Boards think they're doing a good job
By Keith B. Meyer

second Quarter 2008 49 Heidrick & StruggleS governance letter S ome 95 percent of directors rate their boards as either ef- fective or very effective overall. That was the finding of a re- cent study of board effective- ness conducted by Heidrick & Struggles in conjunction with the Center for Ef- fective Organizations at the University of Southern California’s Marshall School of Business. The study incorporated re- sponses from 768 directors, nearly 75 percent of whom are outside directors, at approximately 660 of the 2,000 largest publicly traded companies in the U.S. CEOs tell a different story. In our extensive work with boards, CEOs in informal conversations almost universally confide that they have at most one or two very effective directors who provide wise counsel, offer advice on key issues, and contribute both for- mally and informally to the direction of the company. A fortunate few CEOs say they have as many as three or four such directors. Roughly, then, only about 10-20 per- cent of directors are seen by CEOs as effective. Further, say CEOs, their top management team often regards work- ing with the board as a demotivating experience. The good news is that this disconnect is of relatively recent making; its causes are clear, and there are readily available remedies to repair it. Converging culprits A number of policies, practices, and phi- losophies have converged in recent years to create the current disparity between the views of boards and CEOs. Among the most prominent: • Differing Definitions of Success. In part, assessments of board effectiveness diverge so dramatically because CEOs and boards define success differently. CEOs say they want directors who don’t meddle in the day-to-day running of the business, offer a strategic sounding board for management, and bring to bear their wisdom and experience when the company encounters extraordinary circumstances such as hostile takeovers, shareholder activism, and significant business challenges. In short, they want independent directors who can help them make better, faster, and wiser de- cisions. Meanwhile, many directors define success in terms of committee work, fi- duciary responsibility, and keeping the company in compliance with legal, regu- latory, and other oversight requirements. In our study, they gave themselves high marks in many of these areas. Some 95 percent of respondents rated their mon- itoring of the company’s financial per- formance as effective or very effective; 92 percent said that their representation of the shareholders is effective or very effective, and 90 percent said that they were similarly effective at ensuring ethi- cal behavior. Ye t i n t h e s t r a t e g i c a n d a d v i s o r y areas that CEOs value, directors gave their boards much lower marks. For example, only 59 percent of the direc- tors responded favorably when asked to rate their boards’ effectiveness in shap- ing long-term strategy. Only 61 percent said that their boards were good at iden- tifying possible threats or opportunities critical to the future of the company. Less than two-thirds of directors report- ed that their boards are effective at one of their most important responsibilities: succession planning. Yet, the fact that 95 percent of the respondents rated their boards as effective overall clearly sug- gests that the strategic aspect of their performance weighs far less heavily in their definition of success. • A Hole in the Matrix. In the face of globalization, emerging markets, and changing public expectations, nominat- ing and governance committees have in recent years sought diversity of all kinds in new appointments to the board. They have understandably and laudably wel- comed new perspectives in terms of geography, nationality, industry experi- ence, and functional expertise. In doing so, they have created a matrix, literally or figuratively, within which they checked each of the diversity boxes as they were filled. But what is often missing in the matrix is a box for sound business judg- ment and diversity of thought. Certainly, Boards think they’re doing a good job … … but CEOs disagree. What directors can do to bridge that disconnect. By keith B. Meyer and robert S. rollo Keith B. Meyer is co-managing partner of the North American CEO Practice at Heidrick & Struggles, a provider of senior-level executive search and leadership consulting services (www.heidrick.com). Robert S. Rollo is a partner in the firm’s CEO & Board Practice. 50 directors & boards Heidrick & StruggleS governance letter they should continue to build boards that are diverse across many dimensions, but the advisory and strategic dimen- sions should also be given a prominent place in the mix. • The Changing Talent Pool. Almost invariably when we begin a board search, nominating and governance committees ask for a currently active CEO who has dealt with many of the same strategic challenges facing their company and who knows how to take an all-encom- passing view of a business — in other words, precisely the kind of thought- partner CEOs say they want. But as a re- sult of the good governance movement in recent years and increased pressure on CEOs to take direct responsibility for company performance and shoulder liability for financial reporting, far fewer sitting CEOs are willing to serve on out- side boards. Many companies now explicitly limit the number of boards their CEOs can join. In our 2006-2007 survey, we found that 54 percent of companies now en- force such limits, up from 23 percent in 2001. Forty percent have limits on the number of boards on which their out- side directors can serve, a major increase from just 3 percent in 2001. As a result, the pool of potential CEO/directors who might provide the big-picture advice CEOs seek has shrunk dramatically. • T h e L aw of Un i n te n d e d Co n s e- quences. Besides making the recruit- ment of CEO/directors more difficult, the good governance movement, with its institutional investor activism and regulator y reforms such as Sarbanes- Oxley (SOX), has had some additional unintended consequences. In the envi- ronment of the past several years, it’s not surprising that independent direc- tors would make compliance a prime measure of board success. Further, some boards work hard to get hig h marks from institutional investor ratings, rath- er than partnering with management to understand what is genuinely best for the business. As a result of increased shareholder activism, we also see a con- tinuum along which, at one end, some independent directors take the activists’ “full transparency” point of view, and, at the other end, directors who remain in a defensive crouch, counseling manage- ment to do nothing that is likely to stir up shareholders. Ideally, of course, all independent di- rectors, instead of being merely reactive when it comes to shareholders, would offer the CEO sound judgment based on the needs of the business, and thereby genuinely serve the shareholders. This is not to say that recent reforms weren’t necessary or should be rolled back; only that boards should be on guard against their unintended consequences and, as with all of the trends cited here, take practical steps to neutralize them. Healing the rift In our exp er ience, many new CEOs greatly underestimate the time that they will spend “managing” the board, and if the board is providing little in the way of genuine partnership the CEO’s time could be better spent concentrating on the real needs of the business. In fact, the inability in such situations to balance managing the board with managing the business is often at the root of CEO ten- ures getting cut short. Such outcomes are in no one’s interest — not those of the CEO, the board, or the shareholders. Boards and CEOs should therefore do all they can to make sure that the board provides the kind of support CEOs need so that everyone wins. They can do so by adopting the fol- lowing simple but effective steps: 1. Make “advisory temperament” one of the job specs for new board mem- bers. In searching for new board mem- bers, the nominating committee should explicitly attempt to determine whether a c a n d i d a te i s b o t h i n d e p e n d e n t o f mind and simultaneously inclined to be a mentor, adviser, and sounding board. At one extreme, some candidates might wish to usurp the CEO’s prerogatives, acting in effect as an additional CEO. At the other extreme, some candidates may be too passive, simply going along with the majority and offering little counsel to the CEO. As a practical matter, the advi- sory temperament of a candidate can be assessed through references and through personal interviews, both of which can uncover potential chair warmers, candi- dates who consciously or unconsciously want to run the company, and candi- dates who have the temperament to be of real help to the CEO. 2. Collaborate closely with the CEO on setting the board meeting agenda. The board cannot support the CEO if the board meeting doesn’t address the issues that the CEO regards as critical to the business. In setting the agenda, where the chair and CEO roles are split, the board should make sure those issues get a prominent place on the agenda and get sufficient “air time” during the meet- ing. By carefully creating the agenda together, the chair and CEO can more closely align the flow of discussion with the CEO’s need for meaningful feedback and review of management’s initiatives and activities. Also, if the chair can re- sponsibly push the “recurring” board responsibilities into committee agendas, more time can be freed up for other top- ics at the board meeting. Many new CEOs greatly under- estimate the time that they will spend ‘managing’ the board. — Keith Meyer second Quarter 2008 51 Heidrick & StruggleS governance letter 3. Make the results of executive ses- sions useful to the CEO. Often, follow- ing an executive session of the board, the results are communicated to the CEO in a brief conversation unaccompanied by any practical steps for achieving whatev- er conclusion was reached behind closed doors. CEOs receive what amounts to a to-do list on top of whatever to-do list emerges from full board meetings. In the most extreme cases, executive ses- sions function almost as a board within the board, obliging the CEO to respond to two boards at once. Although executive sessions are re- quired by Sarbanes-Oxley and the New York Stock Exchange, the intent is to im- prove governance, not create competing structures. Better governance means in- tegrating the work from executive ses- sions with the work of the full board and with management. The lead director or nonexecutive chair who presides over executive sessions should therefore de- velop with the CEO a formal, detailed process that not only communicates the w ishes of the nonexecutive directors clearly, but also provides the means by which the CEO might fulfill or respond to them. 4. Expand b o ard assessment and feedback. Providing actionable feedback from executive sessions is only a small part of what should be a more all-en- compassing feedback process between board members and the CEO and the leadership team. Almost all boards — 99 percent in our study — have a formal process for evaluating the CEO’s perfor- mance, and 98 percent have a process for evaluating the board. However, few have mechanisms for explicitly evaluating how the board interacts with the CEO and the leadership team. Board members need feedback not only about how well they do their com- mittee work and the like, but how much they genuinely help the CEO and lead- ership team advance the interests of the company. Board assessments should include candid feedback from the CEO about the effectiveness of the board in terms of the CEO’s definition of success. The head of the governance committee should meet regularly with the CEO to solicit the CEO’s feedback about the per- formance of the board. 5. Refine the role of the lead director or nonexecutive chair. Previously in this space, we discussed at length the role of the lead director (“A Fine Balance: What Makes an Effective Lead Direc- tor,” Randy Jayne and Robert S. Rollo, First Quarter 2007). As we wrote then: “ The lead director shouldn’t confuse real independence with mere contrari- anism. True independence requires the kind of psychological security that is unthreatened by disagreement and ac- knowledges the integrity and contribu- tions of others, on both the board and the management team. In that spirit, the lead director must forge a collaborative relationship with the CEO that is based solely on the good of the company and its stakeholders.” This role of lead director (or nonex- ecutive chair) is difficult to get right, and its breakdown is often the chief cause of board ineffectiveness from the CEO’s point of view. The goal should be to help the CEO succeed, not merely to act as sheriff or alternate CEO. Consider the case of a leading services company whose board, after a series of confrontations and serious disagree- ments with the chairman/CEO, decided to remove him and split the role between a nonexecutive chair and a new CEO, who was promoted from within. Under the circumstances, the new chair could have understandably kept the CEO on a tight leash and become deeply involved in the day-to-day affairs of the company. Instead, the chair announced his inten- tion to be supportive of the new CEO in every way possible, and he followed up with concrete actions. He established oversight relations between the board and CEO that included significant CEO feedback about the board’s — and the chair’s — performance. The chair also designated individual directors to insu- late the CEO from such distractions as activist shareholders and the constant press intrusions that resulted from the company’s highly public troubles. The chair’s deter mination to help the CEO succeed in the area that really counts — superior quarterly results for shareholders — freed the CEO from spending inordinate amounts of time managing the board. Hastening the transition As we’ve said, the disconnect between boards and CEOs in the assessment of board effectiveness arose at this particu- lar time in history as a result of clearly identifiable conditions. It will pass into history for equally identifiable reasons, such as boards moving beyond the ini- tial defensiveness that SOX provoked or more companies learning how to cope with the changed talent pool of board candidates. In the meantime, we find ourselves in a period of transition between today’s new-model board and its full effective- ness from all points of view. Boards and CEOs who recognize the gap and take concrete steps to bridge it can greatly hasten that transition. ■ The authors can be contacted at kmeyer@ heidrick.com or rrollo@heidrick.com or by phone at 312-496-1345. Make ‘advisory temperament’ one of the job specs for new board members. — Robert Rollo
 


Issue: 
2008 Second Quarter

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