Research is a funny thing. On one hand, experience can be greatly helpful: knowing what one is looking for or expecting to see is a boon. On the other, experience can be a hinderance: knowledge often resulting in bias and preconception, and the very real possibility of missing vital clues. This is one of the great dilemmas for board and governance research.
Some forty years have now passed since researchers started investigating boards in earnest. That an answer to the question of the role of the board and how they influence firm performance (i.e., what corporate governance is and how it is practiced) remains elusive is an indictment on the research community. Directors and boards need clear and well-founded guidance so they can become effective in role.
Medical research is conducted by medics; cultural research is conducted by anthropologists; and, engineering research is conducted by engineers, so why is board research typically conducted by academics with little if any business experience? How might a researcher who has never been inside a boardroom hope to recognise the normative practices of board meetings? Or that a subtle interaction between two directors might actually be material to a pending decision?
That most board and governance researchers have never been in a boardroom or served as a director is alarming. Yes, gaining access to observe boards directly is difficult to achieve. But to restrict board and governance research to counting isolated attributes of boards from outside the boardroom is folly. To be useful, recommendations need to account for the socially-dynamic nature of boards and the behaviours of directors (both of which can only be reliably discerned through direct observation).
If the question of explaining how boards influence firm performance is to be answered, three things are needed:
After a longish hiatus—nearly four months—Musings is back. Thank you to regular readers and supporters who have asked about the radio silence. The explanation is straightforward: a busy period of speaking and advisory engagements, research and board work left precious little time to ponder.
But that is history now. My intention is to pick up where I left off in early August, by posting on topical matters and emerging trends; challenging orthodoxy and, importantly, exploring how boards might become more effective in their pursuit of high firm performance and sustainable wealth creation.
Thank you for your interest in Musings. Your feedback and commentary is appreciated.
What can Plato, a philosopher who lived over 2400 years ago possibly teach the leaders of modern companies? After all, the modern form of company only came into being in the last few hundred years, two millenia after Plato died. As it happens, when it comes to strategy and decision-making, Plato can teach us a lot—a point made by the author of this article. Here's an excerpt:
Plato likened the guidance of a state to the navigation, piloting, and crewing of a ship at sea. The analogy holds for the strategist and a war effort. The strategist is the navigator with skills that few others have but he may not always be the captain who leads the crew, those that must actually carry out the strategy. Strategy is not responsive to constant or wild adjustments; the hand on the rudder must be subtle and steady; the mind behind it focused on the north star of the political end state. It is for this reason that one could expect that the navalist’s mind more easily grasps the nature of strategy than that of the continentalist. For centuries, ship’s captains engaged in strategy both military and diplomatic with little guidance and no recourse to seek more just by the nature of communications and the distance that a ship could carry them.
This is one of the best summaries that I have read in a long time. Though written in the context of naval strategy and referring to Plato, the roles and tasks described here are directly applicable to companies and boards. The author writes that strategy (strategos: the art of command) is something developed at senior levels, with the long-term purpose (north star) in mind. The captain's job is to implement the strategy. Teamwork between the strategist and the captain is both expected and crucial.
The correspondence to companies and boards is stark. 'Guidance' (first sentence) corresponds to governance (kybernetes: to steer, to guide to pilot), for example. The senior-most decision-maker is the board of directors; the chief executive is 'the captain'. In naval terms, the best chance of making progress towards the 'north star' occurs when the strategist and captain collaborate closely—and so it is with the modern corporation.
The limited liability company is a great construct; an efficient vehicle for commerce, through which to pursue an overall aim (purpose) and to distribute wealth (however defined) over an extended period. What's more, mixed levels of ownership are possible; greater economies of scale are attainable (beyond what a sole trader or entrepreneur could typically achieve); and, importantly for absentee shareholders, liability is limited to the extent of the capital invested.
Though they offer many benefits, the limited liability company is not without flaws—it is a social construction after all, and a complex dynamic one at that. The motivations, priorities and interests of various interested parties (shareholders, directors, managers and staff, amongst others) are often different. Contexts change, and egos can get in the way as well. Left unbridled, differences can fester, morale can suffer and, in more extreme cases, the company can be torn apart. Wynyard Group and Carillion are two recent example but there are many others. Family firms are not immune to such challenges. In fact, when the wildcard of family dynamics is added to the mix, family firms are actually more, not less, susceptible. Though not always visible, the spectre of undue influence often lurks as a contributing factor, as the following discussion reveals:
Failure to differentiate the roles of 'shareholder' and 'director': Let's start with some definitions. A shareholder is a person or entity that owns shares in a company. Ownership of shares affords certain rights, such as, selecting directors, receiving dividends and participating in major decisions. But those rights do not extend to running the business. That is the responsibility of managers, a delegation via the directors. In family firms, the roles of shareholder, director and manager can become blurred, especially when an influential family member holds multiple roles.
The most common expression of undue influence that I've seen over the years relates to decision-making at the board table: a director with a significant shareholding 'expects' to influence significant decisions in their favour because they own a large parcel of shares. The important distinction that is lost (sometimes it is 'conveniently' neglected) in such situations is that the board meeting is not a proxy for a shareholder meeting. Shareholders and directors vote differently. Shareholder voting is conducted on a 'one vote per share' basis, whereas each director has a single vote at the board table. Regardless of whether directors hold shares or not, every director has an equal say.
If situations like this arise, they need to be nipped in the bud. If they are not, board meetings become a farce; the other directors puppets. This is far from acceptable, especially when the duty of acting in the best interests of the company (not any particular shareholder) is factored in. In most cases that I have observed, attempts to exert such [undue] influence tends to stem from ignorance and a desire to do what they think is fair, not malice. Usually, a quiet discussion with the director concerned is often all that is needed to resolve the matter. Another family member or an outsider (an independent director if there is one, or some other trusted advisor) are useful candidates for this task.
Treating the company as little more than a personal bank account: If I had a dollar for each time I've seen this in family firms... Recently, while observing a board meeting as part of an advisory engagement, a director asked, "Why are we always so short of cash when we are supposedly highly profitable?". The discussion that followed was both enlightening and disturbing—and, sadly, it was not the first time that I'd heard it play out. One director with banking access had been buying personal items with company funds and, from time to time, had been taking 'petty cash' for personal use. He saw nothing wrong with this because "it's my firm anyway".
If a director or shareholder uses company funds to acquire personal items, or uses the company bank account as if it were their own, they are acting in their own interests (whatever those may be). Their actions may put the viability of the company at risk as well. Neither of these motivations is permissible in law. Any shareholder wanting money from the company needs to ask the company, not just take it (that's theft!). Valid payment options include shareholder salaries (payment for effort/services rendered), dividends (a share of the profits), donations (but these may be taxable) and director's fees. The company may also agree to lend money to the shareholder. Regardless of the motivation or the payment option, a written policy which outlines the rules and conditions pertaining to payments to shareholders can help mitigate misunderstandings.
Employment of family members and related matters: Another expression of undue influence is the situation in which a family member 'pulls rank' to secure employment for themselves or another family member. While any family member may nominate anyone else (including other family members), to foist a particular person onto a manager is completely unreasonable. If managers are to be held accountable for performance, they need to be free to make reasonable employment decisions themselves, in accordance with employment policy. In family firms, it is a good idea to add a section entitled 'Employment of family members' in the policy, to set out the rules the be applied whenever a family member is being considered for a role.
While none of these examples of undue influence is unique to family firms, they are usually more visible (and often more destructive) in family firms. Once discovered, they need to be resolved. If not, family relationships can become strained, even to the point of breaking down. Actions that families might consider taking to prevent or at least mitigate the types of problems summarised here include:
Boards wishing to explore matters mentioned here or other matters related to more effective board practice, should get in touch directly to arrange a private briefing.
This article is the second of three on the topic, 'Governance in family-controlled companies'. The first explored some items that are currently front-of-mind for many directors and shareholders of family-controlled firms. The third article, which will present recommendations to improve board effectiveness, will follow in late August.
From entering the business lexicon less than quarter of a century ago, 'corporate governance' has come a long way. Prior to 2000, the term was rarely mentioned in business discussions much less amongst the general public. Boards and directors directed the affairs of the firm, and that was it. Now the term is ubiquitous. Its usage has changed over time as well: from describing the functioning of the board of directors, the term is now used to describe all manner of corporate activity, much of which bears little if any semblance to the board or governance at all.
The proclivity to use the terms 'governance' and 'corporate governance' has trickled down from big business to now infect family-controlled firms. Well-intentioned but inappropriate usage—notably advisers (typically, but only accounting firms) making assertions such as "You need governance"—has had unintended consequences. When attention is diverted away from running and overseeing the business to "implement governance" (whatever that means or entails) without justification, costs have a tendency to go up not down, and a whole new set of problems including confusion, consternation and strained relationships often follow.
Over the last two decades, I've had the privilege of working with the directors and shareholders of hundreds of family-controlled firms, ranging from 'mom and pop' operations to much larger (multi-hundred million dollar) enterprises. Awareness of (and interest in) governance has become palpable, more so if a director has just read an article or heard a talk from an expert purporting a 'best practice' governance solution. Yet directors know that a single answer rarely works everywhere. Context is crucial in business; every situation is, to a greater or lesser extent, unique. As a consequence, the universal application of a formulaic 'best practice' solution does not make much sense. Recognition of this gives rise to many questions, especially from the shareholders and directors of family-controlled firms. Here is a selection of the more frequently asked ones:
These questions are typical of those that have been front-of-mind for the directors and shareholders of the family-controlled firms that I've interacted with in recent months. Curiously, questions about social interaction, boardroom behaviour and family dynamics (the human dimensions) are asked far less often. This, despite the board being a collective of directors—people—who are required to work together in the best interests of the firm. Boards that resolve these so-called 'soft' questions tend to be more effective. But more on that next time.
This article is the first of three on the topic of 'Governance in family-controlled companies'. The second, which explores undue influence and the impact of family dynamic is available here. The final instalment, which will present recommendations to improve board effectiveness respectively, will follow in August. Boards wishing to discuss matters raised in these articles should get in touch directly to arrange a private briefing.
Netflix has been in the news a bit lately, aided no doubt by public interest in its rapidly increasing 'reach', meteoric rise in its stock price and membership of a new generation of behemoth—the FAANG club. Now, the actions of the board of directors have seen Netflix become even more newsworthy, principally a consequence of this article published in Harvard Business Review. The board of directors operates quite differently from many others and, indeed, conventional wisdom. Could this be a contributing factor in Netflix's success?
Conventional wisdom, supported by both agency theory and 'best practice' recommendations of directors' institutes (in the western world, at least), suggests that 'distance' (a clear separation between the board and management) is important if boards are to objective in decision-making. The listing rules of most stock exchanges specify that at least two directors must satisfy established independence criteria at all times. Independence is de rigeuer, even though no consistent link between director independence and firm performance has ever been identified!
Back to Netflix. Two researchers, David Larcker and Brian Tayan of Stanford University, gained permission to investigate how the Netflix board keeps up to date and informed, a prerequisite of effective decisions. They found that the Netflix board does not embrace conventional wisdom. The full research report, from which the HBR article was derived, is available on the SSRN website.
The Netflix approach is based on proximity not distance. The approach has been adopted to help directors resolve a fatal flaw present in most boards: Five out of every six directors do not have a comprehensive understanding of the business being governed. Specific measures in place at Netflix include:
The combined effect of these measures has been profound: directors are much more well-informed than they would have otherwise been. The handicaps of lack of transparency or hard-to-assess information are removed. The perennial problem of information asymmetry that besets boards globally has been, it seems, solved—in Netflix's case at least.
Standing back a little from the Netflix case, several learnings are available for boards, as follows:
Many boards and directors do take their role and responsibility very seriously. But, sadly, a significant number do not display appropriate levels of commitment. If boards are to become more consistently committed to the cause—the pursuit of high firm performance and longer-term value creation—they could do a lot worse than take a page from the Netflix playbook and the advice shared here. If you want to learn more, including scheduling a discrete briefing to explore how a mechanism-based understanding of corporate governance can contribute to improved board effectiveness, please get in touch.
The chattering class has been very active of late, responding vociferously as case after case of corporate failure and misstep has come to light. Carillion plc and the venerable Institute of Directors (both UK), AMP (Australia) and Fletcher Building (New Zealand) are the latest examples that have resulted in consternation and angst.
That seemingly strong and enduring organisations continue fail (or have significant missteps) on a reasonably regular basis is a cause for much concern; the societal and economic consequences are not insignificant. Many commentators (primarily, but by no means exclusively, the media) have responded by berating company leaders (the board and management specifically), placing 'blame' squarely at their feet. This is a reasonable: ultimate responsibility for firm performance lies with the board after all.
Calls for tighter regulation and stiffer codes abound. Yet the geographical spread of these failures implies that local statutes probably aren't a significant contributory factor. The responses of the boards have been telling: some have circled the wagons (a demonstration of hubris?), others have cast out the chairman or chief executive (diverting blame elsewhere?), and some individuals have simply walked away.
At this point, it would be easy to join the chattering class; to stand on the margins and berate all and sundry. But let's not go there. Instead, let's try to identify repeated patterns of activity may have contributed to the situations, in search of learnings. Several things that stand out:
The role of the auditor: Most if not all of the firms mentioned above were attested by their respective auditors to have been operating satisfactorily. Yet they were not, clearly. Whether the auditors were in cahoots with management or the board, failing to discharge their duty to provide an accurate assessment or, even, inept remains to be seen. Regardless, something is amiss. To date, few commentators have called out the audit profession as being an accessory (Nigel Kendall is a notable exception).
Business knowledge: Remarkably few of the directors of the companies identified here seem to understand the business of the business they were governing. Many directors are recruited for their technical skills (notably, legal and accounting expertise), but few if any have any significant experience in the sector that the business operates in—research by McKinsey shows that one director in six possess such knowledge. How any board can make informed decisions when most of its directors do not understand the wider operating context well is perplexing—it would struggle to detect important though weak signals, much less understand the implications of them.
Board involvement in strategy: The boards of all of the firms identified here relied heavily on management to prepare strategy. Directors backed themselves to ask questions in response to proposals when they were presented. While most directors are capable and well-intentioned, such a heavy reliance on management is unwise. If the board is not involved in the development of strategy in some way, as many researchers and commentators recommend, the likelihood of the board understanding what it is being asked to approve and subsequently providing adequate steerage and guidance is low.
If boards are to learn from the failure cases noted here (amongst others), the first and, frankly, most pressing priority is to mitigate apparent weaknesses and focus on what matters. My research suggests that high levels of firm performance are contingent on several factors including:
Some commentators have suggested that the success of the board is entirely a matter of luck. I disagree. While outcomes are not guaranteed, my doctoral research and experience shows that boards can exert influence beyond the boardroom, including on firm performance, but only if they focus on 'the right things'. Unless and until boards start taking their responsibility for the performance for the company seriously the hope of much changing remains, sadly, dim.
I arrived in London yesterday, ahead of what promises to be an interesting week. Formal commitments include delivery of the CBiS seminar in Coventry; planning for a future board research initiative; and a miscellany of meetings in which corporate governance, effective board practice and this recent article will be discussed. Two recent events, Carillion's fall from grace, and the now-public machinations at the Institute of Directors (which have resulted in the resignations of the chairman, Lady Barbara Judge, and deputy, Ken Olisa), are likely to invigorate discussions. Already, I've been asked to comment publicly on the Institute's troubles.
The problems at the Institute of Directors in particular are troubling. They strike at the heart of what many say is wrong with boards and corporate governance; the Institute becoming a laughing stock in some quarters. The Institute's effectiveness as a professional body is contingent on it being the epitome of good board practice. The IoD chief executive, Stephen Martin, said on Friday that the resignations are a victory for good governance. They are not. Rather, they are an indictment of poor governance.
Sadly, the Carillion and Institute of Directors cases are not unique. They are but two of many examples of poor practice that reinforce perceptions that boards are not effective. The ancient Chinese saying (more correctly, curse) seems especially applicable just now.
If trust and confidence is to be restored, the power games, hubris and ineptitude apparent in some boardrooms need to be rectified. Flawed understandings of what corporate governance is and how it should be practiced also need to be corrected, especially the misguided belief that any particular board structure or composition is a reliable predictor of firm performance (the following letter highlights the conventional wisdom problem).
The scene is set for some fascinating discussions this week. I'll let you know how I get on.
GE, a company with a strong history of success including a reputation of being the world's best-run firm, has hit turbulent times. Profit forecasts have dropped by half in the past two years, with the inevitable knock-on effect on the share price. It seems that the size and complexity of the business, and probably some poor decisions in the past, is proving to be a challenge for the board and its ability to fulfil its duties.
Consider the following indicators, reported in an article published in The Economist:
How the GE board can make meaningful decisions given these indicators, much less lead the firm intentionally into the future, is hard to imagine. Sadly, this is not a unique case. Wells Fargo, Wynyard Group and, most recently, Carillion are examples of companies that have suffered through poor reporting, weak engagement and the seeming inability of the board to make courageous decisions.
Fortunately, boards finding themselves in a similar situation are not without options. If they are prepared to retake control of the firm they govern (which will probably require some decisive actions; brevity and clarity of reporting being necessary but insufficient) and take an active interest in its strategic future, then the likelihood of actually making a difference is greatly enhanced.
Another once proud company has just suffered the indignation of failure. Carillion plc, the UK's second-largest facilities management and construction services conglomerate, collapsed on 16 January 2018, after bankers withdrew their support. The fate of hundreds of contracts with public sector agencies, and thousands of jobs were left in the lurch (although some emergency measures have since been put in place).
Though tragic, Carillion's demise should not have been a surprise to anyone for it did not occur as a result of a single external catastrophic event. Consider these indicators:
These indicators, which are not dissimilar to those of other failures (here and here), raise many questions viz. board performance, including questions of accountability; the board's supervision of management (or lack thereof); malfeasance and ineptitude in the boardroom; the efficacy of 'best practice' recommendations; and, the role of auditors. Why the Carillion board failed to act on the indicators listed here (and others not yet public, no doubt) is a matter for due process to uncover. The investigations should not be limited to the boardroom or even executive management. Other questions worthy of consideration include:
Hopefully, the investigations now commencing will result in one or more people actually being held to account. Practical guidance to help boards focus on what actually matters (firm performance) is also needed, if boards are to step beyond conventional wisdom (which is clearly not working), and the damage that inevitably occurs when boards are diverted by spurious (and typically discordant) recommendations that appeal to symptoms or populist ideals is to be limited.
Thoughts on corporate governance, strategy and effective board practice; our place in the world; and, other things that catch my attention.