Why groups of accomplished individuals often perform so disappointingly is one of the enduring problems in management science
Everyone likes to criticize boards. To quote a recent article in The Economist: “For most of their history, boards have been largely ceremonial institutions: friends of the boss who meet every few months to rubber-stamp his decisions and have a good lunch. Critics have compared directors to ‘parsley on fish’—decorative but ineffectual; or honorary colonels, ornamental in parade but fairly useless in battle."
Why groups of accomplished individuals often perform so disappointingly is one of the enduring problems in management science. Although much has been written about board effectiveness, and despite sweeping new legislation such as Sarbanes-Oxley, the fact is that real progress remains elusive. (If you ever want proof of this, I recommend reading Directors: Myth and Reality by professor Myles Mace of Harvard Business School. The issues he pointed out in 1970 remain as relevant nearly five decades later.)
In fact, it remains strikingly hard to even answer a question as simple as “Is this board effective?"; for instance Satyam Computer won the coveted Golden Peacock Award for excellence in corporate governance just a year before it became famous for one of the largest scams in corporate India. The same happened at Enron; awards for corporate governance have correctly been looked upon with scepticism since then. So how do you tell if a board is doing its job? When thinking about boards, I am reminded of Tolstoy who said, “All happy families are alike; each unhappy family is unhappy in its own way."
So recognizing that each board is uniquely different, I believe it is more important to focus on outcomes than how a board operates; “happy", effective boards are those that at the very least avoid four major pitfalls.
Pitfall 1: Failure to detect fraud early and to decisively stop it
This is the most basic and fundamental responsibility of any board. Yet, kleptocracy, fraud and compliance failures are rampant in Indian firms. By this reckoning, a lot of our boards are failing in the most basic fiduciary responsibility. It’s pointless talking about other matters if this isn’t addressed.
Pitfall 2: Failure to hold the CEO accountable for performance
This requires first an objective calibration of performance against the market and set of peer companies rather than simply a focus on hitting arbitrary internal budgets. The board should be asking discerning questions such as what is our growth, margins and return on capital compared with the best performers in our industry? What is our share of industry growth and are we, therefore, losing or gaining share? Are we creating or destroying economic value? How strongly is CEO and senior management compensation aligned with such performance metrics? Have we shown adequate or excessive patience? Such probing questioning is a test of courage for the independent directors.
Pitfall 3: Backing a bad strategy
More companies fall on their own sword rather than a competitor’s; they do this by embarking on a deeply flawed strategy or failing to embrace an industry shift. Examples are legend. Swissair, for instance, went bankrupt due to a strategic blunder. Daimler’s acquisition of Chrysler destroyed billions in shareholder value. Yahoo and HP squandered away billions. Nokia, Microsoft and Intel all failed to grasp the significance of smartphones and allowed others to wrest away leadership. Such blunders reflect not just on the CEO, but the board as well.
It is difficult for a board to set the strategy of a company. Boards often do not have the domain knowledge, the granular understanding of the industry or business or the detailed information required to generate deep insights that should shape the strategy of the firm; therefore, it remains the job of the CEO to develop and propose the strategy. But the real value of the board is the very diverse experiences and expertise that the directors bring and they should, therefore, ask probing questions, challenge assumptions and identify key risks before agreeing to endorse the strategy. A few good practices help:
1. Allocate significant time in each board meeting to go deep on a strategic aspect. Start the meeting with this rather than quarterly financial performance to ensure this is not squeezed in at the end when everyone is tired/watching the clock.
II. Develop an independent perspective on the business, its performance and competitive challenges. Demand that management brings in external information and perspectives by inviting industry analysts, consultants, or even key customers and partners to share their views. Independent directors must make the time to do “deep dives" into key issues or important parts of the business between board meetings. In these days of rapid change, there is a major risk of being inbred; boards must be receptive to new ideas and evaluate them with an open mind.
III. Encourage board members to probe by asking the right kind of questions. These are the questions that highlight huge implicit assumptions and test them. They identify critical risks and ensure management is managing these. Such questioning requires clinical reasoning and curiosity more than industry expertise. It also requires the judgement not to ask interesting, but unimportant questions. A good board member knows how to “go for the jugular and not the capillary".
IV. Have very clear a priori milestones and metrics that tell if you are making progress with the new strategy or not. How do you tell if the new strategy is really working? When is it time to change course?
Pitfall 4: Making a mess of CEO succession
The single most important decision that a board makes is hiring the right CEO. Good boards recognize that CEO succession is a process rather than an event and so they work on this continuously rather than frantically just before the incumbent departs. Boards have visibility to key internal leaders and have a reasonable assessment of their abilities. They ensure that the CEO is focused on developing and evaluating several potential successors by moving them around and giving them tough challenges. They work proactively with a search firm to map industry talent. They confront the CEO if s/he shows no interest in developing successors. When the CEO departs, there is consequently little fuss. A laboured, noisy and anxious succession is a clear sign of a board that hasn’t really focused on succession.
By simply focusing on avoiding these four pitfalls—which in effect are the four principal tasks of any board—companies can make a quantum leap in corporate governance. Equally, these pitfalls provide a quick litmus test of a board’s effectiveness. Sir Winston Churchill famously said that democracy is the worst form of government, except for all the others. Much the same criticism may apply to boards; most boards disappoint, but the world hasn’t yet found a fundamentally better way to govern public corporations. It’s time to make them more effective.
Ravi Venkatesan is a former chairman of Microsoft India and Cummins India Ltd. He serves on the boards of several public and private companies, not-for-profits, start-ups and advisory boards. He is the author of Conquering the Chaos: Win in India, Win Everywhere.