11 Jul 2012  Research & Ideas

Book Excerpt: ’The Future of Boards’

In an excerpt from The Future of Boards, Professor Jay Lorsch discusses why directors are newly questioning their roles.

 

Editor's note: The credit crisis and subsequent recession has thrown many financial and business institutions into, if not chaos, then at least a sense that the landscape underneath has shifted significantly. One institution undergoing such self-review is the corporate board of directors.

So it's more than timely that a book on the subject by one of the world's great experts on corporate governance, Harvard Business School Professor Jay Lorsch, will be published next week. The Future of Boards: Meeting the Governance Challenges of the Twenty-First Century asks two important questions: What role is appropriate for the board? And how can the directors understand enough about the company to meet their responsibilities effectively?

In this excerpt Lorsch looks at how directors are rethinking their roles.

(For more about the book, see our interview with Lorsch.)

The Board's Role

From "Boardroom Challenges," The Future of Boards

The Future of BoardsWhy so many directors were reflecting on the board's role is difficult to pinpoint. A partial answer undoubtedly rests in the fact that regulations and laws offer little guidance about what boards are supposed to do. In most states the basic statute that describes the purpose of boards is phrased very broadly. For instance, in Delaware, which sets the standard for other states, directors find little help in the statute that defines their job: "The business and affairs of every corporation shall be managed by or under the direction of a board of directors." This statute also tells directors that they may delegate the actual running of the company to its officers. Court decisions related to director conduct are largely focused on matters of process-that is, on how boards are to carry out their duties. For example, directors must exercise good business judgment and be loyal to the corporation. As one director told us, "Our board lawyers say, 'You know, the board members are not supposed to be making the management decisions. You're just supposed to be comfortable that the management is going through the appropriate processes to come to well-thought-out decisions.'"

Given the prevailing lack of specificity about their duty, most boards gradually develop an implicit understanding of what their job should be. As long as the business was thriving and management was comfortable with what the board was and wasn't doing, there was no need for greater explicitness.

But the economic shock of 2008 appears to have caused many directors to reconsider what their boards had been doing and to question whether they could or should be acting differently. "I really do think it's time for a lot of reflection by boards right now about what we could have done better in the last six months to a year," one director said. "What did we miss? I think it's always great to have time to reflect backward about what we learned about what we've just been through, or what we're going through, and how we could have served the shareholders better if we had spent our time a different way."

Directors' reflections on the board's role had multiple dimensions. For some, the question was whether and how exclusively the board should focus on compliance with applicable laws and regulations. In their view, the board's primary role is to be rules-oriented. Others viewed compliance as the job of lawyers and conceived of the board's job much more broadly. "I'm more comfortable on some boards than I am on others," one director told us. "Some people have really taken the value of governance, the importance of governance, to heart, and it pervades the company. Others have been slower to that realization, and tend to view governance as something that the lawyers are driving. And therefore it is something that, at the attitude level, slows things down; it's a cost to the enterprise. It gets in the way of being efficient about decision making and moving forward."

This director and a handful of others seemed to be struggling with a hangover from the effects of Sarbanes-Oxley and other regulations, which absorbed so much board time a few years ago. To others, the financial crisis itself meant that boards should intensify their efforts at compliance: "In adversity, boards become more active by definition," one director said. "But what one has to ask is:

Should they be more active when things are good, to make sure that the risk-management processes are in place, that the financial control processes are in place, so that they're assured that the organization has the controls and procedures that will red-light or highlight risks when they need to be highlighted?"

Other directors disagreed, believing that the board should devote less time to compliance issues and more to substantive business matters. Doing both is not easy, as one director pointed out:

"Just the challenge of fitting all of the compliance activities that boards and their committees have to execute on, while still doing these broader and perhaps more interesting things that boards are supposed to do-in terms of providing oversight of the business, oversight of management, particularly oversight of the CEO, as well as engaging in the strategy and the direction of the company-is difficult." For directors like this one, the central issue was how much directors could be expected to do. "I think that the expectation of what a board can or cannot do, either in the public perception or even in the regulatory perception, is overstated," another director said. "At times this is a big challenge for board members. They feel they should be doing more, but doing more is difficult to do." Such comments suggest that, in times of crisis, directors feel a responsibility to take a larger role but aren't certain how to do so.

One director pointed out a significant problem that arises when boards contemplate becoming more engaged: "I think the board is more involved. I think it's busier. I think boards have to be more focused. And I think they have to be careful that they don't start trying to manage the company. They have to give the guidance, or set the trends, but they can't be managing the company." Where to draw the line between the board and management troubled our interviewees. Two directors' comments effectively capture the two sides of the debate. One said, "In today's environment, where there is so much pressure on directors, I think there can be a tendency for directors to want to cross the line a little too much sometimes, on the operating side, probing committees on every little subject that comes up." In sharp contrast, another director said, "At the moment, boards are reluctant to be intrusive into the day-to-day operations. And I think they are reluctant to be intrusive on the personnel management, beyond the top guy and maybe the heir apparent, if there's a change coming. And so they isolate themselves from understanding where the risks are coming from and what those risks are. I don't think they can do the job without becoming more involved."

Whereas these directors puzzle over where the line should be drawn between management and the board, others believe that the crucial issue is how the board interacts with management regarding major decisions. "I've always thought the board should be a catalyst," one director said. "They need to make sure that there's really good open dialogue, and all the dimensions and possibilities are at least given some air time. I think the board's role is to make sure that management, if they are not having these discussions with the board, does have these discussions with the board. And if they're not working on it, they should be working on it." Another director asserted that the board should be even more proactive: "I think the board has to lead more. And the shareholders may not even like that too much, and the management may not like it. But I think the board has to say, 'Wait a minute, what steps are we taking while we're still making that profit on one product? What are we going to do so that we're ready in five years with another new product?'"

As we shall see, directors' preoccupation with better defining the board's role is also linked to their views on board involvement in shaping company strategy. Both questions turn on another matter: how well the board understands the company.

Reprinted by permission of Harvard Business Review Press. Excerpted from The Future of Boards: Meeting the Governance Challenges of the Twenty-First Century. Edited by Jay W. Lorsch. Copyright 2012, all rights reserved.