Are You Underutilizing Your Board?

Many corporations are failing to obtain full value from their boards. This lost opportunity occurs not only in dysfunctional organizations but also in companies that perform well and are market leaders. While many boards unfortunately have weak or even incompetent members, even companies with highly qualified directors often can fail to fully tap the skills and experiences of those individuals. It doesn’t have to be this way. Based on a recent comprehensive study of board reviews and our collective experience of more than 60 years of assessing senior managers and board members, we believe that a set of sound practices for creating and running an effective board can help companies avoid such waste at the top.

Lifting the Lid

Over the past five years, we have performed almost 100 board reviews (see “About the Research”). The businesses involved were based on all continents and in all major industry sectors and covered a wide range of organizations, from large to small, both publicly listed as well as government and family owned. Based on the data collected (see “What Boards Know That Companies Don’t.”), we are convinced that most boards have five key problems.

Inadequate Competencies

Although the vast majority of board members are capable, other members simply are not fully competent for their most critical and delicate roles. Only 60% of directors are convinced that all board members understand the key operating issues of the business or the main sources of risk to the company, and fewer than 55% feel that they, themselves, have a clear understanding of the perceptions of their stakeholders. Our study also revealed a similarly depressing statistic with respect to knowledge of the external environment in which the organization is operating. Only 70% of directors believe their colleagues come to board meetings well prepared, and just 60% feel that all of their colleagues participate effectively at meetings. As a result, only two-thirds of directors feel that their boards are making good decisions.

Lack of Diversity

One positive finding of our study is that almost all directors enjoy working with their boards. But the downside of a comfortable, collegial environment is that it might discourage robust, constructive debate, leading to dangerous rigidity that stifles independent thought and hampers any change efforts. Part of the problem is that many boards lack diversity, not necessarily by design but because of various hidden forces. When selecting directors, for example, one of the most common psychological traps is that of sticking with the familiar or, in other words, looking for what is comfortable and known instead of seeking individuals with the best possible combination of competence and complementarity. But complementarity generally results from differences in experience, interests, style and personality (as well as gender and ethnicity) — exactly the kind of diversity that can lead to richer and more productive board discussions.

Underutilization of Skills

Unfortunately, even competent directors are being underutilized, at least according to their own perceptions. Specifically, only 60% of directors believe that their company is getting their best efforts, and just 55% feel that way about the performance of all the nonexecutive, or outside, directors on their board. The culprit might be two underlying problems. First, only 60% of directors feel that management seeks to involve the board fully in key decisions. Second, many directors simply are not briefed adequately on critical issues. Fewer than two-thirds believe that the information provided to the board enables effective monitoring of management, and fewer than 55% believe the information received for board meetings is sufficiently related to the company’s external environment.

Dereliction of Duties

Even so, companies expect their boards to contribute to, approve and support a corporate strategy, facilitating the right balance between short- and long-term goals. But fewer than 45% of the directors in our study believe their company is fully capturing its strategic objectives, and fewer than two-thirds feel their organization has the right balance between short- and long-term goals. In many cases, directors believe their boards have insufficient debate on strategy and that management delivers what amount to definitive recommendations, rather than presenting options open for discussion.

Companies also expect their boards to help fill the corner offices with the right executives. It is surprising, then, that fewer than one-third of directors are fully aware of the high-potential employees in their organization. Moreover, fewer than 40% believe their company has an appropriate process for managing the succession process for top executives. To make matters worse, boards are also falling short when it comes to supporting the development of the senior executives who are already in place. Fewer than 60% of directors believe their organization has an adequate process for providing feedback to the chief executive officer regarding his or her performance, and fewer than 55% feel that way about the evaluation of senior management in general.

In addition, boards are responsible for the systematic reviews of past investment decisions (especially for major capital expenditures and merger and acquisition transactions) and the assessment of risk to the organization as a whole. Such financial issues have been a historic area of oversight for most boards, although recently many have begun to create additional subcommittees to focus more on financial policy and risk.

Poor Selection and Assessment Processes

Interestingly, board members are very critical about the way in which they, themselves, were selected. Fewer than 60% of directors believe their organization has an adequate process for appointing new board members. (And that sample is from boards that have already taken the step of seeking third-party advice to assess their effectiveness. Directors on other boards might be even more critical of the selection process used at their companies.) A result of that deficiency is the frequency by which boards fail to aim high when selecting directors; that is, mediocre boards tend to recruit mediocre (but not good) directors, and good boards tend to enlist good (but not superior) individuals.

To exacerbate matters, many companies do not properly assess the performance of individual directors, which means that they do not provide feedback and thus fail to obtain the best possible value from board members. In fact, fewer than 30% of directors believe their organization has an appropriate process for evaluating director performance (although they acknowledged that this aspect has been improving). A telling sign of this shortcoming is the sheer number of cases in which a chairman simply endures a poor appointment rather than asking (or forcing) the underperformer to resign.

Toward More Effective Boards

Given the pervasive waste at the top, what are companies to do? Organizations can dramatically improve the effectiveness of their boards by adopting five basic practices: (1) choose the right directors, (2) appoint the right chairman, (3) make succession planning the first priority, (4) focus on a few key agenda items, and (5) review the board’s collective and individual contributions. Although these practices might seem obvious, the simple fact is that far too many organizations either neglect them or make mistakes in implementing them.

Choose the Right Directors

No best practices, governance codes or structural design can make a board effective if it does not have the right members in the first place. But who are the right members? At a minimum, all board directors need a high level of competency in four basic areas:results orientation, the ability to focus on measurable, short- and medium-term results when interacting with the CEO and other directors to make board decisions that will improve shareholder value over the long term;strategic orientation, the skills (and desire) to contribute to corporate strategy and not allow long-range issues to get lost in operational details;collaboration, the ability to function effectively on a team that might meet just a few times a year; andindependence, the willingness to express and exercise one’s best judgment even when it runs counter to the views of management and other board members.

Each of the four competencies can be assessed by behavioral interviewing and by checking the references of those who have worked with a candidate. Taken in pairs, the competencies are somewhat contradictory — results versus strategic orientation and collaboration versus independence. As such, finding a high level of each competency in a single person can be difficult (although not impossible). But the crucial point is that the board, as a whole, must have a balance of all four competencies. Other skills also might be required, depending on specific strategic or operational challenges. Many companies, for instance, are now looking for directors with extensive experience in Asian markets.

What drives a person is also important. Although power and influence are key motivators for an executive’s long-term success, effective directors are more likely to be driven by team achievement. They want the board and the business to succeed, and they realize that other directors with a variety of views and experience are necessary in order for that to happen. The least effective directors are those who are motivated mainly by affiliation. They might cling to their board seats as the last vestige of their corporate lives, seeing them as a source of security and status. Such directors typically will go along with the majority, and their contributions to the board will be limited.

It is important to note that competent (and motivated) individuals are necessary but not sufficient; the board also requires diversity. That attribute is typically seen to be a function of gender, ethnicity, age and domicile, but what is really needed is the type of behavioral diversity that results from different patterns of experience that lead to a range of perspectives (as well as the ability to express those views constructively). Diversity in that sense is served well when, for example, there is a balance of generalists and specialists. Consider the board of an organization that recently faced a major crisis. Composed entirely of current and former CEOs, the board had a surplus of well-honed generalist skills, but it lacked relevant industry expertise (and it governed management loosely, as many CEOs would like to be governed). The result was a lack of awareness that allowed a significant problem in a key division to go undetected.

Diversity in personalities also should be considered. One of our clients faced that issue when the two directors who were retiring were also the individuals known for their highly developed intuition and emotional intelligence. One recommendation from the board review was to ensure that those highly valued attributes were replaced in future board appointments. In cases where a board has been dysfunctional, a comprehensive review could help identify problem areas, such as an abundance of directors who are extremely risk averse.

Of course, finding the right directors is much easier said than done, but boards can greatly improve their odds by first identifying in detail what type of individual is needed. The entire board might find it difficult (if not impossible) to agree on those requirements, but at least the nominating committee should arrive at a consensus. When making a decision, boards should be aware of the following common traps: selecting someone primarily because he is a “known quantity” (even though there are better candidates), making compromises on crucial requirements in order to fill the position quickly, and allowing one board member (often the chairman) to push a candidate through without sufficient consideration of others in the running.

Appoint the Right Chairman

Not surprisingly, great boards tend to have great leaders. Not only does a chairman preside over board meetings, but they often must intervene personally between meetings, either formally or informally. To handle a difficult issue, they might consult with other board members and call a special meeting to resolve the matter. They also typically have the main responsibility for building the board by playing a leading role in choosing its members, often acting as a magnet to attract talented directors.

As well as the four core competencies discussed earlier (results orientation, strategic orientation, collaboration and independence), a chairman needs to be skilled in three other areas. First, he or she needs to be a highly effective leader who invites rich, open, fact-based and logical discussion. This includes empowering all board members to challenge issues (while preventing destructive conflicts), inviting and managing vigorous debate to achieve consensus, and engaging individual board members publicly and privately for their contributions. Second, the chairman should be adept at developing the growth of other board members, providing them with constructive advice and honest feedback. Some boards are known as good training grounds because their chairmen are revered for their coaching and mentoring skills. These organizations gain privileged access to top-notch candidates for director positions because of the limited opportunities for such individuals to learn the distinctive skills of great chairmanship. Third, the chairman needs to hold key executives and other board members accountable by monitoring their performance against objectives, anticipating any areas of difficulty (and putting contingency plans into place when necessary) and applying strong consequences for any person who doesn’t measure up.

Generally speaking, appointing a chairman from within the board or company tends to incur lower risks than searching for that leadership externally because the internal individual both knows and is known by the organization and its leaders. When searching internally, a peer-selection process is typically used. When external candidates are considered, the process is usually conducted by a search committee.

In the United States, the chairman often is also the CEO; in the United Kingdom, the two positions typically are kept separate. Despite the quantity of essays and articles written on the topic, no convincing evidence supports one governance model over the other. The crucial thing to remember is that the chairman and CEO roles have quite different responsibilities, thus requiring two distinct sets of skills. Finding one set of competencies in a person is difficult enough; finding both sets in the same individual is all the more challenging. And when the chairman is the CEO, it becomes even more crucial for the board to have directors who are strongly independent.

Make Succession Planning the First Priority

Setting in motion the right succession plan and selecting the best candidate for CEO is almost certainly the board’s single most important task. After all, it’s top-class management (and not the board) that makes the biggest difference to company performance and value. Selecting the right CEO also is critical because most governance codes require the board to put enormous faith in the ability, wisdom and integrity of that individual. Even a top-notch board can do little to help a poor CEO, but it can play a large role in helping a good CEO become a great one. Appointing the right CEO is crucial as well because that person will play a key role in setting up a team of senior executives, with the chairman and often the nominating committee involved in approving the appointment of those people.

Thus, any board has a continuing responsibility to ensure that it knows the next generation of leaders in the organization and that these individuals are being groomed to cope with the managerial challenges they will face. Succession planning starts with the graduate recruitment practices of the organization and is complemented by management development programs. Of course, the typical board doesn’t have the time to oversee such efforts in detail, but it does have the inescapable responsibility for shaping and guiding succession planning for the CEO and other top executives. At least once a year the head of human resources should present to the board a detailed status of the company’s efforts to manage and develop executive talent. To ensure that such programs are taken seriously, management succession generally should be one of the criteria that the board uses to assess the performance of the current CEO.

The selection of a new CEO should be led by the chairman or the nominating committee, but the process must include all board members at some point. Past research has shown that, when making executive appointments, companies are substantially better off when they consider both internal and external candidates. Making the wrong choice for CEO can be devastating for any organization because many boards have trouble taking action when their CEO falls short of expectations. The issue becomes all the more complicated when the CEO is also the chairman. The best mechanism for addressing that situation is to use key performance indicators to monitor the performance of the CEO in objective, quantifiable terms. It is important to remember that past research has shown that the performance of CEOs tends to decline during the second half of their tenures.

In addition to CEO succession, some visionary boards are now planning for their own succession. One major global resources company, for example, is already in discussion with individuals to become directors in 2008 and 2009. Outstanding candidates are limited in number, are highly recruited and have minimal time available. Thus, gaining their commitment to join a board up to three years ahead ensures that, if necessary, they have the time to shed some of their current duties so that they can take on new responsibilities. Moreover, advance planning helps the board ensure it will have the necessary blend of skills and expertise for the long term.

Focus on a Few Key Agenda Items

Most highly effective boards have tremendous discipline for always establishing a clear agenda that, at a minimum, covers four key items. First, the board should ensure compliance with applicable governance codes and regulations. Although conformance and performance are two separate issues, compliance is clearly an important hygienic factor for all boards. Second, the board must regularly review the CEO’s performance as well as succession planning at the top of the organization. Related to this will be a discussion of compensation for the CEO and key senior executives, which will typically be delegated to the remuneration committee. Third, the board must allocate ample time to discuss the ways in which the company will create and develop long-term value for shareholders. This discussion should include rigorous questioning and probing of the strategic initiatives developed by the company’s executives. Fourth, the board needs to monitor the company’s operating and financial performance, including relevant risk assessments and reviews of major investment decisions.

In addition to those four items, boards should budget sufficient time to discuss, plan and monitor any major activities or specific interventions, such as a companywide change initiative. And boards also need to set aside ample time for handling urgent issues that inevitably will arise. To ensure that urgent issues receive the attention they deserve, some boards agree to focus on at least one key strategic item or priority each time they meet. Another tactic is to have a director (not the chairman) critique each board meeting to determine ways in which subsequent meetings can be conducted more efficiently.

Review the Board’s Collective and Individual Contributions

Many board reviews focus on compliance, which is not surprising given the current climate of intense scrutiny by regulators, corporate governance experts and investors. But reviews also should investigate the effectiveness of the board as a whole and the performance of individual directors.

Given the inherent conflicts and limitations of self-evaluations, board reviews increasingly are being conducted with the assistance of independent professionals. Such third-party reviews usually consist of a customized questionnaire that is followed up with face-to-face interviews, initially with the chairman and then with all directors. The use of a third party can provide valuable benchmarking data and enable the cross-checking of results. The basis of this information gathering is typically a peer-assessment process, which can be very accurate when conducted properly. One effective mechanism is to ask directors to compare the boards that they sit on. To monitor whether performance is improving (or declining), a board can undergo annual quantitative questionnaires. Increasingly, the review process includes giving frank feedback to each director, and this practice has become accepted even in cultures that traditionally have been unaccustomed to it. For individuals who sit on multiple boards, the feedback they receive often contains common themes as well as issues specific to each board.

Because there is no universal model for how a board should operate, every company should determine its own approach for reviewing its board. Various factors, including the company’s strategy as well as the board’s style and direction, will help determine the specific skills, knowledge and experience needed to make the board work effectively as a team. Although tailor-made surveys should address various issues specific to a particular board, at a minimum any review should be designed to answer the following 10 questions: Do we comply with international and local corporate governance standards? How do we compare with the current best practices in board leadership? Do we understand what our shareholders expect of us? Do we have the collective knowledge and competencies needed? Are the boards of our competitors better equipped? Will our board measure up to the requirements of our future strategy? Do we work well as a team, with an appropriate balance between collaborating with and challenging one another? Does our board deliver results, and are we confident in the quality of our decision making? Are all board members contributing their best? And, last, do we need more independent (nonexecutive) directors?

ALL TOO OFTEN, CURRENT BOARD PRACTICES ARE INADEQUATE. This represents a risk for those companies that fail to improve, but it also presents an opportunity for any organization with the determination and discipline to change. In the past, many companies conducted board reviews to address specific problems. Today, reviews increasingly are being driven by companies with progressive chairmen who are looking for ways to make a good board even better. Those chairmen rightly recognize that, as the baby-boomer generation retires and the pool of qualified director candidates shrinks, their board will have a distinct competitive advantage not only in attracting and retaining outstanding individuals but also in setting corporate strategy and in selecting the right top executives, among other crucial functions, which in turn will have a positive impact on shareholder value.