BOARD LEADERSHIP P O L I C Y G O V E R N A N C E I N A C T I O N

E x e c u t i v e E d i t o r

N U M B E R 6 7 , M A Y - J U N E 2 0 0 3

What to do when a board is too large to govern effectively

Why Size Matters by Caroline Oliver

There are a number of reasons why a board may be large, among them the desire to have diverse representation. But whatever the reasons, there comes a point at which a board becomes too cumbersome to effectively represent its ownership. It is difSicult to have meaningful debate in large groups-progress is slow, factions may form, and resources are wasted. In this article, Caroline Oliver lays out some critical questions that boards should consider in order to determine if their membership is too big; she then offers some preliminary suggestions about how a boa’rd may get its membership to optimum size and maximum effectiveness.

NE OF THE QUESTIONS people often ask 0 is “How big should our board be?” This in my mind leads to another ques- tion: “Why does size matter?” This is a relevant question for any board to examine, whether practicing Policy Governance or not, and the answers can be very revealing.

When questioned about their cur- rent size, many boards go back to their

ALSO IN THIS ISSUE

A NEW BASIS FOR GOVERNANCE EFFECTIVENESS &SEARCH ............ 4

FAQ ........................................... 6 What do the new federal governance requirements for corporate audit committees mean for the Policy Governance board?

origins-to the decisions of the people who created them. Boards that are cre- ated by statutory decree, such as those involved in professional regulation or state employee pension administration, are often deliberately composed to reflect a large variety of public and member interests. Similarly, association boards that are created by their membership bodies are likely to become cumbersome as various groups of members seek to have their particular interests reflected. Large community boards are also often the result of lobbying by various groups that fear being marginalized. According to this kind of thinking, board composi- tion becomes a numbers game. Particular segments of membership in effect say, “This board is legitimate only because I can point to a particular board member who is someone like me.” The results can be seen in every sector. The board of the

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- ON A PERSONAL

NOTE

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COMPLIANCE VERSUS EXCELLENCE

by John Carver

T SEEMS THAT everyone is aware of I the tumult in corporate gover- nance. Old methods are being ques- tioned, and codes of best practice seem to be coming from every cor- ner. There is pressure in Canada to institute more stringent rules about transparency and independence. In the United States, the Sarbanes- Oxley Act and subsequent Securities and Exchange Commission and New York Stock Exchange regula- tions have unloaded onto corporate boards a slew of new requirements. In the United Kingdom, the recent Higgs Review is the newest in a sequence of governance codes spanning the Cadbury, Hempel, and Combined Reports. (I was privi- leged in March to meet and begin a dialogue with Derek Higgs.) And these are only three of the countries experiencing the new emphasis on board practices.

Nonprofit boards are taking greater interest in what is occurring

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Why Size Matters (con tinuedfromfront page)

New York Stock Exchange, for example, is twenty-five people, and I have known many nonprofit boards of around thirty people and even heard tell of a real estate board running to over one hundred!

The reason why this matters is that there is a price to be paid for governance- by-numbers, a price paid primarily in effective group process. To understand this price, we need look no further than ourselves and what happens to us all in large groups. Those of us who tend toward being rather loud get louder. Those of us who tend toward being rather quiet get quieter. In my experi- ence, the dominance of the louder voices causes the debate to get more stri- dent and positional, egos to clash, and the stakes to go up. The majority of us, who are unable to get our points across in the larger group, look for a hearing by breaking into smaller groups; schisms develop, and factions grow. Meaningful debate happens in small huddles during meeting breaks, and the meeting itself becomes increasingly irrelevant for any- thing other than vote counting.

There is a price to be paid for governance- by- numbers, a price paid primarily in effective group process.

The reason why this matters is that if the board is too big, everyone has to spend more time and therefore more money on group process. It takes more time to reach consensus, more time to ensure group discipline, more time to organize, and more time to develop and sustain any sense of teamwork. And the reason why this matters is that it ulti- mately defeats the very purposes for which boards exist.

However, once a large board is brought into being, backtracking

becomes extremely difficult. Once people have their feet under the boardroom table, they are unlikely to vote them- selves out of the boardroom. And more often than not, any such vote needs the sanction of an annual general meeting that is filled with people who are looking for more, not less, representation. However, I do not believe that any board that finds itself hampered from fulfilling its responsibility to govern well by its own size should resign itself to the status quo. In fact, I believe that such a board has a duty to move toward effective gov- ernance as soon as it possibly can, and I have some strategies to suggest.

The first step is for the board to clar- ify the principles on which it believes its composition should be based. Usually this involves the board in weighing pos- sible motives in the balance. Is it better to have board members elected, allow- ing for greater visible democracy, or is it better to have board members appointed, allowing for greater flexibility and a more holistic approach to total board composition? Are shorter terms for board membership better because they allow for greater turnover and there- fore less entrenchment, or are longer terms preferable, allowing for stability and increased understanding of the orga- nization concerned? At what point does desirable diversity become undesirable fragmentation? What is the proper bal- ance between representation, on the one hand, and economy and effective- ness, on the other? And to the extent that representation is desirable, should it be based on geography, population, income, gender, employment, or some other kind of segmentation? Or are par- ticular types of governance expertise more relevant? As you can imagine, these are not easy questions to answer in any group, let alone a large one. However, with the help of discussion tools such as weighted voting, they are at least worth discussing. At best, the board will have clarified the arguments it will need to employ to convince owners that a smaller board is in their best interests. At worst, the board will end up a little wiser but without a clear enough posi- tion to make any immediate change. Large group process requires patience!

Corporate Governance

Corporate Boards That Create Value Uohn Carver with Caroline Oliver) was released by Jossey- Bass last year to explain Policy Governance in equity corpora- tions. Recent shorter publications by Carver and Oliver are available free on request in a resource pack from Carver Governance Design, Inc. Contact Ivan Benson, 404-728-9444, or send an email message to ivanbenson@ carvergovernance.com.

I would suggest that the best approach is for a board to recognize that the extent to which there is a demand for the board to be larger than is truly in its owners’ best interests is the extent to which members are failing in their ownership linkage. Owners who are convinced that their interests are being taken into account by the whole board feel no need to have specially designated repre- sentation. Owners who are communi- cated with on a regular basis know that it is not necessary to sit at the board table in order to be heard. And the board that is truly interested in diversity actively seeks out a range of viewpoints far broader than it could ever hope to accommodate in the boardroom. In other words, the best approach to board downsizing is to show board members and owners what true ownership linkage looks like and how much more effective it is than having one or two “representa- tives” trying to be heard above the din in a large, dysfunctional group. How about presenting the annual meeting with a proposal for downsizing and a fully developed policy for regular and thor- oughgoing ownership linkage? How about undertaking to provide full report- ing on that policy every year and to bring any changes to that policy back to future annual meetings?

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L B O A R D L E A D E R S H I P

Personal Note (continued from front page)

in the corporate world than I would have expected a few years ago. There is a ten- dency to want to adopt nonprofit prac- tices that mimic the new corporate behavior. Yet watching the corporate governance saga unfold over the past few years has convinced me that the corpo- rate world, despite going through painful change, will still be left with inadequate governance. In short, people still don’t getrt. Corporate governance-indeed, the-new corporate governance-is not worth emulation by nonprofits. It is still-except for what is provided by Policy Governance-without an orga- nizing theory. It is still focused on mechanics and practices rather than theory-based concepts and principles.

The corporate world, despite going through painful change, will still be left with inadequate governance .

Mind you, there is nothing wrong with increased transparency and inde- pendence. Of course boards should oper- ate in the open and not be subservient to management. Of course audit com- mittees of public companies should not include inside directors. Of course the independence of auditors is tainted when they also sell significant consulting service to the company. Such things are commonsense requirements, yet many if not most boards were somehow unable to figure them out for themselves and toward which even now many boards must be dragged kicking and screaming. But the nature of governance is a much bigger issue than merely avoiding prac- tices that, on their face, are remiss. The real challenge to boards is not to stop practices that impede good governance but to confront the real elephant at the party: a widespread mind-set that caused

these matters not to be self-evident to everyone all along. Boards that cannot govern themselves have little chance of being able to govern companies.

Boards that cannot govern themselves have little chance of being able to govern companies.

The irony is that I have actually been asked whether the new rules call for changes in the Policy Governance model. The answer is no. There is no need for carefully crafted, comprehen- sive principles to be altered due to rules made up with little reference to a consistent system of principles. Rules, when required at all, need to get in line with principles. On the other hand, it is possible that the new rules can cause directors to struggle with the nature of the governance they are then having to practice in the open and with fewer options to be stage-managed. At their best, the new rules might bring boards to a level where they can aspire to the integrity demanded and enabled by the Policy Governance model.

be happening. Laws and regulations are not voluntary arrangements. Corporate boards are quite concerned that they not be caught on the wrong side of the law, so there is a great scramble toward get- ting board practices and documents in tune with the new obligations. Boards are no more interested in good gover- nance than they were before the Enron et al. debacle. But they are pointedly interested in lawful compliance. And for compliance, a board’s best resource is legal counsel, not governance help. Consequently, boards of listed compa- nies across the United States are spend- ing millions to conform to the new regulations. Investors might be better off due to the increased transparency and independence, for these are

Unfortunately, that does not appear to

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- - THE POLICY GOVERNANCE

MODEI.

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OARD LEADERSHIP requires, above B all, that the board provide vision. To do so, the board must first have an adequate vision of its own job. That role is best conceived neither as volunteer-helper nor as watch- dog but as trustee-owner. Policy Governance is an approach to the job of governing that emphasizes values, vision, empowerment of both board and staff, and the strategic ability to lead leaders.

Observing the principles of the Policy Governance model, a board crafts its values into policies of the four types below. Policies written this way enable the board to focus its wisdom into one central, brief document.

ENDS The board defines which human needs are to be met, for whom, and at what cost. Written with a long-term perspective, these mis- sion-related policies embody most of the board’s part of long-range planning.

EXECUTIVE LIMITATIONS The board establishes the bound- aries of acceptability within which staff methods and activities can re- sponsibly be left to staff. These lim- iting policies, therefore, apply to staff means rather than to ends.

BOARD- EXECUTIVE LINKAGE

The board clarifies the manner in which it delegates authority to staff as well as how it evaluates staff per- formance on provisions of the Ends and Executive Limitations policies.

GOVERNANCE PROCESS

The board determines its philoso- phy, its accountability, and specifics of its own job.

M A Y - J U N E 2 0 0 3 3

Ownership identity. The identity of the ownership must be known or at least competently estimated. A great deal has been written in the Policy Governance literature about the importance of the ownership concept, so it need not be repeated here. Organizations always per- form as if someone owns them, even when ignorant of the concept. When left undebated, too often the de facto owners turn out to be the staff or the current clients. Settling on an ownership identity serves to prevent counterfeit “owners” (sueh as staff or current clients) from fill- ing the vacuum, even when that identity is not as convincingly and easily demar- cated, as is the case for the ownership of a membership association.

Settling on an ownership identity serves to prevent co u n t e rfe i t “0 w n e rs ” fro m filling the vacuum.

Ownership linkage. There must be some connection between the board and the ownership. The connection might be as tenuous as a mental linkage, the awareness in board members’ minds that their foremost allegiance-that of the principal-agent sort-is to a certain pop- ulation. Beyond that the linkage might be one of data, as when the board focuses on knowing a great deal about the own- ers. At a more advanced level, the board

might have direct contact with owners or with carefully unbiased samplings of owners. But ownership identity makes little difference if the board is not at some level ownership-aware.

Linkage content. The communication channel between owners and board must carry content relevant to accountability. What passes between owner and board is critical. Owner accountability will be unachievable if the content is about ran- dom subcharacteristics of the organiza- tion rather than about essential, central ones. Hence relevant content would more likely concern organizational purpose than, say, office arrangements.

Synthesis. The board must have a method for reducing heterogeneity or chaos in owner expressions to a consis- tent organizational intent. Owner intent is almost certain to be scattered and conflicting, a raw product with little form that in itself could not be directly translated into organizational direc- tion. Without a way to deal openly and fairly with this diversity, owner account- abilitywill be unattainable.

Agent latitude. There must be some resolution of the degree of agent lati- tude the board will use in translating owner intent to organizational com- mands. Owners have less information about the field of endeavor, research on what is possible, and factors that affect the intents and the organization. They have a right to expect the board to devote time to learning more about these things than they do. “I vote the way my constituents would vote if they knew what I know,” a Texas legislator is

rumored to have said. There must be some resolution along the spectrum that runs from “we don’t care what they say because we know what’s best” to “we’ll take a poll and follow it slavishly.”

EffectinglCorrecting. The board must have in place a mechanism of fulfillment, a way of obtaining actual performance of owner intent, or else all the foregoing components are for naught. Much of the Policy Governance model focuses on how the board can translate its values into organizational performance, empowering and charging management while main- taining control. Whatever the method, for owner accountability to occur other than by accident, the board must have in place some mechanism or process for effecting reality from purpose.

I have tried in this listing to produce as model-free a statement of board pur- pose as I can, although further refine- ment might bring us even closer to that goal. Let me assume that the initial, broadly stated reason for boards (owner- accountable organizations) is acceptable and that the necessary components are reasonable. If this is so, then the result- ing proposition yields a useful point of departure for governance research. What formulations of board practice enable fulfillment of these conditions? Do some do so better than others? More specifically, does the Policy Governance model offer a more successful strategy for their achievement? These are testable hypotheses, the pursuit of which could open up a new and far more useful stream of governance research than anything produced so far. 0

Personal Note (continued ffom page 3)

required. But investors will not be better off due to more effective corporate gover- nance, because effective governance is not required.

Incidentally, a survey by Ernst & Young and CAP Gemini Ernst &Young reported in USA Today illustrates some of the irony in the current American cor- porate world. Eighty-six business execu- tives were asked the top three threats

they felt they faced in the next two years. Market uncertainty was noted by 19 percent and competitive dynamics by 29 percent; we expect business execu- tives to worry continually about such things. The surprise winner, however, was regulatory changes, a worry that found itself on a whopping 38 percent of the executives’ top-three lists!

On that happy note, let us take a look at this issue of Board Leadership. I reply to a question I’ve received from several sources about what the new corporate

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audit committee requirements portend for nonprofit boards. In our lead article, Caroline Oliver considers the issue of oversized boards and offers some direc- tion for how a board might set out to resolve the problem. Finally, I com- ment on the fact that governance effec- tiveness research to date has lacked an underlying conception of what gover- nance is for and then offer a definition of the purpose of governance that might serve as a point of departure for future research. 0

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Why Size Matters (continued from page 2)

My other suggestion might help bring owners and board members along but needs very careful handling to be success- ful. I therefore put it forward reluctantly and only because I know that the down- sizing message can be extremely tough to get through. This suggestion is to leave the large group as a kind of advi- sory council and shift all authority and accountability to a smaller board also directly appointed or elected by the owners. The council therefore becomes in effect a body that the board can use to help in its ownership linkage. This sug- gestion needs careful handling because if the council operates as an authoritative rather than an advisory body, it becomes a superboard. The council must not appoint the board or be allowed to substi- tute for any of the powers of the member- ship as a whole. If it does, board holism and its direct accountability to owners will have been destroyed, and we are back to square one with the real board being an oversized and unwieldy body.

The best approach to board downsizing is to show board members and owners what true ownership linkage looks like and how much more effective it is.

The most commonly used tool for coping with a board that is too cumber- some to do its job properly is of course to create an executive committee. To me, that is the owners’ cop-out solution. It says, “We know we have a board that can’t really do the job, but we don’t have enough drive to do anything about it, so we’ll keep it going for window-dressing purposes, knowing that real power is inevitably in fact being wielded by a sub- group.” The cost to owners for keeping

the larger sham body is often tremen- dous in terms of duplicated and therefore wasted time and effort, in addition to the significant cost of the meetings them- selves. If we had this kind of waste else- where in our organizations, we would soon do something about it, so why are we so often willing to tolerate it at the board level? I would also question whether board members who are unwilling to participate in discussions that could refashion the board as a body that can truly govern rather than just represent the views of individual segments of owners to the CEO are in fact operating as board members at all. However they have been appointed or elected, board members are supposed to act as the agents of the ownership as a whole, not just a particular group.

Good governance depends on having a group of people who can achieve quality dialogue in pursuit of the owners’ best interests .

To sum up, board size matters because it has an immediate and pow- erful impact on the board’s ability to function as an effective group. A board that is too large is too cumbersome for the kinds of discussion that lead to fully informed decisions. A board that is too small runs the risk of endless, sterile, and circular debate. What’s needed is a balance; we need diversity, and we need effectiveness too. How big should a board be? Most people seem to say a board should have between seven and twelve members, but this is a question of common sense, not science. Size matters because good governance depends on having a group of people who can achieve quality dialogue in pursuit of the owners’ best interests. If the size of your board is a problem, my advice is don’t just live with it-start asking questions. 0

BOARD LEADERSHIP P O L I C Y G O V E R N A N C E I N A C T I O N

J O H N C A R V E R , ExecutiveEditor

NUMBER 67, MAY-JUNE 2003

To Create a New Standard of Ewellence in Govemunce

BOARD LWXRSHIP ISSN 1061-4249 (print) ISSN 1542-7862 (online)

JOHN CARVER, PH.D., is widely regarded as the world’s most provocative authority on the gov- erning board role. He has consulted on five conti- nents with a wide variety of organizations and has published more on governance than anyone else worldwide. Carver is creator of the Policy Governance” model of board leadership, arguably the only conceptually coherent, universally applicable model of governance available. Policy Governance is not a set structure, but a paradigm of concepts and principles that enable account- ability, leadership, and productive relationships among boards, their constituencies, and their managements. Carver is author of Boards Thar Make a Difference (jossey-Bass, 19971, the audio program’Empowering Boards for Leadership (Jossey-Bass, 19921, the video program lohn Carver on Board Governance Uossey-Bass, 1993), and with his wife, Miriam Carver, Reinventing Yourhard (Jossey-Bass, 1997).

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(415) 782-3232.

Caroline Oliver is an author, speaker, and consultant on governance issues and current chair of the International Policy Governance Association. She can be contacted at (905) 337-9412 or coliver@ carolineoliver.com or through her Web site at www.carolineoliver.com.

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