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Primer on boards of directors
April 2010
by Peter T. Kissinger  | 
SHARING OPTIONS:

The decade just ended has been particularly unsettling with respect 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 various stakeholders.   
 
Businesses and their shareholders are rewarded for serving customers at a selling price the customer values above the cost the business incurred. Accountability for achieving this is fairly simple when the business managers are owners. When the owners are remote, away from operations and often rather passive, it quickly becomes more complicated.   Theoretically, a board of directors represents the fiduciary interests of the owner shareholders, holds management accountable, considers succession and provides wisdom for matters ranging from compensation to mergers and, of course, strategy. But like for a Democratic legislature, the shareholder voters are rarely perfectly represented. This is perceived more when things go badly, 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. In fact, companies put up defenses to shareholder action that are costly to overcome. 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 from rules that add liability and cost, but contribute nothing to good governance, which requires strong values, not rules. In the life science arena, there can be additional ethical challenges with respect to clinical trials and communicating adverse events.  
 
What do they know and when do they know it?  
 
What is the source of all this angst? For one, board members often don't have time to serve on boards. Likewise, busy executives don't have time to fully engage and inform their own board. Quarterly board meetings come up quickly in the face of day-to-day operating challenges. This is especially true for small public companies without staff to assist with board relations.    When times are good, board meetings can be collegial and congenial affairs. As I've already stressed, the times may only appear to be good. Boards often receive data from the CEO/CFO without questioning its veracity. Enron and Tyco fell into this category and directors used the excuse of hearing nothing and seeing nothing as the reason for doing nothing. Perhaps they were looking for nothing. Auditors, in principle, solve this problem for both board members and shareholders, but auditors work with the information they are given and not with what is left out.   
 
 Risk management
 
A board is about making decisions and thus is about managing risk. A challenge I've faced with several companies is a "transaction orientation" whereby management and dominant board members are so compelled to complete a transaction that they can't hear contrary voices. Rationally considering these voices is not easy when testosterone flows.   
 
I like this quote from Harvard economics professor David Laibson: "There's a fundamental tension, in humans and other animals, between seizing available rewards in the present and being patient for rewards in the future. Now we want chocolate, cigarettes and a trashy movie. In the future, we want to eat fruit, to quit smoking and to watch Bergman films." The other side of this is the long-held notion that what can enhance company value in the short 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 been caught that I now have the time to write this column while working toward my next big assignment. Considering the "stop signs" in the face of not wanting to announce "the deal is off" is an assignment I'm learning from experience as an arrogant person who got ahead of his own ability. Ski too fast, and you get the same result.  
 
Why serve?
 
I've served on boards for companies and nonprofit organizations, all of them on the small side. In every one of these cases, it was difficult to find directors who were competent to contribute and willing/able to give enough time in return for compensation that ranged from nonexistent to pitiful.  
 
These days, active industry executives have time demands that make board service for other firms hard to justify. Recently retired executives can productively serve in this role, but in many cases have taken the assignment too lightly. Many serve on boards to give something back. Others serve to learn something, network with top people and stay sharp from the analytics. In life sciences and other knowledge-based firms, directors are most likely to learn new science/medicine that can benefit patients. That does drive many of us.  
 
Who should serve?  
 
For public companies, there are special qualifications required for the audit committee that are very important to the Securities and Exchange Commission (SEC) and various stock exchanges. Beyond that, I've always felt that a board should largely be of outside experts given that insiders are available to the company day in and day out. 
 
This can be a very good way to attract talented minds to a small company that would be totally unaffordable at early stages of development. Many entrepreneurs like to stack the board with family and friends they are comfortable with. I've done this several times, and learned it is a mistake. It is better (but not easy) to have board members who challenge the assumptions of company officers. Once they've gotten failure behind them several times, serial entrepreneurs understand the importance of this fact and the value that true experts can bring to a business.   
 
Who appointed who?  
 
In principle, a board represents the interests of shareholders and selects the management team. For most small companies, the board is founded by the very same management team. Thus, there is an ambiguity where honest governance becomes uncomfortable and difficult.   
 
The board that ratifies the selection of the CEO and CFO or the director of a museum will say, "They're our choices. It wouldn't be right to doubt them by meeting with other operating managers or visiting disparate facilities in order to get a feel for operations."
 
I've been in positions as an executive and director. It can indeed be uncomfortable to have board members snooping about a company or the nonprofit you are running. Control freaks and imperial CEOs find this most unsettling. On the other hand, a confident leader should welcome and encourage exactly this activity. This is how directors add maximum value. Their experienced eyes can see things in new ways and allow for debate.   I believe employees also have a responsibility. They should reach out to boards. Enlightened companies provide a mechanism to do so and for public companies it is required. Yes, the concept of a "whistleblower" is unpleasant, 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 they act in the interests of owners? This sounds promising at first, but in many cases, executives and directors have made short-term decisions that advance their ownership stake while destroying value for the longer term. 
 
We've all read, for example, of backdating stock options and incentivizing with stock value that motivates the wrong decisions for the long term to enhance value in the short term. Values are values and they are not about shareholder value. You've got values or you don't. Good people do their homework, listen to alternatives and make good decisions regardless of economic reward.  
 
Board size, operations knowledge and meeting frequency  
 
Boards can be too large. Meetings can be too long and too infrequent when shorter and more frequent is better, especially for startups. At very least, directors should be active communicators between meetings and should get to know more than a handful of top executives. Directors should be encouraged to visit operations, visit with key customers and attend the occasional industry trade show.  
 
I realize this can be tough when time and resources are limited. It should be clear that understanding your trustee role makes it more fun and adds a great deal to your value.  Most who know this turn down requests to serve, because they only wish to serve well. 
There is no perfect solution, but employees and shareholders should pay attention to the board and not be a stranger.   
 
A board perceived by you to be too aloof may well be one you've never approached. Have you attended an annual meeting? Have you toured a company you partly own? Do you know that boards of public companies are obligated to make it very clear how you, as an owner, can provide input?  
 
Conclusion  
 
My experience is with small firms and small nonprofit agencies, but there is plenty of trouble at large firms at well, where directors receive lucrative fees. A recent provocative book suggests this is money for nothing. If you work for or lead a large company, you will enjoy reading Money for Nothing: How the Failure of Corporate Boards is Ruining American Business and Costing Us Trillions, by John Gillespie and David Zweig. I'm glad to see the matter getting attention. Let's hope boards will get to work and avoid window dressing directors who retired from politics, athletics or Hollywood. A sweeper from an Olympic curling team may be just what is needed when the bull droppings get too deep. 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 of Prosolia in Indianapolis and a professor of chemistry at Purdue University.
 

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