Importance of a lead director in times of economic uncertainty

Importance of a lead director in times of economic uncertainty
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First Published: Thu, Aug 13 2009. 09 20 PM IST

Updated: Thu, Aug 13 2009. 09 20 PM IST
For several decades,directors of an organization tended to have a clubby relationship with each other—rarely focusing too much on the mundane details of governance, but managing the future of their company. In practice, several of these discussions took place on a golf course or in a club, and there was room to step back and examine the challenges and opportunities facing their business.
Cut to 2009, and the board agenda has become dominated by more dreary elements of governance. Boards and audit committees have to check boxes four to eight times a year, often at meetings crammed into a few hours. This change, caused largely by the big-ticket scandals of the past few years, has come at a price.
Boards now have less time to dedicate to two key elements of their business—the development of strategy and the examination of risk. The absence of involvement in these areas was amply in evidence when distinguished boards were caught on the wrong foot by the financial crisis.
From Satyam Computer Services Ltd to Chrysler Llc., companies are slowly recognizing that not all directors are strategically minded, and that providing dispersed responsibility for the same does not address this critical issue. What is required instead is a lead director who would take responsibility for strategy on their behalf.
This is important for two reasons. First, it focuses responsibility in one individual who has the credibility and independence of being on the board while being distanced from daily operations. Second, it also provides some semblance of a sounding board for the views of the chief executive officer (CEO).
As directors will know, the dynamic of a board meeting is one of information asymmetry, where the CEO, chief financial officer (CFO) and their colleagues have had several days to prepare their case and the board usually has little information to challenge these views—even if it intuitively doubts the strategy being presented.
However, nothing is served by boards frequently second-guessing the executive management and preventing timely action. This can be avoided in large measure if at least one person other than the CEO has some level of involvement in strategy. This could be the lead director, who could play many roles.
First, as strategy work is a continuous and iterative effort, only an engaged lead director can nudge managements to take decisions and explain their rationale to fellow board members. CEOs would normally welcome such an involvement, as few major business choices are black or white, and the support of a fellow director who has had the opportunity to assess all the options and comprehend the logic of the business can be invaluable.
Some of my colleagues enquire how such an arrangement would actually work. Ideally, the strategy team of the company could spend one-two days a quarter with the lead director and be available for him to work with. This would enable the director to ensure that in addition to financial information, data about the external environment, competition, benchmarking and risk are shared with him regularly.
It is also worth noting that questions about a company’s strategy are usually seen to be the ones most loaded with intent. Questions in this sphere of management can appear to be an implicit criticism of the company’s leadership. However, queries by someone whose full-time role is to be engaged in strategy and who can understand the motivations of management tend to be viewed in a more favourable light.
Some CEOs may worry that a lead director might constrain their ability to function with independence. In practice, most CEOs welcome such involvement. The National Association of Corporate Directors (NACD) in the US found in a survey that while CEOs believe involvement in strategy formulation was the second most important task of the board, they actually felt that it was 11th highest on the actual time spent by directors.
Another area where a lead director can add value relates to investment approvals. The most sensitive and frequent areas where boards need to apply thought relate to spending the company’s money. Every investment approval they give is an implicit thumbs up for pursuing a certain pre-agreed strategy. Yet, the multiplicity of diverse investment requests sought by management over time can often lead to confusion among directors whether later investments are really aligned to a strategy agreed to in the past.
The lead director can provide a semblance of continuity and consistency to the multiple investment requests the board gets and enable optimal resource allocation.
Critically, in times of crisis and when faced with very complex executive choices, even good CEOs need the reassurance of senior colleagues who have faced such situations. In such situations, the lead director can act as a liaison between the CEO and the board. That a particular course of action has the buy in of the lead strategy director is in itself a major mechanism for unifying thought in the company and can be a source of confidence for the CEO.
In addition to being the conduit between the CFO and the board on issues of strategy, the lead director should guide shareholders in the right composition of the board to make it more effective and also assist in setting up the agenda for the board and independent directors’ meetings.
The special commission of NACD has recommended a lead director where the roles of the chairman and CEO are not separated. It is sometimes desirable to anyway have a lead director, even if such separation exists. This is particularly relevant because the choice of a chairman may be driven by facts such as the stature of an individual, acceptability to multiple shareholders, etc., and need not necessarily be the director best equipped in terms of time or skills to play such a role.
Nearly 75% of the boards in the US seem to have a lead director, according to a study conducted by Heidrick and Struggles along with the Marshall School of Business, University of Southern California. This trend does not seem to have caught on in India.
Given the very fluid nature of business in a growing economy and faced with changes in markets and regulation, CEOs often have to shift gears and transition from the operational to the strategic. In particular, in times of change, as we see today, when the CEO’s strategic inputs are needed the most, he is usually on the front line with his troops.
In such situations, an additional experienced resource that can provide strategic backup can prove essential. One hopes, therefore, that more and more boards will recognize the tremendous value from having one of their own take over this role.
Govind Sankaranarayanan is CFO, Tata Capital Ltd. He writes on issues related to governance. The views expressed here are personal. Write to him at ruleofthumb@livemint.com
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First Published: Thu, Aug 13 2009. 09 20 PM IST