Inside the Boardroom

How Boards Really Work and the Coming Revolution in Corporate Governance

Richard Leblanc, James Gillies

• Publisher: Wiley
• Year: 2010
• ISBN:
  9780470739952
• Edition: 1
• Topic: Commerce
• Subtopic: Leadership

Distinguished governance experts offer cures for what ails our boards of directors

In light of corporate malfeasance in recent years, the governance of corporations has been receiving great attention from regulators, researchers, shareholders, and directors themselves. Based on Richard Leblanc's in-depth five-year study of 39 boards of directors of both for- and not-for-profit organizations, Building a Better Board goes behind the scenes to reveal the inner workings of boards of directors, including how they make decisions.

Recently chosen as one of Canada's "Top 40 Under 40"(TM), Dr Richard Leblanc is an award-winning teacher and researcher, certified management consultant, professional speaker, professor, lawyer and specialist on boards of directors. He can be reached at [email protected]. James Gillies, PhD (Toronto, Ontario, Canada), is Professor Emeritus at the Schulich School of Business, York University, where he serves as Chair of the Canada-Russia Corporate Governance Program.

CHAPTER 1

BOARDS OF DIRECTORS HAVE FAILED AND WE DON’T KNOW WHY

Directors are like parsley on fish—decorative but useless.

—Irving Olds, former Chair, Bethlehem Steel

The director walks a tightrope. His responsibility is to be supportive to management, but not a rubber stamp. He directs, but he does not manage. Legally he has the ultimate responsibility for both the formulation of strategy and its implementation, but as a practical matter he relies on the CEO. He and his fellow directors elected the CEO, but he may later have to remove him. He is responsible for the long-run health of the corporation but most of the information he receives on its performance relates to the short run. He has a legal responsibility to the shareholders, but he has a moral responsibility to the employees, customers, vendors and society as a whole. He is responsible for keeping the shareholders informed, but at the same time he should not disclose information that would be adverse to the company’s best interests. He has personal goals, as does the CEO. However, the director must ensure that neither his goals nor those of the CEO overshadow their obligations to the corporation and its goals.

—Charles A. Anderson and Robert N. Anthony, in The New Corporate Director

It was the best of times; it was the worst of times.

—Charles Dickens in A Tale of Two Cities

Few people buy shares in a company for the sake of buying shares. Rather they become shareholders in the expectation that the value of their shares will increase—that they will make money. When they entrust the use of their funds to the corporation, a legal entity governed by a board of directors, it is an act of trust on their part that the board will make decisions that will not only conserve their capital but also increase it. And, by taking it, a board of directors is committing itself to accepting the responsibility of using other people’s money in an intelligent, prudent, honest and successful manner.

Nothing is more important to the well-being of a corporation than its board of directors. The board, by law, has the responsibility for the overall performance of the business. It has the power to appoint the management of the enterprise, to delegate to it specific responsibilities and to oversee the strategic direction and the setting of long-term goals for the company. It is a self-governing body that has the power, within very few limits, to manage its own affairs. In short, the board, by law, is the decision-making body of the corporation. To the extent that the directors acting collectively as a board make wise decisions, the corporation will prosper; to the extent that the board does not, the corporation will stagnate or fail. Consequently, knowing how and why boards make decisions is fundamental to an understanding of why some corporations succeed and others do not.

And yet, in spite of the importance of board decision-making in the life and death of companies, little is known about how boards work. Almost nothing is known about the decision-making characteristics of individual board members, and even less is known about the manner in which individuals act together to arrive at board decisions, either in a crisis or in the normal course of business activity. In short, almost nothing is known about arguably the most important function of boards of directors—the way in which they make decisions.

IGNORANCE ISN’T BLISS

There are many reasons why companies succeed. Sometimes it is because the board of directors has selected extraordinarily good management; sometimes it is because of a technological advantage; sometimes it is because of extraordinary timing in the production of a particular product.

Similarly, there are many reasons why companies fail. Sometimes it is because of exogenous events that the board of directors did not foresee and over which they had no control. Occasionally it is because the board is badly advised or there is fraud that they don’t know about.¹ More often it is because they do not always insist on and/or participate in the development of effective strategies and astute activities that increase shareholder value. Indeed, unfortunately, many times it is because the board does not always effectively monitor the management of the enterprise, with the result that the owners lose money. And, all too often, a board monitors the activities of a company so poorly that the shareholders lose all their investment.

Boards of directors are not made up of stupid people. To the contrary, they often have as their members some of the brightest and best members of the community—men and women who have proven their capabilities in a variety of activities. Moreover, the tasks that directors are expected to perform are not only well-known, but under normal conditions are not overly onerous. And the motivation for directors to do well is great. Certainly no one joins a board of directors to help a company fail, or indeed does when the prospects of failure are expected to be substantial. Just the opposite: people join boards to assist in guiding an enterprise to success. And yet some boards make poor decisions that lead to disaster, whereas others make good decisions that lead to success.

But why is this so? Why do some boards choose brilliant chief executive officers while others do not? Why do some pick strategies that prove effective while others never seem to get things right? Why do some seem exceptionally able to calculate the risk involved in mergers and the advantages to be found in divestitures, whereas others engage in merger activities that never turn out well? Why do some boards seem continually to make wise decisions that lead to above average returns for the shareholders, whereas others never seem to be able to make any money?

ASKING THE RIGHT QUESTIONS

Unfortunately, no one knows the answer to the most important question about corporate governance—“How do boards of directors make decisions?” No one knows the factors that lead to good or bad decision-making. No one knows how directors work together to decide what should be done in the best interest of the corporation. No one knows the factors that lead to good decision-making by a board when good decisions are identified as improving shareholders’ value and stakeholders’ interests. And, most importantly, no one knows how boards should be selected to assure that their decision-making capabilities are maximized. In short, no one knows the characteristics of an effective board.

It is the thesis of this book that board decision-making is a function of the competencies and behavioural characteristics of individual directors and how they fit together. It is argued that improvement in board operations will not be achieved, as is so often contended, by the enactment of more regulations and laws governing the structure of boards; rather that it will come through the willingness of directors, managers, regulators, shareholders and corporate leaders to accept new and different, somewhat radical, criteria for the selection, appointment and evaluation of directors.

Coming out of the trials and tribulations associated with corporate governance during the first years of this century is evidence to support the proposition that there is momentum to adopt new approaches to the creation of boards. Whether the momentum is sufficient to bring about a true revolution in corporate governance in the twenty-first century depends, in the final analysis, on the number of “change agents” there are among directors and corporate leaders who are willing to make major changes in their own organizations-corporate boards.

THE “SUMMER OF FRAUD”

The early years of this century have not been a period of particular pleasure for North American corporations and the people responsible for their regulation and governance. To the contrary, it has been one of the most devastating periods in the modern history of corporate capitalism. Corporate malfeasance and individual scandals have rocked the capital markets and destroyed investors’ confidence and faith in many of the institutions that are fundamental to making the capitalist market system work. During the two-month period from May to June of 2002, referred to as the “summer of fraud” by James B. Comey, Deputy Attorney General of the United States,² the headings of major stories in the leading business magazines told the story.

Table 1.1

Headlines of Major Stories in Leading Business Magazines, May-June, 2002

• “Special Report: The Crisis in Corporate Governance,” Business Week, May 6, 2002.

• “How Corrupt Is Wall Street?” Business Week, May 13, 2002, 37.

• “Trouble in the Boardroom,” Fortune, May 13, 2002, 113.

• “Enron’s Demise Has Taken the Shine Off the Boardroom Table,” Financial Times, May 30, 2002, 14.

• “Tyco Board Is Criticized for Kozlowski Dealings,” Wall Street Journal, June 7, 2002, A5.

• “The Wickedness of Wall Street,” The Economist, June 8, 2002, 11.

• “SEC Wants CEOs, CFOs to Vouch For Reports, Disclose More, Sooner,” Investor’s Business Daily, June 13, 2002, A1.

• “Under the Board Talk: American Companies Need Stronger Independent Directors,” The Economist, June 15, 2002, 13-14.

• “Designed by Committee: How Can Company Boards Be Given More Spine?” Special Report on Corporate Governance, The Economist, June 15, 2002, 69.

• “The SEC’s Accounting Reforms Won’t Answer Investors’ Prayers … But Changes in the Boardroom Could Rebuild Trust,” Business Week, June 17, 2002, 28-29.

• “When Directors Join CEOs at the Trough,” Business Week, June 17, 2002, 57.

• “Venal Sins: Why the Bad Guys of the Boardroom Emerged en Masse,” Wall Street Journal, June 20, 2002, A1.

• “Restoring Trust in Corporate America: Business Must Lead the Way to Real Reform,” Business Week, June 24, 2002, 31.

• “System Failure: Corporate America, We Have a Crisis: 7 Ways to Restore Investor Confidence,” Fortune, June 24, 2002, 62-77.

• “WorldCom’s Travails Could Affect Its Directors,” Wall Street Journal, June 28, 2002, A9.

In a chart entitled “A Question of Accountability,” The New York Times³ listed examples of major American companies where there were “auditing lapses,” “the hiding of loans or losses,” “insider trading” and “inflating revenue.” It reads like a Who’s Who of North American business—Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, PricewaterhouseCoopers, Adelphia Communications, Enron, Kmart, PNC Financial Services Group, Tyco International, WorldCom, ImClone Systems, Computer Associates International, CMS Energy, Dynegy, Edison Schools, Global Crossing, Halliburton, Lucent Technologies, Network Associates, Qwest Communications International, Reliant Resources, Trump Hotels and Casino, Waste Management and Xerox. Canadian examples of corporate failures and scandals include Livent, BreX, YBM Magnex, Philips and, most recently, Hollinger.

And is there anyone who has not heard of the stock market adventures of Martha Stewart? And that some leading executives have gone to jail for fraudulent practices?

Even in the heady days of the “takeover movement” in the early 1990s, when such high-powered players as Ross Johnson and Michael Milken were in the headlines, there was never such attention paid to the corporate community and the organizations with which it is associated—investment bankers, accountants, lawyers, brokers, commercial banks and investment advisers.

By any definition, the attacks and reports have not been undeserved. The damages and losses to corporate stakeholders resulting from the above failures and abuses were widespread and incredibly damaging. Retirees, employees, shareholders, bondholders, creditors and suppliers lost upwards of tens of millions and in some cases billions of dollars as a consequence of mismanagement, accounting fraud, false reporting and totally misleading, if not downright dishonest, investment advice. The investments and pension plans of literally thousands of individuals and families were “wiped out” or essentially rendered worthless as a result of the breakdown in the institutions of capitalism. Given these scandals, it is not astonishing that the confidence the public once had in the fairness and honesty of the economic system has been significantly eroded. Nor is it surprising in the wake of such activities that, in the early years of this century, the American public began to be less willing to invest in much lauded American companies to the extent they had in the late 1990s.

CORPORATE ACCOUNTABILITY GOES CENTRE STAGE

Naturally, as the concern for “corporate accountability” gave way to questions about “corporate responsibility” and finally “corporate corruption,” there was strong political reaction. In July 2002, the President of the United States, George W. Bush, delivered a major speech—a speech billed as important as a State of the Union address—on corporate responsibility. In this address, he outlined proposals for imposing strict discipline and punishment on corporate wrongdoers, and reiterated his administration’s support for corporate governance reforms. He pledged a strengthening of the Securities and Exchange Commission (SEC) and endorsed the new listing proposals being advanced by the New York Stock Exchange (NYSE). Not to be outdone, in the same month, the United States House of Representatives and the United States Senate overwhelmingly passed H.R. 3763. Widely known as the “Sarbanes-Oxley Act of 2002,” this legislation called for broad new regulations, described as the most far-reaching in over seventy years, affecting issuers of publicly traded securities, corporate directors and independent advisers such as auditors and lawyers. The Act was signed by the President and enacted into law on July 30, 2002.

Unfortunately, no one knows whether the Sarbanes-Oxley legislation will do much to improve corporate governance in America, other than increase the costs of operating governments and corporations. According to law, the major responsibility for the operations of corporations lies with the board of directors, and the plethora of new regulations are designed to impact boards’ operations, even though no one knows very much about how boards of directors work.

For the first seventy-five ...