Raising the Bar on the Board

The issue of raising the bar on the board is becoming increasingly critical to long-term success in an increasingly complex marketplace and environment of increased investor and governmental scrutiny. This is particularly the case with boards of many small to mid-cap businesses, not for profit boards and boards with low turnover and directors who are well past normal retirement age.

Boards have often developed a “culture of entitlement” and mutual self-protection i.e. “I’ll protect your place at the table, if you’ll protect mine.” Given the sense of threat in the current national scenario of increased liability for directors, the difficulty is that the more capable directors, and CEOs, look around the table and become concerned about the “lump under the carpet.” They discuss behind the scenes, “What do we do to “raise the bar” for directors on our board when they are our friends, and we have served together so long, on this board — and often on other boards.”

What is the evidence there is a problem? A 2002 McKinsey study of 200 directors sitting on 500 boards revealed some compelling results relevant to this issue:

  • 84 % of directors said the risk of being held personally liable as a director was very much or somewhat higher and 82% believed this threat had increased somewhat or very much in the past year.
  • Directors rate 45% of their colleagues as average to low performers; and state that as for themselves, they are willing to be evaluated. 20% consider any third party evaluation completely inappropriate.
  • Many companies have seen their D & O insurance soar 300%-700% in the past year AND the number of insurance carriers has decreased.

Search firms looking for directors, especially strong directors, report having to approach 4 to 5 times as many possible candidates to successfully complete a search. Qualified candidates are evaluating the boards and directors, asking to sit in on meetings, and sending a team of financial experts to examine the company’s accounting procedures before they agree to serve.

What is at Stake?

“What is at stake if we address the issue of raising the bar on the board?” AND “What is at stake if we don’t address it?” At stake, if a board considers addressing the issue, is usually “anxiety” about straining relationships with directors they have come to know and like personally. This can be of particular concern in a situation where most directors live and move in the same social system. Such directors anticipate a strain will affect relationships among their various businesses, other boards and even among spouses.

At stake for not addressing the issue of “raising the bar” on the board are a whole series of things that include:

  • Diminished decision-quality due to directors who don’t add value to the business and depend on the input of a few;
  • Possible loss of a good CEO, or other executive leadership, who feels handicapped by a weak board that will not develop itself to fulfill its role as a strategic partner and/or delays or avoids key decisions that put the organization at a competitive disadvantage;
  • Not being able to attract and recruit the best directors when those prospective candidates for empty seats see a board with weak practices and weak directors who perpetuate them. Such capable directors avoid the perceived liability. The McKinsey study reported that 25% of the 200 directors surveyed had turned down or quit a board seat in the past year out of concern for personal legal liability. Board recruiter Christian and Timbers reported 60% of the prospective nominees are turning down appointments. They also do not want to waste their time. The National Association of Corporate Directors reports that directors now spend 175-200 hours a year on meetings, travel and preparation per directorship, an increase of 100 hours from 1999. And boards are limiting the number of board seats their own CEO can accept in order to keep the CEO focused on their own business;
  • Missing an opportunity to show shareholders that the board leadership is willing to do what is necessary to assure effective oversight of the strategic direction and fiscal soundness of the organization;
  • The most capable directors may choose to resign from the board, given increased liabilities, if the board does not do what is required to enhance the effectiveness of its processes and the director talent;
  • Attracting attention of investor or investor groups wanting to “put someone on your board” which can seriously affect control of the board, direction of the organization, shareholder value and corporate publicity, if there is a proxy fight.

So directors face what feels like compelling reasons not to “raise the bar” AND compelling reasons to in fact “raise the bar.” The rationalizations that have worked in the past for not raising the bar comprise the “ostrich strategy” – saying things like, 1) “we will just wait and hope weak directors will retire, move or resign; 2) it won’t get any worse than it is now and it will become some other Chairman or board’s problem to deal with; 3) it isn’t really broke; and 4) someday all this hoopla about boards will be over and things will get back to normal.”

What Creates a Need to Raise the Bar?

How do boards find themselves in a situation wherein they need to take steps to raise the bar? There are some common “wake-up calls” or situations that focus attention and call for expedient action. Here are some common conditions:

  • Merger and acquisition processes that place directors from the acquired companies on the new board as a part of the condition of the purchase/sale. With a whole series of acquisitions, such as in the banking industry, boards have mushroomed in size. Perhaps more importantly, the board of the larger company becomes bloated with a lot of directors from the smaller organizations who do not understand the business of an organization many times larger, in more divergent markets and more financially complex. Such “acquired” directors are also rarely strategic thinkers or broadly exposed to the world outside of a small community or market.
  • Boards have retirement policies and term limits which they do not enforce, especially the term limit policies. Directors are automatically re-elected by what, in the past, has been laissez faire shareholders. Other boards have a practice of allowing directors to stay on the board until they die or are unable to serve and voluntarily retire from the board. When we encounter boards with Chairmen in their 80’s and 90’s (literally) as we follow their progress they have often guaranteed the opposite of the legacy they intended and the organization loses its identity. This occurs as a result of not being willing to migrate from a dying market, not preparing successors and not introducing change required to remain truly competitive.
  • As an organization grows rapidly, and expands its market locations and/or product lines, it needs more strategic thinking from its board. If the board seats are full and awaiting a retirement, there is no room to add that strategic perspective until someone retires.
  • The board needs to attract stronger directors with particular competencies that align with the corporate vision/strategy and such directors are attracted to strong, not weak boards.
  • The best CEOs we have seen are often frustrated by a weak board and weak directors. Such CEOs tell us they have raised the bar on management and now have to “kick the ball and drag the board.” These CEOs are usually very politic in how they manifest their assertiveness in challenging the board to do what it needs to do. But their frustration grows if they keep running into obstacles and do not see the board’s leadership being willing to get the board to take steps to develop itself. This puts the board at risk for losing a good CEO. Boards even rationalize, “The CEO’s happy and we pay him/her well so he/she won’t leave”.
  • The underlying social structure of the board creates norms of directors not being willing to challenge each other. This affects decision quality with key strategic decisions being dependent on the quality of thinking and perspective of a few directors.
  • A particular difficulty occurs when a key problem for the board is a large shareholder’s or Chairman’s behavior and its effects on board dynamics and decisions. We know of a Chairman who has been the direct cause of three desirable acquisitions not to occur when the acquisition candidates said “Not, as long as he is Chairman.” Does that affect shareholder value? Why do other directors and the CEO not address the issue?

So What’s a Board Leader to do?

Six key points come to mind as recommendations.

First, be proactive. Don’t wait for the problem to occur or become acute. It feels personal then and directors become resistant when they feel something is being railroaded and their seat at the table may be in jeopardy – along with the loss of face in the community and/or among professional peers. Even the strongest directors want a “fair process.” For the most part, assisting the board in dealing with these issues is not something the attorneys and accountants want to become involved with because of their own client and interpersonal relationships. Professional board consultants and coaches are the most appropriate choice to support board leaders who choose to address the issue.

Second, introducing a “fair process” over time, about 18-24 months, accomplishes the following:

  • builds understanding of the need for change,
  • builds a picture of what is at stake,
  • provides time to understand available options and strategies and implement them with consideration,
  • allows sensitivity for directors to respect each other and see that decisions made are good “business decisions,”
  • allows directors who choose to “opt out” of involvement with the board to find a way to come to peace with the matter personally and be able to communicate the thinking behind his/her decisions to family and friends in a comfortable manner.

Third, let the corporate vision/strategy be the focus of the process and shape changes that need to occur. Again, this keeps the change impersonal, future focused and focused on the needs of the organization in which directors have a personal financial stake. It also gives directors the rationale and “talking points” they need in order to explain what happens when shareholders and personal relationships inquire. Moreover, having directors rate the importance of certain director competencies in light of the strategy sets the stage for development, more focused recruitment of new directors and having directors begin to reflect on the extent of their own contributions to the board compared to what the board needs from them. A perceived gap between what directors bring to the board compared to what the board needs can create movement – often voluntary departure from the board to make room for other talent. O. J. Simpson was on the Audit Committee of Infinity Broadcasting. Maybe he could learn something there, but one would have to question his probable contribution.

Four, use a process of having the board compare itself to “best practice” benchmarks of what good boards and good directors do and what various groups are beginning to expect of a well governed organization. When a board sees a “gap” between its practices and what good boards do, it gives directors pause to evaluate, “Is that something we should be doing?” The stronger directors are likely to say, “Yes” and the weaker ones reluctantly concur. It gets key practices “on the table” for discussion. For example, boards have come face to face with independence issues they have never questioned before, such as attorneys or accountants whose firms do a lot of work for the organizations where they are on the board. The McKinsey study reported that more than a quarter of the directors believed that their “independent” colleagues are not truly independent.

Five, focus the board on board development, not board evaluation. Focusing on evaluation tends to scare people who have not been subject to evaluation in some while and now feel “above it.” The McKinsey study concluded, “At this point in their careers, directors don’t want to be evaluated.” However, the best directors do not mind. Also, it is hard to argue with development as an initiative. In fact, many directors will eagerly embrace and promote ongoing education for directors given their increased sense of exposure of late.

Six, provide a support system for directors within the fair process. Executive coaching often helps executives develop or make career decisions and has been used for years. Director coaching is an emerging frontier and requires good professional skill from an outside coach AND board support. Using an outside professional for on-on-one feedback and counseling with all directors allows those who are perceived as weaker to save face as they construct an appropriate plan for dealing with their performance issues.

The Lump Under the Carpet

Otherwise generally bright, experienced and caring directors have often become frozen in believing that they must “live with” the dynamics they experience on the board — the lumps under the carpet — that now cause sleepless nights due to possible liabilities, concerns about effects on their own businesses/livelihoods and social awkwardness. And simply forming a governance committee and studying Sarbanes-Oxley are not the answer to the challenge.

There is a fair process that board leaders can use to guide the board through a development agenda. Experience and data says that the inertia existing on most boards is such that the board must be led to do what it needs to do, not just simply put the idea to a vote without preparation as to what is at stake and orientation to a fair process. Most boards and leaders will back off from what appears to be an awkward or difficult path if they believe they have a choice and do not see a way to be successful in undertaking the challenge. They do not want to fail.

Experience also tells us that once the board gets into the process it is very grateful to the leaders for taking them there. So a key question in the end is will a board’s leaders lead – or follow – the board. The question is where will that leadership come from, the CEO, the independent Chair, a Governance committee or a strong and creditable independent director.

Well known leadership researchers provide an appropriate summary of the role of leaders who are willing to assume the mantel of creating a future legacy:

  • Challenge the process of what “has been” with a new norm focused on reflection, development and continuous improvement,
  • Bring the awareness of need and what is at stake into focus,
  • Inspire and catalyze a shared vision,
  • Mobilize the formal and informal leadership within the board to be unified in its commitment to initiate and persevere with a fair process for development,
  • Bring the necessary competencies to the board that aligns with corporate vision and strategy and enable it to act and,
  • Model the way.

Adopting and implementing a fair process is usually welcomed by a board, especially now when anxiety about liability is great and shareholders expect board accountability. The legacy the current leadership leaves is in the hands of leaders today – status quo, regressiveness or proactivity. It really does not take courage to lead directors who feel some discomfort with a current state or other directors who are happy with the status quo. It takes vision from leaders and the support of experienced professionals who can help shape and facilitate a fair process.