Wise Counsel?

Wise Counsel?

Summer 2010 By BEVERLY BEHAN | PHOTOGRAPHY BY TIM FLACH/STONE +/GETTY IMAGES

How to get your board back on track.

BEVERLY BEHAN has worked with more than eighty-five boards of directors over the past decade. She is a regular columnist (“The Boardroom”) for Bloomberg Businessweek, president of Board Advisor LLC, and co-author of Building Better Boards: A Blueprint for Effective Governance. Her next book, Great Companies Deserve Great Boards: A CEO’s Guide to the Boardroom, is scheduled for publication in 2011.

Get any group of CEOs together and before long, discussion turns to their boards of directors.

They find common ground quickly, and the comments aren’t pretty. No one gushes about how the company would grind to a halt without the board’s input and guidance. Far too often, CEOs see their boards as providing a remarkably low return on investment of their time.

No question, today’s boardroom is a different environment than that of the 1990s, when board service was largely honorific and directors were expected to rubber-stamp every management whim. But while boards have become more independent, more engaged, and subject to an ever-increasing array of regulatory reforms, they have not become high-performing—even in directors’ own eyes. This is evident in nearly every survey released by the National Association of Corporate Directors. In the 2009 Public Company Governance Survey of 623 respondents who work with or serve on boards (two-thirds of whom were outside directors), only 23 percent rated their boards as “highly effective.”

CEOs are hardly more generous: If you ask most top executives how many of their board members they view as highly effective—which Heidrick & Struggles partners Keith Meyer and Robert Rollo did in 2008—they will typically tell you that they have two or three “stars” but see the rest of their directors, and the board as a whole, as relatively unproductive.

What’s Wrong in the Boardroom
When candid, CEOs frequently offer a range of complaints about their boards. Most view them as a necessary evil rather than an asset. They describe board meetings as “running the gauntlet” to get approvals on things the company needs to do. Some structure pre-reading materials and board meetings themselves to minimize discussion and resistance. Drawing on the board as a thought partner—a genuine resource with which to debate challenging issues facing the company—never even occurs to them, apart from a couple of directors whose advice they genuinely value and whom they generally consult “offline.”

It’s disheartening to see the working atmosphere in most boardrooms. Few people do their best work in a stale or stifled atmosphere, particularly if they are working together as a group, as boards must do. Yet many boards lack energy; agendas produce overloaded PowerPoint festivals instead of two-way conversations. I’ve heard one CEO describe his board as “an aquarium full of dead fish” and another lament the fact that “such a smart and accomplished bunch of people seem to zone out when they get into that boardroom.” But this doesn’t have to be the case. A senior executive at a company whose leadership overhauled its approach recently told me, “Working with the board is one of the best professional-development experiences I get as an executive” and went on to name three specific areas in which his board had made a significant contribution to the company over the past year alone, mostly in the areas of strategy and succession planning.

The problem begins with the composition of the board. Typically, boards have been unwilling to confront or ease out underperforming directors; instead, they rely on retirement ages and term limits to cull the herd, taking out both stars and dogs. Many boards routinely reject efforts to increase board size, which delays the recruitment of new directors until a retirement looms. This means that CEOs and shareholders often must wait years before bringing aboard directors with backgrounds and experience the company needs for meaningful boardroom dialogue at its stage of growth.

After so much attention from pundits and shareholder activists, why have boards not yet become the corporate asset shareholders deserve? In my view, most boards have not yet completed a much-needed evolution that began with the fall of Enron. Since that time, the role of boards has morphed from largely decorative to one of corporate policeman. Shareholders need and deserve a firm hand and tough questions at the top of the company—indeed, this was long overdue. But as my co-authors and I noted in 2005’s Building Better Boards, the best boards play two distinct but equally important roles: a watchdog role and a sounding-board role. Over the past decade, boards have been made to focus on their watchdog role through torrents of regulatory reforms and nightmares of having the company they govern turn into the next Lehman or Merrill Lynch. Shareholders are much better served than they once were.

Distracted by their work as watchdogs, few boards have developed their sounding-board function, which is what CEOs and management truly need. This deficiency is evident not only in comments regularly made to those of us who work with boards and CEOs but in the views of directors themselves. For instance, in the 2009 NACD Public Company Governance survey, only 15.7 percent rated their boards as “highly effective” in CEO succession, with 29.4 percent checking “not effective”—even though choosing the right CEO is any board’s most important decision.

The boardroom focus on regulatory compliance has seeped into the way boards have approached the more substantive areas of their work as well. Prompted by governance rating ser­vices such as Institutional Shareholder Services, boards have looked to checklists and “best practices” as bellwethers of board effectiveness rather than standing back to examine how the board is actually functioning and making the kinds of meaningful changes that can significantly impact the board’s operation. A couple of examples from recent experience: One company’s board separated the roles of chairman and CEO on the basis that this was a governance best practice, only to install a non-executive chair incapable of running an effective meeting. The board of another created a risk committee but is now mired in confusion over what this committee does vis-à-vis the audit and finance committees, creating endless board debates about an area that had previously been overseen pretty well. In both cases, the functioning of these boards and the value they could contribute would have been affected far more positively by changes in the way the board engaged in strategy, provided pre-reading materials to its members, and structured its meetings.

Beyond the Regulatory Mindset
Over the past three years, I have found more CEOs interested in making changes in how their boards are working. Moreover, their objective is quite different than is sometimes (though not always) the case with governance-committee chairs. Caught up in the regulatory mindset, many governance committees are seeking nothing more than a sort of Good Housekeeping Seal of Approval—an exercise that might increase their board’s score in a governance rating or justify current board practices as “good governance.”

CEOs, on the other hand, are nearly always focused on creating fundamental change in how the board operates. As one CEO rather colorfully noted: “My board members are running around saying how great they are because someone gave us a governance rating that said we were better than 90 percent of all other boards in our industry. Well, if that’s the case, it sure doesn’t say much for corporate America, because our board is terrible, as far as I’m concerned. They lack a solid understanding of the very fundamentals of this business, waste a lot of time in meetings, and always seem to get wrapped up in the minutiae of one division that two or three of them are most familiar with. I would kill for a board that would genuinely give me insights and raise really thoughtful questions about the major issues we are dealing with in running this company. Call me crazy, but that’s what I thought a board was supposed to do.”

Perhaps ironically, if you ask most board members why they signed on to serve as directors, their aspirations are very much in line with this CEO’s vision of a board’s role: They want to draw on a lifetime of business experience to benefit a company, its leadership, and its shareholders by helping it to grow and be successful. Yet, in the wake of the past decade’s scandals and meltdowns, many directors have refocused on ensuring that “we keep out of trouble.” They are resigned to providing only a fraction of the value of which most boards are capable.

It takes two years to achieve dramatic and sustainable improvements in board performance. In most cases, it is not necessary to drastically change the board composition—typically, bringing two or three directors with much-needed perspectives and backgrounds into the boardroom is usually sufficient, and not all need to join the board at the same time.

Moreover, changing the roster of directors is seldom the silver bullet for boardroom malaise. Bringing on directors with highly relevant backgrounds will typically result in a noticeable uptick in board effectiveness, but composition is only one element in the board’s overall functioning. You can assemble the greatest team of directors ever in terms of their experience and accomplishments, but if you don’t give them the right information, if your meetings drone on or focus on the wrong issues, and if the board is not properly engaged on critical areas such as strategy and succession, you will still end up with an underperforming board and a frustrated CEO. Indeed, nothing is more common than a group of boardroom all-stars who fail to function effectively as a governance team.

Making It Work
Creating a truly outstanding board requires management and the CEO to consider eight factors that contribute to how a board functions, plumbing the depths of how the board is actually working—and revealing constructive ways in which it can improve:

Board composition. Do the skills, experience, and backgrounds of the people gathered at your board table make sense within the context of your company’s business model and strategy? Are there skills and/or backgrounds that would clearly make a real difference to include in your board debates—but you haven’t been able to add them because you’re waiting for upcoming retirements? Or is yours a situation in which the company has morphed from a regional monoline to a global conglomerate but the roster of directors has stayed pretty much the same? Do you have directors who look good on paper but fail to make a meaningful contribution in the boardroom? What kind of orientation do new directors receive to get them quickly up the learning curve of the company’s business? Does the board composition reflect diversity of perspectives—a balance of active versus retired executives, international perspectives if this is a key element in corporate growth, etc.?

Board information. Most boards today are overloaded with data—typically financial data—with the “aha!” moment buried around page 47 of the pre-reading package. Some CEOs—even those who complain of a lack of input from their board—do this intentionally, keeping directors in the dark by overwhelming them. The quality of board discussion and decision-making is directly proportionate to the quality of information the directors receive, and even if the information is all there—somewhere—failing to organize it succinctly undercuts the value of assembling it in the first place.

Board agendas and meetings. Nothing is more common than overpacked agendas with little meaningful dialogue on key issues—maybe 80 percent presentation and 20 percent discussion. If your balance isn’t close to 50/50, your board is functioning primarily as an audience, leaving your directors’ talent underleveraged. Small wonder that it is difficult to pinpoint meaningful contributions—directors spend most of their time listening. A related issue is the balance of board time devoted to regulatory/compliance issues versus that spent on weightier issues such as strategy and succession. Are the critical issues placed near the front of the agenda, or is that prime slot filled up with compliance issues and committee updates?

Board leadership. So much debate has ensued about the separation of chairman and CEO roles that it is often easy to overlook the essence of the role itself: How effective is the chairman in running the board meetings? Does he draw out different perspectives from around the table on key issues, or does he hog the airtime? Does he know when to call the question on an issue and move on? Or does the board routinely go off on tangents? What about the leadership of committee chairs, and the behind-the-scenes role of the chairman or lead director? Whether the independent board leader is a non-executive chair or lead director, fundamental issues remain: How effective is she in working with the CEO and with the other directors? Does she keep a finger on the pulse of the board through regular contact between meetings? Are director confidences respected? Is she willing to address thorny issues of director performance?

Board committees. Much of the board’s work is done in its committees, the big three being audit, HR/compensation, and nominating/governance. The question here is seldom whether each committee is complying with the terms of its charter but, rather, how effectively the committee is actually functioning. Does the chairman run effective meetings and ensure the quality of pre-reading materials? Does the committee get effective support from company executives and external advisers? What is the interface between the committee and the rest of the board—in other words, how are non-committee members kept abreast of the committee’s work and decision-making? Boards take very different approaches in this area: Some rehash entire committee meetings at the full board meeting; others tell non-committee members to simply read the committee minutes for an update—a strategy that has backfired more than once when directors not serving on the compensation committee found themselves forced to defend the company’s generous CEO pay package.

Board dynamics/culture. Boards are really all about people, and interpersonal working dynamics are critical to the board’s overall effectiveness in functioning as a governance team. What is the climate of your boardroom? Is it relatively uninspiring or a vibrant, energized place to exchange ideas and make decisions? Are directors candid or cautious in expressing their views? Has the board become polarized, through either a merger or different generations of directors that have created “camps”? Many boards describe their culture as collegial, but does that denote an atmosphere of healthy mutual respect or a clubbiness characterized by groupthink? Can board members handle conflict and strong differences of opinion? Are challenges and different points of view encouraged or suppressed?

Board/management dynamics. The working relationship between the management team and the board is equally important. Is this characterized by candor and mutual respect, or do board members treat executives in a high-handed manner? Is management comfortable sharing bad news and tough issues, occasionally using the board as a thought partner to wrestle with these? Or is everything presented to the board fairly buttoned up, with the hope that questions will be minimal? Are top managers open to directors’ advice, or do they quickly turn defensive? Has the board fallen into habits of micromanagement, delving into picayune details that not only waste board time but leave executives feeling second-guessed?

Board processes. This refers to the way that the board engages in some of its most critical areas of oversight and decision-making, including corporate strategy, risk, succession planning, and CEO evaluation. Directors themselves admit to doing a marginal job on strategy and succession, and many have been revisiting risk, the boardroom topic de jour in the wake of the financial crisis. Most CEOs find their annual evaluation process less than inspiring; some evaluations actually involve board members rating the CEO on aspects of performance that they have little basis to judge, such as the CEO’s communications within the company. Many boards that actually have a lot of the other seven elements in good shape fall short in the area of board processes—perhaps ironic because this is the element of the eight here for which a high-performing board can often make its most significant contributions to the company it governs.

Analyzing all eight of these factors will enable the management team to accomplish several things: First, they can set priorities based on a broad review instead of adopting a piecemeal approach. Second, they can tailor any board initiatives so that they reflect the unique context of their own board and are therefore more likely to be effective when implemented. Third, if they have engaged all of the directors and those members of the executive team who regularly interface with the board in this analysis, management typically has the benefit of everyone’s buy-in and insights on these issues. Finally, it should help management to understand the board’s strengths, as every board has some areas in which it is highly effective, and avoid tampering with these.

I

t is often some combination of frustration and courage that causes CEOs to step up to the thorny issue of revitalizing their boards. Anyone who does quickly realizes that the traditional toolbox of survey-style board evaluations and best-practice reviews fails to yield substantive results. Once CEOs focus on the factors outlined above, however, low-hanging fruit quickly emerges and boardroom change can be dramatic. One defense-company CEO whose frustration with the board was causing him to toy with the idea of resigning opted instead to make significant changes in how his board was working. Two years later, he told another CEO, “I’ll bet you’re expecting me to say my board is ten times better than it was two years ago. Well, it’s not. It’s ten thousand times better.”

It often surprises this CEO—who had to overcome initial resistance from the board—how quickly directors began to embrace the changes as they recognized how much more effective the board was becoming. It’s not only more rewarding for the CEO to have a better board—it’s more satisfying for directors to serve as members of such a board. Don’t be surprised if they introduce similar initiatives at the boards of other companies on which they may serve. When that happens, you’ve done another CEO a big favor. And that’s a far better conversation for two CEOs to be having about their boards than what we’re generally hearing today.