Candour, clear expectations key for boards avoiding dysfunction…and scandal

How to avoid poor, and maybe fatal, biz decisions.

 

Scandals emerge when management acts illegally or unethically. Just look at companies like Wal-Mart, Barclays, HSBC or SNC Lavalin. The board of directors has a role to control and monitor management and take the reasonable steps to ensure compliance. When scandals happen, people look to the board as to whether it properly monitored management.

But the board also has a secondary role, and that is a strategic or advisory one, which includes taking steps to ensure corporate performance and value creation. This second role is often marginalized at the expense of the monitoring one.

I am currently conducting interviews with top-rated activist investors, private equity leaders, hedge funds, traditional investment firm, directors and CEOs on building a high performance board that is less compliance-oriented and more value-creation oriented. One theme emerging is that many public company boards are too compliance focused, with directors and chairs not selected on value creation track record, mindset, results, performance, and holding management to account.

See my slides that I am presented at an Institute for Corporate Directors event.

When I say “holding management to account,” it is important to examine the relationship between the board and management. What exactly are the board’s expectations from management? What about management’s expectations of the board? It’s vital to define these expectations. When I recently trained a group of directors and CEOs from the banking and agricultural sectors in Texas and Arizona, this topic was a focal point of discussion.

What follows is a guide for avoiding dysfunction between the board and management to avoid poor, and maybe fatal, business decisions, but more importantly to set the stage for mutual benefit, respect and value creation. It is important to see the board-management relationship as a two-way street. It’s vital to define both sets of expectations.

What a board expects from management

1. No surprises or spin

There should be no surprises for a board. CEOs and senior management need to tell the board the true state of affairs in their company, without any spin. Directors know when they are not getting the “real deal” from management. If the CEO manages the board, or holds cards too close to the vest, this will be a problem.

2. Bad news must reach the board ASAP

The board needs to be the first to know of problems when they arise. Management needs to have systems, processes and incentives within the organization that promote full transparency and reporting, right up to the board and its committees. The board needs to be assured of this. Here are some high-profile examples in which boards weren’t immediately made aware of internal problems: Wal-Mart (bribery), SNC Lavalin (bribery), JPMorgan (derivative risk-taking), Barclays (Libor scandal) and News of the World (phone hacking).

3. Deep expertise in the business

The board wants to see expertise across the full management bench, with no gaps. A problem arises when the board sees a weakness which the CEO does not agree with. Some CEOs have had trouble dealing with boards opining on C-level positions and oversight functions (e.g. internal audits). If a CEO does not accede to the board’s preference, this will be a problem.

4. Visibility of management thinking

The board should see proposed strategic options from management, including which ones were rejected and why. Management’s thinking and assumptions need to be fully transparent to the board, in writing, and open to critique. A red flag occurs when management’s thinking is not visible.

5. Full access to information

Information has five dimensions: quality, quantity, source, format and timeliness. There should be no information funneling or blockage to any dimension. To do its job, the board is entitled to any piece of information or access to any personnel. Management should support full information flow, including to information that does not support management’s positions.

What management expects from the board

1. Candor

Directors need to be candid and speak their mind in board meetings, not have hidden agendas, nor speak inconsistently outside of meetings. If directors are inconsistent, it can cause a schism in board-management relations and trust. The board should speak with one voice and not send mixed messages to management. Directors who undermine fellow directors or management without being direct have been described as sneaky, manipulative or lacking integrity.

2. Integrity and independence

Directors cannot act in self-interest, nor use their position to self-deal. If a director becomes beholden to management, this will undermine management-board relations. Management is entitled to directors preserving their independence and not placing management in compromising positions. I’ve spoken with directors whose independence is compromised by taking consulting contracts with the company, vacations with senior management, jobs for family members or friends, and social relations.

3. Direction

A good, smart CEO wants a strong board. A board of directors should direct management, in order to prevent the CEO from making that one big mistake. The board should be in charge at all times and management should know this.

4. Reacting in a measured way

If management is to be transparent, the board needs to react appropriately. If there are leaks, or the board is constantly critical, the CEO will not bring his or her real thinking to the board. This tone will cascade to senior management. This could cause governance failure as the board is shut out.

5. Trust and confidence

Management gets demoralized when they feel the board lacks trust or confidence in them. If a board does not have trust or confidence in its CEO, it has the wrong CEO. But if only a small minority of directors feel this way and cause dysfunction as a result, then these directors need to go.

6. Knowledge of the Business

Management expects directors to invest the time to understand the business fully, especially if they are not from the sector. Otherwise, these directors will be of limited strategic use to management and their opinions will not be taken seriously. Prior to Bill Ackman’s involvement in Canadian Pacific, for example, not a single independent director had rail experience. Likewise, not a single independent director of the JPMorgan board had banking experience prior to the derivative failure. Management gets frustrated by dated, legacy directors who have outlived their usefulness. Boards should know when this happens.

7. Meeting preparation

Management expects each director to arrive fully briefed and ready to discuss the matters at hand. Otherwise, the engagement level degrades and gets sidetracked. The chair of the board should set these expectations and lead by example.

8. Asking good questions

Lastly, management knows that the best directors ask compelling questions that cause them to really think. If directors have a hobbyhorse, or ask inane questions in the eyes of others around the board table, their credibility will suffer. These directors should be removed from the board.

Richard Leblanc is a lawyer, corporate governance academic, speaker and independent advisor to leading Canadian and international boards of directors. He can be reached at rwleblanc@gmail.com.

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