Adding Value in the Boardroom

Powerful forces are redefining the roles and activities of corporate boards — among them are the volume of M&As, the focus by institutional investors on the role of governance in underperforming and failing companies and the accelerating rate of turnover among CEOs that is placing enormous pressure on boards to take a more active role in succession planning. These forces are only likely to increase in strength over the next few years.

In response, corporate boards in the United States have been experimenting with new governance initiatives. Several have become widespread practices among the largest U.S.companies. Many boards are now composed primarily of outside directors and have a profile that is more representative of society as a whole; they operate according to written guidelines, meet regularly in executive sessions without inside directors, and conduct formal appraisals of the CEO. But have these changes resulted in more-effective boards?

Indeed, as measured by comparative financial data, our research shows that some of them have, and new ideas still largely in the proposal stage may lead to further progress. Looking ahead, greater concern for multiple stakeholders may some day have a major impact on board practices and structure (and thus effectiveness). Regardless of these actual and potential changes, we believe that boards must have three key ingredients in order to be effective: knowledgeable members, up-to-date company information and the power to counterbalance the CEO. (For a complete look at the research and data that support our conclusions, see the book “Corporate Boards: New Strategies for Adding Value at the Top,” by Conger, Lawler and Finegold.) As board practices continue to evolve, these ingredients will remain central to the recipe for effectiveness.

The Sources of Effectiveness

The first step in creating a board that adds value to the company is selecting directors who have breadth and depth of knowledge about the industry and its competitive challenges. In a world dominated by complex technologies and rapidly shifting markets, that is crucial. It’s important to recognize, too, that the right knowledge has to be a key focus in selecting directors; companies don’t have the time to develop it in their directors. The most that an organization can do is schedule a week to introduce a new director to the company and, if necessary, send the person to a business school seminar for new board members; companies don’t have the training resources and directors don’t have the time to go beyond that. As a practical measure, companies seeking the right mix of members should carefully develop a matrix that matches people against knowledge needs and should then recruit aggressively to fill any gaps — in international experience, say, or in the understanding of a cutting-edge technology.

Once a board has been put together like a carefully selected tool kit, it is necessary to provide members with the right company information — they should have easy access to abroad set of leading indicators of organizational effectiveness. The more-effective boards in our research understood company strategy and financials; they knew how competitors were performing and were aware of potential future competitors and new entrants to the industry. They also benchmarked their company against top performers in comparable industries. Needless to say, it’s a taxing job for company directors to keep on top of all this information, but the rise of company intranets has made it much easier for far-flung board members to find what they need to know.

A well-informed board is close to useless if it can’t act. Effective boards have the power to oppose and challenge the CEO; in our research, such power was the single board attribute with the largest direct impact on company financial performance. To be more specific, boards that conducted a formal evaluation ofthe CEO, that were made up primarily of outsiders (10 out of 12 directors, say), and that had clear control over the nomination of new directors and the CEO’s successor had significantly higher returns on assets, sales and investment than those that did not. We are convinced that these elements of board power will remain essential to effective boards for the foreseeable future.

The Next Board

Although boards with the right amounts of knowledge, information and power can help companies negotiate the turbulence of the modern world, the perfect board has yet to be invented. Some companies are pushing out the boundaries of accepted practice. For example, while board evaluation of the CEO is becoming increasingly common, some boards are turning the spotlight on themselves (and even on individual directors). One way to do this is through self-evaluation, which can result in some easily made improvements as directors find they have common concerns that no one has wanted to raise publicly. Another way is by working with outsiders who can conduct interviews with directors or carry out 360-degree feedback that involves vendors, customers and investors.

Other ideas being tested in some companies include the use of nonexecutive chairs and lead directors to serve as an even greater counterweight to the CEO’s authority; limiting the number of boards a director can serve on (an idea that makesa great deal of sense, given the increasing amount of workexpected of board members); and adding foreign nationals to U.S. boards. Apart from potential cultural reasons for the absence of foreigners, distance has made it difficult to ask busy people to attend eight or nine meetings a year. Videoconferencing may put an end to this problem and allow boards to take on a truly multinational character.

The Stakeholder Challenge

Most of the major corporate governance initiatives aim to create boards that are more responsive to shareholders. But that perspective may be too narrow in the 21st century. The decisions and actions of a board may need to be judged on criteria that go beyond financial performance to include their impact on employees, suppliers, customers and communities. These stakeholders, after all, are increasingly seen as investors of one kind or another in the success of a company.

There is little if any support for a stakeholder approach at the top of U.S. companies today, and even European businesses have become more and more intrigued by the U.S. model. But companies may start to change their thinking even while rejecting the social argument that businesses exist to serve the broader society and not just their shareholders. The adoption of a stakeholder perspective would be consistent with important trends that are unfolding in the global business environment, especially those concerned with knowledgeworkers and supplier relationships.

If knowledge workers, for example, are a company’s primary capital, it may want to have direct access to their thinking. In a networked world, the same view applies to suppliersand customers. If they are indeed the important determinants of a company’s success, as everyone says they are in principle, then putting their expertise on the board ought to make the business more effective. And companies that are heavily regulated or subject to interest group pressure may want to consider adding directors from the government or pressure groups. These are fairly radical suggestions, and their implementation is not on the near horizon; the important thing to note is that they are supported by a business case, not just an appeal to social conscience, however important that may be.

Strategic Advisers

Companies that adopt the right board practices can realize a payoff in financial performance — the results of our research are clear on this. The adoption of the right board practices, however, is a necessary but not sufficient condition for having an effective board. They can, for example, be adopted for the wrong reasons. One CEO told us that he adopted certain practices because investors were impressed by them, and he believed that by adopting them his company’s stock price would rise. We suspect that other CEOs share this view. We also believe it is possible for a board to be effective without adopting all or even most ofthe new practices we have outlined here if it has a positive relationship with an effective CEO. The adoption of the right practices, however, increases the likelihood o feffectiveness; they can also be an insurance policy that preserves good governance when the leadership changes or in times of crisis.

In the span of a few decades, many U.S. corporate boards have gone from being relatively ineffectual pawns that could be easily controlled by management to becoming strategic resources that can provide advice and exercise independent oversight to ensure that firms stay focused on creating value. It is important not to overestimate what boards can achieve — they remain, by necessity, relatively removed from the day-to-day running of a business. Still, our analysis of high-performance boards strongly suggests that it is both feasible and beneficial for boards to build their capabilities by adopting new governance practices that increase their information, knowledge and power so that they can perform more effectively as strategic advisers and overseers of corporate performance.