Heidrick & Struggles on Boards/media/Publications and Reports/Heidrick... · Assessing the merits...

Heidrick & Struggles on Boards our thoughts on the perennial and pressing challenges facing boards today

IntroductionEach year sees more demands and higher expectations placed on

boards of directors. The issues they face are more numerous – and

nuanced – than ever. To explore those issues, Heidrick & Struggles

publishes its ‘Governance Letter’ in Directors & Boards magazine,

treating perennial as well as pressing challenges with the depth they

deserve. In the pages that follow, you will find all of the letters for 2014.

To each of these discussions, the Heidrick & Struggles authors bring

their long experience in helping boards become more effective,

achieving the right mix of competencies and expertise, and leading

the way in good corporate governance. That experience, combined

with the wisdom of the many directors and other corporate leaders

they spoke with in the course of writing, have generated a wealth of

insights we think readers can readily put to work.

H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4

2 Heidrick & Struggles on boards

How board governance and company culture intersectBecause culture can directly affect performance and business results,

understanding how the organization manages and measures culture should

be a part of the board’s mandate.

Assembling a venture-backed company boardRead what some leading venture capitalists had to tell us about the unique

challenges of assembling boards for portfolio companies.

Time’s up: Director tenure moves to the front burnerInsistent questions about length of director service have been pushed to the

fore by four trends are converging to give the issue new momentum.

How directors can mentor potential CEOsTo strengthen the leadership pipeline and minimize CEO succession risk, smart

organizations facilitate relationships between high-potential executives and

corporate directors.

Assessing the merits of an activist investor’s point of viewFew companies are immune to the attentions of today’s new breed of activists,

and directors find themselves squarely in the middle, compelled by their

responsibility to the stockholders to carefully weigh the soundness of activists’

proposals and respond appropriately.

These articles were previously published in

Directors & Boards magazine throughout 2014

www.directorsandboards.com

47

111418

Heidrick & Struggles’ Governance Letters 2014

Heidrick & Struggles 3

Most directors today are accustomed to

thinking about culture and its profound

effect on business performance in the

organizations they lead or have led.

As sitting or former CEOs, divisional

presidents, or functional heads, they

have likely led culture change. But

as independent directors of other

companies, they may devote little, if

any, time to understanding the cultures

of the organizations they oversee and

the impact – positive or negative – that

culture has on company performance.

When urged to do so, they typically raise any of several

objections, beginning with the fact that the day-to-

day functioning of the culture is largely inaccessible

to directors. Culture does not show up in the financial

documents or other materials they review, and directors

have only limited contact with the organization and its

leaders. “How can you address what you cannot see?”

they ask.

On the other hand, despite limited contact, some directors

say that they have an instinctive grasp of the company’s

culture and silently factor it into their thinking already. Still

other directors believe that wading into culture, regardless

of how accessible it is, might be seen as meddling,

crossing the line between overseeing the enterprise and

managing it.

Culture is as culture doesIn answer to the first objection, culture does not have to,

and should not, remain invisible to the board. Directors

oversee strategy and are held accountable for shareholder

value – and they must address impediments to

achieving those goals. Because culture can directly affect

performance and business results, understanding how the

organization manages and measures culture should be a

part of the board’s mandate.

Numerous straightforward methods exist for taking

the cultural temperature of a company. The board

can begin with the company’s existing set of values.

These will, of course, differ from company to company.

However, the ultimate goal of any culture remains the

same: high performance against the measures the board

and the executive leadership team have established to


How board governance and company culture intersectFew issues of organizational effectiveness and performance

have moved so decisively to the front burner in recent years as culture.

by David Boehmer and Mike Marino


enable and gauge long-term success. In our experience,

cultures that generate high performance do share many

essential values. In the top quintile of such organizations,

boards and leaders typically emphasize and hone these

characteristics:

• Strategic thinking

• Integrity

• Results

• Collaboration

• Customer focus

• Innovation

• Optimism and confidence

Based on the company’s values, a cultural diagnostic can

be conducted with senior leaders. The diagnostic would

ask those leaders the extent to which they encounter

specific, relevant behaviors that align with those values, as

well as troubling behaviors that may need to change. With

innovation, for example, leaders can be asked to what

extent they agree with a series of descriptive statements:

The organization is open to change. Creativity is

welcomed. People are agile and flexible. These statements,

and others like them, would together cover the many

behaviors that innovation encompasses. Other values to

be assessed would receive similar treatment.

In responding to the diagnostic, leaders need not act as

anthropologists and analyze the rituals, unspoken norms,

folkways, beliefs, assumptions, attitudes, and myriad other

factors that figure in culture. They need only judge the

extent to which people in the organization exhibit the

behaviors that characterize each of the values and the

desired culture those values frame. And it is behavior –

what people actually do – that determines the extent to

which the desired culture is a reality.

The eye of the beholder At the opposite end of the spectrum stand those board

members who believe that the culture of the company is

readily visible, at least to them. They reach this conclusion

any number of ways: interactions with management,

comparisons with other companies they’ve known,

assumptions about the typical culture of the industry,

and ‘gut feel.’ In any case, the characterization of the

culture remains largely anecdotal and personal. Further,

assessing culture through intuition and instinct can

produce perceptions and misperceptions that vary widely,

depending on the beholder.

Even when the individual members of the board agree

about the nature of the company’s culture, they can

quite simply be mistaken. For example, the board of

a leading health services organization believed that

the organization’s culture was, among other things,

highly collaborative. In a field where lives are at stake

and optimal outcomes depend on input from multiple

sources, the board understandably placed a high value on

collaboration. But when senior leadership was surveyed

about relevant behaviors, the board was surprised to

learn that leaders encountered less mutual support,

cooperation, and teamwork than the board had assumed

was the case.

In both cases – widely varying perceptions and mistaken

consensus – the absence of objective, empirical

evidence leaves the board with little basis for discussion

other than opinions and conjecture. As a result, it will

be unable to achieve what should be the ultimate

objective in addressing company culture: making better

governance decisions.

“Even when the individual members of the board agree about the nature of the company’s culture, they can quite simply be mistaken.”


Gaining an edge in governanceAs the third of the three objections mentioned previously

asserts, the board certainly should not address culture

with the aim of micromanaging it. However, a judicious

use of real knowledge about the culture can give a

thoughtful board an extra edge in addressing some of

its chief governance responsibilities: CEO succession,

compliance, and risk management. A number of highly

progressive boards are already addressing culture, not

with the aim of micromanaging it, but to take culture

appropriately into account within the bounds of the

board’s oversight role. In fact, the board of the health

services organization cited earlier undertook its look at

culture in order to fine-tune its search for a new CEO.

Board members believed that an objective view of the

senior leadership team’s operating culture – its attitudes,

beliefs, and behaviors – could enhance the overall

selection process and decision.

The board’s behavioral survey of leadership had turned

up not only less than desirable alignment with the ideal

of collaboration but also with another of the board’s

essential values – innovation – which the board believed

was becoming increasingly critical for the organization’s

continued success. With these findings in hand, the

nominating committee made it a point to explore the

historical ability of the CEO candidate finalists to promote

collaboration and innovation, giving more weight to both

attributes in the hiring decision.

The cultural exercise was not a substitute for the job

profile and search criteria that the board had been using

in the succession process, but served as an additional

helpful tool. The profile and the search criteria already

included collaboration and innovation as key aspects of

the role, and all of the finalists possessed competency

in both, as well as in the other values that constituted

the board’s desired culture. Otherwise, those candidates

would not have advanced so far in the winnowing

process. However, not all of the finalists possessed

those cultural competencies to the same degree. By

revising the weighting of qualifications in light of the

behavioral survey, the board was able to make a more

finely calibrated decision. They chose not just an excellent

candidate but an excellent candidate who was also likely

to make a real difference to the culture.

A similar dynamic holds for compliance and risk

management. Cultural assessment can reassure the

directors that they are unlikely to face surprises in

compliance, or it can raise red flags that put the issue near

the top of the board’s agenda. Similarly, assessment can

help determine whether the degree of risk taking that

leaders perceive in the culture is in line with the board’s

tolerance for risk. But it is no substitute for policies,

processes, and controls designed to assure compliance

or manage risk. Nevertheless, by uncovering the extent

to which behavior reflects such overarching values as

accountability, integrity, and results, the board does not

have to wait until a failure of compliance or a setback due

to carelessness – or recklessness – signals that something

is awry in the culture. In fact, it may be too little, too

late, when a real crisis surfaces that could cause serious

reputational and financial damage.

The next frontierFew issues of organizational effectiveness and

performance have moved so decisively to the front

burner in recent years as culture. Only two decades

ago, insistence on the importance of culture often drew

blank stares and, occasionally, amused contempt. Few

leaders now doubt the relevance of culture to company

performance, employee retention, corporate reputation,

customer loyalty, and a host of other areas that contribute

to competitive success. Board governance is now shaping

up as the next frontier in this extraordinary progress as

boards increasingly recognize that accurate knowledge

of company culture can enhance governance decisions

– putting values in the service of the value directors are

obligated to protect and enhance.


Establishing and maintaining an effective

board requires skill and tact under even

the most favorable circumstances. From

exercising oversight, to balancing the

competing interests of stakeholders, to

addressing the many other issues that,

broadly speaking, fall under governance,

the challenges can be daunting. In the

fast-forward world of venture capital,

those familiar issues are greatly magnified

by rapidly changing competitive markets

for portfolio companies, explosive growth

rates, succeeding rounds of investment,

and potentially conflicting exit timing and

strategy among the investor base.

Based on our experience helping VC firms build and

maintain boards for their portfolio companies – and on

a series of conversations we recently conducted with

leading venture capitalists – the most intimidating of

those challenges not only differ in degree from those

faced by public companies, and even other private

companies, but often differ in kind. While no perfect

responses to these issues exists, understanding their

dynamics and addressing them can help ensure that the

board of a Venture Capital-Backed Company (VCBC) does

what any effective board should: advance the interests of

the enterprise with appropriate corporate governance,

which, in the long run, advances the interests of the

VC firm.

Board compositionThe venture capitalists we spoke with agree that board

composition bears careful thought at every stage of

funding. At the Series A level, the VC firm will potentially

find in place a very small board that might include

a founder, CEO, an angel investor, and perhaps an

independent director, all of whom could possibly be first-

time directors. Filling out the board, ideally to a maximum


Assembling a venture-backed company boardVC-backed companies need a board optimally composed, structured,

and incented for each stage of a fast-moving development cycle.

There are unique challenges that have to be met.

by Mark H. Livingston and Rebecca Foreman Janjic


of five members at this stage and no more than seven over

all the rounds of financing, calls for a balance of expertise

among members: operational, strategic, financial, and

industry-specific.

However, Series A investors and later investors that come

in on subsequent rounds want to have their interests

vigorously represented, which could possibly conflict with

the aim of having the right mix of expertise on the board

and a board that is aligned strategically. That basic tension

– between the ability to raise capital and the desirability

of having a fully functional board with the right mix of

skills, which actively supports the successful development

of the company – can be especially strong during the

early stages of funding and the company’s development.

Further, there can be difficult sensitivities to manage with

a founder who has chosen unqualified yet personally

close directors to serve on the start-up board. The venture

capitalist must balance the desire to upgrade the board

with the potential for conflict in forcing the issue prior to

or just after investing.

At every stage of development, there remains the allure

of filling a board seat with a ‘door opener’ – someone

presumed to have connections at companies with which

the VCBC would like to do business. However, because

executives who hold current operating positions are

unlikely to be able to take on the intensive demands of

VCBC board service, the ‘door opener’ is likely to be a

retired executive. Unfortunately, the useful life of those

connections diminishes far more rapidly than is presumed,

as retired executives networks begin to stale within their

first year of retirement (with the exception, perhaps, of

those executives still active through industry associations

and related boards). Since quickly removing the director

is extremely difficult, the VCBC board must live for far too

long a time with someone whose value rapidly wanes and

who may lack relevant competencies. As one prominent

venture capitalist advises, the wiser course is to put

presumed ‘door openers’ on an advisory board or sign

them to consulting contracts.

Rapid board evolutionAs the VCBC evolves through the four typical stages of

its life cycle – seed funding, early commercialization, late

stage expansion, and liquidity – the board must evolve

with it, maintaining the right mix of expertise for each

stage and being prepared to change directors when

circumstances warrant. Maintaining and refining that

mix of directors is even more difficult with VCBC boards

because of the rapid pace at which VCBCs develop and

change. They may double in size yearly and suddenly find

themselves in unfamiliar territory when, for example, rapid

expansion thrusts them into challenging supply chain

issues or other strategic manufacturing decisions.

Not only do VCBCs scale rapidly, but they often pivot

strategically in the course of their development.

Their technology may take off in a new, unforeseen

direction. They may find different markets that are more

accessible and accepting than the markets they had

initially addressed. Or the business model could change

dramatically, from, for example, an asset-intensive strategy

to a licensing model. Such changes can render the skills

of current board members obsolete almost overnight,

requiring the difficult and delicate task of easing them

off the board in favour of people with more relevant skills

and experience.

Board members must not only apply differing business,

strategic, and operational knowledge at each stage of

the VCBC’s development, but they must also be able to

apply different governance skills as the company grows

and changes. In the early stage, the entire board usually

implements and oversees governance duties as a body.

During early commercialization, the board may designate

a lead audit member or form an audit committee to

review critical financial information and assess the finance

team. In late-stage expansion, the board should create

compensation and nominating/governance committees.

The role of chairman also varies over time, and the

delicate question of who should fulfill those duties (the

CEO, an independent director, or a venture capitalist)

is a particularly challenging decision. In many cases,

VCBC boards have to discharge a critical governance


responsibility that every board faces eventually: choosing

a new CEO. Although notable exceptions occur, few Series

A CEOs have the skills required to lead a company through

late-stage development and rapid scale-up.

When choosing a new CEO or new directors, VC firms

and VCBC boards may feel impelled by the accelerated

development cycle to take a shortcut: appoint people who

don’t need to be assessed for the job.

Simply recruit people who have an impeccable resume

or bear a well-known name that is likely to excite

stakeholders or potential investors. Such compromising

on the assessment of candidates is risky. No matter how

good candidates look on paper or in the press, they

should be thoroughly vetted through referencing, proven

assessment tools, and structured interviews – tools that

can enable decision makers to measure candidates against

required skill sets, create the right mix of skills for the

board overall, compare candidates, and ensure the right

dynamics for the board.

Board recruitmentBoard service makes great demands on any director’s

time, in public or private companies. The demands on

VCBC directors can be greater. Compare the intensity and

velocity of overseeing an established company, growing

at a rate of 10 percent annually and facing no crises, with

that of a company growing at 10 times that rate. “Directors

of VC-backed companies find themselves faced with a lot

more 10 p.m. phone calls than other directors do,” says

a veteran venture capitalist. Further, while the boards

of public companies typically meet four to six times a

year, which is certainly demanding enough in terms of

preparation, travel, and participation, a board of a fast-

growing VCBC may meet as often as monthly. Finding a

board candidate with the right qualifications who is willing

to make that kind of time commitment can be difficult.

The willingness of well-qualified candidates to serve

will also be affected by the unique circumstances of a

particular board. For example, some experienced public

company directors, accustomed to having enforceable

oversight power, might decline to serve on a VCBC board

that is advisory only versus those VCBC boards where

all directors – independent or a VC – have equal voting

rights. Other experienced public company directors might

welcome an opportunity to experience the VC world and

be part of industry-changing technologies away from the

scrutiny of proxy advisory firms or activist funds, as well

as avoid the frustrations of the heavy compliance load for

today’s public company directors.

Similarly, a first-time director might prefer the decreased

liability and lower pressure of a purely advisory board or

a governing board where the decisions being made are

far more focused on company strategy and overall growth

than on high-profile compliance or compensation issues

subject to public filings. Many candidates, regardless

of the board’s status, will be attracted by the chance to

interact with today’s generation of entrepreneurs, taking

equity in these exciting enterprises and perhaps directly

investing their own money to boot.

In recruiting directors for VCBC boards, we take care to

convey to potential candidates the unique circumstances

of the company and its board. As one senior venture

capitalist says, “Each director slot we seek to fill is a

bespoke description of role, contribution potential,

and desired characteristics driven by the nature of

the company.” Whereas in large public companies

the processes, committee structure, and governance

“At every stage of development, there remains the allure of filling a board seat with a ‘door opener.”


regulations would be instantly recognizable to an

experienced director, VCBC boards run the gamut from

boards that resemble public company boards to small

boards dominated by a single investor or a powerful

personality. Securing a candidate who is the right fit for

any board, public or private, involves a careful, deliberative

process, but as with so many aspects of high-velocity

VCBCs, the process must often be tightly compressed, with

no sacrifice of candidate quality, integrity, and culture fit.

Board compensationPerhaps few things have changed as dramatically with

VCBC boards in the past decade as the issue of director

compensation. Though the bulk of director compensation

still comes in the form of equity, candidates now expect

at least some modest cash compensation for their service

– and they are increasingly willing to request it. Says a

leading venture capitalist, “Twenty years ago, in the then

unlikely event that a board candidate asked for cash, I

think most VC people would have found it offensive.” No

more. VCBCs increasingly offer some cash compensation,

and, say a number of venture capitalists, the VC firms that

resist the practice are swimming upstream.

Board diversityBoard diversity may be seen not merely as an issue of

board composition but as an issue of board competencies.

Today, many of the world’s leading global companies

define diversity not in terms of race and gender only but

also as differences in nationality, cultural experience,

career experience, and skill sets such as operating,

marketing, technology, and product development.

Although not subject to the same scrutiny around

diversity as a public company, VCBCs are serving end

markets, which may place significant value on how a

company’s board reflects the world around them and

their own customer base. Health care appears to be an

industry vertical with less of a challenge in delivering

gender diversity than the technology or industrial sectors.

A key consideration may also be the future desirability

of a European listing of shares, taking into account the

increasingly tight regulatory frameworks around board

diversity in the European Union.

Venture capitalists expend an enormous amount of time,

energy, and intellectual firepower finding entrepreneurs

and businesses that offer an extremely rare combination

of innovation, a compelling business model, an impressive

management team, and great potential for rapid growth.

To this winning formula the VC firm brings needed capital

and often expertise in its chosen technological field. But

to ensure that the formula produces maximum yield,

the best venture capitalists add one further ingredient:

a board optimally composed, structured, and incented

for each stage of a fast-moving development cycle to

ensure ongoing, meaningful, and desired support for their

portfolio companies.

“Strategic pivots can render the skills of current board members obsolete almost overnight.”


Over the past 10 years directors have

devoted an enormous amount of time

and attention to a long list of pressing

concerns, from compliance to risk

oversight, succession planning, and more.

Now, another long-simmering issue has

become one of the latest flash points

in board governance: director tenure.

Insistent questions about length of

director service have been pushed to the

front by four trends that have converged

to give the issue new momentum.

First, the bar for independence on the part of directors

has been raised considerably. Formerly, an independent

director was simply a board member from outside the

company. Subsequently, independence also meant that

the external director had been appointed by the board,

not the CEO. Today, the argument goes, someone who

has been on the board for 15 years, working with the

same CEO, can become too cozy with management

and, for all intents and purposes, can cease to be

genuinely independent.

Second, boards, institutional investors, and advocates for

good governance increasingly frame director tenure as a

question of board “refreshment.” They recognize that as

a company and its strategy change over time, a reliable

mechanism must be found for bringing new ideas and

fresh perspectives to the board – an understanding of

markets, geographies, business models, or functions that

have become newly critical for success.

Third, facing the dizzying emergence of new technologies,

many boards want and need to tap into the pool

of candidates who are on the cutting edge of these

revolutions – many of whom are relatively younger than

the average director. Just a few years ago, for example,


Time’s up: Director tenure moves to the front burnerTerm limits and age limits are blunt instruments for addressing the real

issue: creating and maintaining a high-performance board with the right

mix of competencies.

by Matt Aiello and Lee Hanson


cyber security, digital marketing, and big data hardly

registered on board radar screens. The convergence of

social, mobile, cloud, and information technologies now

offers additional complexities. Older board members,

especially those who are no longer active executives, may

have less feel for these transformational and potentially

perilous waves now washing over every industry. Tenure-

limiting mechanisms are seen as a means to make way for

candidates who are completely at home in this new world.

Fourth, limiting tenure, either by age or term, has also

been strongly advocated as a way to make room on

boards for traditionally underrepresented pools of

talent, such as women and people of color. By increasing

board turnover, tenure-limiting mechanisms increase

the opportunities to create more diverse boards. On the

evidence of the Heidrick & Struggles Board Monitor,

established in 2009 to capture key characteristics of newly

elected independent directors of Fortune 500 companies,

turnover among board members has remained stable

– and low – throughout the past five years. From 2009

through 2013, the number of newly appointed directors

of Fortune 500 companies averaged 326 per year, with a

turnover rate that ranged from 5.4% to 6.8%. With SEC

regulations now calling for more transparency about

diversity and the selection of directors, and with quotas

gaining ground in the European Union, the push for

mechanisms that enable more diverse boards continues to

drive much of the conversation around tenure.

Longer tenure and response of the investor communityThe evidence does suggest that tenure has grown longer.

Public company researcher GMI Ratings, commissioned by

the Wall Street Journal, found last year that among Russell

3000 companies, 6,457 independent directors – nearly 34%

of the total – have served a decade or longer. That’s up

from 3,216, or about 18%, in 2008.

The investor community and their advisors increasingly

see such long tenure as problematic. In ISS’s 2013–2014

Policy Survey, 63% of investor respondents specifically

cited the worry that long tenure diminishes independence.

For its part, ISS is considering whether director tenure

should be taken into account when classifying directors as

independent or in making recommendations on director

elections. And in its ISS Governance QuickScore 2.0, a

corporate governance risk scoring tool for institutional

investors, director tenure of longer than nine years is

included as a weighted factor. Similarly, the Council of

Institutional Investors, representing institutional investors

whose combined assets total US$3tr, now includes

tenure as a factor in determining director independence.

Meanwhile, regulatory bodies in a number of countries

around the world have set an upper limit on tenure –

typically nine to twelve years – after which a director’s

independence is regarded as problematic.

Age limits versus term limitsIn our conversations with directors and other corporate

governance experts on the topic of age versus term limits,

we have often encountered a paradox. The use of age

limits far outstrips the imposition of term limits, yet few

observers think that age limits are as effective as term

limits for refreshing a board. Many, though far from all,

seasoned board members share this view. Nevertheless,

in our experience, about three-fourths of major public

company boards have a mandatory retirement policy for

independent directors, while only a small percentage of

boards employ term limits.

Critics of age limits point to the tendency of boards in

recent years to continually push the age limit up – as high

as 75 in some instances, and now typically 72. Further,

boards often waive the limit for particular directors when

it appears desirable to do so. A director approaching

retirement age might be in the midst of leading a CEO

succession or providing invaluable oversight during

a major acquisition, or the director might simply be

seen as irreplaceable – a bearer of institutional memory

who understands the full context of the company.

Nevertheless, critics counter, an easily waived age limit is,

in effect, no limit at all. “Age limits is a corporate construct,

not an investor-led construct,” says one of the leading

voices on governance in the investor community.

“It hasn’t worked.”


Advocates for term limits believe that set terms can

avoid the potential problems that come with age limits

or no limits: erosion of genuine independence over time,

inability of the board to refresh itself in a timely manner,

and loss of touch as the company’s business environment

changes dramatically. Further, such limits increase board

turnover, offering more opportunities to diversify, in every

sense of the word, including securing the competencies

that the board needs as the company evolves. Term limits

can also address the longstanding reluctance of many

boards to appoint young directors. On a board lacking

term limits, the appointment of a 40-year-old who could

turn out to be an underperformer and remain a director

for 30 years might be seen as an unacceptable risk. Term

limits could mitigate at least some of that risk.

Blunt instrumentsThough term limits provide greater flexibility in board

composition and may inspire more confidence in

investors than age limits, many of the interested parties

agree that both mechanisms are blunt instruments for

addressing the real issue: creating and maintaining a high-

performance board with the right mix of competencies.

For example, when applied consistently, both approaches

indiscriminately eliminate outstanding performers

and underperformers alike. Further, both mechanisms,

especially age limits, can allow manifestly poor performers

to linger for years. And neither adequately addresses the

issue of timeliness in bringing new competencies onto

the board.

An alternative to both age and term limits is sometimes

seen to lie in using board evaluation, as a means not only

of improving performance but also of enabling board

refreshment. Through rigorous self-evaluation, perhaps

supplemented by a third-party facilitator, boards can

identify and replace underperformers, insufficiently

independent members, or those with competencies that

are dispensable in a changing business environment. We

have worked with a number of directors in leadership

roles who have taken the evaluation process very seriously

and at its conclusion diplomatically and humanely

eased members off of the board for the greater good of

the company.

In an ideal world, such rigorous director evaluation or

some similar process would regularly and reliably enable

board refreshment – and with more surgical precision than

the blunt instruments of age and term limits. However,

putting evaluations to work in that way can be extremely

difficult for many boards, especially where members have

been pulled from the same network or have established

strong personal relationships among themselves over

many years of service.

Until that ideal world arrives, term limits appear to be a

potentially effective means of satisfying the need for board

refreshment, director independence, technology-savvy

younger directors, and diversity of all kind. They also give

directors sufficient time to render real service. And the

length of term need be neither arbitrary nor universal. It

is possible that the optimal term may vary by industry, by

company, or by some other variable, such as the director’s

length of service in relation to the CEO’s tenure.

There is no perfect solution when it comes to refreshing

boards, but terms limits will likely continue to gain traction

as an effective approach.

“Term limits can also address the long-standing reluctance of many boards to appoint young directors.”


Virtually every director we speak to

strongly affirms that CEO succession

planning is their board’s number one

priority. And most subscribe to the

view that under ordinary circumstances

promoting from within is preferable to

bringing in an outsider – too much is at

stake to risk a cultural mismatch.

Beyond risk reduction, internal promotions reveal much

about the company’s health and sustainability. According

to Glenn Hutchins, co-founder of Silver Lake Partners and

director at Nasdaq OMX, “The best organizations are those

that promote CEOs from within. It shows that you are a

company that attracts and develops its own talent. This

is motivating because your best people see that they can

aspire to the top levels of the organization.”

Less appreciated in boardrooms, however, is the notion

that promoting an internal superstar can be risky when

board members lack a deep understanding of their

executives’ leadership potential. When an internally

promoted CEO doesn’t work out, the reasons can seem

mysterious. But most of the time it happens because

boards do not fully understand their internal candidates’

character nuances and leadership potential and, as a

result, cannot predict how they will actually perform when

in-role.

Truly understanding an executive’s leadership potential

to serve in the CEO role can be challenging. How

does one distinguish between equally qualified high

performers? How does one compare the stellar CFO to

the top-performing executive vice president of sales?

As former Agilent Technologies CEO and current eBay

director Ned Barnholt observes, “When you get to the

point of interviewing candidates for the CEO role, they

all have a pretty high baseline of technical and strategic

competence. At that point, the key differentiators are the

soft skills.” But properly assessing an executive’s soft skills

and potential is an almost impossible task when directors

have exposure to internal candidates that is limited to the

cursory once-a-year dinner or golf outing. And even more


How directors can mentor potential CEOsPutting substantive mentoring into practice is not easy, nor is it a short-

term ad hoc solution. It requires commitment from the board, buy-in

and support from the CEO, and careful pairing of board members with

rising stars.

by John T. Thompson and Karen R. West


importantly, executives that could be great never get the

proper development opportunities if the skill gap was

never identified in the first place.

This tough issue can be solved by breaking down the

traditional barriers between directors and high potentials.

To strengthen the leadership pipeline and minimize CEO

succession risk, smart organizations facilitate relationships

between high-potential executives and corporate

directors. Well before an actual succession event,

corporate directors are paired with rising stars in formal

mentoring relationships. The pairing results in a mutually

advantageous relationship that leads to better corporate

performance. The directors better equip themselves

for their CEO succession duties by gaining an intimate

knowledge of internal high-potential talent, and the high

potentials receive invaluable mentoring from seasoned

corporate leaders.

A framework for conversationMany boards do use occasions such as dinners or golf

outings to get directors together with rising stars,

and such socializing and informal contact is certainly

worthwhile. But to contribute most fully to CEO

succession planning discussions, directors need to have

ongoing, substantive, one-on-one conversations with

internal leaders. In this highly interactive process, board

members and high-potential candidates develop formal

relationships that last a year or more.

To ensure that these discussions are in fact substantive,

we have found that three critical dimensions of potential,

which we apply in our leadership consulting work, can

provide directors with a frame of reference over the course

of the mentoring relationship. In ongoing discussions

with the mentee, the director simultaneously addresses all

three of these dimensions, not as a checklist but as strands

of the conversation to be woven in as appropriate, with

the aim of helping the mentee expand the soft skills of

leadership critical for success in the top job. These three

dimensions of potential include the following.

Self-awarenessSelf-awareness is the ability to understand oneself in terms

of strengths, weaknesses, and motives, as well as an ability

to regulate emotions and to understand the ways other

people affect your behavior. A mentee will likely have

some idea of his or her motives before the relationship

commences. Beneath instrumental motives such as desire

for advancement or financial reward are many possible

deeper motives: desire for achievement, intrinsic love

of the work, desire to make a meaningful contribution

to a greater good, and countless others. The mentor’s

goal in this strand of the conversation is not to tell the

mentee what motives he or she should have, but to help

the mentee draw on the energy supplied by the deepest

motives he or she does have.

In the course of the company’s development program,

mentees should have gained some prior awareness of

their strengths and weaknesses. The mentor can help

the mentee explore those strengths and weaknesses in

the context of the mentee’s current role and how those

traits are likely to play out in different roles and different

business situations. As this suggests, self-awareness

and the behaviors it results in do not take place in a

vacuum – they are intertwined with situational and social

awareness, the other two dimensions of potential, which

is precisely why the conversation proceeds on all three

levels simultaneously.

“Most directors have gotten where they are through finely honed leadership ability, and few people are better placed to explore the nuances of leadership with rising stars.”


Situational awarenessWe define situational awareness as the ability to read and

understand contextual clues about the dynamics in a

situation and the ability to react accordingly. Executives

with a high degree of situational awareness are able

to discern issues that others miss. They can also frame

problems so that others can understand the situation and

help develop actionable solutions.

Achieving situational awareness often requires diagnostics

that are appropriate to the state of affairs. In business

there are innumerable diagnostics: quantitative and

qualitative analytical techniques, business frameworks,

third-party assessments, ‘gut-feel’, experience, and many

more. Mentors can encourage mentees to expand their

repertoire, to consider many possible angles of approach;

and, as they seek contextual clues to the real situation, to

be wary of falling into the scores of cognitive biases that

researchers like Nobel prizewinner Daniel Kahneman have

so vividly warned against. Confirmation bias, for example,

is the tendency to overvalue evidence that confirms a

favored belief or the failure to impartially seek evidence.

Champion bias is the tendency to evaluate a proposal on

the basis of the track record of the person proposing it,

rather than on the facts. Loss aversion is the tendency to

feel losses more acutely than gains of the same amount,

leading to unnecessary risk aversion. In addition, the

mentor should stress the necessity of clear framing of a

situation in a way that others can understand, even if it is

highly nuanced and multidimensional.

Social awarenessThe third dimension, social awareness, is the ability to

understand one’s impact on others, to manage one’s

reputation, and to strategically flex one’s leadership style

to best suit the needs of various audiences. The mentor

should explore the mentee’s understanding of which

people, audiences, and stakeholders in the organization

are critical for success and how best to influence them.

They should also explore the different leadership styles

likely to be most effective with different audiences, as

well as how to develop leadership styles that may not

come naturally. Most directors have gotten where they are

through finely honed leadership ability, and few people

are better placed to explore the nuances of leadership

with rising stars.

The real goalThroughout these intertwined conversations, the objective

is to expand the executive’s awareness along all three

dimensions. The goal is not to solve a particular business

problem, though these conversations might greatly help

the executive in such endeavors. If the goal were to solve

a business problem, then the director would be acting

less as a mentor and more as a superior, devising metrics

for the candidate’s progress and setting performance

targets. Further, some high potentials, thrust into a stretch

assignment, may in some sense fail or otherwise fall short.

Even so, the mentoring should have laid the groundwork

for success in future roles.

If solving a business problem is not the goal, how then do

you gauge whether the mentorship is proceeding well?

There are three telltale signs: First, the mentee begins

interacting with you more like a peer than like someone

involved in an extended job interview. Second, you

begin to realize that the mentee is expanding your own

awareness in unforeseen ways. Third, the mentee begins

to cascade mentorship downward in the organization,

multiplying the benefits of your effort.

A case in pointPutting substantive and systematic mentoring into

practice is not easy, nor is it a short-term ad hoc solution. It

requires commitment from the board, buy-in and support

from the CEO, and careful pairing of board members with

rising stars. It requires time, patience, and honesty from

both directors and executives.

A pioneer in this approach is Frontier Communications,

an 87-year-old communications firm based in Stamford,


Connecticut Frontier’s chair and CEO, Maggie Wilderotter,

is the longest-tenured female CEO of any Fortune 500

company. She also sits on the boards of Procter & Gamble

and Xerox Corporation. A big believer in having her

company’s board members mentor its rising stars, she

established what she calls a “buddy system” to enhance

the company’s succession planning process. Ten to fifteen

high-potential executives are paired with board members

over a two-year period. The pairs are expected to meet

at least three times a year outside of the boardroom. The

pairings focus on creating a practical plan that helps fine-

tune the executive’s soft leadership skills. After two years,

the pairings rotate.

“The buddy system gives board members more

accountability and knowledge about the company and

its talent,” Wilderotter says. “It takes risk off the table

because everyone is involved in the succession planning

process, not just a small group of people on a nominating

committee.”

A win all aroundTogether, both parties in a mentoring relationship

produce results neither could achieve on their own.

In fact, it’s a win-win-win: for the organization, the

mentee, and the mentor. With all directors having a

more robust understanding of internal talent and the

company’s strategic challenges, the board can have rich

succession planning discussions that strengthen the

entire organization, create a more robust leadership

pipeline, and reduce risk. High-potential mentees get the

opportunity to further develop the soft skills they will

need to be considered a serious CEO candidate.

And, as we have found, delighted directors often get to

say, “I got as much out of it as my mentee did!”

“Together, both parties in a mentoring relationship produce results neither could achieve on their own. It’s a win-win-win: for the organization, the mentee, and the mentor.”


Comb through any major business

publication or website over the past

two years and you were likely to see a

story about “the golden age of investor

activism.” And no wonder. According to

the firm Hedge Fund Research, activist

investing was the top-performing strategy

among hedge funds in 2013, with such

firms returning, on average, 16.6% while

other hedge funds returned 9.5%. Activist

funds continued that dominance in 2014,

earning through the first half of the year

almost double the returns for the average

hedge fund.

Not only have the returns grown, but so have the targets.

According to the financial information firm Activist Insight,

which tracks trends in shareholder activism, the number of

companies worth more than US$10bn that were targeted

by activist investors was almost twice as high in 2013 as it

was in 2012, rising to 42 large-cap companies, from 23 the

previous year.

The activists’ campaigns are also enjoying more success.

Institutional Shareholder Services (ISS) estimates that

activists secured board seats in 68% of proxy fights in 2013

(not including cases in which board seats were gained in

a settlement without a fight), versus 43% in 2012. In the

context of M&A deals, says the Harvard Law School Forum

on Corporate Governance and Financial Regulation, it has

been estimated that the percentage of activist attacks that

were successful in either raising deal price or terminating

a deal was 71% through November of 2013, an enormous

increase from 25% in 2012.

What this suggests is that few companies are immune

to the attentions of activists either now or at some point

in the future, especially if the stock slips significantly

or the company performs poorly. Inevitably, directors


Assessing the merits of an activist investor’s point of viewBy adhering to these recommended principles and practices – objectivity,

dialogue, appropriate involvement of management, attention to major

investors, and prudent use of outsiders – boards can more adequately and

accurately respond to an activist’s approach.

by Theodore L. Dysart and John S. Wood


will find themselves squarely in the middle, compelled

by their fiduciary responsibility to the stockholders to

carefully weigh the wisdom, value, and soundness of the

activist’s proposals and respond appropriately. Assessing

those proposals begins with an assessment of the

activists themselves.

Assessing the activistAs John Cahill, chairman of Kraft Foods Group and

a former partner at private equity firm Ripplewood

Holdings, observes, activists run the gamut from those

who want to cooperate with the board and management

of target companies to “headline hunters” who do not

genuinely have the best interests of all shareholders at

heart. Many activists, he says, are reasonably easy to work

with, and most want to be extended the respect of a

conversation about the issues. When confronted with an

activist, the first task then for the board is to determine

where that activist falls on the spectrum.

Many activists we talk to agree. A founder of one of today’s

most successful activist firms says that boards should look

at the activists’ track records. Determine whether they

have a fixed “duration of capital” for their investments

that would allow little flexibility in their demands. Review

the kind of strategic, operational, and financial changes

they have urged on other companies in which they have

invested. And, he says, boards should seek references.

Bankers, he says, are a particularly good source of

information on an activist’s past behavior and reputation.

Fred Reynolds, former CFO of CBS Corporation and a

director for, among others, AOL, Mondelēz International,

and the Hess Corporation, takes a similarly nuanced view.

Not all activists are alike, and not all encounters follow

the same script. Even with activists whom you respect,

as he does Starboard Value, which publicly announced

its designs on AOL in late 2011, there may be legitimate

disagreements that cannot be resolved. When the AOL

board and Starboard were unable to resolve their strong

disagreement about the company’s strategy, the parties

engaged in a proxy fight, resulting in the re-election of all

eight of the existing board members and the rejection of

the candidates proposed by Starboard.

Assessing the argumentsAs the AOL case suggests and as activists and directors

alike say, the real challenge for board members, after

assessing the activist, is to adequately assess the

activist’s arguments. Says one director with meaningful

experience dealing with activists, “If, as a board member

in this situation, you are relying solely on the information

provided by management, then you are probably the

least informed person in the room.” A director who has

been on both sides of the situation points out that there

is an “asymmetry” of information: Activists usually have

considerable resources, including teams of analysts, to

delve into the details of the companies on which they

focus – resources that boards lack.

Nevertheless, the board is best positioned, as John Cahill

says, to play the role of Solomon. Our conversations with

board members and activists indicate that directors can

best fulfill that role by adhering to the following basic

principles and practices.

Don’t make it personalOften, activists first declare their intention in highly critical

open letters published in the Wall Street Journal or the

like. Those letters can sting. But, says one director who

has twice been on the receiving end, you cannot take

“Don’t take an activist’s criticism personally and let it cloud your judgment.”


the criticism personally and let it cloud your judgment.

Refusing to take it personally can be particularly difficult

for directors who have been explicitly targeted by the

activists for removal from the board; nevertheless,

objectivity on the part of all directors is essential for

reaching the optimal resolution.

Consider talking with the activistsEven if initial research about the activist is unfavorable,

independent directors could benefit from hearing

firsthand the investor’s alternative strategies. Given

activists’ considerable resources, they may have

perspectives to offer that management may not have

been able to provide or may not have considered.

Don’t exclude the CEOInitially, at least, the CEO should be included in those

discussions. Including the CEO gives directors the

opportunity to hear management respond to criticism

and make the case for the current strategy in the face

of the activist’s analysis and evidence. “Unless the board

is completely at odds with the CEO,” says a longtime

director who currently sits on the boards of several leading

companies, “directors should take care not to undermine

him.” Roles and responsibilities in dealing with the activist

should be made clear, he says, along with consistent

lines of communication so that the company speaks with

one voice.

Nevertheless, says the longtime director, it is only human

nature for activists to temper their argument when

confronting a distinguished CEO. The independent

directors should therefore also meet with the activist in

private, he says, where they may hear a less inhibited

version of the argument. That doesn’t mean going

around the CEO – management should be apprised of the

meeting as a normal part of the process of dealing with

the activist, much as executive sessions are a normal part

of other board deliberations.

Listen to other investorsBefore tipping their hand, activists have also likely

marshaled support for their position among at least a few

other major investors. While boards should always listen

to their major shareholders during the normal course

of investor relations, they may want to listen even more

attentively now. Though the logistics on both sides can be

difficult and SEC regulations governing company contact

with selected shareholders must be strictly observed,

these conversations can provide additional perspective on

the activist’s proposals.

Use outside resources prudentlyOften, the first reaction of the board is to call in outside

counsel, investment bankers, and strategy firms for the

express purpose of mounting a vigorous defense against

the activist. These resources can be invaluable, especially

if no accommodation can be reached and the situation

escalates to a full-scale proxy fight. But they can also

unnecessarily inflame the situation in the early stages of

the board’s consideration, or the outside resource may

apply a standard template to the situation, resulting in a

foregone conclusion.

By adhering to these principles and practices – objectivity,

dialogue, appropriate involvement of management,

attention to major investors, and prudent use of outsiders

– boards can greatly increase their chances of adequately

and accurately assessing the merits of the activist’s case.

Whether the activist is proposing to return excess cash

“Not all activists are alike, and not all encounters follow the same script.”


to shareholders, sell off a poorly performing business,

reallocate capital, or take some other bold action, the

board can only benefit by seeking the broadest range of

reasonable perspectives. Further, the board may find that

it has a wider range of satisfactory options for resolving

differences. For example, board members may adopt

recommendations that have real merit, while resisting

those they see as destructive; or they may compromise

with the activist on issues of board composition. On the

other hand, they may conclude that the activist’s case is

without merit and that the best course of action is to fight

wholeheartedly. But whatever decision they reach will at

least have been given the full consideration it deserves.

The best defenseVirtually all of the directors we have talked with agree

that the best defense against activists is to be sure that

the company isn’t vulnerable in the first place. To guard

against that possibility, directors should ask the tough

questions before the activists do, stress-testing the

current strategy against alternatives and diplomatically

and tactfully taking on the role of devil’s advocate. Is

there a potential for a spin-off or sale of an asset? Is the

company perceived as having management problems?

Are there major opportunities for cutting costs that would

tempt an activist? What are the fixable problems that are

constraining company performance? Says John Cahill,

even a director who is not an industry expert can push

those directors who are experts to ask probing strategic

questions and keep pushing until all directors fully

understand the questions and the answers.

Above all, say directors, the board and management

should continually communicate with major, long-term

investors, not just when activists appear. “Those long-

term investors want to understand your strategy and its

risks,” says one veteran director. “They want to know what

Plan B is in case Plan A doesn’t work. They want to know

how you’re allocating capital and what your priorities

are for allocating excess cash flow. And if you have an

advantageous risk-adjusted internal investment you want

to make or a promising acquisition, then they will often

encourage you to go ahead because they want growth.”

Of course, despite all of the board’s best efforts at ensuring

strong company performance, understanding alternative

strategies, and communicating with investors, an activist

may appear anyway. For example, the stock can suffer

large declines for reasons beyond the company’s control.

Large cash reserves, accumulated precisely because the

company is performing well, can make a tempting target.

And the sheer amount of hedge fund money available for

investment can increase the likelihood of an activist play

for any company. In the event, the well-prepared board

will not only squarely address the only question that

ultimately matters – what is the best way to create the

most value – but also know how to arrive at the

best answer.

CEO & Board Practice The Heidrick & Struggles’ brand and our Chief Executive Officer and Board

Practice have been built on our ability to execute on top-level assignments and

counsel CEOs and board members on the complex issues directly impacting

their businesses.

We pride ourselves on being our clients’ most trusted advisor, and offer an integrated suite of services to

help manage these challenges and their leadership assets. This ranges from the acquisition of talent through

executive search to providing counsel in areas that include succession planning, executive and board

assessment, and board effectiveness reviews.

Our Chief Executive Officer and Board Practice leverages our most accomplished search and leadership

consulting professionals globally who understand the ever-transforming nature of leadership. This expertise,

combined with in depth industry, sector and regional knowledge, differentiated research capabilities and

intellectual capital, enables us to provide sound global coverage for our clients.

Leaders in Heidrick & Struggles’ CEO & Board Practice

Americas

Bonnie Gwin New York [email protected]

Jeff Sanders New York [email protected]

EMEA

Will Moynahan London [email protected]

Asia Pacific

Karen Choy Singapore [email protected]

George Huang Beijing [email protected]

Fergus Kiel Sydney [email protected]

Harry O’Neill Hong Kong [email protected]

Graham Poston Singapore

[email protected]


Contributing authorsMatt Aiello Partner Washington, DC [email protected]

David Boehmer Regional Practice Managing Partner London [email protected]

Theodore L. Dysart Vice Chairman Chicago [email protected]

Rebecca Foreman Janjic Partner San Francisco [email protected]

Lee Hanson Vice Chairman New York / San Francisco [email protected]

Mark H. Livingston Partner Houston [email protected]

Mike Marino Partner and Executive Vice President Senn Delaney a Heidrick & Struggles company [email protected]

John T. Thompson Vice Chairman Menlo Park [email protected]

Karen R. West Partner Chicago [email protected]

John S. Wood Vice Chairman New York [email protected]


Copyright ©2015 Heidrick & Struggles International, Inc. All rights reserved. Reproduction without

permission is prohibited. Trademarks and logos are copyrights of their respective owners.

201501JNTSRG118

Heidrick & Struggles is the premier provider of senior-level Executive

Search, Culture Shaping and Leadership Consulting services. For more than

60 years we have focused on quality service and built strong relationships

with clients and individuals worldwide. Today, Heidrick & Struggles

leadership experts operate from principal business centers globally.

www.heidrick.com

T H E L E A D E R S H I P C O M PA N Y ®

T H E L E A D E R S H I P C O M PA N Y ®

WE HELP OUR CLIENTS CHANGE THE WORLD, ONE LEADERSHIP TEAM AT A TIME™

Heidrick & Struggles on Boards/media/Publications and Reports/Heidrick... · Assessing the merits...

Documents

Transcript of Heidrick & Struggles on Boards/media/Publications and Reports/Heidrick... · Assessing the merits...