When you survey business and management publications and listen to Wall Street and other business analysts, most of the attention is focused on what the senior management team of the organization is doing to generate earnings and to build and sustain high performance. The spotlight continues to focus on CEO performance, and CEO turnover continues to rise. In fact, the average tenure of CEOs in the S&P 500 today is slightly over six and a half years. Pressure is applied with fervor by investors who still feel entitled to double-digit growth in performance.
When CEOs do not deliver, it often means a changing of the guard … sometimes within less than a year from when the last changing of the guard occurred. While one Fortune Magazine writer asserted that the majority of CEOs fail due to a lack of execution, there is more to the story than just how well the strategy is executed by the organization’s troops. And while it is legitimate to hold the CEO accountable for the organization’s performance, the CEO is not the sole captain of the accountability boat. The CEO’s partner, the board of directors, stands at the wheel as well. When you look for the foundations of performance, take the elevator all the way to the top floor and consider what happens in the boardroom.
Misalignment: Between Board And Management
When the board is fulfilling its role, it is providing proactive external leadership in a collaborative partnership with the CEO. Three of the appropriate responsibilities in which the board shares accountability with the CEO for sustaining a healthy and high performing organization include: 1) providing guidance to ensure that strategic direction is on course, 2) monitoring results of strategic initiatives and key internal performance indicators to ensure that actions pursue both short-term and long-term benefits for the organization, and 3) attending to their own mechanisms and membership in governing or guiding the organization on behalf of all owners. While these three areas are not the entire set of responsibilities for the board, they are the source of major potential misalignments. Consider the following examples of the effects of misalignment between the board and the organization.
With fiduciary responsibilities and the role of representing shareholders, boards are rightfully concerned with major capital investments and strategic decisions, and it is both common and well advised, if not mandatory, for CEOs to “test their thinking” and secure the board’s support as a partner before making those decisions. The decisions appropriate at the board level commonly include the sale of assets or plans for an acquisition that have not been previously discussed. In our discussions with directors, we are told that many directors sit on boards in which not even the executive committee members have a hint of acquisitions or moves into new markets or product lines before they are accomplished.
Why would management not discuss these plans with the board, and what results when the board is surprised by the news? Management may take the view that strategy is management’s prerogative, and they do not want the board’s input. There may have been an experience in which some board members have been rooted in the past or were risk averse when management has felt a mandate to take advantage of an opportunity or risk getting left behind in their market. When management sees the board as an obstacle to survival or interfering with the actions perceived as necessary to reaching goals for earnings and growth (and therefore, performance bonuses and options), the adage of “it’s easier to beg for forgiveness than ask for permission” is likely to become the modus operandi. Another perspective is when a board is populated with directors who have a disproportionate or naïve amount of trust in the CEO or with directors who readily defer to the management team alone in making strategic decisions. In that situation, management has no option when they have prompted the board to fill the strategic role and still get no constructive input.
What are the effects of these actions? First and foremost, the shareholders lose their representation in the high stakes decisions that affect the organization’s future. The loss of submitting strategic decision-making to vigorous challenging by the board means that when management does not bring those decisions to the board, the board has had its role usurped. When the board blindly empowers management to make high stakes strategic calls alone, the board has abdicated its role. Another by-product of management not utilizing the board as a sounding board can be the development of an adversarial relationship between the board and management and a growing mistrust of management. In that situation, it is likely that if a key decision comes under fire, the CEO and executives will not have the support of the board. There is no partner in the boat with management. Eventually, another effect of not engaging the board can be a loss of director talent. The most progressive and valuable directors report that they are willing to serve on boards for the stimulation and opportunity to make a difference. When that condition does not exist, we have known many valuable directors to leave the table.
A fourth downstream effect of the board being “asleep at the switch” can sometimes be the worst-case situations, such as the fiasco at Enron. When a company’s financial statements are so complicated that Wall Street analysts cannot interpret them, why isn’t a board challenging the statements and the direction the company is taking? Sometimes, the CEO is saying to the board, “just trust us”; when the appropriate question is not about trust but fiduciary responsibility. These effects spell misalignment, with management taking strategic actions without the awareness and/or support of the board.
Long-Term Versus Short-Term Misalignments
A key responsibility for directors is to ensure that the organization’s purpose or mission, core values and culture are preserved in order to sustain the organization’s existence for the future. In the book, Built To Last, authors Collins and Porras found that the organizations that thrived financially over time pursued both profit AND their purpose for existence with equal vigor. That requires constant vigilance in the pursuit of both long-term outcomes while not sacrificing short-term performance. Achieving both sets of outcomes simultaneously is one of the biggest tests of an organization’s leadership. With the short-term performance pressure from the Street, leaders must have the support of the board in order to invest for the long term.
Misalignments in the pursuit of meeting both the long-term and short-term goals often develop with the best of intentions. An organization is successful; it’s growing revenues, profits, market share and creating jobs. The organization is caught up in the excitement of planning and constructing new facilities. Managers usually recognize the need to deliberately perpetuate the culture and to develop the talent in order to retain the talent recruited and to build bench strength for the future. At about the same time in the life cycle of the organization and its industry, growth often slows and management’s attention turns to managing margins and achieving higher efficiencies as a means to reaching earnings targets. At a time when it is crucial to develop the infrastructure needed to perpetuate the growth, business plans often call for reducing costs as a means of maintaining margins. It requires vigilance and courage for a board to continue to support the investment in developing the leadership and professional staff when the pressure is there to defer the $200K to $400K budgeted for development for the sake of boosting short-term earnings.
When the board ignores the need or does not support the organization’s building for the long term, through development of its talent, several effects result. As the organization grows and adds to staff, it is critical to spend time and money acculturating the talent as a means of preserving, not diluting, the organization’s culture. The culture can make or break the organization’s ability to execute its strategy. Additionally the staff will need to develop leaders, and not just expect bright technical experts to automatically know how to motivate and lead others. As the Gallup organization found in its research, people are attracted to an organization because of its success and reputation, but they usually leave an organization because of poor leadership from their managers. Finally, there is a temptation to simply recruit talent to fill in gaps instead of developing homegrown leaders. It seems more expedient. The danger is that the leader comes in knowing how to deploy leadership from the last culture in which he/she succeeded, but those leadership actions may not perpetuate the values and norms needed by the distinctive culture of the new organization. Without the board’s mandate and support, the long-term effects of these unmitigated forces will be turnover, draining the organization of the intellectual capital that built it to its current level of success, and diluting the culture required to assure strategic success. Further, the word spreads through the industry about the working conditions in the organization and can dissuade other “A” players from considering employment there.
The board and organization need to be unified in order to support a leader such as Howard Schultz, the CEO so successful in building Starbucks Coffee from a local company to a worldwide company. Schultz has lived his passion and vision to build an organization around its values for respecting its employees and educating its customers and has carefully cultivated his relationships with the investment banking community. He has refused to work with professionals who did not know how to place adequate financial value on the intangibles needed to build a thriving and enduring organization. It also requires support from the board for a leader to say, as Schultz does, that he will not be pacing the floor at 4:00 AM worrying about what the Street will say about his earnings. He intends to maintain his focus on continuing to do the right things to build the company, despite dire predictions from Wall Street. His results? At the end of the last fiscal year, 9/30/01, net sales rose 22% for the year and net income rose 92%. Not bad short-term performance from an organization determined to build for the long term.
Board Governance Misalignments
A third area to examine for the effects of misalignment between the board and management is the process and mechanisms the board uses to run itself. Until the last decade, little attention was paid to governance practices. The norms that developed in how boards operate created some unintentional outcomes that were little known beyond the directors and senior managers who were directly involved. When institutional investors began to pay more attention to board practices and their effects, progressive leaders and boards began to take steps to shape practices that created better organizational outcomes. What are some of the norms that have created misalignments and less than desirable organizational results?
One practice, still not uncommon, has been for the successful retiring CEO to remain on the board as Chairman to provide continuity during the transfer of power to the new CEO. In some situations that reassures investors and other executives that experienced leadership is still available for counsel and it may prove to be effective. So what is the problem? In some instances the retired CEO remains active on the board over time, observes the new CEO recommending a strategic direction dramatically different from that which worked so well during the retired CEO’s day, and the old CEO simply cannot let go of the past. With the mantra, “It ain’t broke, so why fix or change anything?” we have observed the retired CEO create factions within the board and campaign to win other directors to his “side”, absolutely convinced that the current CEO was going to fly the organization into the mountain. When the landscape is shifting daily during periods of discontinuity, and timing is critical for moving opportunistically to survive the shift, this struggle within the board dilutes the focus of the executive team and can have devastating outcomes for the organization. It is far more effective to define a fixed transition time, if any, for the retiring CEO who will remain on the board, with retirement from the board mandatory within 12 to 18 months.
Another situation that can develop is the board that gets involved too closely with operational details. A common example is when board members know employees well and interfere with management’s responsibility to manage performance accountability. We have observed one situation in which an executive was impeded by the board from dismissing a manager who was having devastating effects on morale throughout the organization. The manager was a friend of a couple of directors who maintained that customers loved the manager, and that the business community’s backlash to dealing fairly with this manager would hurt business. In effect, the board held the executives hostage, preventing them from taking effective managerial actions. The effect was that turnover in areas in which this manager operated continued at a much higher level than elsewhere in the organization, and employees avoided dealing with this manager whenever possible, thus impeding information flow and meeting customer needs in timely ways.
A final example of how governance practices can result in misalignment between the board and what the organization needs comes from how directors are brought to the table. It is a common practice for the CEO to recruit and recommend directors for the board. It is understandable that the CEO wants someone at the table who he/she can respect and with whom it is easy to work. The problems occur downstream when a director is ineffective, the CEO is also the chair, and the director’s performance needs to be addressed. At that point, it is uncomfortable for the CEO to deal with performance issue of a friend, so the weak director is tolerated and a disproportionate workload goes to other directors to cover for the weak member. Another effect of the CEO recommending new directors is that later the directors feel beholden to the CEO for their seat at the table and can find it difficult to challenge the CEO’s thinking on critical issues when input is needed. Or, they have a difficult time managing CEO and executive compensation objectively. It would seem disloyal to say “no” or to seem to lack support for the CEO who brought them to the table. It is a far more effective practice to have a nominating or governance committee responsible for recruiting new members based on an objective set of competencies needed to support the organization’s strategic direction. Contribution and performance should be the focus instead of personal relationships.
Looking Beyond Fiduciary Responsibility
Most directors pay attention to the fiduciary responsibilities and are diligent in their efforts to represent the interests of all shareholders. Looking beyond the immediate effects to prevent misalignment effects from hurting organizational outcomes is equally important. Those misalignments commonly occur in guiding the strategic direction, managing the pursuit of both the long-term and short-term goals of the organization and attending to how the board governs the organization and itself. Performance accountability does indeed begin at the very top, with the board holding itself accountable.