Closing the Governance Gap in Joint Ventures

Companies are entering into joint ventures at an unprecedented rate. Across a wide range of industries, firms are using JVs and other partnerships as a way to make their businesses more sustainable and to gain access to capabilities, capital, and scale. Pepsico recently entered into a joint venture with Beyond Meat to develop and market sustainable protein-based snacks and beverages. General Motors has entered into more than 10 JVs in the past two years alone, including one with Plug Power to develop hydrogen fuel cells for light commercial vehicles. Globally, the number of material new JVs has more than doubled in the past two years, outstripping merger and acquisition activity during the same period.1

While JVs make meaningful contributions to corporate revenue and can enable new growth strategies, they also increase their shareholders’ risk exposure, often in ways that are hard to manage; this is especially true of ventures that are not majority owned or controlled. Over the years, joint ventures have been at the center of numerous corporate scandals, missteps, and catastrophes, including bribery schemes, antitrust violations, environmental incidents, worker and public health and safety breaches, and human rights violations.2 And as large global companies seek new capabilities through JVs, many choose nontraditional partners — industry disrupters, venture-backed startups, sovereign wealth funds, and state-owned enterprises in less-developed countries — which makes managing risk via good governance even trickier and more important.

However, despite joint ventures’ importance and risks, the governance of most is not good — and executives serving on their boards recognize it. When we asked JV board directors and CEOs from more than 250 JVs about the governance of the joint ventures they oversee and run, less than 10% viewed them as high performing, while almost half saw them as weak. More tellingly, when we closely examined the underlying policies and practices of governance in large joint ventures — including the tenure, time commitment, independence, and training of directors, as well as board preparation and the management of conflicts of interest and competitively sensitive information — we saw significant gaps. Our in-depth investigation of more than 100 joint ventures around the world shows that the median JV has in place barely 50% of the basic practices of good governance.

Good governance matters in JVs. We see a clear statistical correlation between good governance and the medium-term financial and strategic performance of JVs. For instance, joint ventures with top-quartile governance scores are four times as likely to be exceeding the owners’ financial and strategic expectations compared with JVs with bottom-quartile governance scores. Good governance allows joint ventures to quickly spot and respond to risks; access synergies with their owner companies; and grow, restructure, and otherwise evolve in a manner that reflects the needs of the owners and the changing demands of the market. JVs with weak governance are more likely to stagnate and suffer from swings between excessive overreach and alarming lapses in oversight. And the consequences of good governance will only grow as companies come under more pressure from investors, regulators, and advocacy groups to elevate environmental, social, and governance performance, including in their joint ventures.

Governance Challenges in JVs

Governance in joint ventures is pound for pound more challenging than governance in public companies. To understand the differences, it is useful to compare JV and public company governance on a few dimensions.

For starters, consider the number of shareholders and their goals. In public companies, the shareholders number in the thousands and are united only in maximizing dividends and share price and, perhaps, making a positive contribution to society. In JVs, there are usually just two to four shareholders, who are corporations and often competitors. In JVs, shareholders almost always have their own strategies and objectives that go beyond maximizing the entity’s profits and valuation, and they feel entitled to see these specific objectives reflected directly in the direction of the business. For instance, companies often enter into JVs to build capabilities and learn, or as a way to gain a foothold in a market. These participants’ individual strategies, as well as their investment and risk appetites, often change over time and are prone to misalignment. Therefore, at its core, JV governance is about not only overseeing the business but also bridging shareholders prone to divergence.

Or consider the commercial relationship between the shareholders and the company. In public companies, shareholders almost never have material business relationships with the enterprise. Yes, a shareholder of Apple or Toyota may buy the company’s products, but they are never a material customer, supplier, or service provider to it. This is not the case in many JVs. In joint ventures, it is quite common for shareholders to be major suppliers, customers, or service providers of the JV; receive licensing or other fees from the JV; or secure other synergies with the JV. Because these commercial flows and operational interfaces are rarely symmetrical and not always fully transparent among the shareholders, they create additional governance challenges.

Airbus, the global passenger aircraft maker, illustrates the problems such challenges create. Structured as a joint venture for its first quarter century, its four European aerospace company owners each designed and manufactured major component systems, which they sold under a complex transfer pricing arrangement to the JV. Airbus then performed final assembly, marketing, and sales. These complex commercial arrangements with opaque costs reportedly meant that no one knew whether the JV was actually profitable. Airbus’s annual pricing meeting was famously referred to as the Liar’s Club, with each partner trying to maximize profits on components sold to the JV while trying to expose the pricing bluffs and sleights of hand from other partners.

A third dimension is to look at the composition of boards. In public companies, the directors are collectively elected by the shareholders and are either independent nonexecutives or other members of management. In all instances, they are structurally positioned to represent the interests of the shareholders as a whole. This is not exactly the case in JVs. In JVs, directors are nominated by — and almost always current executives of — an individual shareholder. As such, they must invariably balance their fiduciary duties to the JV with their loyalty to their employer.

Laying the Foundation for Great JV Governance

Having worked with hundreds of JVs, we’ve come to realize that the most essential enabler of governance has nothing to do with boards, committees, and other visible structures and mechanics of governance. Rather, it comes from clarity on the JV’s purpose and operating model. Without it, the JV owners and board directors will be unable to do the work of governing the company and will constantly be dragged down by partner skirmishes and mistrust.

It seems obvious that the shareholders should agree on such things before closing the deal. After all, such basic parameters affect the strategy and business plan, funding model, management selection, organizational design, role of the board, needed director skills, and so on. But often, shareholders bring differing views that are not reconciled during negotiations.

Consider a 50/50 basic materials JV in the United Arab Emirates that was building a multibillion-dollar production facility. Three years into its life, just as the production facility was coming online, it became clear that one of the shareholders saw the JV as a true business with its own brand, independent management team, and sales and marketing function, with the intent of maximizing profits and growth. In contrast, directors from the other shareholder saw the JV as simply a production asset that would sell its output through the shareholders, not have its own brand, and continue to leverage shared services and technology from that one shareholder. While the directors and board meetings were cordial, below the surface the governance of the JV was highly dysfunctional. The CEO hired to oversee the startup phase was caught in the middle and was constantly whipsawed by his directors as he tried to get the JV going. This delayed hiring and marketing decisions and prevented a cohesive organizational culture from emerging.

The JV described above is not an isolated example. Time and again, we have seen governance fail because the partners lacked a shared view of the JV’s purpose and operating model. To avoid this trap, shareholders must establish agreement on the following two questions:

How independent will the JV be, and how might this change over time? Some prominent JVs, including Dow Corning and Chevron Phillips Chemical, evolved to become highly independent businesses, while others, such as Orbitz and Mastercard, went even further and became publicly listed. But in most instances, joint ventures are quite interdependent with their owners from the start and maintain some dependency throughout their lives. Defining what this will look like, including what roles each partner will play in the business, is essential to building a winning JV business and a governance model that can function effectively.

What is the JV’s economic model? Not all JVs are structured as true P&L entities. Rather, it may be more appropriate that the joint venture be a cost center or a managed margin business where, for example, the owners receive privileged pricing as customers of the JV. It is also important to agree on whether the JV is intended to be a business with its own strategy and growth agenda or an asset with a scope limited to operating, say, a manufacturing plant. There are no universal answers to such questions. What is essential is that the shareholders have a shared and specific view on the answers for their JV.

Alignment on the answers to those questions is the foundation of a JV operating model framework — a set of jointly agreed upon principles that includes a well-thought-out approach to governance (more on that below). It should also provide a fairly detailed road map for what specific roles the partners will play in the JV, including defining whether there are certain markets, assets, functions, or processes where one partner will take a lead role or provide support — and how this will change over time.

The Five Pillars of JV Governance

Once the partners are aligned on the venture’s purpose and operating model, five things are key to getting the mechanics of JV governance right. Each reflects unique elements of the shared ownership structure of JVs and are additive to the general good governance practices found in public or private companies, many of which also apply to joint ventures.

Board posture. It is self-evident that any board should be involved in reviewing and approving the company’s strategy, major investments, annual plans and budgets, financial and operating performance, management compensation, succession planning, and other matters. In JVs, however, it is far from obvious how involved the board should be. For a corporate board, the answer is clear: Delegate to management, and play an active role in reviewing, challenging, and approving the plans developed by management. For public companies, regulators and other market bodies help define standard expectations for a board’s role. But for JVs, such generally accepted norms do not exist. In fact, less than 10% of JV boards act like a corporate board and give the JV CEO the high levels of delegated authority and autonomy typical for a corporate CEO.

Indeed, it is common for individual directors and other shareholder executives to have highly divergent views on the right posture. For example, in one power industry JV, the CEO of one shareholder got in the habit of calling the JV CEO weekly to discuss electricity prices, updates on contractor activities and schedules, and granular operating metrics. There was no bad intention; the shareholder CEO was deeply familiar with the industry and interested in what was happening with the JV, which was strategically material to his company. The parent CEO wasn’t the only shareholder executive who was engaging with JV management outside the board. Functional experts, including those from finance, compliance, and marketing, routinely sought information, made requests, and offered advice to functional leaders in the JV. This level of involvement was confusing to the JV management team, which was spending 30% to 40% of its time addressing shareholder requests.

A better approach is for a JV board to start with a principles-based discussion on what type of board it wants to be. It can be helpful to think about possible board models on a continuum of engagement — from a hands-off “corporate-style board” to a highly interventionist “board of managers,” with a few models in between. Then, an explicit conversation with management about the JV board’s posture will make it clear what to expect.

Once the board is directionally aligned on where it would like to be and how this might evolve over time, it can be valuable to go deeper. The board could identify eight to 12 core governance processes — such as strategy setting, capital allocation, financial management, operations, and pricing — and agree on the appropriate level of board and shareholder involvement in each. (See “Clarifying the JV Board’s Posture.”) As a general rule, we believe that the shareholder companies, operating through the JV board, should play an activist role in three governance areas: capital allocation, risk management, and performance management. Involvement in these areas is central to ensuring sufficient performance pressure and protecting shareholder interests. On the other hand, the parents should work to limit their interventions in more operational processes, such as staffing, pricing, procurement, and product development. Distance on these dimensions gives the JV management team the freedom to act as entrepreneurial managers.

A JV board’s posture might change over time. For example, as a JV starts up, the management team might be thin, and it might be necessary for the board to play a much more hands-on role. As the JV management team matures and the business stabilizes, JV boards often choose to reduce their level of involvement. What’s critical is that the board discusses and agrees on how directors, committee members, and other parts of the shareholder organizations will collectively and individually interact with management. They should further translate this into reporting and audit processes, delegations of authority, and the scope and composition of committees, among other items.

Board composition. Boards are only as good as the people on them. In JVs, board composition introduces a number of unique features. For starters, it is often valuable to have each shareholder designate a lead director — a first among equals of its board representatives. A lead director will spend relatively more time on the JV than fellow directors and will work with the JV CEO and the other lead director(s) between board meetings. Lead directors serve as a sounding board to the CEO, help to identify and address issues, and ensure that their company is providing needed support to the JV. When no directors take on such a role, JV boards tend to lack a sense of personal accountability, as directors are busy executives with their attention drawn elsewhere. A number of leading companies — including Dow and Australian mining giant BHP — require each JV board to have a lead director from their company. And companies have found that when these directors hold integrated accountability within their companies for the strategy, performance, and risks of the JV, it drives ownership of problems and performance.

Another best practice in JVs is to limit the number of nondirectors in board meetings. The number of formal directors on JV boards tends to be fairly small, with JV boards having a median of six official directors. But JV boards often have far too many people in the room, including shareholder functional experts, nonboard committee members, and the full management team, which can swell the number of people in the boardroom to 15 or 20, or more. When JV board meetings are filled with backbenchers, board discussions are less open and probing, more prone to grandstanding, and less inclined toward compromise. Perhaps most important, such expanded attendance tends to undermine the board’s ability to build a collective sense of itself.

Also key is promoting the need for continuity and time commitments among directors. A typical JV board director spends just 10 to 15 days per year in their capacity as a director and serves on the board for just 30 months. This is far less than what is needed — and less than the 30 to 35 days per year and 8-to-10-year tenure of public company directors. When selecting directors for a joint venture, shareholder companies need to make sure that those who are nominated actually have the time to fulfill their roles. They should also consider ways to reduce turnover — for instance, by not linking the role on the board to a specific position in the parent company or by selecting more senior executives who are less likely to rotate jobs every few years.

JV boards also have a significant opportunity to increase gender diversity. Our data shows that only 10% of JV board directors are women — with the oil and gas, mining, and chemical industries below 5%. A failure to appoint more women to JV boards potentially harms the performance of joint ventures, increases risks, and contributes to broader gender inequity in companies, given that JV board roles can be powerful credentials for promotions to senior leadership positions.

Board time allocation and workings. JV boards tend to do a good job — and spend a substantial amount of time — managing the current financial and operating performance of the JV. This is hardly surprising, given that most JV directors are finance or operating executives within their parent companies. Conversely, JV boards tend to not spend enough time on other areas — notably, strategy and talent, where the typical JV board spends a median of just 15% and 10% of its time, respectively.

JV boards are also prone to spending far too much time listening to a parade of management presentations and not enough time discussing critical issues, soliciting the input of directors, and building consensus. Because JV directors are busy shareholder executives, many use board meetings to get educated on the issues. This is not a good use of the board’s precious time. As one senior JV board director told the CEO, “As directors, we owe it to you to have read and absorbed the pre-reading, and you owe it to us to not present it to us.”

JV boards should discuss how they want to spend their time. It’s easy to define and track how much time is spent on different topics or whether time is spent in presentation versus discussion mode. The board of Prime Therapeutics — a JV established by 19 Blue Cross and Blue Shield health plans, subsidiaries, and affiliates of those plans, and the fifth-largest pharmacy benefits manager in the United States — has taken this one step further. During a period in which it was trying to elevate its governance, it tagged each board agenda item based on its purposes — such as educating the board, testing ideas and soliciting advice, or gaining approval — and used it as a tool after board meetings to reflect on whether the goal was achieved.

Board committees. In corporate boards, the purpose and use of committees is well established. Committees are generally helpful to the workings of the board, as they allow a subset of directors to review and work out the details in areas such as finance, audit, and compensation, and to make recommendations to the full board.

In JVs, committees can also be extremely useful; they allow the board to make better use of its time and leverage the expertise of committee members. But in JVs, committees can also create real problems and dysfunction. In JVs, committees tend to proliferate and cover numerous individual functions of the business, such as purchasing, operations, safety, regulatory affairs, and marketing. They also tend to be composed of shareholder functional experts who do not serve on the JV’s board of directors. Left unmanaged, committees can seriously undermine management accountability. At an extreme, a committee can trigger an insatiable appetite for information among shareholder functional organizations. More than a few JV CEOs lament the double-jeopardy situation they have landed in, when every decision has to be vetted by a committee before being taken to the board. In the worst situations, committees with decision authority that do not include board members can subvert the primacy of the board-CEO relationship, the principle of which is that the JV CEO should report to, and only to, the JV board.

It doesn’t have to be this way. In our experience, effective JV boards will limit the number of committees and legislate that each committee have at least one board director on it, ideally as chair, to help preserve the board-CEO relationship. And, to avoid confusion, effective JV boards sharply define each committee’s scope, composition, and powers in a charter that is endorsed by the full board and shared with all committee members.

Internal shareholder governance. Governance in JVs is not just about the board, committees, and management. The most sophisticated shareholder companies think deliberately about how they organize themselves internally to enable good governance. The work of internal shareholder governance includes such critical activities as supporting the company’s JV board directors, managing internal approvals and audits, coordinating services and support to the JV, and ensuring that the venture is receiving the needed expertise and other help from the company to succeed.

There are different ways to configure these internal governance teams. For larger JVs, it often makes sense to designate a JV manager — that is, someone 50% to 100% dedicated to the JV who reports to the lead director and manages the integrated day-to-day relationship with the venture. It also can be quite helpful to designate functional focal points — that is, named individuals from finance and planning, marketing, operations, safety, legal and compliance, and sustainability who are part of the shareholder governance team and serve as the lead for that function in its interactions with the JV.

The size of this shareholder governance team should reflect the materiality and risks of the JV, as well as the complexity of the shareholder company’s operational interactions with it. The oil and gas industry tends to have quite robust shareholder governance teams in place. With larger JVs that are not operated by the shareholder, such governance teams tend to include five to seven full-time equivalents (FTEs). Other industries tend to underinvest in these teams. For instance, large mining companies dedicate a team consisting of a median of 2.3 FTEs to oversee their largest noncontrolled JVs, which leaves little bandwidth available to influence partners and JV management teams to better manage environmental issues, human rights, and community engagement. Companies in the chemical, industrial, aerospace and defense, automotive, and power sectors have even smaller shareholder governance teams.

For decades, the governance of joint ventures has escaped the close scrutiny of corporate boards, leadership teams, regulators, and external stakeholders. To be fair, some JVs have been extremely well governed — likely because they were lucky enough to have a few skilled and committed directors who understood the general principles of good governance and how to marry that with the unique aspects of JVs. Most JVs have mediocre governance — and, in too many cases, suffer from dysfunctional and ineffective boards and owners.

The pressures are building for this to change as regulators, investors, and advocacy groups are starting to ask tougher questions about a company’s joint ventures. Companies will need to respond.