The demise (I hope) of the “blue-chip” director

The ‘best’ directors often fail.

 

Would you let an amateur perform dental work on your children? Or would you pay anyone besides a mechanic to fix your car’s engine? Of course not.

And yet in corporate governance, boards are often filled with inexperienced directors. Take JPMorgan, for example. Last year, the bank reported losses of $2 billion resulting from risky derivative transactions. (The actual figure is projected to be much higher.) The company’s risk committee was roundly criticized in the aftermath. The chair of the three-person committee, James Crown, was the only member with Wall Street experience, but hadn’t worked in the industry for more than 25 years, according to Bloomberg.

This isn’t a rare case, either. Many boards look great on paper. They’re often populated with so-called “blue-chip” directors: former politicians, ambassadors, CEOs, presidents, consultants, lawyers, academics and so on. But as with JPMorgan, several companies’ boards are filled with ill-equipped directors who possess only a vague understanding of their company.

The problem is that requirements for being a public company director are astonishingly minimal. In several countries, you do not have to understand the business or industry in order to sit on a company’s board, while in Canada, a director does not even have to be financially literate (at least initially) to sit on the audit committee of a public company. And yet we expect these directors as fiduciaries to oversee shareholder investments and the company’s best interests.

Some progress, however, has been made. In a study I was asked to conduct, I recommended to the Office of the Superintendent of Financial Institutions that boards of financial institutions should have directors with industry and risk expertise. This is now the law in Canada, but it took until 2013 to pass. The Securities and Exchange Commission in 2009 (after the financial crisis) enacted a law that directors had to be selected on the basis of qualifications, skills and competencies.

Still, there’s work to be done. There’s still grey area in these requirements—much more so in SEC guidelines—over what “expertise” actually means. When I speak with activist investors, they continue to express their frustrations over the experience of certain directors.

Thankfully, activist investors and the media are now scrutinizing the background and expertise of board members. This is a welcome development. There needs to be a fundamental change to how directors are selected and how shareholders are able to remove directors without the appropriate background or experience.

The three most important attributes for a director are knowledge of the business, financial acumen and backbone. Most directors are not selected from these criteria. But if directors don’t fulfill these requirements, they sit in meetings without any ability to meaningfully contribute. Most of the time, they are silent, pretending to understand the issue at hand. In other words, they’re taking up a valuable spot.

Compare this ill-equipped director with someone selected properly, based on mindset, experience and strategic track record. These directors are a pleasure to see. Management has to bring their A-game for these directors. They continually ask good questions and share opinions based on applicable experience. These directors hold management accountable and have the heft to do so. They tell management how to perform better and how to recognize opportunities to find value. There is no ambiguity in these boardrooms over who is in charge. Management is accountable to the board and the board to shareholders.

Sadly, this ideal director is in the minority.

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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