11 Jul 2012  Research & Ideas

The Future of Boards

In The Future of Boards: Meeting the Governance Challenges of the Twenty-First Century, Professor Jay Lorsch brings together experts to examine the state of boards today, what lies ahead, and what needs to change.

 

In discussions that continue to swirl in the aftermath of the financial crisis, the question of corporate governance's role is often front and center. In The Future of Boards: Meeting the Governance Challenges of the Twenty-First Century, Harvard Business School Professor Jay Lorsch brings together eight experts and practitioners, all with ties to HBS, to examine the state of boards today, what lies ahead, and what needs to change in the context of an increasingly global world that has seen the complexity of corporations increase to a dizzying degree.

"I do think there's a movement away from maximizing shareholder value as the primary focus and motivation for a corporation's existence"

Topics tackled include how boards can most effectively oversee company strategy, CEO succession, and executive compensation. Also considered is the very human nature of boards (which all too often can lead to dysfunctional group dynamics) and the perspectives brought to the table by board leaders and director. Finally, the benefits of two opposing leadership structures are debated: one chapter argues for electing a chairman who is separate from the CEO, while another makes the case for a lead director to serve as a liaison between the other board members and the CEO.

As clear-cut as these subjects may seem, the underlying question, as Lorsch sees it, is far more complex: What is the broader mandate of business in the context of today's society?

"Nobody has a monopoly on what the truth is in that realm," he says.

Lorsch is the Louis Kirstein Professor of Human Relations at HBS, where he has taught and researched for over 47 years. He is the author of many articles and books about boards of directors, including Pawns or Potentates: The Reality of America's Corporate Boards, with Elizabeth MacIver, and Back to the Drawing Board: Designing Corporate Boards for a Complex World, with Colin B. Carter.

(Read an excerpt from The Future of Boards.)

Julia Hanna: You've been studying board dynamics since the 1980s. What is a trend that you've seen developing more recently?

Jay Lorsch: I do think there's a movement away from maximizing shareholder value as the primary focus and motivation for a corporation's existence, and toward a growing recognition that companies are economic institutions that provide benefits to many constituents in the form of salaries and goods and services as well as returns to investors. So the question becomes, what is the board's responsibility in that context?

Q: The survey that you summarize in the book's first chapter shows that directors are really wrestling with that question.

A: In 2009, eight senior members of the HBS faculty, all of whom serve on boards themselves, agreed to interview five directors each. We decided to focus on two broad questions: How well did these boards function before the recession? And, what aspects of the board's way of functioning troubled members as they looked to the post-recession future?

We were trying to get people we knew who we thought were experienced members of boards and would tell it like it is. I think we succeeded. They were pretty candid. It was close enough to the 2008 financial crisis that a lot of them were still shaken up. They were reflecting on what had happened and why their boards weren't more on top of these problems.

Q: What were some of their thoughts?

A: It was clear that many felt the impact of corporations' increasing complexity. You need people with more knowledge to serve on the boards of such companies, but that runs counter to the legal prescriptions that require board members to be "independent." So how do you meet the obligation of having board members who are independent but who still have an understanding of the business? That's pretty difficult to do.

In the context of the financial crisis, there were a lot of people who have said—I think correctly—that if you have too many people on the board of financial institutions who don't know anything about financial institutions, then you have a problem.

Q: But you also make the point that it's not possible for a board member to know everything. It's important that they know enough to question senior management intelligently but respectfully.

A: Yes, one theme that I hope comes out clearly in the book is the importance of the relationship between the board and top management. Boards are very much a human institution. The law can certainly shape and constrain a board, but at the end of the day, people and how they relate to each other are of crucial importance. If you're going to have a successful board, you need to think about it in terms of successful human relationships. I think that's a tenet that really makes HBS somewhat different from other business schools; not that other academic institutions don't recognize that as well. But I think it's more deeply engrained in our history and the way we think about things.

Q: In terms of board structure, two of the book's chapters make opposing arguments. David Nadler of Marsh & McLennan is in favor of a chairman of the board who is a separate and distinct from the CEO. Raymond Gilmartin, Merck's former chairman, president, and CEO, makes the case for a lead director who acts as a liaison to the CEO but is the equal of other board members. (Gilmartin is also a Harvard Business School Executive in Residence.)

A: The debate between having a lead director, or a chairman who is separate from the CEO, is an interesting debate, and it's ongoing. I hope the book will give people who are involved in making these choices a chance to consider two different points of view and understand the pros and cons. There isn't a one-size-fits-all solution.

"When it comes to compensation, we can't see the forest for the trees"

Bill George's chapter ["Board Governance Depends on Where You Sit"] offers the perspectives of different board positions on the work of corporate governance. Bill is on our faculty now, but serves or has served on numerous boards and is the former chairman and CEO of Medtronic. Reading his contribution to this book gets to the crux of the issue. Yes, a board seems like a relatively simple institution with 10 people sitting around a table, but it's a lot more complex than it appears.

Q: A chapter you coauthored with HBS Professor Rakesh Khurana, "The Pay Problem," tackles the knotty issue of compensation.

A: When it comes to compensation, we can't see the forest for the trees. We've created a system where there's a lot of focus on the details: Should you pay in stock or options? What proportion of the compensation should be in incentives? Plus, the overall approach (thanks in part to the use of compensation consultants) has moved from an individual, situational negotiation to one that is market-based. Yet no one goes back to ask the fundamental question: Is the premise that underlies this whole complicated house of cards a valid one?

For example, do these incentives actually serve as a motivation? Would people work less hard if you didn't have them? Our argument is that we don't think so. How much is enough in terms of pay?

Q: The feeling in the popular press and amongst many politicians is that CEOs simply get paid too much compared to everyone else.

A: Yes, but that doesn't get us anywhere, and it's not completely valid anyway. They sure get paid a lot, don't get me wrong. But they're not the only ones. Real estate tycoons, singers, sports stars—it's part of the American way. The piece that is missing is why. Why is this country so driven by the attainment of wealth? If you go to other countries, there are people who work very hard, who have a nice standard of living, but they're not so focused on one thing.

Q: What you're talking about raises complicated issues. Do you think the agency theory of maximizing shareholder value [originated by HBS Professor Emeritus Michael Jensen] was so quickly accepted and absorbed into how people think about corporations and boards because it's so simple?

A: Yes, but simplicity can be a snare and a delusion. It's true: If you don't use agency theory, what do you use? Then you get into a very messy debate. To what extent should boards focus on shareholders? To what extent should they focus on other stakeholders in society at large? A lot of people are arguing about this now, and they use different words that aren't always precise.

One issue that Rakesh Khurana and I argue is that you can't reward senior management for something over which they have limited control, and shareholder value is not something that most managers can totally control. The economic performance of the company overall offers a clearer view, but most compensation plans don't take that into consideration.

The bottom line is that you and I can talk about shareholder value not being the primary consideration—but if you're a large investor in a company, you might think that's the only thing that matters. No one can say they have complete access to the truth—everyone has their point of view. It's not unlike what goes on in Congress. It boils down to a set of beliefs. I prefer a more balanced view of the role of the corporation in society. If the only reason a corporation exists is to make money for its founders and shareholders, then the other people engaged in its work may not be getting commensurate rewards for the efforts they're putting in. One of the things we're trying to reflect in the book is that there's a healthy skirmish going on among directors themselves as to the appropriate way to think about this.

Q: Do you have a sense of where you'll turn your attention next?

A: We did a diagnosis in our chapter about compensation, but I think there's much more that can be said about what's wrong with it and how to fix it. My research associate and I also want to get a questionnaire into the hands of practicing directors to see how they're thinking about their jobs and the issues they face. I think we have a good handle on it, but I want to see if we can strengthen our existing database, and determine if there's more to be said through that additional understanding.

Part of what this is all about is getting away from so much normative argument to a more realistic picture of the human aspect of boards. We want people to understand that these are human institutions populated by serious people trying to do an important job—yet we mostly put up legal barriers and neglect to give them the help that they need. That's too bad, because we don't have any other way to govern these institutions.

Additional Reading On HBR.com, Lorsch and Justin Fox have teamed up to write What Good are Shareholders?

About the author

Julia Hanna is associate editor of the HBS Alumni Bulletin.

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Comments

    • Anonymous

    Yes, board members have certain legal requirements, but to be effective they must not be limited in their thinking. "Groupthink" is a very real problem on many boards.

    It's time that boards represent all the stakeholders including labor and society, not just management and shareholders.

    It's time for boards to be more carefully constructed by using Myers-Briggs, for example, to obtain greater diversity in thinking.

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

    The role Boards are expected to play is complex and vast. In fact, every conceivable issue relating to the corporate entity has to be taken up and finally decided for the buck stops there. Directors have onerous fiduciary responsibility and have to beware lest any action/decision tentamounting to misgovernance take place. Each director has to participate in the board deliberations using his own independent faculties without fear or favour. Ultimately, the collective judgement of the Board is what rules. Besides the matters listed in the article there are very many others and these would vary from company to company. Broadly, however, those listed out do assume lot of importance.

     
     
     
    • Viktor O. Ledenyov, Ukraine

    In my opinion, in the time of globalization, there is no easy answer on the highlighted question: What is the broader mandate of business in the context of today's society?

    Viktor O. Ledenyov, Ukraine