Primer on boards of directors

Do you know what the board is doing? Does the board know what you are doing?

Peter Kissinger
The decade just ended has been particularly unsettling withrespect to underperforming company boards. Why has this happened? I'm not sure,but let me start with the definition of a business and the roles of variousstakeholders. 
 
 
Businesses and their shareholders are rewarded for servingcustomers at a selling price the customer values above the cost the businessincurred. Accountability for achieving this is fairly simple when the businessmanagers are owners. When the owners are remote, away from operations and oftenrather passive, it quickly becomes more complicated.
 
Theoretically, a board of directors represents the fiduciaryinterests of the owner shareholders, holds management accountable, considerssuccession and provides wisdom for matters ranging from compensation to mergersand, of course, strategy. But like for a Democratic legislature, the shareholdervoters are rarely perfectly represented. This is perceived more when things gobadly, but as we have seen, things may only appear to be going well. 
 
Shareholder dissent of the "tea party" sort is not uncommon.The chance for input is rare and the opportunity to vote is rarer still. Infact, companies put up defenses to shareholder action that are costly toovercome. While these defenses seem appropriate to thwart unfriendly advances,they are just as inhibitory to long-term owners. 
 
 
Lately, boards have been put under additional stress fromrules that add liability and cost, but contribute nothing to good governance,which requires strong values, not rules. In the life science arena, there canbe additional ethical challenges with respect to clinical trials andcommunicating adverse events.
 
 
What do they know and when do they know it?
 
 
What is the source of all this angst? For one, board membersoften don't have time to serve on boards. Likewise, busy executives don't havetime to fully engage and inform their own board. Quarterly board meetings comeup quickly in the face of day-to-day operating challenges. This is especiallytrue for small public companies without staff to assist with boardrelations. 
 
When times are good, board meetings can be collegial andcongenial affairs. As I've already stressed, the times may only appear to begood. Boards often receive data from the CEO/CFO without questioning itsveracity. Enron and Tyco fell into this category and directors used the excuseof hearing nothing and seeing nothing as the reason for doing nothing. Perhapsthey were looking for nothing. Auditors, in principle, solve this problem forboth board members and shareholders, but auditors work with the informationthey are given and not with what is left out.  
 
 Risk management
 
A board is about making decisions and thus is about managingrisk. A challenge I've faced with several companies is a "transactionorientation" whereby management and dominant board members are so compelled tocomplete a transaction that they can't hear contrary voices. Rationallyconsidering these voices is not easy when testosterone flows. 
 
 
I like this quote from Harvard economics professor DavidLaibson: "There's a fundamental tension, in humans and other animals, betweenseizing available rewards in the present and being patient for rewards in thefuture. Now we want chocolate, cigarettes and a trashy movie. In the future, wewant to eat fruit, to quit smoking and to watch Bergman films." The other sideof this is the long-held notion that what can enhance company value in theshort term can hurt it in the long term, and vice versa.
 
Finally, more firms die from indigestion than starvation.I've been caught by these failings several times. It is only because I've beencaught that I now have the time to write this column while working toward mynext big assignment. Considering the "stop signs" in the face of not wanting toannounce "the deal is off" is an assignment I'm learning from experience as anarrogant person who got ahead of his own ability. Ski too fast, and you get thesame result.
 
 
Why serve?
 
I've served on boards for companies and nonprofitorganizations, all of them on the small side. In every one of these cases, itwas difficult to find directors who were competent to contribute andwilling/able to give enough time in return for compensation that ranged fromnonexistent to pitiful.
 
 
These days, active industry executives have time demandsthat make board service for other firms hard to justify. Recently retiredexecutives can productively serve in this role, but in many cases have takenthe assignment too lightly. Many serve on boards to give something back. Othersserve to learn something, network with top people and stay sharp from theanalytics. In life sciences and other knowledge-based firms, directors are mostlikely to learn new science/medicine that can benefit patients. That does drivemany of us.
 
 
Who should serve?
 
 
For public companies, there are special qualificationsrequired for the audit committee that are very important to the Securities andExchange Commission (SEC) and various stock exchanges. Beyond that, I've alwaysfelt that a board should largely be of outside experts given that insiders areavailable to the company day in and day out. 
 
This can be a very good way to attract talented minds to asmall company that would be totally unaffordable at early stages ofdevelopment. Many entrepreneurs like to stack the board with family and friendsthey are comfortable with. I've done this several times, and learned it is amistake. It is better (but not easy) to have board members who challenge theassumptions of company officers. Once they've gotten failure behind themseveral times, serial entrepreneurs understand the importance of this fact and thevalue that true experts can bring to a business. 
 
 
Who appointed who?
 
 
In principle, a board represents the interests ofshareholders and selects the management team. For most small companies, theboard is founded by the very same management team. Thus, there is an ambiguitywhere honest governance becomes uncomfortable and difficult. 
 
 
The board that ratifies the selection of the CEO and CFO orthe director of a museum will say, "They're our choices. It wouldn't be rightto doubt them by meeting with other operating managers or visiting disparatefacilities in order to get a feel for operations."
 
I've been in positions as an executive and director. It canindeed be uncomfortable to have board members snooping about a company or thenonprofit you are running. Control freaks and imperial CEOs find this mostunsettling. On the other hand, a confident leader should welcome and encourageexactly this activity. This is how directors add maximum value. Theirexperienced eyes can see things in new ways and allow for debate.
 
I believe employees also have a responsibility. They shouldreach out to boards. Enlightened companies provide a mechanism to do so and forpublic companies it is required. Yes, the concept of a "whistleblower" isunpleasant, but transparency is the best way for a board to not need one.
 
Directors as owners
 
 
Should board members also be obligated to be owners so theyact in the interests of owners? This sounds promising at first, but in manycases, executives and directors have made short-term decisions that advancetheir ownership stake while destroying value for the longer term. 
 
We've all read, for example, of backdating stock options andincentivizing with stock value that motivates the wrong decisions for the longterm to enhance value in the short term. Values are values and they are notabout shareholder value. You've got values or you don't. Good people do theirhomework, listen to alternatives and make good decisions regardless of economicreward.
 
 
Board size, operations knowledge and meeting frequency
 
 
Boards can be too large. Meetings can be too long and tooinfrequent when shorter and more frequent is better, especially for startups.At very least, directors should be active communicators between meetings andshould get to know more than a handful of top executives. Directors should beencouraged to visit operations, visit with key customers and attend theoccasional industry trade show.
 
 
I realize this can be tough when time and resources arelimited. It should be clear that understanding your trustee role makes it morefun and adds a great deal to your value. Most who know this turn down requests to serve, because they only wishto serve well. 
There is no perfectsolution, but employees and shareholders should pay attention to the board andnot be a stranger. 
 
 
A board perceived by you to be too aloof may well be oneyou've never approached. Have you attended an annual meeting? Have you toured acompany you partly own? Do you know that boards of public companies are obligatedto make it very clear how you, as an owner, can provide input?
 
 
Conclusion
 
 
My experience is with small firms and small nonprofitagencies, but there is plenty of trouble at large firms at well, wheredirectors receive lucrative fees. A recent provocative book suggests this ismoney for nothing. If you work for or lead a large company, you will enjoyreading Money for Nothing: How the Failure of Corporate Boards is RuiningAmerican Business and Costing Us Trillions,by John Gillespie and David Zweig. I'm glad to see the matter gettingattention. Let's hope boards will get to work and avoid window dressingdirectors who retired from politics, athletics or Hollywood. A sweeper from anOlympic curling team may be just what is needed when the bull droppings get toodeep. An engaged board can be very helpful to employees and shareholders alike,but the assignment is part-time, and that limitation must be kept in mind.                
 
 
Peter T. Kissinger is chairman emeritus of BASi, CEO ofProsolia in Indianapolis and a professor of chemistry at Purdue University.
 

Peter Kissinger

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