given additional powers to intervene

in areas where – due to lack of competence, conflicts of interests, and other factors – they may

not be well-suited. In light of the perceived failure of boards to constrain executive pay,

policymakers in several countries are debating changing “say on pay” resolutions from precatory

to binding. Signaling a radical change of approach, the Bank of England recently proposed

hiring senior supervisors to challenge bank executives on strategic decisions, a function that

hitherto has been assumed principally by the board.5 Reducing the board’s role in these critical

areas would lower its standing and could unleash a vicious cycle that leads to further diminution

of its authority.

Third, persistently poor stewardship by the board will destroy company value. In North

America and Europe, boards of financial institutions that failed to check management’s

aggressive forays into US sub-prime mortgages saw their firms decimated during the financial

crisis. At a large European retailer, the board’s failure to identify a CEO successor in a timely

manner created fissures in the boardroom and brought about disruptive shuffling and re-shuffling

of the management team over an 18-month period. Given the tumult inside the company,

performance deteriorated, as demonstrated by lost market share, contraction of margin, lower

operating profit, and product and marketing missteps.

4 US Securities and Exchange Commission, “Shareholder Proposals,” Staff Legal Bulletin No. 14E (CF), October 27, 2009. 5 Brooke Masters, “King pledges radical change on bank scrutiny,” Financial Times, March 1, 2011.

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Measures to help boards reach their potential

Given what’s at stake, there is great urgency for boards to elevate their performance.

Having spent nearly 15 years examining, advising, and interacting with scores of boards in

developed and emerging markets, I have concluded that their effectiveness would improve

markedly if – alongside establishing core building blocks such as appropriate board size, well-

functioning committees, proficient company secretarial support, and professionally-administered

board evaluation – they focus their efforts on a handful of behavioral and functional areas. In

particular, boards and their members should:

• Think like an owner

• Know their companies

• Be prepared to “roll up their sleeves”

• Take charge of their priorities

• Hire a collaborative CEO

• Protect their authority and independence

Many of the behavioral and functional considerations discussed herein have received

limited mention in corporate governance codes and other best practice guidance, which continue

to focus predominantly on structures and processes.6

Signs of change are emerging, though. The recently released UK Financial Reporting

Council’s Guidance on Board Effectiveness, for instance, acknowledges the limits of the

prevailing approach and admonishes boards to “think deeply about the way in which they carry

out their role and the behaviors that they display, not just about the structures and processes that

they put in place.” 6 Effective board leadership, which has received increasing attention, is discussed in several of the recommendations rather than treated separately.

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Think like an owner

Boards are vital stewards, responsible for ensuring the long-term viability and health of

firms under their charge for the benefit of current and future owners. As such, it is important that

they adopt an ownership mindset. Yet, few do so. While the non-executive directors populating

boards are generally hard-working and earnest, they often have a limited conception of their

roles. One US commentator with several board memberships has complained that the vast

majority of outside directors are “kibitzers,” passive participants who do not believe it is their

role to challenge management beyond asking a few questions at board meetings.

Contrast this with family firms, the largest of which generally outperform their listed

counterparts and are directed by active owners within and outside the board.7 According to the

chairman of a large and successful family-owned construction firm founded more than 100 years

ago:

“Directors with an ownership mindset – whether from the family or outside –

have passion for the company, look long-term, and take personal (as distinguished

from legal) responsibility for the firm. They will spend time to understand things

they don’t know and not pass the buck to others. They will stand their ground

when it is called for. Ultimately, the success of the company over the long-term

matters to them at a deep, personal level.”

Blame for a diminished view of a director’s role lies within and outside the boardroom.

Some directors, for instance, continue to treat their roles as sinecures. At one financial

7 For example, among the 1,000 largest companies in the world, the 200 family-owned firms have higher return on investment (26% vs. 21%) over a five year period. John Ward (lecture), Governing the Family Business Course, Kellogg School of Management, Northwestern University, October 2008. See also Ronald Anderson and David Reeb, “Founding-Family Ownership and Firm Performance: Evidence from the S&P 500,” 2003.

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institution, the lead director mentioned privately to a colleague that “I didn’t sign up for this”

when it became clear that shareholders expected him to step up his involvement after an activist

investor started questioning the firm’s strategy and leadership structure.

At some companies, senior executives fear that if boards are empowered, then

management will inevitably be weakened. In response, they endeavor to limit the board’s

involvement in strategy development and other key activities. Others may also create physical

and psychological distance between the board and the firm. At a global mining company, the

chief executive insists that the board chairman sit on a different floor from the executive team

and frowns upon non-executive directors meeting with senior executives outside his presence.

At the same time, corporate governance gurus, concerned about micro-management and

conflicts of interest, have advocated an arm’s length involvement for the board, epitomized by

the widely accepted “wisdom” that boards should keep their “noses in, fingers out.”

In spite of this, some public company boards do exhibit an ownership mindset. Harvard

Business School Professor William George describes the board of Medtronic, where he was

formerly chairman and CEO, as one where successive generations of directors demonstrated

deep devotion to the firm, focused long-term, and played an instrumental role in helping the

company grow and prosper.

To embed an ownership mindset in the boardroom, companies should start at the director

recruitment stage. To assess whether a director candidate is likely to be an effective steward for

shareowners, it is useful to ask the following questions:

• How should non-executive directors be involved in strategy development?

• What type of information would you need to discharge your responsibilities effectively

and how would you obtain it?

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• In your previous board roles, in which areas did you have the greatest impact?

• In a group setting, when have you taken a stance against the then prevailing majority

view and what was the outcome?

There are no particular “winning” responses. What’s important is assessing the extent to

which a candidate exhibits energy, a proactive attitude, and an independent mind. Conversely,

warning signs include an excessively deferential attitude toward management – for example,

inability to recall any occasion when he or she disagreed with the CEO – and an overly passive

view of their roles.

Furthermore, boards should gauge a candidate’s inherent interest in the firm and time

availability because the absence of either will hinder a director’s ability to think and act as an

owner.

Once they come on board, companies should strive to strengthen directors’ commitment

to the firm. As discussed further below, this is best achieved by involving them meaningfully in

substantive board work. At the same time, emotional bonds can be deepened through social

interactions, such as group trips to visit facilities abroad, dinners with different management

members, retreats that include spouses, and other informal social gatherings.

Financial tools can, within limits, also help tighten the connection between directors and

their firms. To strengthen directors’ sense of being an owner, some companies require outside

board members to receive their fees in stock and buy shares using their own money. To

reinforce a long-term orientation, some firms mandate that non-executive directors retain all

equity acquired until they have retired from the board.

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Lastly, it has been noted that passion for the company can be passed from one board

generation to the next through overlapping tenures between the retiring directors and their

successors.

Know their companies

For a board to add value, individual directors must possess a strong understanding of the

company and its industry. In my conversations with CEOs over the years, many wished their

outside directors had a better grasp of the business and industry dynamics. At a global mining

company, the chief executive remarked, “Although I appreciate the diverse skill set and

experience of the directors, there are not enough miners on the board. As a result, it is difficult

to engage them in the way that would be most helpful to management.”

Deeper knowledge would certainly enhance non-executive directors’ contributions to

board discussions. More importantly, it could also enable boards to better appreciate the

strategic significance of seemingly minor developments – such as a gradually widening gap

between reported profits and cash flows – or the hazards that may lurk beneath ostensibly sound

courses of action. At a European engineering company, an outside director with broad sector

experience was the only board member to recognize that a proposed expansion into an “adjacent”

business line was likely to destroy value and damage the company’s culture because success in

that market segment required a way of thinking and operating that diverged sharply from the

firm’s modus operandi.

Due to the belief that outside directors without close links to management and the

company are better monitors, the trend globally has been to populate the board with

“independent” directors. Consider the US. In the 1950s, outsiders on a typical American board

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usually included the firm’s banker, legal counsel, and others with extensive ties to the company.8

In 2010, Spencer Stuart reported that 84% of board members in S&P 500 companies were

independent and 53% of surveyed firms had only one non-independent director, the company’s

CEO.9

The drawback is that independent directors usually lack deep familiarity with the

companies on whose boards they sit. In financial institutions that collapsed during the financial

crisis, it appears that the non-executive directors – most of whom were independent – largely

failed to appreciate the risks that their firms were taking and were genuinely surprised when their

banks’ condition deteriorated rapidly.10

Consequently, there is a heightened need to ensure that outside directors know their

companies well. However, the challenge of getting directors to be functional should not be

underestimated.

According to the board secretary of a continental European engineering firm, “Given the

highly technical nature of our business, it usually takes a new director a few years to get up to

speed.” Two years after assuming the role, the chairman of a global telecommunications firm

admitted, “This is a complex business and I am still on a massive learning curve.”

While some companies do a good job on director induction and ongoing knowledge

development, poor practices are pervasive, particularly the emphasis on passive learning through

8 For further information, see Jeffrey N. Gordon, “The Rise of Independent Directors,” Directorship, February 1, 2008. 9 Spencer Stuart, “2010 Spencer Stuart Board Index,” 2010. 10 See, for example, discussion in European Commission, “Corporate Governance in Financial Institutions: Lessons to be drawn from the current financial crisis, best practices,” Commission Staff Working Document, 2010.

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perusing written materials and attending lectures and presentations. Prompted in part by

regulators, some firms focus excessively on legal and compliance matters.11

At some companies, quality of information is also a problem. It is either not enough, too

much, or the wrong kind.

At a European consumer electronics firm, the lead director is only provided monthly

management accounts and broker reports to help her keep abreast of company developments.

Unsurprisingly, she responded obtusely when asked about the firm’s strategic direction and

industry trends. At a FTSE 100 retailer, the board receives weekly sales data for the company.

Such information may be too granular for the board and invite micro-management.

Echoing the sentiment of non-executive directors at many companies, the chairman of a

business services provider lamented, “We get a lot of data but not much information.” Similarly,

an outside director of a global mobile phone operator complained that “the packet of materials

for each board meeting is at least 300 pages, with no synthesis or summaries to help you focus

on the most critical areas.”

To bolster non-executive directors’ understanding of the company, written materials

provided to the board must improve. All board papers, for instance, should contain a summary

page explaining the topic to be discussed, key issues to consider, potential impact on the firm,

and action required from the board.

Furthermore, interactive, experiential activities – for example, visits to factories,

suppliers, and customers – should be emphasized. Such mode of information acquisition will

likely yield a deeper understanding of the firm’s business and industry dynamics than passive

11 Take the recent proposal by stock market operator Hong Kong Exchanges and Clearing to require non-executive directors at listed firms to undertake 8 hours of training per year. According to its Head of Listings, mandatory training has been proposed because directors need to “keep up to date with regulatory changes.” While board members should be aware of legal requirements, this should not be the sole or primary focus of board training.

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absorption of written reports and lectures. One FTSE 100 chairman remarked that after site

visits, “non-executive directors usually ask more insightful and penetrating questions.”

At a large European grocery chain, the board meets in countries where the company plans

to expand and regions with the greatest growth potential. Similarly, a leading Asian

telecommunications group holds at least one board meeting a year in a country where it has a

substantial investment or interest in investing. During these visits, meetings are often arranged

with local business leaders, government officials, and business partners.

At a UK-based business services company with operations in more than 50 countries, the

chairman visits three countries a year to spend time with local managers. In addition, two board

meetings are held at business units in the UK or abroad each year.

Importantly, information shared with the board should include dissenting opinions. One

bank chairman invites the research analyst with the most bearish view of the firm to address the

board. Another chairman asks “outlier” analysts holding diametrically opposite opinions of the

company to engage in a debate before the board.

Moreover, non-executive directors should take personal responsibility for their own

learning and not over rely on the chairman and management to supply them with information.

Given the complexity of some industries – financial services, global mining, and

pharmaceutical, to name a few – there may be a limit to which outside directors are able to

acquire the requisite depth of knowledge solely through service on the board.

Several years ago, I met with a former CEO whose company I served when I practiced

law and for whom I retained the utmost respect. Fifteen months earlier, he had switched from

serving as the chief executive of a major electronics firm to chairing the board of a leading

mining company. Although he had spent more than 150 days in his first year “getting up to

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speed,” he spoke about company and industry issues only in broad, general terms. It was

obvious that, despite his earnest efforts and considerable intellect, he was a long way from

mastering the intricacies of the mining industry.

While not all outside directors need to be industry experts, a good proportion of them

must possess strong company and industry expertise in order for the board to contribute to

strategy development in a meaningful way, challenge management effectively, and monitor

performance robustly. As explained by the chairman of a European bank that nearly collapsed

during the global financial crisis, “The problem was not insufficient flow of information to the

board. Rather, the board reluctantly accepted management’s judgment – even though

management’s responses were not convincing – because the non-executives felt they did not

have adequate understanding to keep pushing.”

Recently, some boards have increased the proportion of non-executive directors with

sector expertise. British bank Barclays, for instance, now requires 50% of outside board

members to possess a financial services background.

Be prepared to “roll up their sleeves”

There is broad acceptance that listed company boards should operate on the basis of

“noses in, fingers out.” That is, they should probe and offer guidance but let management handle

execution and other details. This advice is sound with respect to most matters that come before

the board.

Good stewardship, however, calls for fuller contributions from the board on key

corporate decisions and activities, particularly those that affect its ability to govern the company

effectively. Consequently, it is necessary for boards to engage intensively in such critical areas

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as strategy development and risk management. Furthermore, on matters where management

faces severe conflicts of interest, such as CEO succession planning and executive remuneration,

boards must absolutely take charge. In other words, they need to “roll up their sleeves” and

drive the work.

At many companies, board involvement in strategy development has increased over the

past decade. Take a global universal bank, where deeper board engagement on strategy came

about through a change of leadership. Under the old chairman, the board’s input on acquisition

opportunities and the firm’s strategic posture was extremely limited. When the new chairman

came onboard, he met with directors individually to obtain their views on the desired strategic

direction for the institution. He then organized the board’s first-ever strategy retreat, a two-day

event that examined the bank’s diverse businesses in-depth and explored the mega-trends that

would shape the firm’s positioning in key markets. A year later, he convened another strategy

away-day to evaluate progress on implementing the key changes the board had previously agreed.

According to one board member, “The new chairman is much more open and the bank’s current

strategy was developed with full involvement of the board. There was and is iteration with board

members individually and collectively.”

Substantive board involvement in strategy development brings important benefits. It

enables companies to tap the skills and experience of non-executive directors while

strengthening their understanding of, and commitment to, their firms.

Following the global financial crisis, boards are also stepping up their oversight of risk

management, particularly at banks. The lead director of a European commercial bank explained

to me recently that whereas the board previously focused on broad, entity-level risks, today it

scrutinizes risks much more granularly – for instance, by types and sub-types and by individual

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businesses and key operating units. It is also alerted to risk concerns through more sophisticated

mechanisms and at an earlier stage.

It has often been said that the board’s most important role is to “hire and fire the CEO,” a

short-hand for the responsibility to ensure that the right leadership team is in place at all times.

To discharge this duty effectively, the board must actively steer succession planning and

leadership development.

For a host of reasons – including a desire to maintain control, lack of objectivity, and

worries about bringing up a serious challenger – the CEO is poorly positioned to spearhead

succession planning. Yet, the board’s stewardship is arguably weakest in this area.

In the UK, a veteran board evaluator observes that poor succession planning is – by a

considerable margin – the most commonly cited board deficiency. In the US, a recent survey

revealed that only 42% of directors felt their board’s role in succession planning was effective.12

Although 82% of US firms polled by Korn/Ferry in 2007 had a succession plan in place, the

CEO led succession planning in 44% of them.13

In some cases, the board’s neglect of succession planning borders on the unconscionable.

A 2009 National Association of Corporate Directors survey showed that 61% of US companies

did not even have an emergency succession plan to cover a situation where the CEO is,

proverbially speaking, “hit by a bus.”14

Recently, directors have started to realize that their involvement in succession planning

must grow. According to Spencer Stuart, 57% of the respondents to its 2010 US board survey

identified it as a priority issue, compared to 19% in 2008.

12 Jennifer Pellet, “What is Wrong With CEO Succession?,” Chief Executive, May/June 2009. 13 The Korn/Ferry Institute, “34th Annual Board of Directors Study,” 2007. 14 Antony Goodman, “The little black book of succession,” Financial Times, February 1, 2010.

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Given the unpredictability of CEO tenure – even at well-performing companies15 – and

the long lead time needed to develop CEO-caliber leaders, boards must pay close attention to

succession planning at all times.

In a widely studied case, the board of General Electric spent six years – involving

multiple stages of identifying, testing, and evaluating high-potential executives – to select the

successor to CEO Jack Welch.16

At a global bank, the board maintains a list of 3 names for each senior management role,

and retains a search firm to periodically canvass externally for promising candidates. At a

pharmaceutical firm, the board chairman attends internal review meetings regularly to evaluate

for himself how leadership and management development is shaping up.

Succession planning can, and should, be woven into the board’s other activities. At a

European energy distribution company, board members meet the next layer of management

during site visits, thus enabling them to see how high-potential managers operate in their home

environment. At a mid-cap construction company, the non-executive directors meet after each

board meeting to evaluate the executives who appeared before them.

The board’s leadership in succession planning is particularly important in smaller

enterprises where, due to limited company or industry growth prospects, a talented chief

executive is likely to be lured away by a larger firm at a future point in time. The chairman of a

high-street retailer stated, “Our CEO is up there with the very best. Given that she is highly

attractive to private equity-run firms and larger listed companies, the board does not expect her

15 In recent years, a number of successful CEOs in the US have been unexpectedly forced out due to improper personal conduct. 16 See Geoffrey Colvin, “Changing Of The Guard,” Fortune, January 8, 2001.

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to stay here forever. Consequently, we devote considerable time to developing and grooming

executives.”

In markets where dispersed share-ownership is the norm, compensation has long been

seen as an important tool to align the interests of executives and their firms. However, many

boards appear insufficiently engaged in setting executive remuneration, delegating key activities

to the human resources department and compensation advisers.

In the UK, for instance, it is not uncommon to see a compensation committee chairman

yield the floor to the pay adviser to describe the firm’s remuneration plans to institutional

investors because he doesn’t fully grasp the details.

In the past, the board’s failure to constrain inappropriate compensation practices brought

significant harm to some companies. In the 1990s, issuances of “mega” stock-option awards at

American firms contributed to scores of accounting manipulation cases in the ensuing years.

More recently, US boards drew considerable flak for condoning the back-dating of stock option

grants. The subsequent crackdown by US regulators and prosecutors impacted nearly 150 firms

and took down several highly-regarded CEOs.17

To elevate board performance in this area, directors need to re-orient their views on

involvement in setting executive pay. A veteran UK remuneration adviser has noted that “some

non-executive directors feel that they got the short end of the stick to be on the remuneration

committee and adopt a laissez-faire attitude, letting the HR department be in charge.” The

compensation committee chairman of a giant mining company echoed the same sentiment,

admitting that “most directors feel they add more value when contributing to discussions on

strategy rather than on remuneration.”

17 Mark Maremont, “Backdating Likely More Widespread,” The Wall Street Journal, August 18, 2009.

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Yet, setting remuneration is one of the most vital and challenging board responsibilities.

First, boards need to ensure a strong pay-for-performance linkage, particularly given the rising

quantum of executive compensation, and be able to justify pay arrangements to shareholders,

policymakers, and other external parties. Second, given the highly personal nature of

compensation and hostile atmosphere surrounding some pay discussions, boards must be willing

to stand firm on unreasonable pay demands while ensuring that executives feel they have been

treated fairly. According to a Nordic bank chairman, “you need to be careful that the executives

do not interpret the board’s decisions on bonuses to mean the board thinks they are not good

enough.”

Recently, attitudes have begun to shift. According to the 2010 Spencer Stuart board

survey, US directors identified executive compensation as the most important board issue, with

80% of respondents listing it as a key topic.

While the board must inevitably delegate day-to-day work – such as compiling data and

preparing board meeting materials – to the HR department and pay consultants, it needs to take

charge of the overall process, starting with the selection of remuneration advisers. A seasoned

UK compensation adviser has observed that boards that delegate to the HR department the task

of coming up with a short-list of pay consultants usually end up with aggressive advisers “more

sympathetic to management demands.”

Crucially, compensation committee members must understand the key drivers of the

business and the competitive landscape – including the company’s key competitors – so that the

right metrics and targets will be used to measure and reward management’s contribution to

company performance. Particularly at banks, they also need to comprehend the impact of pay

arrangements on risk-taking by employees, from the executive suite to the trading floor.

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Notably, strategy development, succession planning, and executive remuneration are

closely linked. For instance, when recruiting externally to fill a key position, a common

consideration is whether to target candidates employed at similarly-sized or much larger firms.

This decision is usually informed by the firm’s growth strategy and will, in turn, impact the

remuneration arrangements of the ultimate recruit.

To ensure active board involvement does not lead to micro-management and other

inappropriate interference, the board must be led by a chairman who does not harbor ambitions

to be the CEO and is genuinely content to play a behind-the-scenes role.18

The ability to step back and surrender the stage does not come easily to many chairmen,

especially those with CEO experience. The chairman of a large business services firm, who

previously ran another FTSE 100 company, conceded that it was difficult to move from CEO to

chairman because “it is in my instinct to get involved – with the best of intentions – but, over

time, I have learned to curtail that behavior.”

To build cohesiveness and avoid misunderstanding, the board should periodically agree

among its members and with the CEO areas where:

• Management will lead (e.g., strategy development, operational matters)

• Board will lead (e.g., CEO succession planning, remuneration for top management)

• Board and management will share authority (e.g., leadership development for senior

executives, relations with shareholders and other external parties)

18 For further discussion on the desirable traits of a non-executive chairman, see Robert F. Felton and Simon C.Y. Wong, “How to separate the roles of chairman and CEO,” The McKinsey Quarterly, 2004.

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Take charge of their priorities

As the board’s responsibilities have broadened over the years, its workload has grown.

Following the global financial crisis, boards are now expected to devote greater attention to risk

management oversight and remuneration of below-board staff. However, because most boards

still meet only 8-10 times a year, it is critical that they prioritize their activities and manage their

time efficiently.

At many companies, particularly those with a combined chairman-CEO, management

dictates much of the board’s agenda. However, the board and management may not always hold

the same view on the priority issues that the board should address – for example, regarding the

firm’s long-term strategic direction, approach to achieving growth, and succession planning and

leadership development.

Operationally, some boards ensure that important topics are not missed by scheduling

discussions of strategy, health and safety, and other significant matters at pre-set intervals – that

is, the same time each year. However, such “standing calendar” items are not always managed

dynamically, resulting in board discussions degrading in quality over time and matters that have

become less significant crowding out increasingly substantial topics.

Rather than relying solely on management and standing calendar items to inform them of

issues requiring their attention, boards should also annually decide their top 3-5 priorities for the

next three or more years. Because boards, compared to management, are less able to rely on

operational, financial, and share price metrics to gauge their performance,19 doing so will also

provide them with a clear yardstick to evaluate how well they are fulfilling their responsibilities.

19 Board activities – for instance, spearheading succession planning – are often less visible to the outside world and may not impact the firm’s bottom line in the near to medium term.

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Specific board priorities will, of course, vary across companies and time. In start-up

enterprises and firms in distress, the board may need to devote a substantial amount of time to

strategy and operations while in mature, well-functioning companies, it may make more sense

for the board to focus on setting challenging performance targets, directing succession planning,

and keeping management egos in check.

At a book retailer whose industry is undergoing radical change, the board has decided to

dedicate half of its time to evaluating potential acquisitions, new business categories, and other

strategic options. At a once-struggling industrial conglomerate, the board shifted its focus from

“steadying the ship” to exploring growth opportunities when it became clear that the firm’s

recovery was well underway.

With growing confidence in senior management, the board of an emerging market bank

decided to reduce its involvement in operational matters – including lending decisions – so that it

could concentrate on strategy. Conversely, following a corruption scandal the board of an

international food services company started to spend more time on operations – in this case, by

evaluating potential risks arising from its far-flung operations and putting in place mechanisms

to prevent a recurrence.

In terms of board meetings, board evaluation responses across companies commonly

point to the same deficiencies – excessive focus on routine operational issues, too many

presentations by management, and insufficient time for meaningful discussion of strategic

matters.

In explaining “board failure” at a bailed out bank, the former chairman stated that “there

was a lot of presentation but not enough discussion and debate.” At a global telecommunication

firm, the chairman complained that “there is too much fixed agenda and too little floating agenda.

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Looking forward, we would like to allocate only 30% to board minutes, historical data, CEO

reports, and other backward-looking stuff and 60-70% to technology space, competitor space,

and other strategic matters.”

Boards can free up time at their meetings by asking sub-committees to shoulder more of

the workload. According to the company secretary of a leading mining company, “It is

important to farm general monitoring functions to sub-committees so that the whole board can

focus on the most important tasks.”

In addition, board agendas should be prioritized so that routine and “backward-looking”

matters consume a modest amount of time. At one firm, items falling under “for information

only” – for instance, monthly operational reports – are not discussed during the board meeting

unless a director notifies the chairman beforehand that he wishes to raise an issue. Similarly,

items for discussion should be organized so that formal presentations take up no more than half

of the allocated time.

Significantly, boards that take charge of their priorities will ensure they are not rushed on

important decisions. At some firms, strategic matters – such as entering a new market segment –

are decided over multiple board meetings. At the first meeting, the issue is introduced and initial

questions are answered. At the next meeting, a full debate takes place. Finally, the board

renders its decision at the third meeting.

Hire a collaborative CEO

Boards are highly reliant on management to provide them with information on the

company. Executives who report to boards know all too well that they can enlighten outside

directors or keep them in the dark through their choice of words or the tone in their delivery. As

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one financial executive put it, management presentations could be delivered “in such a complex

way that [the non-executive directors] would be prevented from asking whether the emperor is

naked, for fear of looking stupid.”

In recent years, there have been high-profile incidents of CEOs failing to inform or

involve their boards on critical developments, such as merger discussions. Such breaches of trust

have often led to the CEO’s ouster.

At a European electric utility, the board discovered to its dismay that the CEO was not

entirely forthcoming about the deteriorating performance of the company. Although the board

sought to remedy the situation by retaining an executive coach to counsel the CEO, it ultimately

concluded that trust could not be restored and fired him.

Fortunately, executives are increasingly conscious of the importance of keeping their

boards fully informed. One Canadian bank chairman summed up recent trends in his country

with the following remark, “I think [Canadian CEOs] are less imperial, more consultative, and

know much better in this day and age how to use a board as a sounding vehicle to try out ideas to

get a debate going up front before making decisions.”

Nevertheless, given the risk that they can be manipulated by management, boards must

ensure a collaborative CEO is in place.

Boards should look for collaborative traits when selecting a new CEO. For instance, they

should understand how a candidate who is a sitting CEO at another company interacts with his

board. Boards should avoid candidates who give the impression that the board is an entity to be

“managed” rather than a body to whom they are accountable.

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Collaboration with the board should be built into the CEO’s job description and feedback

provided regularly. To evaluate the CEO’s cooperativeness with the board, a UK chairman

includes the following questions in the annual board evaluation survey:

• Does the CEO share enough information with the board?

• Were all of the questions that the non-executive directors wanted answered answered?

• How well does the CEO get along with the chairman and other directors?

At a UK energy company, the board provides periodic feedback to the CEO on his

communication approach. Recently, the chairman told the CEO that he was “communicating

more effectively with the other board members, especially the outside directors, who are kept up

to date via e-mails, phone calls, and timely dissemination of research reports on the company.”

Trust, of course, is built over time through repeated encounters. On their part, CEOs

must be equally forthcoming about successes and failures and be willing to ask for help. They

can also demonstrate good faith and strengthen trust by empowering the board. At a multi-

national minerals extraction firm, the chief executive felt that the outside directors didn’t fully

understand the challenges the company faced. To deepen their knowledge, he started holding

some board meetings at operating sites in different geographies.

Through their own behavior, boards impact management’s willingness to cooperate. For

instance, they can gain the CEO’s trust and confidence by demonstrating an ability to add value

and not micro-managing the executive team. On the latter point, a FTSE 100 chairman remarked

that “the test is whether executives consider board counsel on matters within management’s

areas of responsibility as advice which they can accept or ignore. If they feel that they must

follow it, the line has been crossed.”

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Protect their authority and independence

To be effective, the board must possess adequate authority and independence from

management. Board authority, however, ebbs and flows. In some cases, such as when it cedes

the chairman’s role to the CEO, the board consciously reduces its authority. In other instances,

authority recedes gradually and without notice, until it is too late.

Similarly, although directors are loath to admit it, independence of mind – the most

critical facet of independence – is likely to erode over time. A prominent UK board director

believes that “true independence is at its highest point the day a person joins the board.

Thereafter, it slowly degrades as non-executive directors progressively identify with the

corporate ethos and vision.”

Accordingly, boards must be ever-vigilant about preserving their standing and objectivity.

Although not widely discussed, one of the biggest threats to the board’s authority is an

increasingly successful CEO. In many industries – from financial services to entertainment to

retailing – boards have seen their authority slowly chipped away as their CEOs experience ever

greater success.

The process of a board surrendering its authority is often gradual and imperceptible at

first. Tell-tale signs, which may be more apparent to outside observers or in hindsight, include

less robust questioning by the board of management’s proposals over time and its readiness to

agree to management’s demands on matters – for example, relating to remuneration or waiver of

code of conduct requirements – that the outside world would consider unreasonable. Some

boards realize the extent to which they have relinquished their authority only upon a change of

CEO or, when something goes wrong, such as a crisis or scandal.

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Take a large industrial company. At the beginning of the CEO’s tenure, the board’s

domain over him was clear and respected. Over time, as management delivered consistently

strong performance and the chief executive’s stature inside and outside the firm rose, he

consulted the board less and less. Toward the end of his tenure, the CEO began to view board

meetings as rubber-stamping events. To be fair, the chairman and other non-executive directors

deserve some blame because they willingly ceded authority to the chief executive, although they

may not have fully realized it at the time.

Recognizing this risk, the UK Walker Review states that “if the embedding of authority,

perhaps based on some early success or reputation, makes the CEO become effectively

unchallengeable (and possibly a control freak), the CEO will be a major source of risk and will

probably need to be removed.”

Combining the chairman and CEO roles is one of the most significant ways to rob boards

of their authority. As a matter of principle, it is highly problematic for a board, whose principal

task is to oversee management, to be led by the head of management. The board’s standing is

particularly damaged when, as commonly practiced in the US, a well-performing CEO is

“rewarded” with the chairman’s title.20

Boards can take a number of steps to protect their authority and independence. First, as

the discussion above suggests, boards should ensure that the chairman and CEO positions are

occupied by different individuals. Appointing a lead independent director in lieu of a non-

executive chairman, the preferred option in the US, is insufficient because lead directors at most

US companies do not have primary responsibility for developing board meeting agendas,

20 Conditional upon satisfactory performance, many US companies will award the chairman’s title to a CEO 1-2 years following his initial appointment.

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interviewing board candidates, and other activities that safeguard board authority and

independence.21

Second, boards need to be on top of succession planning and leadership development so

that CEOs will not be able to hold them hostage. At a financial institution, the board was unable

to steer the firm in a different direction because, with no successor waiting in the wings, it had to

rely on the incumbent CEO to integrate a recent acquisition even though his aggressive growth

strategy had put the franchise at risk. At a European retailer, the board’s failure to identify a

successor enabled the chief executive to successfully extract from it the chairman’s seat as well.

Third, given that a successful CEO’s clout will grow, boards should pay attention to the

relative status of people in the boardroom, particularly vis-à-vis the chief executive. Discussions

with chairmen and direct observations of boardroom dynamics have revealed that CEOs are not

always respectful of non-executive directors whom they perceive to be less qualified than they

are. Equally, outside directors who are in awe of, or intimidated by, a chief executive can be

overly deferential to management.

In the UK, a senior board adviser has observed a CEO-board power differential between

the largest FTSE 30 and mid-size FTSE 250 companies. At mid-size firms, where the board

usually contains some executives from larger FTSE 100 enterprises, the CEO is typically less

influential in the boardroom than his counterparts at the largest corporations, where the non-

executive directors are of comparable, and sometimes lesser, standing than the CEO.

As a principle, boards should ensure that the statures of non-executives are equal to or

greater than the CEO’s and comparable to each other. At one UK company, the chairman has

deliberately recruited to the board individuals who are chairmen at other listed companies. That

21 For further information, see Spencer Stuart (2010), p. 23.

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way, the board is more likely to be respected by the highly successful CEO and non-executive

directors will also treat each other with regard. At another firm, a director candidate will be

nominated to the board only if all of the current non-executive directors support his appointment.

The chairman reasoned that “the board’s time is so precious that you cannot have a situation

where one director is not respected by all others.”

Relative stature between the chairman and the CEO is particularly important. One UK

senior independent director explained, “You need a person who can tell a CEO that he is acting

like an idiot when necessary.” In Britain, chairmen are usually a decade or so older than their

CEOs, which enhances the chairman’s ability to serve as mentor to the chief executive.

Lastly, boards should put in place term limits for directors and the CEO, with flexibility

on the exact timing of exit.22

Director term limits are intended to ensure new perspectives come into the boardroom

and the board remains sufficiently detached from management. At a food services company, the

board – many of whose members had served for years – became too close to the CEO and did

not challenge him on his undisciplined growth strategy. The strategy subsequently unraveled,

forcing the company to undertake a costly and embarrassing restructuring and leading to the

ouster of the CEO and the long-tenured directors.

One European chairman believes that “although you don’t want too much turnover, you

need a constant flow.” At a Canadian bank, non-executive directors are normally allowed to

serve for 10 years. Although the board has no formal policy on term limits, a UK company

chairman usually seeks to rotate a director off the board after 6-7 years of service.

22 Term limits can be expressed precisely (e.g., 10 years) or as an estimated range (e.g., 10-12 years).

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Correspondingly, limiting CEO tenure may help the board preserve its authority.

Moreover, it will force boards to devote greater attention to succession planning and leadership

development. Perhaps paradoxically, it may also help the company to remain competitive over

the long-term.

Some CEOs also support term limits for their ranks. Former Medtronic CEO William

George, for instance, endorses a maximum tenure of 10 years. At a European company, the

successor to a long-tenured chief executive acknowledges the risks that an increasingly dominant

CEO poses to the board and the company and has pledged to remain in this post for 6-8 years at

most.

One American CEO who imposed a 10-year limit on his own tenure felt that it helped

him become a better leader. Because he couldn’t count on staying indefinitely, it injected a sense

of urgency into his work. He also devoted a great deal of time to thinking about the long-term

health of the company and the steps he should take to sustain its success after his departure.

Term limits may also make sense due to evolving company requirements for the CEO

position. In explaining why the board of a mobile telephone operator chose an executive with a

different skill set to succeed the current CEO, the chairman said, “The outgoing CEO is a

conceptual thinker, courageous and has a lovely temperament. But he didn’t like difficult

conversations. His successor is just as smart but has a much tougher management style and will

deal with performance issues without hesitation. Now that the overall strategy is in place – to

establish a substantial presence in key markets – we need to focus on instilling greater discipline

in management, particularly on costs. So, the timing was right on making the CEO transition.”

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Conclusion

At the end of the day, boards that operate to their potential are characterized by constant

tensions within the boardroom because strategic and other challenging issues are brought to the

fore and its members, committed and knowledgeable, look to contribute in a substantive way.

With mutual esteem and an esprit de corps between the board and management holding them

together, coupled with management’s respect for the board’s stewardship role, this tension –

rather than leading to endless bickering and gridlock – helps to facilitate healthy and constructive

debate and improves decision-making. As former UK Financial Reporting Council Chairman Sir

Christopher Hogg has noted, “Good boards are pretty uncomfortable places and that’s where

they should be.”

The steps outlined in this article, applied pragmatically and sensibly, should help boards

get there.

Elevating Board Performance

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