Building a Better Board

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."