CHAPTER 5
Redesigning the Board’s Committees
In meeting its responsibilities, the board has a singular constraint: time. A typical board might meet for only fifty hours a year—nowhere near enough time to develop the depth of knowledge necessary to oversee talent, strategy, and risk. As part of its new playbook, the board should elevate the work of its committees so that the directors can dig deep and manage their agenda.
This way of working is closer to how privately held companies function as they help the CEO create long-term value. Indeed, redesigning the committees for the new TSR will transform the way in which the board and the CEO collaborate. It’s through the committees that the board can best establish its working relationship with the CEO.
Committees can facilitate quality, depth, and informality of conversation. Their size and focus can help directors explore ideas with the CEO and build relationships and trust. They allow for a candid give-and-take and let directors and management express different points of view without hurting anyone’s feelings. That dynamic will help the CEO succeed.
The committee structure can also help stakeholders from outside the company understand the board’s work. Ron O’Hanley of State Street says, “The first thing we look at is how the board goes about effectively overseeing the talent acquisition and development process, the strategy process, and the risk process. How does the board intervene? For strategy in particular, boards don’t get to spend enough time. We’ve made boards so busy for lots of different reasons that strategy always gets pushed to the end of the meeting or to the annual board strategy offsite.” A division of labor will redress this problem.
We propose that the board revamp itself around two new committees: the talent, compensation, and execution committee, which will oversee recruitment and pay of senior management and monitor their performance; and the strategy and risk committee, which will have prime responsibility for eliminating the board’s asymmetry of information with management. Each of these committees should have four or five members; three of them should be independent directors. The two committees should also have cross-membership, with one director in common.
To manage for the new TSR, the directors need knowledge. They also need the time to think and reflect. And to give them that time, the board must use its committees well, with each able to delve into the issues related to their special briefs. (See figure 5-1.)
Organizing the Committees
For committees to be effective, their work must be clearly defined. The responsibilities and lines of communication of some committees already have that clarity. The role of the audit committee is largely structured by laws and regulations. And since the audit committee must link with internal and external auditors, the way they work together is fairly well established.
For other committees, the board must do more to clarify the depth and focus of their work. Most important, to be effective collaborators with management, the committees must take care to be independent of it. To meet those goals, the chair of each committee must take a strong leadership position. Today, committee chairs rarely seek to develop their own sources of analysis, expertise, or even judgment. That must change.
Besides giving board members the time and wherewithal they need to do their jobs, the committee structure can help the lead director become more effective and knowledgeable. In 2019, one of us (Carey) identified seven Fortune 500 companies, including Phillips 66, in which the lead director serves ex officio on all committees, sitting in on meetings on an impromptu basis. Doing so gives the lead director or nonexecutive chair insight into the deliberations of the committees before they present to the full board. We also recommend having either the lead director or one of the other committee chairs, selected on a rotating basis, sit in on every committee meeting, which will help facilitate the selection and appraisal of committee heads.
The lead director should have the responsibility for appointing the committee chairs and should assess their performance annually as well. The lead director should also create a succession plan for the chairs and should move directors through a variety of committees to give them perspective on the entire company. Because of their greater responsibility and the demands on their time, we recommend paying the committee chairs a higher fee than the other directors—perhaps $75,000 more per year.
As part of its brief, each committee should assess management and share its conclusions with the whole board in executive session—focusing on where management can do better and where the board can offer coaching. In turn, the CEO and the management team should evaluate each of the committees to help determine which ones add value and which do not.
The committees should have a clear twelve-month plan for their work and their goals, and they must keep the board up to date on their agenda at meetings throughout the year. That communication is essential to ensure that the board is fully informed when making critical choices, such as CEO selection, merger and acquisition decisions, capital structure plans, allocation of resources for future growth, and trade-offs between short-term and long-term objectives—all at the heart of managing for the new TSR.
Talent, Compensation, and Execution Committee
This committee will oversee key functions that most companies address separately but that ought to be coordinated.
The most important role of the committee is to understand the changing mix of capabilities that the company will need for the long term and the pathways for improving talent as conditions change. An example of where this function is crucial might be a company whose specialty is mechanical engineering but that must shift its focus to software engineering.
The committee should also prepare for CEO succession. It must identify and learn as much as it can about second- and third-generation CEO candidates and their development paths. Looking further ahead, the committee should identify CEO candidates in different age ranges as well as candidates for other essential senior posts—the CFO and the CHRO primary among them. Candidates for those roles should be geared for future needs.
Besides making sure it is familiar with the quality and strength of the company’s management team, the committee should also continually map out who is available elsewhere. For instance, it should know the top three CFOs in its industry in case its own should leave, and it should track them, like football players. Indeed, it should apply the recruiting principles of sports teams to its executive team.
Compensation
Compensation and the basis on which it is determined drive the behavior, focus, and concentration of almost every human being. In companies, compensation is the lever that can determine the behavior of the top fifteen or twenty executives as they exercise their judgment on the balance between short-term and long-term objectives.
Having a compensation committee is also a legal requirement. One of its central roles is to set out the principles that guide compensation policy. To do so, directors must delve deeply into the company’s business and its competitive marketplace. They should base their policy not on past performance but on the innovations relevant to performance now and in the future.
Public companies must do more to close the gap with private equity in how they compensate key employees. All compensation committees at public companies use outside consultants. Private equity companies do, too, but they also have tools that more effectively reward exceptional performance. A private equity firm might grant extraordinary shares or options to executives for a certain level of achievement, and if someone is failing, it will withhold money or even fire the person.
The committee can help the board maintain control over company compensation. Once the committee knows the talent in the company, the CEO won’t easily be able to deviate from the committee’s assessments. By developing knowledge and a database about talent both inside the company and among its competitors, the committee will build the expertise necessary to represent shareholders.
Execution
A key role of this committee will be to monitor performance over time so that it can understand the causes of failure and success in each of the company’s lines of business. It will have the power to get external data on the competition and the marketplace and compare the company’s performance with that of its peers. And it will decide what the performance measures will be.
The committee should undertake this analysis transparently and with the knowledge of the CEO. The work should be collaborative. The goal is to help the CEO and to detect unacceptable behavior by management, such as units that pull results forward from future periods to meet quarterly estimates or that cut ads just to hold down current expenditures. In other words, the committee will help the CEO perform a culture audit.
The committee should also give backbone to the CEO and absorb pressure from shareholders when the company doesn’t make its quarterly numbers, keeping the right balance between short-term and long-term goals. A committee can meet this goal; the whole board cannot. It doesn’t have the time. Occasionally, the informal nature of the collaboration between committees and the CEO might encourage a director to try to manage from the boardroom, but you can be on guard for that.
Ed Garden of Trian Partners argues that the compensation committee is the most important one on the board because it has the power to influence management behavior, which entails monitoring execution of company plans. He says, “We’ve seen so many situations where companies are underperforming, yet management is being paid a lot of money.”
For example, Trian recently dug into the numbers of a big company in which it had become a major shareholder. Garden says, “The management team continued to miss their own targets and under perform versus peers, yet they were being paid above their target compensation level. And you scratch your head and say, like, why? How could the compensation committee come to that conclusion?”
For that reason, Garden sits on the compensation committee of every board he joins. He says, “I always make the point to the other board members, to management, to other shareholders that we’re glad to pay management a lot of money if they build the business and do it the right way. But what we’re not going to do is pay people just for showing up.”
In such circumstances, the job of the compensation committee is to hold management to account. In the boardroom, when management presents slideshow comparisons of performance or the budget against the previous year, very rarely does it do so against the competition, and the directors don’t have enough time to dig in and ask the right questions. Indeed, only a few board members will have any questions at all, and they are likely to ask them only here and there. Nobody wants to embarrass management.
This mindset must change. The committee must develop the depth of knowledge about the company’s operations so that the full board is better prepared to make sense of management presentations, drawing on data both from inside the company and from the wider marketplace. In so doing, the committee will help the management team improve.
For instance, say a product launch turns out to have been better than budgeted. The committee should ask the CEO about the people who oversaw the launch. How is the company compensating them? The committee will then have more concrete knowledge about key talent. Or say a product design failed. Why did it fail? If the manager can answer that question, now the committee knows that this is a person who can understand and explain why something went wrong. The job of linking execution with key talent and their compensation can take place in this setting.
This committee should meet quarterly. If the directors on the committee evaluate performance four times a year, they will learn the business in depth. And that knowledge will give the company a competitive advantage. The board should survey management every year to evaluate the committee and show how useful it is.
The lead director should chair this committee. The best candidate is typically a former CEO—someone who has experience with transitions.
Strategy and Risk Committee
The central role of this committee will be to evaluate strategic options and alternate business models. These include the choice of goals and objectives; the competitive advantage of the company and its shelf life through the eyes of the customers; the possibilities for flexible response if conditions change; and the capabilities that the company will need for the future and the ones that it can discard.
To do its job, the committee must seek independent sources of information—about data, external trends, future scenarios, and competition—and should do so with the knowledge and help of the CEO. Jeffrey Ubben of ValueAct Capital and Inclusive Capital Partners says, “Strategy is the domain of the whole board, but it cannot be done by the whole board. The committee has to prepare the way for the board because of the depth of work necessary to understand the external market, the competition, the key performance indicators, and the balance between short-term and long-term goals.” The chairman of the strategy committee can be a member of the compensation committee and vice versa, so communication is straight, direct, and unfiltered.
Here the committee can learn about the projects and innovations that will build the future and the resources needed for them—the allocation of funds for those initiatives and the assignment of people. And it is here that the committee can evaluate risks and their possible causes, such as debt liquidity or the failure of an acquisition, as well as possible benefits, such as risk that enhances the market value of the company through acquisitions or new projects.
When such issues arise, the committee chair can ask management to present them for review. The committee can then seek external help to analyze them. By reevaluating strategy every quarter, a four- or five-member committee with a solid chair can take a forward-thinking look on resource allocation, future building, and risk.
On the composition of the committee, at least one or two members should come from outside the industry. If the company has a technology committee, it should have one member in common with the strategy and risk committee. People from inside the industry will have viewpoints that reflect the company’s experience. Outsiders will bring an uncontaminated opinion. Diversity matters here—diversity of risk, of experience, and of skills. The strategy committee should also ask if the management team has a diverse perspective, and new people who can shake things up.
For example, in 2014, Providence Health of Seattle recruited a key Amazon employee, Aaron Martin, a senior manager of the Kindle division. At Providence, he would serve as senior vice president of strategy and innovation and supervise work on algorithmic and related technologies. The company also invited him to attend executive leadership meetings and encouraged him to ask questions and make suggestions that challenged the mindset of the existing team. He did, without fear that health-care insiders would consider some of his questions dumb.
Those questions began to alter the thinking of the leadership team and helped Providence assume the outlook of a digital player. Providence has since made huge strides toward its transformation into a data company, aligning with Microsoft and Amazon through large database acquisitions and creating alliances to get data from health-care companies and doctors. Martin is now chief digital officer and sits on the strategy committee of the board. The lesson: sometimes you have to bring along a disrupter to ask dumb questions when the old executive leadership people don’t fully recognize what is possible.
After sitting together for a time, the strategy committee’s presentations to the board should evolve. Rather than featuring five-year plans with a slew of numbers, they will express clear goals. They will offer an assessment of options, risk, implementation, and competitive advantage based on external factors—market data, customer information, technological trends, new players in the field. Focused presentations will help the rest of the board ask good questions about projects that the company is pursuing to build the future.
The strategy and risk committee will have cross-membership with the talent, compensation, and execution committee, which will help build value and balance short-term and long-term goals.
Audit Committee and Nominating and Governance Committee
These two old-line committees are both mandated by statute, but they also sit at a sensitive juncture between the board and management, of special significance at a time of rapid change and financial threat.
The audit committee does the heavy lifting on the oversight of financial risk. It has the authority to make decisions, and its work is evaluated publicly, giving it clear accountability. It has outside auditors, through which the committee will have access to independent, external sources of information, helping it correct the board’s information deficit with management.
The audit committee is also one of the most demanding committees to serve on. Mary Erdoes of J.P. Morgan Asset & Wealth Management describes the requirements vividly. She says, “As head of the audit committee, you already have one of the most painful jobs in that we send you reams of paper every single month. And the audit committee meets more frequently than the rest of the board. And they have to go through every line of business and every audit. So that is a massively full-time job, especially as head of that committee.”
The members of the audit committee also have to spend a good deal of time on the road to familiarize themselves with company operations. At J.P. Morgan, Erdoes says that the head of the audit committee flew to a different location almost every month. As she puts it, “He’d go to Japan. He’d hold town hall meetings with the people there. Then he’d meet with the Japanese regulators. Not every board member will have the time to do that, depending on the stage of their life, but boy, when they can, it’s just like a totally different level of help for that company.” In appointing the audit committee chair, look for someone who can make that investment.
In one respect, the nominating and governance committee is the pivotal committee of the board: the recruitment and dismissal of directors and the organization of the board and its committees are all within its ambit. Ideally it will have four members, all independent directors. We prefer each member to be the chair of another committee, which will ensure that the committee has the relevant information about all of the board’s work.
The chair of the nominating and governance committee is of vital importance because of the committee’s mandate over the leadership structure of the board. Just as the board prepares for succession of management, this committee must prepare for the succession of its own leadership, as well as the leadership of other committees and the board as a whole. It must search for directors before it needs them, drawing on its own network, the networks of other directors and the CEO, and headhunters. And it will need to plan at least three years in advance to ensure it has time to attract the right people for membership.
If it doesn’t meet its recruitment goals in a way that adds value, the informal network of directors loyal to the CEO will seek to take on the committee’s role. And if management selects the directors, the board will lose control of its independence. The key is whether the committee has the guts to make the right decisions, to establish the right processes, and to modify them as conditions change.
Today its centrality is heightened. Together with the audit committee, which is responsible for overseeing the management of liquidity, the governance committee is at the heart of one of the most sensitive dances with management, and one that will be of crucial importance in the postpandemic era.
In most circumstances, a bright line exists between the CEO and the board, dividing their separate responsibilities. For the board, the line means that the directors must not stray into the territory of management and attempt to run the company.
But some functions will straddle the line. For example, management may choose to focus on efficiency—the optimal use of resources to create long-term value. The board will properly focus on resiliency—enhancing survivability in times of stress and therefore instructing on necessary changes in priorities and capital allocation. And in so instructing, the board is straddling the bright line.
Yet here the board must do so, because it is accountable for priorities and capital allocation in times of risk. The top ten investors will ask the board questions about those matters. They will ask, for example, what priorities are you setting? What are you doing to enhance resiliency? What is your process for capital allocation? If you have a disagreement with the CEO, how do you deal with it?
A change in priorities and capital allocation can demand a change in key performance indicators and incentives for management. That is, the key performance indicators for resiliency will be very different from those for efficiency. That difference exists because the goals will be different. If your goal is efficiency, you will aim to maximize performance for earnings per share. If you change your goal to emphasize resiliency, you must now maximize performance for liquidity. (The rebalancing in performance indicators will also demand coordination with the strategy and compensation committees.)
Resiliency becomes a priority for the continuity of the business when volatility is high or at times of surprise, as with unexpected negative results. The response in those circumstances must be to avoid taking on too much debt or risk and to refrain from attempts to maximize earnings by skating on the edge.
In other words, the need to enhance resiliency is a continuous phenomenon of uncertainty, which can bring deep volatility and which will come unannounced, and in any number of forms—a transformational act of terror, a financial meltdown, a pandemic. In overseeing decisions about liquidity, and in adjudicating the lines of demarcation between the board and management at a time of great volatility, the audit and the nominating and governance committees must constantly refresh the knowledge and expertise of the board, making sure it has the right members for the demands of the day and the right balance between financial risk and reward.
Cybersecurity, Ad Hoc, and Temporary Committees
The board must have the flexibility to create and dissolve committees as the needs of the company change. For instance, Wendy’s established a technology committee because it was transforming itself from a standard fast-food company to one with a digital ordering platform that would be essential to its operations. The company needed help in this transformation. In creating and staffing a technology committee, it had to decide whether it had directors who could understand the technological needs of the company. As an alternative, it would have to create or consult with an advisory group.
In speaking of the company’s challenges, Ed Garden of Trian says, “We owned 20 percent plus of Wendy’s, and we said to Wendy’s management team, ‘You may sell cheeseburgers for a living, but make no mistake, you’re a technology company.’ MobilePay, mobile ordering, the iPhone has changed everything about our business. So why not bring in technology expertise? And by the way, those people tend to be younger and probably not have the résumé that the search firm has historically pursued.”
A technology committee could either be temporary or become permanent depending on the evolution of the relevant technology and the future needs of the company. The composition of the committee and its work could also change with the passing years.
Many companies used to have operating or executive committees of the board, but most have abandoned them because directors didn’t like the two-tiered board structure that ensued. Don’t dismiss the idea out of hand; circumstances may sometimes require such an approach. In its stead, one increasingly popular option is the temporary board task force. Vanguard recently used one to help with its strategy in a new country and another to develop a product for a market in which a couple of its directors had deep knowledge.
Companies are also using ad hoc committees to address rapid changes in their risk profiles, particularly in technology. Even more than vulnerability to a hack of their customers’ personal information, what keeps CEOs awake at night is the risk of a catastrophic breach of the products themselves, as companies integrate more electronics into their goods and then bring them online. The CEO of one prominent Fortune 50 corporation says, “At first we were handling it in our risk committee, but we decided for a period of time to have a dedicated cybersecurity committee.”
So, for many companies, the lineup of committees will be fluid, with some committees going out and others coming in. A company will always need new talent in the boardroom, as it does in its managerial ranks, because strategy must change as the business environment changes; otherwise the company will run significant risk. As new risks and strategies emerge, so will new committees.
CHECKLIST FOR REDESIGNING THE BOARD’S COMMITTEES
- Give critical responsibilities to board committees to overcome the information asymmetry with management.
- Let the lead director serve ex officio on all committees and appoint the committee chairs.
- Use committees to collaborate with the CEO and the management team in an informal setting.
- Be sure each committee has a clear twelve-month agenda that it shares with the whole board.
- Have the lead director or one of the committee chairs sit in on every committee meeting.
- Revamp the compensation committee to include responsibility for talent and execution.
- Give the strategy and risk committee primary responsibility for overcoming the asymmetry of information with management.
- Make sure that potential recruits to the audit committee have the time to invest in the job.