CHAPTER 6

Diversifying Information

Information is the lifeblood of the board of directors. Reducing the asymmetry of information between the board and management is essential to the board’s mission of overseeing talent, strategy, and risk.

To oversee talent, the board must attain a deep understanding of the people who are setting the agenda for the company today and who’ll be creating it for the future. Doing so means knowing the skills of the current team members, their bench strength as a source for the next generation of leaders, and the marketplace for talent outside the corporation.

To oversee strategy, the directors must know enough about trends in the industry to guide the company on the path toward long-term growth. They must learn the ins and outs of each of the company’s lines of business so they can help management make informed decisions about which ones to nurture and which to exit, and when to proceed with a merger or acquisition and when to take a pass.

To oversee risk, the board must have a grasp of the perils of the marketplace today and the vulnerabilities of the company to forces that might rise to the level of existential threat. The board must also be able to judge the level of risk worth accepting in order to promote long-term growth.

All of these roles require the directors to have information unmediated by management; without it, they won’t have perspective on what the CEO is telling them. And even though each member of the board might be independent in their mindset and values and courage, the board as a whole cannot be independent without its own sources of information, especially ones that reach outside of the corporation. Independence of information—its sources, selection, format, timeliness, frequency—is the basis for independence of judgment, intuition, thought, and action.

This imperative is not about databases or mass quantities of intelligence. It’s about access to the information that matters—data that is relevant to the business of the corporation and that encompasses varied approaches to governance, from conservative to risk taking. The information must support strategic thinking from different perspectives, too, demanding not only diversity of age, gender, ethnicity, and experience on the board but also diversity of sources. And because the information landscape is changing so rapidly, boards must continually take note of new technologies and modes of analysis. The premium is on thinking that crystallizes quantities of information into qualitative statements.

Information independence is a matter for the committees as well as the whole board. As we’ve seen, give-and-take and the suspension of egos is easier in groups of four than in groups of ten, and the ensuing informality of discourse helps drive new ideas. So the deep work between managers and directors will take place in the committees. In that setting, directors can better clarify their expectations about the kind of information they want from management. Then the committees can sift and analyze the material and send their findings to the board.

In the course of tapping all sources of information to stay informed, board members may run into a sacred cow: thou shalt not trust external experts, especially ones who might take a view opposed to management’s. But boards cannot rely solely on management for intelligence about the forces of change and disruption in the wider market. Sometimes the right questions are the awkward ones that come from outsiders, guiding the board into new avenues of research and analysis. At the same time, in developing alternative viewpoints, directors must always keep the CEO in the loop, as private equity companies do.

Still, as one expert after another told us for this book, it’s the data advantage of managers over directors that imperils the work of the board. Directors who lack information may equate caution with safety, to the detriment of long-term planning.

The data gap means that the board can’t easily challenge management when the company is going astray. If the CEO gives the board an explanation for disappointing execution, the board needs its own information sources so it can determine whether to adopt a different point of view. Indeed, look inside a company that is ailing, and you will often find a breakdown at the board level. As Ed Garden of Trian Partners puts it, “Companies are underperforming, and management is telling the board all the reasons it’s not their fault. And the board doesn’t know enough about the nuances and the subtleties of the business to push back. The information advantage that management has is the culprit.”

With the directors in the dark, the board will struggle to play a useful role. Directors may wish to have meaningful discussions about strategy, but most don’t understand the company or the industries well enough to do so. As a result, boards often don’t know where to focus, so they engage in superficial discussions and interject unhelpful suggestions, leading to frustrating interactions between management and the board.

In this chapter, we’ll offer ideas to help you and your fellow board members as you seek information both from outside the company and from your own management. And we will show you how some exemplary directors get the information they need, and the commitment that’s necessary to do it. (See figure 6-1.)

Information from Management

One of the major challenges directors face is that management will often inundate them with information. At board meetings, the typical management presentation will consist mostly of historic data, which, besides eating up much of the session, inevitably skews the discussion toward short-term thinking. Management might not offer alternatives to its plans or discuss emerging trends, whether on public policy, technology, new competitors, or new models of operating.

To get much of that information, the board will have to go outside the company. But directors must still rely on management for information necessary to determine whether the company is well positioned for the long term. And that will require consultation and collaboration with the CEO and the management team.

The key managerial officer for this role is the CFO. The CFO should be the linchpin in generating the information that goes to the board. Ideally, a single director or a committee will sit with the CFO and design the format for the information that will go to the board. The aim is to give the directors and their committees all they need to assess company strategy, including current news, planned initiatives, and internal analyses of the competitive landscape.

Common practice has been for management to slap together two-hundred-page reports and send them to the board. We think that this routine is a terrible practice. A page a week from management to the board should be sufficient. If any directors wish to know more, they can pick up the phone and call.

To help assess talent in the company, directors should spend time with a wide array of insiders. At Tyco International, Ed Breen would arrange dinners with a variety of executives and in-the-trenches staffers. He would also arrange for three or four directors to visit a company site on their own for a full day with the local management team and their staff, spending time on the factory floor or in the research labs. The directors would learn about not only the managers running the show but also the degree to which the local workforce is engaged with the long-term objectives of the company and how much it values the leadership.

The gold standard for how a CEO can help keep the board informed and give it an outside view is GM’s Mary Barra. She is a firm believer that not all good ideas come from within the company or from its board members. So at least once a year, she has a buy-side and a sell-side analyst come in and make a presentation about the company on whatever subject they wish. Barra says, “We really try to be challenged with those who are aware of the industry and have different perspectives.” Indeed, on our own boards, we like to bring in analysts whose outlook differs from ours to expose directors to alternative ways of thinking.

Barra tries to impart information with discipline, taking care to make good use of the board’s time rather than burying directors with paper. At the urging of the board, she provides directors with a daily news digest summarizing coverage of GM and its competitors, offering both snippets and full articles for directors who want to read more. Once a month, the company also sends board members a public policy briefing because so much of what is happening in the industry has global policy and regulatory implications.

Before meetings, directors get a two-page brief laying out the issues of note and the decisions that management has made in response, along with a rundown of matters to be discussed at the meeting and the insights she’d like from the board. And she sends the board a collection of analyst reports every week. She says, “Sometimes you read them and as the CEO I cringe a little. But it’s a perspective. And we make sure they’re well rounded and have opposing views.”

All this information is useful because it has been curated rather than delivered by the ton. And it’s the sort of intelligence that can help the board add value going forward. Once it has comprehensive information relating to the competition, both on business matters and on talent, the board can make a real contribution by raising issues that management might not have considered. Barra says, “You have different board members who want to dig into certain areas more than others, either to learn more about the business or to deep dive into something. We try to be as time conscious as possible, but we probably overcommunicate a little bit, and then it’s left to the board member how much they want to dig in.”

Barra is lucky to have a board willing to spend the time necessary to keep abreast of issues, especially with a company in the midst of a longterm transformation. As a result, ideas flow in both directions. She says that rarely does a week go by when she doesn’t receive at least one note from a board member about something that’s happening to make sure she knows about it and to seek her perspective.

The care that Barra takes with her board’s time raises an important point: true, directors should be well informed by management, and they should never be surprised. Yet they should also never have to search for a needle of insight in a haystack of verbiage. Vanguard’s Jack Brennan recounts, “I just did a presentation for bank directors at the Fed. And these poor guys are saying, ‘I get a thousand pages for every board meeting. It just can’t be valuable.’”

Often that sort of information dump is deliberately obfuscatory. Directors should resist it. CEOs sometimes use board meetings, too, as a way to hold directors at bay. Warren Buffett says, “If the CEO really wants to keep you under control—and there’s been a half dozen in my experience—they’d basically just control the clock. They schedule presentations that don’t tell you one damn thing about the business. And they use up the time, and they know when you want to get the hell out of there. A CEO that wants a puppet board can still get one, I’ll put it that way.”

The Activist Perspective

One of the signal characteristics of private equity is a tight alignment between managers and owners. The interest that activist investors take in public companies reflects that mindset. We think that public companies should do more to bring that attitude into their own arsenal of ideas.

To that end, boards should try to anticipate the information that a shareholder activist might seek out. To see the business as an activist would, Raj Gupta of Delphi Automotive asks outsiders to analyze the business and write a letter to management as if they were activist shareholders. The letter should be well documented, using external sources of information, and the tone should be realistically direct and hard-hitting. Such a perspective may embolden the board. In like manner, CEOs should invite one or more buy-side analysts to participate on all investor calls and have them ask questions. In the end, the aim of the directors and management will be the same: to create value for the long term.

Boards of private equity companies gather information because their livelihood depends on it. Public companies should act that way, too. Buffett says, “Of the twenty public boards I’ve been on, only one, Data Documents, started as a private company. We went public, but when it was private, that’s the best board I’ve ever been on. We held meetings at my house for a while, and we would go till three in the morning. And we wouldn’t be doing one damn thing that would be required by the government or the New York Stock Exchange.”

In our experience, activists can help you spot reasons for poor performance and vulnerability to takeovers. These investors are generally pretty smart and do very good analytical work. They start with the assumption that the company has underperformed relative to its peers. Then they look for reasons why this might be so. Is it due to poor management? Does the company have a portfolio that is overly complex and difficult to manage? Or does it have an underleveraged balance sheet?

Those factors divide analysts into P&L activists and balance sheet activists. The balance sheet activists will tell you to buy shares and pay a dividend and do it quickly. The others will point to the places you’re underperforming because your costs are too high or your products are commodities or you need to simplify your portfolio. The implication is that if your management isn’t capable of making the adjustment, then your stock will continue to languish. So boards must be almost ruthless in probing whether management is creating value for the long term. If not, they must take action before the activists come in.

We also like companies that look beyond management for ideas on how to develop skills needed for the future. Michele Hooper of the Directors’ Council brings in a nominating advisory committee made up of outside investors and a clinician to help generate ideas for the skills matrix at UnitedHealth Group, on whose board she sits. She says, “We’re an insurance company and a health-care company, and we talk about our long-term direction and the experience and skills we think we’re going to need. And then we ask them for their input. Do you think we need to tweak it?”

Some people question why she would do something as scary as talk to her investors in that level of detail. Her experience is that the openness has yielded great insights and robust discussions about where the company is going. Other companies are going even further and are beginning to develop their own in-house universities. They are working with educational institutions to develop programs and curricula that will help give their entry-level workforce the sort of experiences that will be useful in the long term.

Outsiders can also help you see when your company is going astray. Among the first places we look to spot a breakdown in strategy or execution are analyst reports and board meetings with big investors. The board of one company we know—number three in its field—meets with investors every year, and management discusses its execution record for the period. Stating the specifics—the dollar amount invested in health care, say, or the number of positions eliminated in a stagnant division, or the percentage increase in cash flow—tells investors that the company does what it says it will do. But to get a good assessment of execution, the board should also hire an independent company to conduct meetings with customers. The objective would be to generate a net promoter score, a measure that is a proxy for the willingness of customers to recommend the company’s products and that ranks the company against the competition.

The board can then see if the company has been improving or declining over time. The results will help you tell whether management is giving you the real reasons for the company’s performance or is just making excuses. Beware if you hear management say, “We’re doing all we can.” Or “I’ve assigned the VP to do this.” Or “this is a one-off mistake.” Or “my regional manager died and we didn’t replace him for two months.” Or “it was an accounting mishap in China.”

Having plenty of information to sift is one thing. How to make sense of it? Analysts and activists can help here, too. Sometimes it’s not one big thing that spells trouble, but a lot of little things that begin to show a pattern. Former CA Technologies CEO and IBM executive Bill McCracken points out that with GE, no big red flag went up all of a sudden but rather a series of yellow flags over quite some time. He says, “Boards need to ask themselves a question: how many yellow flags make a red flag?”

At GE, the warning signs were there to see in the form of analyst reports that raised questions about revenue recognition and accounting principles and write-downs over a five-year period. McCracken says, “How many insurance companies exited the long-term-care insurance business before GE even declared that they had a big write-down coming at them?”

An example of a sharp outside perspective on GE’s problems arrived in 2015, two years before Jeffrey Immelt stepped down as GE’s CEO. Trian Partners issued an eighty-page white paper exemplifying how activists pull out facts in a way that managements and boards could, but typically don’t—digging into the business, analyzing the numbers in depth against the competition, and arranging facts differently.

Among its findings: results at GE Capital completely offset the strong earnings growth of the industrial side of the business. The reason was GE Capital’s very high capital intensity—a balance sheet item expressing the ratio of assets to sales. Management should consider capital intensity alongside gross margins—a profit and loss item. But Immelt never ran a balance sheet. GE totally missed that part of the equation. Getting rid of GE Capital did not free up capital to return to the shareholders. GE also overpaid for acquisitions. As a consequence, GE’s ten-year compound annual growth rate was only 1 percent, and its total shareholder return over the period was only 10 percent—dead last among its peers. Gross margins were declining, too. Trian’s conclusion: the reduced earnings per share and intensive use of capital caused GE’s share value to decline by $11.20, or 45 percent.

If management has not already provided the board with the information necessary for this sort of analysis, the board must raise the issue in executive session and demand it—every detail of corporate performance versus the competition over time, in revenues, in margins, in EBITDA, benchmarked against the best and worst in the industry. If the company isn’t able to provide that data, the board must seek it elsewhere. Otherwise, McCracken concludes, “That’s where shareholders get very disturbed when they look back in the bright light of inspection. You say, ‘Jeez, how did you miss that?’”

We believe that if the board takes the initiative to gather outside information for analysis and recommendations, the behavior of managers will change. They will think more broadly too, oriented toward the future. And when they assimilate a wider view, the need for outside checks should diminish. That modus operandi is how private equity works: the deal person always digs deep into the data on which the success of the business model depends. Public companies should do more to be as good as private equity in ferreting out and consuming information, aiming toward long-term results.

Wendy’s is an example of how bringing in an outside viewpoint can help a company turn around and reorient toward long-term value. Around the time of the 2008 financial crisis, Wendy’s got in trouble because it was trying to make quarterly numbers. And it did so by cutting the quality of its food, using cheaper buns, cheaper cuts of beef, cheaper condiments. It neglected its stores as well, forgoing upgrades.

Trian Partners had a 20 percent share in Wendy’s at the time and helped engineer a turnaround. Ed Garden of Trian recalls, “We went in there and said, ‘Stop the madness. We’re going back to basics.’” Wendy’s then improved the ingredients of the burgers and the condiments and began renovating the stores, putting in flat screens and Wi-Fiand fireplaces.

Trian’s involvement, and the size of its stake, helped the company deal with shareholders. As Garden puts it, “We gave management cover to stop worrying about the next quarter and start worrying about 2025.” Indeed, the stock was stagnant from 2009 to 2012. The shareholders said, “We don’t care about the improvements; the stock hasn’t moved.” Garden responded, “We believe the stock will move as we build the business.” The shareholders would make five times their money.

To us, it’s a prime example of how a long-term private equity mindset can help companies in the public realm. Smart companies will emulate them. Shelly Lazarus, former CEO of Ogilvy & Mather, likes to talk to analysts and investors without management present. She found that the matters on which they focused were different from the ones that would arise if she were meeting with only her fellow directors, so for her, the encounters were eye-opening. She says, “I’ve become a huge advocate of listening to investors and shareholders, which I don’t think is part of the best practice for boards even today.”

But even if they have no position in the company, activist investors are worth talking to because they can give the board a good take on the company’s strategy versus the behavior of the broader marketplace. State Street’s Ron O’Hanley speaks vividly of a conference in which he asked the attendees to imagine that he was an activist investor and that they were on the board of Pfizer. “I come in and I say to you, would you like my opinion as to how your strategy stacks up against that of Eli Lilly?” recalls O’Hanley. “You can see that the CEOs in the room had a look of sheer horror on their faces. But the board members all sat up straighter, thinking, oh, that would be great.” The lesson: outsiders who make managers a little bit nervous can help directors generate novel strategic options.

How Directors Can Take the Lead

Getting your hands on the information you need involves more than commissioning reports and inviting outsiders to address the board. To be a good director, and to get up to speed, you have to invest your personal time in addition to the time you spend at board meetings. Good CEOs will invite their boards to customer events, exhibitions, and dinners where directors can see their company’s products, mingle with their workforce and clientele, and hear how both groups view the company; the same holds true for annual investor events.

Directors must take advantage of such opportunities. They will gain multiple insights into the company from different perspectives—from investors, customers, external advisers, experts. Far from simple socializing, in those settings you will see the company’s position in the competitive landscape, along with the trends that will affect the industry in the years ahead.

Directors should also be ready to broaden their scope beyond the customary ways of analyzing company operations. For instance, in reviewing performance data, they should seek out more than the standard metrics of market share, margins, and profitability. In order to assess performance related to talent, Lady Lynn Forester de Rothschild, CEO of E.L. Rothschild and cofounder of Inclusive Capital Partners, has focused on employee retention levels versus her company’s peers. She says, “These are hard-to-get comparables, but we do ask that from our managers to show us how we keep people.” Great CEOs now also measure diversity in the lower ranks.

In our view, the job of directors is to make sure that such input doesn’t come only through management’s filter. In this regard and others, the Directors’ Council’s Michele Hooper is unparalleled as a director, both dedicated and meticulous. She doesn’t just read reports; she observes, collects information over time, and gets the touch and feel of the companies where she’s a director.

Hooper explains that in the normal course of events, directors will hear from the CEO and the management team about their vision of the industry and where the company is going. She says, “To me, that’s one data set, and it’s not sufficient. As a board member, I’ll call it the starting point. And that’s why you have to go out and do your own homework.”

So instead of relying on management, Hooper goes to conferences on her own, where she can learn about new directions in, say, technology and big data and disruptive competitors—issues that directors from many companies are dealing with. While she’s on the road, she will talk to these colleagues to get a sense of new research she might wish to understand.

Hooper is unusual in the initiative she brings to her boards. She says, “I view my board work as a profession. My job isn’t simply to get the board books and talk to the person in the company who’s dealing with issue X. I also view it as my responsibility to do my own competitor analysis.” All directors might wish to adopt her approach to the job as they seek to create value for the long term.

CHECKLIST FOR DIVERSIFYING INFORMATION

• Tap external experts to help you assess management’s explanation of performance.
• Obtain news, planned initiatives, and internal analysis of the competition to help you assess company strategy.
• Resist management information dumps; have them send you brief updates every month.
• Benchmark your customer satisfaction against your competitors’ performance to gauge management’s explanation for performance.
• Demand that management provide you with every detail of corporate performance versus the competition over time. Compare with analyst reports.
• Meet with analysts and investors without management in the room.
• Take advantage of opportunities to meet with your company’s workforce and clientele.
• Focus on metrics like employee retention versus the competition as well as standard metrics of market share, margins, and profitability.
• Go to conferences on your own and talk to fellow directors there to get a sense of new research you might want to tap into.