11 May 2011  Research & Ideas

Building a Better Board

While corporate board members take their jobs more seriously than ever, they are not necessarily as helpful or effective as they could be, says HBS senior lecturer Stephen Kaufman. He recently sat down with HBS Working Knowledge to discuss what he considers to be the biggest practical issues facing boards today. Key concepts include:

  • Board directors may not give an honest assessment of the company because they fear reprisal from the CEO or the other board members.
  • In accurately evaluating a CEO's performance, board members must get feedback from other employees at the company, who possess insight into day-to-day operations that the directors do not.

 

When Stephen Kaufman took the helm at Arrow Electronics in 1982, it was de rigueur for CEOs to sit on the boards of several other companies in addition to running their own. Back then, serving as a board member didn't require much of a time commitment, and governance was a matter of trust.

"There has been a tremendous shift to the better over the past 15 years"

By the time he retired in 2002, the board-serving landscape had changed considerably. These days, serving on a few boards can comprise almost a full-time job. While quarterly board meetings used to last maybe half a day, including a catch-up-with-the-buddies lunch, meetings now span a day and a half and they happen up to six times a year. While reviewing relevant materials used to mean flipping through the annual report on the plane ride to the annual meeting, it now means spending several hours poring over hundreds of pages of company documents and SEC filings looking for problems, unreasonable risks, or even signs of fraud.

"I see much more time being spent—more meetings, longer meetings, more meaningful meetings, and more pre-meeting materials to be studied," says Kaufman, a senior lecturer at Harvard Business School who sat on one outside public board during his tenure at Arrow and has since served on four other public boards and five private boards.

"There has been a tremendous shift to the better over the past 15 years," he says. "The improvement started on its own without any major external events in the late 1990s, accelerated dramatically with the accounting scandals of the Enron era plus the passage of Sarbanes-Oxley, and then continued to change under the pressure of shareholder activism. There's a lot more attention paid to non-fun stuff now, much of it being compliance mechanics that add very little to the competitive position or underlying value of the enterprise."

But while board members are now taking their jobs more seriously, their input is not necessarily as helpful or effective as it could be, Kaufman says. He recently sat down with HBS Working Knowledge to discuss what he considers to be the biggest practical issues facing boards today: how to get and give honest assessments without eroding collegiality and trust; how to evaluate the CEO using factors that go beyond financial results; how to diagnose the corporate culture; and how to contribute meaningfully to strategy development.

Making it safe to be critical

Chief among the responsibilities of a corporate board member is to develop and share an honest assessment of the company's performance, including the performance of the CEO. The problem is that directors sometimes worry that delivering honest criticism will hurt the group's collegiality or, worse, result in reprisal—namely, getting kicked off the board and losing a gig that often pays six figures annually, plus stock options or shares.

"At $150,000 a year—a typical compensation package for a Fortune 1000 company director—it's real money," Kaufman says. "So who's going to tell Bill that we really like his ideas, but that his management style pisses people off? It can feel very risky for board members to think, 'If I pick on Bill, will he pick on me?'"

"The goal of the performance review is not just to fill out a report card, but also to help make a good CEO a great CEO."

Corporations can mitigate this issue in a couple of ways, he says. For starters, they can hire an outside recruiter to enlist new board members, so that the board includes more than just acquaintances of the CEO or other current directors. This can serve to cut down on the clubby board atmosphere. Outside recruitment has grown more common in recent years, in part because of improved governance and in part because the usual playing field of director candidates has begun to thin out organically.

"As business in general globalized and became more competitive in the '90s, as the world became more difficult, CEOs got busier and joined fewer boards," Kaufman says. "That was one of the things that led boards to look further afield for directors. They ran out of active CEOs they knew from other companies who were willing to serve."

Boards also can make it feel safer for directors to give honest assessments by hiring an outsider to interview each board member individually and aggregate the information for both the board and the CEO. "That person puts together a report that says, 'Here's what your fellow board members said you could do to be more effective as a board member or as a CEO," Kaufman says.

More comprehensive assessment metrics

Historically, a board member's assessment of a CEO's performance simply involved asking a couple of questions. One, did we make the numbers? Two, is the stock price doing OK? "It was a 10-minute conversation, and that was that," Kaufman says.

These days, the assessment is usually much more wide-spread, taking into account both quantitative and qualitative metrics other than just recent financial results, such as customer satisfaction, employee engagement, and even the CEO's leadership style and character. But even these broader assessments can lack accuracy and credibility. Too often, the board members' appraisal is based largely on how the chief executive acts at periodic board meetings and occasional one-on-one meetings, rather than on how he or she handles day-to-day activities with customers, managers, and front-line employees during the rest of the year. The CEO who seems measured, thoughtful, and open for three or four hours in the board room six times a year may actually be inciting a mass exodus among unhappy customers, disgruntled subordinates, or disengaged employees.

"I can give great PowerPoint presentations, but that doesn't tell people whether I'm Attila the Hun or a New Age Leader, or if I create a culture of fear, a culture that accepts and respects dissent, or a culture of energy and enthusiasm," Kaufman says. "A board sees the CEO at highly structured—and possibly well-rehearsed—board meetings, at a few dinners and perhaps at an annual golf outing. That doesn't tell the board whether the CEO is a listener or a lecturer, an autocrat or a democrat, or a fan of yes-men. But those are the things you need to need to know if you want to give a CEO meaningful counsel. The goal of the performance discussion is not just to fill out a report card to justify the compensation decision, but also to help a good CEO become a great CEO."

When he was at Arrow, Kaufman instituted a policy where the independent directors based their assessments of him on direct, private conversations with company executives at multiple levels of management. (He detailed the process in a 2008 Harvard Business Review article, "Evaluating the CEO.") He suggests that this, or a similar process should become industry standard.

"When companies get into trouble it doesn't usually happen overnight; it happens over the course of two or three years. Figuring that out before the numbers go bad is the greatest art of a board member."

Incorporating input from across the company also helps directors to gauge corporate culture in a way they can't from the ivory tower of the boardroom. It's important to ask questions such as, Are employees engaged? Are they enthusiastic? Are all the really smart engineers quitting in frustration? Are the best salespeople looking for new jobs? Are the high-potential, next-generation senior managers energized and growing? The answers can help the board realize whether a company with great financial results today may have terrible results in six months, six quarters, or six years—unless there's an intervention.

Kaufman recommends that board members periodically request that the company conduct anonymous surveys about employee engagement and the company culture, and then ask that the data be shared in raw form, "not the chewed and digested and spun form." He also suggests urging board members to make occasional visits to company facilities and sit in on town hall meetings.

"When companies get into trouble it doesn't usually happen overnight; it happens over the course of two or three years," Kaufman says. "Figuring that out before the numbers go bad is the greatest art of a board member."

Shaping strategy

Boards of directors also are expected to help steer strategy development, not only in small venture-backed and private companies, but in large public companies, too. Kaufman says this is increasingly difficult to do well.

"To develop good, actionable strategies you need to understand customer needs, customer behavior, and the technology behind the product or service," he says. "How is the technology developed? What changes or threats are on the horizon? What value does your product create for your customer? If you don't know these things then it's hard to develop strategy because you really don't know what's needed or what's possible. It's relatively rare that many directors really understand the physical technology or how the business operates at the street level. Therefore, it's really hard for a board to be deeply and constructively involved in developing the strategy."

Other than company insiders, those most likely to understand a company's technology and customers are its competitors and—in the case of B2B enterprises—its customers. But senior executives from such companies are generally discouraged from serving because of potential conflicts of interest.

Meanwhile, companies are under increased pressure to diversify their boards in order to include more minorities, women, and social activists. While shaking up the historical old boys' board networks may be good for balance, Kaufman observes that it can make strategy development and performance oversight that much harder. "The push for diversity creates a tension for us. We need to ensure that we recruit directors who understand the underlying technology, customer needs and patterns, and operational characteristics of the business, so they can contribute effectively to the critical strategy and investment decisions that come before the board," Kaufman says. "One lesson from the recent global financial crisis was that some financial institution boards had few directors who really understood the workings of—and risks inherent in—the sophisticated and complex derivative instruments being created and sold."

About the author

Carmen Nobel is senior editor of HBS Working Knowledge.

Comments

    • Greg Cook
    • Educator, Somerville Public Schools

    The challenges facing businesses today are, in the end, a lot of the same challenges we're facing in education. We both have systems that thrived during the Cold War when half the world was pursuing an economic system that was doomed to failure and another quarter of it was still quite agrarian. It was a world where one could get by glad-handing in the old boys network. That is obviously no longer the case. Now we need honest, legitimate metrics for both business and education. And we need checks and balances to protect the folk that need to take action and right the ship.

     
     
     
    • Shann Turnbull
    • Principal, International Institute for Self-governance

    "The biggest practical issues facing boards today" not mentioned in the article is how to discover when a director's trust in management is misplaced. This was also the most urgent issue when I became the new chairman, CEO or non-executive director of a newly acquired publicly traded corporation.

    Four years after graduating from Harvard with an MBA in 1963 I became a member of a private equity group that obtained control and re-organized a dozen publicly traded corporations. None of the firms possessed systemic feedback communication systems independent of management whose future employment we were determining.

    This is not necessarily the situation in Europe and Japan that can have formal feedback systems from their stakeholders independently of management. Professor Michael Porter identified that these connections also provide competitive advantages in his 1992 report for the Council on Competitiveness.

    A core role of directors is to monitor and control management but US boards have no creditable systematic process for achieving this independently of management. Even reputable newspaper editors instruct their journalists to get the other side of any story. A process not systematically provided to US company directors.

    In addition, US boards are still half a century behind the frequency of monitoring management. The article reported that US boards now meet "up to six time a year" but in Australia board meetings were held monthly even back in the 1960's.

    The need for "building better boards" is also more pressing in the US because they are far less accountable to shareholders. US corporations commonly use a voting system where it is not possible for shareholders to vote against any director. Most other countries allow shareholders to vote directors off a board.

     
     
     
    • Dr.K.Prabhakar
    • Professor, Velammal Engineering College

    Thank you Stephen for your valuable insights. I agree with your changed experience from last decade to the present decade CEO interaction. However, one this that is missing in your posting is are we really giving "betters" or products or services that are good to people? I think you never questioned the fundamentals by which CEO has to evaluated. Apart from engaged employees, satisfied customers if the question is are you giving products and services that make consumers betters~ I used the words of Umair Haque. If the CEO is confident and convinced that what he or she is doing is for betterment of society; the next aspect of presentation will be easy to evaluate. Do you employees believe you? How much trust they have towards you and within themselves? If the question is affirmative without the training of King's Speech ( as touted by his good assistants); How much you hate greed and love austerity and humanity truly? This is the last question and if the answer is a honest yest. There is no need to go further. I think to a large extent your mission will be accomplished as a Director.

     
     
     
    • Keith Williams
    • UK Business Mentor of the Year 2010, Self

    A very comprehensive and concise article, congratulations. Mr Kauffman clearly identifies the dilemma fo all none-exec directors, how to tell the CEO or function heads they are mistaken. As a part time director it is too often the fear of not having all of the facts that caused the NED to hesitate. Unless the NED has sufficient respect from the Board he will not feel confident to express his opinions frankly. The real question might be, how does the NED create and maintain that level of respect?

     
     
     
    • Maria Dixon
    • Director, ISM Shipping Solutions

    Magistral! I am really grateful for this article and my question is that if a "diversed" board with people not knowing very much about services or products and a "buddies" board with again not knowing about services or products, the formula for disaster would be equal - however, in one of the cases the golf may be worst!

    Now seriously speaking, everyone can learn, you can see the wood he/she is meade of when interviewing a potential board member.

    I will hire him/her and send him/her to the shop/factory floor for 3 months - full time - to learn how the companies produces, how to make the products or services, that man or woman will understand what is really all about when sitting on the Ivory tower.

    If they sweat like the workers and see the problems and in my case in the shipping industry, send someone to sail for 3 months on a cargo ship then they will see problem with cargo, ports, fatigue, food, disease, etc!

    The best bosses and professionals are those who started fm the bottom and went up - who worked and studied and know the significance of life instead of knowing the best golf courses in the world!

    In the UK we had a TV series where the bosses were working anonymously in their own factories and and the end of each programme that CEO had a new mentality, and created new schemes, rewarded loyalty and workers, send them to more training and helped them, etc, etc, why? because he was there at 05:00am in winter shifting boxes and knowing how hard they all work for their slary and for the company.

    This is what we need today worldwide, more human CEO able to look after his/her workers as a family.

    Thanks again for allow us to submit our thoughts!

     
     
     
    • venkata subrahmanyam voruganty
    • associate professor, JBIET

    to build a better board you need to specify the interse healthy relationships between all the existing and new board members. the authority or dependency interrelationships need to be mapped very carefully and arranged in such a way that they do not cross wires any where. smooth flow of ideas, building up of source confidence, smooth integration into the group are more important than the individual achievements or individual singularities.

     
     
     
    • Joe Schmid
    • Managing Principal, Oak Leaf Consulting, Llc

    Considering the foundational fiduciary duties of a BOD, establishing a corporate metrics system, and how this matrix cascades down into all levels and aspects of the company, is the most strategic thing a BOD does. This system provides a continuum of 'real time' stakeholder monitoring. What good does a periodic third party assessment deliver - an after-the-fact report on what has taken place months or years before? The matrix provides factual assessments, evaluations, and the diagnostics needed for governance. It removes a dangerous layer of subjectivity and drives additional factual information into decision making helping to minimize hesitation and false starts. An organization's metrics are the sources of its rewards. People move to where the rewards are and stay away from where the rewards aren't.

    The role of the outside directors is the most markedly changed since the '80's. The pressures, blind eye, and GATGA factor on inside directors are at least the same if not more. The reliance on outside directors to be the 'third eye' has increased. The speed of business innovation and change has ramped to levels not thought of in the '80's. BOD's have to keep pace. Mr. Kaufman is dead on with his remark ". . . Figuring that out before the numbers go bad is the greatest art of a board member." The 'science' that supports the 'art' is in the matrix of 'numbers' - not just the end-game financials.

     
     
     
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited

    In my view, first of all,there needs to be a fair mix of executive, non-executive and independent directors. The total number of directors should not be too large or too small and the size and operations of the company must weigh while zeroing on the size. Once done, the next imperative is the quality and focus of the directors. The Board must critically appreciate the role being played by each director , the CEO and the Board as a whole. Each director must participate in the decision making processes and yes-men be shown the door. A word of caution about independent directors. There is lot of debate on how to ensure independence. Once the ID is paid by the company, he seems to believe he is obliged to the Board and preferably need not dissent with the views of others particularly the Chairman. No doubt the scenario is changing with all directors being made accountable for wrong decisions but much more needs to be done. Do directors devote sufficient time to their assigned duties and responsibilities? Do they participate in the meetings regularly? Are they possessed of proper knowledge of the Company's vision, strategic expectations and goals? Are they fairly well-versed in understanding processes particularly the financial? Have they a keen eye on watching the interests of minority shareholders? Are they quick to react to any abnormalities coming to light and do they take corrective measures expeditiously? Do they reviewperformance vis-a-vis Codes of Conduct of self and peers on ongoing basis ? In a nutshell, do they call a spade a spade without any fear and are serious towards all their fiduciary duties at all times?
    In adition, there is much more to do as the role is very complex. Hence, each company board presents vast scope for improvement and must strive for it constantly.

     
     
     
    • David Frishkorn
    • VP Chief Compliance Officer, Comverse Technology, Inc.

    Overall, this is an excellent article covering some of the key reasons for the evolution of board composition and the challenges facing board members today. Stephen Kaufman seems like a very balanced and practical executive manager and I especially like that the author did not put undue emphasis on Sarbanes-Oxley as the catalyst for all that is different. Global business has changed in many ways, and in many good ways, with or without the effects of SOX. I also really like the argument for board diversity, but would add that in addition to the immutable characteristics cited, boards will also benefit from a diversity of educational, experiential and expertise backgrounds. Audit Committees need financial experts in their mix. Does the general board also need management, motivation, governance, compliance, compensation and technical experts as well?

     
     
     
    • Goomena
    • SEO Manager, Goomena.com

    It does take skills for an accountant to pick up that the numbers are slowly going bad, and in turn, be able to fix them before imminent downfall.

     
     
     
    • ADAM BRIEAND
    • Principal, Engineering College

    The challenges facing businesses today are, in the end, a lot of the same challenges we're facing in education. We both have systems that thrived during the Cold War when half the world was pursuing an economic system that was doomed to failure and another quarter of it was still quite agrarian. It was a world where one could get by glad-handing in the old boys network. That is obviously no longer the case. Now we need honest, legitimate metrics for both business and education. And we need checks and balances to protect the folk that need to take action and right the ship.