CHAPTER 2
Understand the Role
Stewardship Thinking
How a person approaches board service and thinks about the role of director really matters. Is there a proper metaphor to describe the job?
In my experience, the best directors think of themselves as stewards. They ensure careful and responsible management of the company or organization with which they have been entrusted. They are tough-minded monitors of and thoughtful advisors to those charged with managing. As representatives of owners and stakeholders, they insist on high performance and strive to grow value through prudent risk taking. As stewards, they consider matters not through the lens of self-interest but through the lens of what is best for the organization they oversee.
The metaphor of governance as stewardship yields many insights for a director. It has led me to think carefully about the privileges and responsibilities of board work. It has guided me in handling difficult situations like being a director of a failing company and managing a potential conflict of interest. It has helped me clarify what real director independence is and what director effectiveness requires. It has served as a reminder that in the leadership of organizations, there is a distinct difference between governing and managing.
I have been privileged to work with some wonderful directors. They were diligent in their work and wise in their judgments. They asked penetrating questions. They challenged management with high aspirations and stretch goals. They monitored results and rewarded high performance. They worked through knotty problems. They made tough decisions and took hard action when required. They helped renew the board by leaving when the time was right. They were great stewards.
Regrettably, I have also had experience with lesser directors. Their self-opinions were inflated. They expected to be served more than to serve. Their inattentiveness was embarrassing. Their contributions were of the Johnny and Judy one-note variety. Their disregard for boundaries undermined the chain of command. They folded in the face of conflict and controversy. They were poor stewards.
In this chapter, I share some guiding ideas for great governance—what I call stewardship thinking. Because I have experienced both the best and worst in governance, I know what a difference it makes when directors adopt a stewardship attitude toward their duties. The cornerstone of stewardship thinking in governance is to understand and embrace both the privileges and responsibilities of being a director.
The Privileges of Board Work
By any measure, being a director is a privilege. It’s true that some people have abundant board opportunities from which to choose. But in my experience, most people are pleased and even thrilled to be invited to serve. If a primal human need is confirmation that “I’m here and I matter,” an invitation to serve on the board of a good organization, for-profit or nonprofit, is one of life’s confirming experiences.
Being a director includes the privileges of service, membership, protection, pay, and respect.
The Privilege of Service
We talk about “serving” on a board. Service is the mindset that directors and trustees should bring to their work. It is best described in the work of Robert Greenleaf on Servant Leadership.5
Greenleaf’s view was that the best leadership begins with a desire to serve, not ambition for power, position, privilege, or prestige. Servant leadership is marked by humility, dedication, and deep recognition that what matters most is the organization and its people. Privileged positions are seductive. An attitude of servant leadership helps directors maintain proper focus in what can be a heady environment.
Servant leadership, like stewardship, reminds directors that they are not at the pinnacle of the organization; they are part of a strong base. The people of the organization do not serve the board; the board serves them. The future of the company or nonprofit is not assured with directors simply along for a prosperous ride; rather, every entity is at risk in a dynamic, competitive environment. In evaluating their own performance, directors must ask, “Has the company or organization entrusted to us thrived on our watch? Do we continue to control its destiny?”
The general concept of servant leadership is ancient. But it is associated in many people’s minds with Christian beliefs, even though the New Testament and life of Christ do not appear to have been the conscious inspiration of Robert Greenleaf’s work. I suspect the association is due to the revolutionary leadership example Jesus set by associating with the poor and ministering to those in need, regardless of status: “For even the Son of Man did not come to be served, but to serve, and give his life as a ransom for many.”6 Christian business leaders like the Gordons and Max DePree of Herman Miller embrace servant leadership and strive to make it a bridge between their work lives and their Christian beliefs.7
The Privilege of Membership
Board service is not just a group activity. It’s a team sport. Membership on a board is satisfying because companies and organizations compete, and it’s really fun to win.
The board is just the beginning of belonging for a director. She becomes associated with the organization and industry of which it is part. She develops networks of relationships that last for years with fellow directors and people who work with the board, including members of senior management and outside experts.
A good board bonds. Experiences over time create shared history and a collective memory of crises handled, obstacles overcome, problems solved, and goals achieved.
Does this focus on belonging imply that boards are, as some charge, clubby and incestuous, insulated and self-perpetuating? They can be. But one of the most impressive things about an effective board is its ability to manage competing values, like being simultaneously independent and collegial, critical and constructive.
Directors need both unity and occasional dissent. Too little unity and the board can’t come to decisions and give clear direction to management. Too little dissent and groupthink sets in with all its perils. Too much unity and the multiple views and different takes of individual directors are lost. Too much dissent and the board dissolves into a destructive conflict.
It is important for directors and management to remember that while they all belong to the organization’s leadership, their roles are distinct and different. The board governs. Management manages. The board’s job in a company is primarily to represent owners. In a nonprofit, it is to represent stakeholders. Directors are obliged to monitor management with vigilance, ensuring integrity and high performance. Directors must emphatically not manage. One good description of the board’s proper role is nose in, fingers out.
The Privilege of Protection
Directors make decisions that sometimes don’t work out, such as appointing a CEO who turns out to be a dud or overpaying for an acquisition only to write down its value later. Companies can go bankrupt on a board’s watch. We live in a litigious society. When things go wrong, people are encouraged to sue, and they do.
So a natural question is “At how much risk are directors?” The answer is not much, if risk means directors having to pay money out of their own pockets.
There are two reasons. One is the business judgment rule. The other is that company assets and directors and officers insurance provide resources to help satisfy successful claims against the board.
The Business Judgment Rule. A director or trustee is a fiduciary. A fiduciary is a person to whom property or power is entrusted for the benefit of another. As such, the director has certain duties. He or she also has protections under the law. Arguably the most important for directors is the business judgment rule.
The rule specifies that courts will not review the business decisions of directors who performed their duties
1. in good faith;
2. with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and
3. in a manner directors reasonably believe to be in the best interests of the corporation.
The business judgment rule does not necessarily protect directors from charges that they wasted corporate assets or committed fraud, misappropriation of funds, or others. Nonetheless, the rule creates a strong presumption in favor of boards, freeing members from possible liability for most decisions that result in harm to the corporation.
The business judgment rule, along with limited liability for investors and the rule of law, are key underpinnings of modern, developed economies. They facilitate pooling capital and taking risks required to develop products and services and produce and distribute them on a large scale. They allow individuals, including directors, to act in ways essential for economic development while keeping personal liability at an acceptable level.
Company Assets and Directors and Officers Insurance. Companies can indemnify their directors through provisions in their bylaws or certificates of incorporation. This means that company assets are available to defend directors in legal actions and to settle claims. In companies rich in marketable assets with conservative balance sheets, this provides a lot of protection. In companies with few tangible assets, it provides little protection. In the case of bankruptcy, it may provide no protection at all.
Directors and officers policies, commonly called D&O insurance, provide cash to cover most or all settlements or judgments in cases against directors. In large companies, such policies may be written to provide $50 to $100 million or more of coverage.
Do directors ever pay settlements out of their own pockets? Rarely but occasionally. For example, it was reported in 2005 that directors of WorldCom and Enron agreed to settlements that included personal payments.8 Ten former outside directors of WorldCom agreed to a $54 million settlement for their roles in the company’s $11 billion accounting fraud. A third, or $18 million, was paid by the directors personally with the balance paid by D&O insurance. The $18 million reportedly represented 29 percent of the directors’ cumulative net worth excluding primary residences, retirement accounts, and judgment-proof joint assets. Ten former directors of Enron agreed to personally pay $13 million of a $168 million settlement for their alleged role in Enron’s fraudulent accounting practices. This was 10 percent of their personal pretax profit from Enron stock sales.
These were rare exceptions to the norm of directors seldom paying settlements personally. Nonetheless, there are certain risks from which no one can indemnify a director. One is being vastly underpaid when the work of a board is most difficult, like in a crisis. Another is being sued and spending hours producing documents for plaintiffs’ attorneys and testifying in depositions. And directors’ reputations can suffer when things go wrong.
The Privilege of Pay (for-profit boards)
Let’s be honest. A part-time job with interesting work, good colleagues, and only occasional heavy lifting that pays (in the case of corporate boards) five or six figures is an attractive proposition.
There are exceptions. For directors who are CEOs or independently wealthy, board compensation is chicken feed. When serious trouble strikes, directors would gladly return all they’ve earned just to make it go away.
Still, for most directors, board compensation is meaningful money, and because of the way the pay is structured, it can be a path not only to current income but also to long-term wealth building.
What do directors earn? We know with certainty what public company directors are paid because companies are required to disclose it, in detail, in their annual proxy statements. (Comprehensive data on private company board pay is not available. My impression is that it varies greatly from company to company, as do the duties of directors.) Not surprisingly, boards of the largest public companies earn much more than those of smaller companies.
These days, the value of what directors are paid depends a lot on how company stock performs. This is because most directors are paid, in part, in stock or stock options. The purpose is to focus directors, as well as management, on growing the company’s earnings and enterprise value.
Surveys of public company director compensation suggest that directors are paid, on average, between $100,000 for smaller companies (those with revenues up to $500 million) and $250,000 for the largest companies. There is, however, substantial variation around mean compensation levels.
There are variations in how directors are paid. A normal arrangement is a two-part pay package. First is a base retainer plus committee fees, which can be taken in cash or deferred until retirement from the board and, until then, invested in the company’s stock or, sometimes, other stock and bond funds. Second is equity-based pay, that is, restricted shares of the company’s stock (restricted because shares are granted then vest over a period of time) or stock options (the right to buy company shares in the future at the price on the day of the grant).
Paying directors in stock and options is a development of the last twenty years. A fellow director, older than I, once told me that in the 1960s and ‘70s, directors were paid relatively nominal amounts and only in cash. In fact, he said, independent directors were forbidden or discouraged from owning stock in the companies on whose boards they served because it was considered a conflict of interest! The shareholder value revolution twenty years later changed all that. Directors owning company shares became de rigueur on the theory that the practice would align the board’s interests with shareholders who elect them. Today the smallest public companies pay about half of director compensation in equity, and large companies pay nearly 80 percent in equity.
Another change in practice over the last twenty years is the elimination of most forms of compensation for directors beyond cash and stock. Large companies used to provide directors with pension plans and perquisites, such as the right to direct a corporate contribution to nonprofit organizations of their choice. The shareholder value movement argued, correctly in my view, that directors should not be incented to remain on the board for the purpose of accruing service that would increase their pension benefit. This could reduce director independence and impair healthy board turnover. Director-designated corporate contributions were deemed a misuse of shareholder resources because they would likely benefit the director more than the company.
The Privilege of Respect
Being respected by others is a basic human need. Respect is a central theme in film and drama.
In the great film On the Waterfront, Marlon Brando as Terry, laments his lost boxing career to his brother, Charley: “You don’t understand. I coulda’ had class. I coulda’ been a contender. I coulda’ been somebody!”
In the central line of Arthur Miller’s great drama Death of a Salesman, Willie Loman’s wife, Linda, cries out plaintively about her struggling husband: “Attention, attention must finally be paid to such a person!”
Being a director is being somebody. Attention is paid to directors.
The Responsibilities of Board Service
Serious responsibilities are involved in joining a board.
The proper context for understanding these responsibilities in the private sector is what academics call agency theory. The board exists to solve the principal-agent problem of separation of ownership and control. The owners of a public company, the shareholders, benefit from limited liability (they cannot lose more than they invest), but they need someone (an agent) to lead and manage the company on their behalf. Shareholders have ownership, but as a practical matter, most of the time management is in control. To solve the problem, shareholders elect directors to represent them. The board selects and oversees management on behalf of the owners.
The problem of competing interests between owners and managers is not theoretical. Consider this:
Interests of Owners |
Interests of Managers |
Maximize value |
Maximize compensation |
Safeguard assets |
Enjoy perquisites of the job |
Lead to create value |
Lead to satisfy multiple stakeholders |
Given competing interests, the board’s responsibilities are to (1) ensure the interests of owners dominate those of management by being vigilant about the use of company resources and (2) align the interests of owners and managers through the design of incentives (pay for performance) so that management wins when, and only when, owners win.
As duly elected representatives of the company’s owners, the board of directors is responsible for maximizing value over the long-term. There is long-standing debate10 over whether the proper focus of directors is on shareholder value or stakeholders’ interests. While thoughtful directors recognize and are responsive to legitimate interests of multiple stakeholders (owners, employees, customers, suppliers, communities), the cornerstone of board responsibility in the United States is to maximize shareholder value over the long term.
There is an important exception to the criterion of maximizing long-term value. When the board is considering a transaction that involves an inevitable change of control or breakup of the company, directors generally have a fiduciary duty to maximize the value of the company by considering alternative transactions and selling to the bidder offering the greatest short-term value. Once the sale or breakup of the company is inevitable, the board’s focus turns to obtaining the most value in the short term for the company.
As fiduciaries, directors have specific legal duties. They also have professional responsibilities. These duties are similar for company and nonprofit boards.
Legal Duties
Directors have fiduciary duties of care and loyalty.
Duty of care requires that directors, in the performance of their responsibilities, exercise the care (watchfulness, attention, caution) that an ordinarily prudent person would exercise in the management of his or her own affairs under similar circumstances. Actions that do not meet this standard may be considered negligent and any damages resulting may be claimed in a lawsuit for negligence.
Directors are required to make informed business decisions by considering all material information reasonably available to them, including adequate review of key transaction documents, either by reading them or having them explained by experts.
Duty of loyalty requires that directors put the interest of the company above their own interest and that of any other organization when a conflict exists. It prohibits self-dealing by corporate directors. They may not use their position of trust and confidence to further their own interests or entrench themselves.
Professional Responsibilities
As a director, I have seldom found it difficult to exercise my duties of care and loyalty. Doing so is my natural inclination. In addition, directors receive reminders and guidance about discharging their legal duties from the board’s counsel. They also have access to investment bankers, compensation consultants, and other experts.
What has proven more challenging to me and, I suspect, many directors is sorting out what my broader responsibilities are in difficult circumstances. Here are two examples.
What to do about a failing company? I was on the board of a rapidly expanding retailer. Top line growth was high due to increases in same-store sales as well as new store openings. Earnings were good and the balance sheet was leveraged but not excessively.
Then things began to go less well. Revenue growth came increasingly from new stores as same store sales stagnated. Gross margins declined as management cut prices to try to juice sales. Earnings went flat then started to decline. Cash flow was strained as a result of flat earnings and continued expansion. I found myself paying close attention and feeling concerned. I extrapolated trends. I didn’t like where things were going.
During this time, management tried to be reassuring. But in the process of what psychologists call sense-making, that is, figuring out what various bits of information might mean, four things occurred in close succession that unnerved me.
First, the very talented president and CEO of the company resigned and took a bigger and better job elsewhere. I thought we should appoint an interim and do a search for his successor. The rest of the board was comfortable with an internal promotion and felt that an interim title would signal weak support and failure would be a self-fulfilling prophecy.
Second, one of the directors pointed out in a board meeting especially poor performance of one of our stores and asked management for an explanation. The new CEO said, “A Walmart opened down the street and that hurt us. But I’ve competed against Walmart; if we hang in there, they’ll let up.” I thought this was the dumbest assertion I’d ever heard in a business meeting. I challenged it. The executive softened his stance but only a little.
Third, we did a tour of the company’s distribution center. The purpose was to show off the inventory management system, but what I noticed was poor housekeeping. There were boxes in aisles, open cartons, and a general sense of disarray. Soon after, my dad was looking for a particular product that I was sure would be carried in one of the company’s stores because we were a category killer retailer. We went shopping. Sure enough, the store carried it, but that day it was stocked-out. My dad wasn’t impressed, and I was embarrassed.
Fourth, we decided to borrow money because earnings were stagnant, the balance sheet was strained, and growth was chewing up cash. Management told the board what the interest rate would likely be, and we deemed it acceptable. I’ll never forget learning soon after the bond offering that the final rate was more than a third higher than we had expected—a junk bond rate! I was shocked. The public debt market was telling us something very different about the risk profile and credit worthiness of the company than we were hearing from management.
I sat down over a weekend and thought about what I had been experiencing. Something about it seemed familiar. Then I remembered a presentation by John Hackett, the brilliant chief financial officer of Cummins, I had heard a decade earlier. His title was “How Companies Fail.” It was a “stages” approach, like Gail Sheehy’s life phases in Passages or Elisabeth Kubler-Ross’s process of grief in On Death and Dying. I was stunned to realize, based on Hackett’s stages of how companies fail, that I was a director of a company midway through a process that could result in bankruptcy.
The question was what to do? This was a difficult situation for a director. I had legal duties of care and loyalty and the protection of the business judgment rule. But I was deeply concerned about the company’s prospects. Financial failure would be the antithesis of my responsibility as a fiduciary, deeply harmful to shareholders and stakeholders alike. But in conversation, I found that others on the board were not nearly as concerned as I, and management was relentlessly reassuring.
I had a great desire to flee. I felt like a passenger on the Titanic who was convinced we’d hit an iceberg and were likely to go down while everyone around me was still enjoying dinner and dancing. Resigning from the board was an option, of course, because directors can do so at any time and are not obliged to provide an explanation. But it seemed to me that cutting and running without making the best case possible to my board colleagues as to what I believed was happening and, more important, what actions needed to occur to rescue the situation would be irresponsible.
So I put together a short presentation and shared it with the chairman and independent directors. It included five actions the company had to take for me to continue in good conscience as a director: conserving cash, halting new store openings, closing money-losing stores, discontinuing a related diversification, and evaluating whether we had the right CEO or needed to recruit one fully up to the difficult job facing us.
The board discussed my analysis and recommendation. They disagreed. I resigned. Eighteen months later, the company declared bankruptcy.
I took no pleasure in it, and I don’t intend this as an “I told you so” tale. Rather, it is a story of the real nature of a director’s responsibility in a difficult business situation. Absent extreme good luck, most directors will experience some failures because pursuing returns for shareholders involves risk. I’ve always liked my dad’s notion that in tough situations your conduct has to allow you to look yourself in the mirror in the morning. That’s a good standard to guide a director in a tough spot.
What to do about a possible conflict of interest? Directors have to be attuned to potential conflicts of interest when they consider joining or remaining on a board. They must honor their duty of loyalty to the company if push comes to shove. And independent directors must be prepared to challenge the prevailing wisdom, including backing up conviction with resignation if necessary.
It would be nice if conflicts were all crystal clear. Then deciding how to handle them would be easy. But they’re not. I had an experience that illustrates the point. The story is short because my board service lasted exactly one meeting.
It occurred while I was dean of the business school at the University of Michigan. I became acquainted with Sam Wyly, one of our graduates. Sam was a successful, colorful, and sometimes controversial Texas entrepreneur. We had several meetings. Sam visited the school, and I ultimately asked him to consider a $10 million gift to fund half the cost of constructing a much-needed new building on campus. Through this process, we got to know each other, and Sam invited me to join the board of a public company, Sterling Software, of which he was chairman. He and his brother Charles were major investors.
I engaged in careful due diligence and determined that the company was solid and had a good reputation. I was confident in my ability to be independent in thought and action as a director because that’s my makeup. (Like most university professors, I am skeptical of authority and don’t like anyone telling me what to do.) So I joined the board.
I thought things would be fine until I attended my first meeting. There, I was surprised to find myself thinking and feeling uncomfortable about the concurrent timing of Sam’s major gift to the school and my joining the board as an independent director of a public company he chaired. Could I be as independent as I naturally was? With Sam, his brother, and his son all on the board, I wasn’t sure I could. I decided to play it safe and never find out. I went to Sam after the meeting and told him I was concerned that I could find myself in a conflict between my roles as dean of the business school to which he was a donor and an independent director. Out of an abundance of caution, I had decided it would be best for me not to serve on the board. Sam was gracious, and that was the end of it. It was a decision that cost me a lot of money—several million dollars in light of stock and options and the later sale of the company—but it passed the “look yourself in the mirror” standard.
The Rise of the Independent directors
Independent directors now dominate the boards of public companies, holding over 80 percent of board seats. Only independent directors can serve on three key committees: audit, compensation, and governance.
An independent director can only fulfill her duties—legal and practical—if she resolves to be truly independent as well as candid and constructive.
Independent. Corporate boards used to be composed mainly of company executives and professionals who served them, such as bankers and attorneys. This was good in terms of directors’ knowledge of the company and their ability to come to agreement and get things done. It was often not good in terms of directors putting their own interests (jobs, compensation, and benefits for inside directors, professional work and related fees for outside directors) above those of shareholders. It also hindered tough-minded monitoring and dismissal of underperforming CEOs. Relationships were too cozy and reciprocal.
The shareholder value revolution of the 1980s had profound consequences for board focus, size, and composition. Total shareholder return (share price plus dividends) became a key measure of board performance and effectiveness. A vigorous market for corporate control was reflected in acquisition and merger activity.
As a result, the human makeup of boards changed dramatically. Independent directors came to dominate public company boards. Boards became smaller: nine to twelve directors is customary now instead of fifteen or more. The chairman and CEO roles, previously united, are now frequently divided. The board’s agenda, once the exclusive domain of the chairman/CEO, is now set in consultation with a lead independent director. Executive sessions of the independent directors occur regularly whereas previously they were rare and almost always signaled that the CEO was in trouble. Board compensation is now substantial because independent directors are no longer paid indirectly through legal and consulting fees and banking relationships.
The rise of independent directors has created an important question: What does independence really mean? It’s useful to draw a distinction between technical independence and real independence. Technical independence, as required by the SEC and stock exchange listing standards, increases the odds of, but does not ensure, real independence.
In my experience, real independence is rooted in a director’s attitude and state of mind combined with a willingness to speak up and, if required, act in ways not in one’s immediate self-interest.
Independence requires a director to
• be curious, with a big appetite for facts, concepts, insights, ideas, and people from whom the director can learn so that independent thinking is well-informed;
• question and challenge, especially traditional practices, conventional wisdom, and majority views;
• trust but verify, one of President Ronald Reagan’s favorite phrases;
• have perspective that puts current issues and events in context: past and future, related matters, and relative importance. This is sometimes called the helicopter view; and
• be creative, offering novel and innovative solutions to problems with which the board and management are wrestling.
Hallmarks of independent behavior are
• asking questions more than broadcasting;
• drilling down when warranted;
• precipitating conflict when required;
• tolerating discomfort;
• speaking truth to power;
• searching for common ground and solutions around which the board can unite; and
• resigning from the board if legal and professional duties or the dictates of conscience cannot be fulfilled.
The independence of a director is of little value unless it is combined with two others qualities: candor and constructiveness.
Candor. Candor is a fiduciary duty in addition to care and loyalty.
Directors are selected for their judgment, above all. The board, senior management, and the company only benefit if directors are candid, that is, speak out honestly about what is on their minds. They call things as they see them. They raise questions, including uncomfortable ones.
Of course, directors have to be selective. Is the issue worth addressing? Has someone else already made the point? Are they talking just to hear themselves speak? The most valued directors listen a lot and speak selectively. It’s important to protect the value of your verbal currency.
Being candid sounds easy, but it’s not. I served on the board of a small, family-owned company with a long history. The family CEO had done a good job with the company on his watch. But it was a difficult, cyclical business, and he had weathered several recessions with requisite cost cutting, including layoffs—always a difficult task.
One day I got a call at the office. I could hear the emotional distress in the CEO’s voice. “I have to see you,” he said. “I want to sell the company. I’m talking with each director.”
I was shocked. There had been no warning of this, and the company had been in existence for many decades. I agreed to meet with him that afternoon.
When he walked in, I could see the stress on his face. He saw bad times coming and did not—did not—want to be at the helm through another recession. He had put out some feelers and found a buyer willing to purchase the company for a particular sum. He asked what I thought.
The answer he was looking for was obvious. He was seeking support to do what he desperately wanted to do. Providing it would have been easy. I had no ownership stake in the company, I served as a director at his and the family’s pleasure, and the modest directors’ fees were of no great consequence to me.
Yet with several hours to consider the matter, I had decided what I thought and was candid with the CEO:
I understand. I had to lay people off at Cummins, and it was the hardest thing I’ve ever done professionally. So I empathize. But I cannot in good conscience advise you to sell the company or support your doing so. This is a family business built over generations. I believe its market value is exceptionally low right now because you’re not the only one who believes a recession is coming. A fire sale of the company today at a low point in its value would be wrong—for you and the family. I urge you to lead the company through this downturn and use the time to fix everything that will increase its value when volume returns. Then, reconsider whether to sell the company at a value that reflects the work that you, your father, and others have done over so many years to make it what it is today.
The CEO was disappointed and disagreed. We all like to hear what we want to hear, not necessarily what we need to hear. One of a director’s most important duties is to be candid and honest, especially when doing so challenges a consequential direction that management or the board wants to pursue but with which the director disagrees.
The end of this particular story is a good one. Other directors expressed views similar to mine. The CEO led through the recession. Three years later, revenues and profits were strong, and he sold the company with the full support of the board and family for four times what he had been offered just thirty-six months earlier. That’s the difference directors can make at a critical time in a company’s and an executive’s life. Candor is required, even if it is uncomfortable or inconvenient.
Constructiveness. I have found there is a big difference between quality academic research and successful leadership and management. In their search for truth, faculty must be analytical and deconstruct what they examine. Leaders and managers should be analytical, but they must also take constructive action in order to create value and move their organizations forward.
I have enormous respect for the scientific method and the value it brings to a world drawn to fashion, fads, false correlations, and fatuous theories. But I also deeply appreciate that leaders and managers must go beyond analysis and understanding to action and results.
This is the reason for a culture gap between academics and leaders/managers. Academics are inclined to be skeptical of leadership slogans such as “The Way Forward,” a recent theme and name of a restructuring plan at Ford Motor Company. They can also be skeptical of their colleagues whose work appears to be longer on inspiration than evidence.
The need for constructive action is why I sometimes say to executives considering a change, “Remember, you need to be right twice!” It’s usually not hard to figure out what you want to stop doing when a person or course of action isn’t working out. The harder part is figuring out what to do next, such as recruiting the right person or embarking on a new strategy.
Good directors understand this. So they push themselves when opining on a situation about which they are concerned to share not only their analysis but also what might be done to make things better. As a director, when I’m concerned but can’t come up with good alternatives, I will simply describe the communication of my concern as “sharing agony” and admit I don’t know what to do about it. This is better than either of the alternatives—worrying in silence or offering a lame suggestion in which I’m not confident.
Leading the Company: Governing versus Managing
Directors must wrap their minds around the role of the board versus the role of senior management in leading the company.
It’s challenging because while the board has ultimate accountability for company performance, it is definitely not the board’s job to manage the company.
One governance reform that has been suggested is making directorships full-time jobs to level the playing field between senior management and the boards to which they are accountable. This is a terrible idea. There are sound reasons that the CEO reports to a board of able, committed part timers versus full timers.
The CEO reporting to a group ensures that multiple points of view and time for deliberation will be reflected in major decisions. This is not a guarantee against reflexive, impulsive, and occasionally catastrophic decisions, but it helps.
The board being part-time reduces the odds of ambiguity and confusion over who is in charge. Unity of command is the principle that no one in an organization should report to more than one person. It may seem a little quaint and antiquated in a world of matrix structures and network organizations, but it is essential at the most senior level. People must understand that the board appoints the CEO, the CEO reports to the board, and everyone else reports directly or ultimately to the CEO.
Take my word on this. It’s based not only on sound management theory but also on my own hard-won and unhappy experience. In one of my jobs reporting to a board, several board members developed the habit of going directly to one of my subordinates to get what they wanted. Neither they nor he informed me. It ended badly, as such things usually do.
The board’s being part-time does not guarantee unity of command, but it helps reduce the potential for directors to compete with senior management over who performs executive and operational functions of leadership. The executive function of management is to execute policy, direction, and decisions that, at a high level, are made by the board, usually on management’s recommendation. The operational function of management is to operate the company on a day-to-day basis, fulfilling the organization’s mission, doing its business, and attending to myriad details. Neither the executive nor operational function is the work of the board.
What, then, is the board’s work? In a word, it’s governance.
In later chapters, I will discuss in detail what constitutes the substance and process of great governance. Suffice it to say that governance involves four key functions of the board:
1. Appointing, incenting, evaluating, and, when necessary, removing the CEO and senior management.
2. Setting aspirations and direction and approving strategy and policy, plans, (annual and long-range) and performance measurements. This includes making the most consequential decisions that define the entity’s
• risk profile (strategic bets and capital structure);
• culture (tone at the top, beliefs, values, style); and
• future (major initiatives, capital investments, mergers and acquisitions).
3. Monitoring results and verifying the integrity and accuracy of disclosure, especially of financial condition and results.
4. Self-monitoring and renewal of the board.
When the board performs these functions well, it enables senior management to lead the company effectively and facilitates the work of the organization.
A different take on governance, wholly consistent with these four functions, involves a paradox, one that seems little understood by many governance reformers. The board has two responsibilities vis-à-vis management:
• Monitoring and holding management accountable for performance and results
• Supporting and helping management succeed in achieving high performance and intended results
There is nothing novel about the coexistence of these functions. They can appear contradictory but don’t need to be. Parents face a similar challenge. We have to expect a lot of our kids, monitor their behavior and performance, and ensure proper consequences. We also need to support, advise, and occasionally reassure them as they face new challenges, difficult situations, and trying circumstances. Tough love comes to mind.
Done well, the board’s performance of these dual roles has complete integrity, in the purest sense of the word. They are performed seamlessly and are mutually reinforcing. They engender respect.
They can be done wrong, however. I remember a director whose day job involved doing depositions; his style was skeptical and intimidating. He had the same style as a board member interacting with management. I also remember a director whose transparent need for acceptance and affection made her incapable of asking hard questions or being straight with management about performance failures. Her questions were all softballs, and her evaluative comments about management were relentlessly complimentary.
Like the best parents, good directors know that monitoring and disciplining are necessary but not sufficient conditions for growth, development, and high performance. The same is true of help and support. A rich mix of both is essential.
Boards in a Goldfish Bowl
Corporate (and to a lesser degree nonprofit) directors function in a charged environment these days. More than ever, directors are held accountable for performance. Shareholders and stakeholders expect the board to attend to their many, often competing, interests, claims, and concerns.
Boards are under increased surveillance because of highly visible calamities that have befallen some companies. Think Lehman Brothers and General Motors. Over and over, the question has arisen: Where were the boards?
Investors and the public are understandably skeptical about the attentiveness and effectiveness of boards, especially in light of the power, privilege, and rewards their members enjoy. The authors of a recent book titled Money for Nothing: How the Failure of Corporate Boards is Ruining American Business and Costing Us Trillions11 are unrestrained in their indictment of directors. From inattentiveness to excessive executive compensation, their criticisms are relentless.
Yet there is no shortage of institutions and individuals setting ground rules for boards, looking over directors’ shoulders and advising or urging governance reform. A short list would include traditional parties like Congress, the SEC, and stock exchanges and more recent entries like proxy advisory services and activist investors.
Proxy advisory services such as ISS and Glass Lewis analyze companies’ annual proxy statements and governance practices and advise institutional investors on how to vote their shares. Matters include director elections, executive compensation, and various initiatives put forth by management and investors who qualify for proxy access. These services have become quite powerful because their advice is influential on voting outcomes.
Also influential are activist shareholders such as Bill Ackman, Daniel Loeb, Nelson Peltz, and Carl Icahn and the investment vehicles they control. Institutional investors are also a powerful force. They target boards and companies for change, sometimes on their own, sometimes in partnership with activists. The largest of them, such as Blackrock, Calpers, and TIAA-CREF take an interest in governance because their size does not permit them to do the “Wall Street Walk”—that is, sell shares if they disagree with the company. Others, such as union pension funds and religious orders, choose to stand and fight on principle rather than sell and exit.
In short, boards may meet in private, but they live in a goldfish bowl.
Conclusion
Great governance requires directors who understand the role of the board. Governance is best thought of as stewardship.
Directors should know and embrace their responsibilities as they enjoy their privileges. The best directors are independent in the deepest sense—attentive, curious, challenging, and unafraid to take action when required. They monitor management and hold them accountable while providing help and support.
Effective stewardship requires a deep understanding of the entity being governed. This is the subject to which we turn next.