The CEO and the Board: Are outcomes improving?

Episode #248 The CEO and the Board: Are outcomes improving?

BOARD PURPOSE AND COMPOSITION

I just want to take a quick fly over the top of a previous episode, to make sure we’re all on the same page regarding the board / management relationship. This was Ep.54: Managing the Board. As you can tell from the episode number, it’s been a lot of years since I’ve had a look at the dynamics of the board relationship. And arguably, things have changed quite a bit since then.

The pandemic seemed to accelerate a range of social trends, and it gave us pause to think more holistically about what we’re doing.

What hasn’t changed is the role of the board, which is:

• To appoint the CEO;

• To provide high level oversight of corporate activities and performance; and

• To oversee the management team as they execute the day-to-day operations of the company.

As part of the oversight function, the board will typically provide direction on the big ticket items of risk, strategy, and corporate governance.

Every country has different rules for the composition and structure of boards, but the principles are generally the same:

In Europe, companies frequently use a two board model. They have a management board and a supervisory board that sits over the top.

Countries like the US, UK, and Australia typically have a single board, although even here there are some stark differences in approach.

Boards are generally comprised of different types of directors:

• There are non-executive directors who are typically engaged on a part-time basis with no involvement in the management of the business (or, at least they shouldn’t have).

• These are further broken down into classifications of independent and non-independent directors.

• Then there are executive directors who both sit on the board of the company and they’re also part of the management team.

• Of course, the popular title of managing director is a designation for a CEO or president who’s also a member of the board.

• In US businesses, it’s common to have an executive chair. This person is both the top executive on the management team, and the chairperson responsible for managing the board.

From where I sit, the Executive Chair model would seem to dilute the independence of the board. When the CEO answers only to himself (and, of course, the fellow directors that he largely controls), it looks a little bit too much like the fox is in the hen house.

In many countries, publicly listed companies have a legal requirement for a minimum percentage of independent directors. But whatever the type, composition, and structure of your board, its primary function is to supervise and provide oversight of management on behalf of the owners. It’s not intended that the board gets into the day-to-day operations of the business.

gender diversity on boards

I just want to make one quick comment on gender diversity on boards. This has been a focal point for many years now, and a range of jurisdictions have enacted non-binding targets for female representation. Some have even gone further and put laws in place.

The state of California has passed a law dictating that publicly traded companies must have a minimum representation of women on their boards. You’d think this makes a whole lot of good sense, right? But interestingly, a study from the Harvard Law School Forum on Corporate Governance found that despite the unquestionable benefits of having greater board diversity, it was likely that the law enacted in California will have a negative impact on shareholder returns. This is due to supply-side constraints in the director market. Go figure, right!?

But this just demonstrates a couple of principles we should already know. The first is that historical problems of this nature are never solved easily–but of course it doesn’t mean we should stop trying. The second is that you shouldn’t take anything on face value. Just because it makes sense, and it seems like it should be true, doesn’t mean it is. So always dig just a little bit deeper.

Another evolving reality is that boards are increasingly seen as the ultimate point of accountability. Corporate law reflects this, with personal liability for directors in the event of company failures being the norm now in many countries.

But interestingly, I still take the view that boards have limited control over what really goes on. I know many professional directors are going to disagree with me on this: but that would most likely be a reflection of ego rather than reality…

Just think about this for a minute. Directors spend very little time, if any, in the business. I’ve seen directors come onto a major board in an industry they have no idea about, and they don’t even bother to visit the company’s operating sites to work out how it runs. How can they possibly understand the business? How can they know what the key value drivers are?

For many, a board seat is about status and power, which isn’t particularly conducive to good governance, right? And to further dilute their effectiveness, the only lens they can see the business through is the lens that management presents: board papers, meetings, and eventually results (which is a rather untimely lag indicator).

I stated clearly in Ep.54 (and I’m not sure my view has changed much since then), that the board really only has one defense against being blindsided: a CEO who is open and transparent, who doesn’t do coverups, who doesn’t present a view of the business through rose-colored glasses, and who isn’t afraid to communicate the unvarnished truth in the boardroom.

I’ve seen what can happen to even the smartest, most engaged and diligent directors when they’re let down by a disingenuous CEO. And no matter how good they are, they can’t possibly control or manage a situation that they have no visibility of.

Now, I know this sounds a little pessimistic and negative, but I genuinely believe that this is the nature of the relationship between the board and the management team. I was pretty fortunate to work for some outstanding chairmen. They managed to run a really tight ship even despite having some directors on the board who I would describe as ‘marginal, at best’; they managed to get the right balance between challenging and supporting the management team, which is not an easy balance to strike; they understood the line between management and governance and they didn’t cross it for the most part; and they kept the other directors under control, making sure that they observed the same standards.

If you’re a CEO, you need to be a good steward of your privileged position; be worthy of the trust that the board places in you and the management team; make sure they know what’s going on at all times (in material terms, of course, not the minutiae of the business); keep the board informed about your thinking; the progress of the team against agreed targets; and use your judgment  as to when to engage with the chair.

In Ep.54, I proposed eight rules of thumb for managing the board, from a CEO and a key management personnel perspective. So, it’s definitely worth tracking down the free downloadable that we produced. Remember, every board is different and provides its unique challenges.

WHAT’S CHANGING?

That view of the board I just presented was a pre-COVID view.

I recently came across a great interview that was done by an old mate of mine, Joseph Tesvic, who’s a senior partner with McKinsey, based in Sydney. The interviewee, Alison Watkins, is the real deal. She had a successful CEO career across multiple industry sectors, and she now sits on the boards of some of Australia’s top organizations: CSL, Wesfarmers, and the Reserve Bank, which is Australia’s equivalent of the Fed.

I just want to summarize some of Watkins’ comments and ultimately ask the question, “Is the Board / CEO relationship changing?”

A BROADER FOCUS

First of all, Watkins mentioned a move away from the narrow focus on financial results. Her view is that the previous board obsession with financial outcomes is now much broader, with a focus on reputation, risk, and sustainability. She says there’s now a healthier balance, and that the conversation is more multifaceted.

From my perspective, this might well be the case. If there’s one thing directors are fanatical about, it’s ensuring that their reputations remain intact, so they’re likely to reflect societal standards. We’ve seen much more commentary and focus in the last five years on a company’s social license to operate.

For example, regulations in Australia on executive remuneration, and the implications this has for directors’ reputations has curbed some of the worst cases of corporate excess. And with an ever-increasing focus from customers on what goes on inside a company, it’s only natural that good governance and financial results become more intertwined.

THE DEMISE OF THE OMNIPOTENT CEO?

Watkins also made an intriguing comment about the fact that she believes the days of the all-powerful CEO are over. She said that she’s seeing a much more collaborative approach from CEOs. They’re no longer bombastic and egotistical. Apparently, they now just want to be part of the team.

Well, it’s great to hear that, and I really hope that’s the case. But I’m not sure how much faith I’d put in this view. There’s still a massive problem with information asymmetry. CEOs have much greater access to information than their board, and this, in its own right, is likely to keep CEOs in the box seat. Now, I’m not sure that balance has shifted back to the board too much. If it had, we’d see less anecdotal evidence of CEO and management going off-piste.

Part of me thinks that human nature doesn’t fundamentally change. CEOs know they need to play a different game now, but they’re typically the smartest people in the room when it comes to optimizing their own position. Knowing how to manage the board relationship is a core skill, which I’m sure many CEOs have absolutely mastered, and they’ll be able to effectively move with the changing perceptions without ultimately ceding power back to the board.

Or maybe that’s a little too cynical?

A BETTER BALANCE OF SKILLS

Watkins points to a greater focus on balancing the range of skills that are present on a board, perhaps a more thoughtful approach to director appointments. This may well be the case.

She says there should be at least one or two former CEOs on any board, and of course it needs specialist skills in legal and finance. But then it depends on what else is required based on the specific context and the needs of the business.

It’s really good to hear the balance is coming back, and I think a certain level of experience should be mandatory. I’ve worked with directors who are technically capable but completely incapable of thinking at the level required to be a director on a board. Appointing people who are too junior or who haven’t had sufficient business experience is just dangerous.

If that’s the case, the board lacks the credibility it needs to have with management. And if the board doesn’t have management confidence, the CEO is much more likely to pursue his own agenda, and part ways from the board’s stated direction.

MORE FOCUS ON RISK

One comment that was incredibly encouraging is that Watkins is seeing a greater focus on risk management, in CEO and board interactions. It’s great to hear that increased discipline in risk management is emerging. I’ve watched this evolve, and it’s great to have someone like Alison Watkins citing it as a major shift in CEO Board relationships.

Risk is everything, and the sensible evaluation of risk at the board level is crucial. The board is ultimately responsible for setting a company’s risk tolerance and risk appetite parameters. So, it’s only fitting that the board interrogates this in respect of all major business activities. Understanding the key assumptions that underlie any risk, and being able to interpret risk-based scenarios is a core competency for every director.

BALANCING ORGANIZATIONAL OBJECTIVES

The final comment that I picked up on is that Watkins is seeing greater balance in organizational objectives. She points out, quite rightly, that you cannot ignore shareholder returns. Without shareholder funding, the business wouldn’t exist, so it would be negligent to ignore that fact. As CEO of Coca-Cola Amatil, Coke’s Australian subsidiary, Watkins said they managed to find a better balance. Of course, they had to produce the financial results–but they also thought a lot about societal issues: sugar, plastic and recycling, and carbon emissions.

It’s recognized widely now that companies who don’t pay attention to this are going to feel the negative repercussions in the markets they operate in. The Board / CEO relationship is where this has to change. As incentive systems become more holistically focused, it’s going to move management teams along the continuum. But unfortunately, the subjective and qualitative nature of some of the new focus areas make it easy for management to game the system for a financial free kick.

WITHOUT THE RIGHT CEO RESULTS WILL BE… UNPREDICTABLE

On the balance of things, I think there’s definitely been a shift in the Board / CEO relationship in the last five years. Societal standards are shifting, and the screws are tightening on directors with their personal liability and reputations being on the line more than ever. This is forcing the board to pay closer attention, so that it doesn’t become this week’s headline.

But by the same token, I can’t help but think that the information asymmetry and the lack of time spent in the business still makes it incredibly difficult for a board to exercise its governance duties effectively… especially if it doesn’t have the cooperation of a high integrity CEO.

So, whatever you do, if you’re sitting on a board, make sure you focus on the most critical success factor: the relationship with the CEO. If the CEO is open, transparent, and courageous, you’ll be able to build an incredibly effective governance structure around that relationship. If not, then the board is ultimately at the mercy of the management team.