Board effectiveness: the truth beneath the surface
Simply tightening procedural rules for boards is barking up the wrong tree: the ‘social system that a board actually is’ needs to be addressed
In pursuit of our values-based approach to governance, culture and leadership we are often confronted by the inherent dysfunctionality of otherwise completely structurally sound boards of directors. This is not through a lack of development of carefully crafted remedies for failures of governance. In response to the King IV requirements of good governance structural remedies that focus on rules, procedures, composition of committees have been devised with the aim of producing astute and involved boards.
However, research conducted by Yale professor Jeffrey Sonnenfeld show that there were no board patterns of incompetence or corruption in great companies such as Enron, Tyco, WorldCom or Adelphi, which experienced unprecedented corporate meltdowns. Steinhoff is a case in point in the SA experience. In fact, these companies followed most of the prescribed standards of board conduct. Members showed up for meetings; they had lots of personal money invested in the company; audit committees, compensation committees and codes of ethics were in place; the boards weren’t too small, too big, too old, or too young.
There was no structural differentiation between the well-managed boards and the failed boards, even when the issue of independence in relation to ownership is evaluated as a key determinant of fiduciary responsibility. All things considered, these boards passed the litmus test for board adequacy to do a good job.
Sonnenfeld suggests the approach taken by most corporate governance practitioners — simply tightening procedural rules for boards — is barking up the wrong tree, and that “the social system that a board actually is” needs to be addressed. He sees the most pressing need for all boards to be strong, high-functioning work groups whose members trust and challenge one another and engage directly with senior managers on critical issues facing corporations. This challenge has serious ramifications for highly segregated and unequal socioeconomic backgrounds such as those found in SA. Can we even get to a point of honest conversation in our board processes?
The fact that there is no obvious differentiation between well managed boards and the failed boards in terms of structures and procedures calls for a careful evaluation of the inadequacy of the conventional wisdom that precipitates such random governance failures. Sonnenfeld’s study evaluated seven key components regarded as essential to effective board participation.
Regular meeting attendance
On perusing Fortune’s list of most admired and least admired companies in the US, the records show no difference in attendance records of board members. Minnow’s Corporate Library data reveals the same acceptable attendance records at both most-admired and least-admired companies. While this might be a hallmark of the conscientious director and an objective measure of commitment, it has no bearing on the success of the company in question.
The presumption that personal interest arising from significant shareholding results in more vigilance and holding executives to account did not reflect any difference between good and bad boards of directors from the data provided by the Corporate Library. A contra-indicator came from the 2001 comparison of members of the board of GE, 2001 most admired company where the average shareholding was less than $100,000, while the members of the least admired companies held substantive equity stakes.
All but one of the directors of Enron at the time of its collapse owned large chunks of the stock, and some continued acquiring shares even as the stock started to collapse. Even having skin in the game did not yield any differentiation in terms of board performance.
Board member skills
Whereas financial literacy is internationally highly valued by corporates, it did not show any differentiation. Enron was exemplary in terms of the levels of financial skills — a former Stanford dean who was an accounting professor, the former CEO of an insurance company, the former CEO of an international bank, a hedge fund manager, a prominent Asian financier, and an economist who was the former head of the US government’s Commodities Futures Trading Commission.
These formidable board members still claimed they were confused by Enron’s financial transactions. Steinhoff had six CAs with substantive corporate governance skills, so might have been expected to avoid the unconventional methods of accounting that destroyed so much shareholder value. Board skills did not differentiate between Fortune’s most admired and least-admired companies. All had the requisite skills at similar levels.
Board member age
There is a debate among corporate governance experts over whether older boards are more or less effective. Sonnenfeld’s research over the last 25 years indicates that the older and more experienced the board the deeper the insight and sense of evaluating risks that might impact the enterprise. In SA there has been an increase in the number of less experienced, although financially well educated, board members from the ranks of the previously disadvantaged. We have no assessment of the general impact of this trend, although Sonnenfeld’s research seems to strongly favour experience for board balance and effective functioning. The contribution of those with extensive corporate experience seems invaluable.
The past CEO’s presence
There are divergent views on the impact of past CEOs on board processes. There is a school of thought that the old “hyenas” want to rule from the grave and tend to obstruct executive management’s implementation of corporate strategy. However, Intel, South Western Airlines and Home Depot in the US all credit the invaluable inputs of their retired CEOs to effective board process. Even on this measure the results are mixed in relation to most admired to the least admired corporations.
Eminent good governance proponents, including our judge Mervyn King, argue that accountability is best handled by a majority independent board of directors. Arguments have been made that Tyco’s confusing spiral of acquisitions and self-serving decisions could have been avoided had the board had a majority of independent directors.
Evidence of comparatives between most admired and least admired companies in the Fortune list gives no meaningful distinction despite the fact that the New York Stock Exchange Corporate Accountability and Standards Committee has strongly recommended that the boards of companies be constituted by a majority independent directors.
Board size and committees
There is a generally accepted assumption that a small board of directors is preferable to a large board of directors. Yet the evidence shows well managed boards in both small and large boards. There is another belief that committees like the audit and compensation committees are invaluable in managing company risks. Evidence again shows that such structural organisation has not always yielded the necessary operational efficiency in terms of board responsibility. Size does not seem to matter.
As structural and process issues do not seem to result in any marked improvement in board efficacy, the research suggests that the answer lies in the human element. Sonnenfeld argues that exemplary boards are “robust, effective social systems”. Logically, it is important to assess and draw parallels with our local situation.
• Thabe is managing executive of Angavu Ethical Solutions. This is part one of a two-part series.
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