For years, independence has been held up as a desirable—even necessary—attribute of boards; the moot being that independent directors are a prerequisite if boards are to consider information objectively and make high quality decisions. In practice, the listing rules of most stock exchanges state that at least two directors must satisfy independence criteria, and many directors' institutes promote independence as a desirable attribute.
But does the presence of independent directors actually lead to improved business performance? Notable investor, Warren Buffett, has his doubts.
Buffett took the opportunity at the annual meeting of Berkshire Hathaway, an investment firm, to question the merit of appointing independent directors. He said that many independent directors cow-tow to the chief executive, an assertion that is tantamount to suggesting that the balance of 'power' and 'control' lies with the chief executive not the board. If this is correct, directors are not acting in the best interests of the company (as the law requires). Thus, independence becomes meaningless.
Buffett's solution is to recommend that directors need to have skin in the game. But if they do, what is their motivation likely be? Will the holding of shares lead to directors becoming more effective?
Long-standing research(*) suggests that, as with other static attributes of boards (board size and the board's 'diversity' quotient are topical examples), structural (or, technical) independence per se provides little if any guarantee that board decisions will be of high quality, much less assurance that the board will be effective or that high performance will be sustained. Much storied cases, such as, HSBC (USA), Mainzeal (New Zealand), Carillion (UK) and CBA (Australia), amongst many others, make the point plain.
If the board's role in value creation is not dependent on structural attributes (in any predictable sense), should independence be set aside? Not completely. Independence can be helpful, if it means independence of thought; directors who are capable of critical thinking and who exercise both a strategic mindset and wisdom, as they seek to make sense of incomplete data in a dynamic environment. But even this proposal is limited: independence of thought is hardly a silver bullet. Context is crucial. Shareholders and boards must be careful not to fall into the trap of thinking about corporate governance or board effectiveness in deterministic or formulaic terms.
If boards are to have any chance of exerting influence from the boardroom, directors need to embrace an holistic understanding of how best to work together as they assess information, make decisions and verify whether the desired outcomes of prior decisions are achieved or not. For this, the actions of boards (function) trumps what they look like (form). Emerging research suggests that board effectiveness has three dimensions, namely, the capability of directors (technical expertise, sector knowledge, wisdom, maturity); what the board does when it meets (determine purpose, strategy and policy, monitor and supervise management, provide an account to shareholders and other stakeholders); and how directors behave (individually and collectively).
(*) see Larcker & Tayan (2011) Corporate governance matters, for example.
Over the last twenty years, I have spent countless hours serving on and advising boards, and thinking about governance and the characteristics of effective boards. To have been invited to work with boards around the world as they have sought to realise the full potential of the enterprises they govern has been a real privilege. But with such privilege comes responsibility—the importance of standing back from time-to-time to take stock and reflect on learnings cannot be overstated, which is exactly what I have been doing over the last few days.
Two things in particular stand out just now. First, boards are increasingly aware that ultimate responsibility for enterprise performance lies with the board itself (not the CEO); and second, social media is starting to get in the way of effective learning.
That awareness is trending upwards is great news. But the supplementary question of how high performance is achieved and sustained remains problematic. The market is awash with best practice recommendations and supposedly definitive guidance ("five ways to...."), many of which have been implemented diligently. But alas, company failures continue to be blots on the landscape.
Directors want reliable guidance, but many directors struggle to sort the wheat from the chaff. They say that the plethora of often discordant information is more a hindrance than it is helpful. Privately, some admit that they have become confused about the purpose of the board, what corporate governance is and how it should be practiced. Others have suggested that the question itself (of the board's role in achieving high enterprise performance) is 'wicked', meaning it is easy to describe, but really difficult if not impossible to solve due to incomplete or contradictory information and a highly contextual setting—a moving target camouflaged in a landscape that is far from static.
The other thing that has become relatively clear in recent times is the role and impact of social media: it seems to be getting in the way of meaningful debate on big questions and wicked problems. Yes, news feeds and the 'like' button can be additive, but self-proclaimed experts offering opinions disguised as 'solutions' generally add little except noise and clutter. If progress is to be made, more reliable guidance is needed to help boards focus on what actually matters—enterprise performance. For this, researchers need to go to the source (the boardroom), to discover, analyse and report what really happens when the board is in session, including what boards do; how decisions are made; and how power is wielded and influence is exerted. Interviews, surveys and the quantitive analysis of large datasets all have their place, but the direct (and ideally, long-term) observation of boards in action is the gold standard. Researchers, advisors and directors need to continue to pursue meaningful dialogue—not sound bites—both with each other and at conferences and other interactive forums (workshops and masterclasses, for example) to explore situations, discover what works (and what doesn't) and, crucially, understand the contextual limitations and nuances of various options. A commitment to read widely and critically is also important.
Press on we must; the question of how boards influence enterprise performance is far too important to ignore. Tough problems need time and space for critical thought and analysis. Thus my decisions to step away from Twitter and to change my use of LinkedIn—to create more space for critical thinking and analysis. My hope is that what emerges will be of some use to helping boards address something that has remained constant: responsibility for enterprise performance starts—and ends—with the board.
I'm in London for the weekend, an interlude between inter alia commitments hosted by the Institute of Public Administration (a masterclass for board chairs, in Dublin); Lagercrantz Associates (a workshop, in Stockholm); and the Baltic Institute of Corporate Governance (a masterclass and the BICG conference keynote, in Vilnius).
To work with people across cultures, countries and contexts is a great privilege. Discussions reveal differences in perspective and approach. Yet, some things are consistent, transcending borders and cultures. One example is 'good governance'. Directors everywhere want to know how to achieve good governance.
This is a tough request. The problem is that 'good' is a moral qualifier, implying someone or something is morally excellent, virtuous or even righteous. But that is not all it means. A quick check in any dictionary reveals at least 39 other definitions! Which one does a person have in mind they ask for help to achieve 'good governance' or 'good corporate governance'? And what about other directors around the table. Do they have the same understanding or not?
It's little wonder that directors have become confused about the role and purpose of the board.
Pragmatically, corporate governance is the means by which companies are directed and controlled (Cadbury, 1992), that is, it describes the work of the board. The objective is to produce an agreed level of performance (however measured). 'Effectiveness' is a more appropriate qualifier than goodness. If something is effective it is adequate to accomplish a purpose; producing an intended result.
Returning to the question of how to achieve good governance. After reminding the enquirer that so-called best practices offer little guarantee of success (which one is best anyway), I usually steer the discussion away from goodness towards effectiveness (performance), and suggest that Bob Garratt's Learning Board matrix, and the Strategic Governance Framework are useful starting points for a lively discussion at the board table.
Once directors acknowledge that high company performance is the appropriate goal, and that success is a function of effectiveness more so than goodness, they start to ask more relevant questions, such as, "What actually matters?" and, "How do I as a director and we as a board become more effective?"
The 2018 edition of the Global Peter Drucker Forum, the tenth annual gathering of leaders, philosophers and students of management was convened in Vienna, Austria this week, at the Hofburg, the Imperial Palace. The location was a wonderful, historical backdrop for two full days of discussions and debates on topical issues directly relevant to managers and leaders around the world.
Overall, the purpose of the Forum is to share expertise and build capability in line with Peter Drucker's philosophies. This year, the theme was management . the human dimension. It was the second time I have attended the Forum. The decision to do so was relatively straightforward; made soon after I had the opportunity to stand amongst giants in November 2017. As was the case then, the programme followed a reasonably conventional format dominated by panel-based discussions and plenaries. One major difference from last year though was the scale of the event. Some 500 people attended in 2017. The tenth anniversary edition took a step up, to enable 1000 people to join the conversation. This led to some quite different dynamics at a personal level (notably that it was much more difficult to find people or to access the speakers). As a consequence, some intimacy was lost. But this is a minor point, especially when viewed in the context of a very well-run event.
The following three summaries, presented in no particular order, provide a glimpse of the ideas shared and learnings from the first day. (If you would like to know more, please get in touch.)
Business and society: Four panelists including Jean-Dominique Senard, CEO of Michelin Group, and Yves Doz, Emeritus Professor of Strategic Management at INSEAD, shared their thoughts on the importance of holding business and society together (the implication being that business and society have, or are at risk of, drifting apart). Key takeaways:
Human questions, machine answers: Hal Gregersen kicked off this session with some stark predictions:
The insight from the first of these numbers is that predictions of cataclysmic job-loss and unemployment are little more than scaremongering. However, the second number demonstrates that the impact of technology on work will continue to be very significant into the future. But we need to get past the numbers for focus on what actually matters: it is people.
People everywhere need to become more adept at using computers, especially for menial and repetitive tasks, and, even more importantly, people need to be taught to be some computers can never be: humans; empathetic, curious, social beings. As humans, our ability to thrive in a world seemingly falling head-long into the embrace of AI is to ensure we ask the 'right questions', many of which will be social, ethical and spiritual.
Other speakers added that capabilities need to prevail over skills. This might sound like semantics, but the difference between the two is both significant and important. Curiosity, situational awareness, contextual understanding and creativity are far more important than operational or tactical skills, for example. Such capabilities need to be nurtured and exercised, lest they become like unused muscles—atrophied.
Re-engaging the humanities: The aim of this fascinating session was to argue the merit of re-connecting humans with the humanities. The starting point for the discussion was an assertion that humanity's adoption of technology has come at a great cost: mankind is rapidly losing touch with what makes him distinct from other species. Simply, the pursuit of technological 'solutions' has seen many lose sight of the meaning of life.
Humans are social beings, and meaning is revealed through interaction and insight. Unlike molecules that behave in a consistent manner when they are heated (cooled) or put under pressure, humans do not. As a consequence, if organisations are to thrive in the future, conceptions need to change. Rather than using deterministic and mechanistic models to understand and explain organisations and performance, a biological 'ecosystem' may provide a more instructive. In this context, the term 'ecosystem' means a community of organisms that interact contingently and their physical environment. While such communities have defining characteristics, 'success' is dependent on many factors, and it is neither predictable or guaranteed.
A summary of observations and insights from second day is available here.
My speaking and advisory tour of several European cities got off to a great start on Sunday evening. The first port of call was Stockholm. Liselotte Hägertz Engstam, an established director and board chair in the Nordics, hosted a seminar at Tändstickspalatset; a great venue. The theme was [the] Board's role in innovation strategy and governing new digital business models. Some 35–40 directors and board chairs with just over 100 board mandates between them, gathered to hear two speakers, namely, Stephanie Woerner and yours truly. The following paragraphs tell the story.
Digital business model and board contributions
Stephanie Woerner, a Research scientist at Sloan School of Management in Boston, explored value creation in the digital economy. She observed that many (most?) corporations were somewhat lumberous, offered rather average customer service and, tellingly, were ill-equipped to take advantage of emerging 'digital opportunities'. As such, they are at risk of losing out to younger, more nimble businesses. Woerner identified six questions that companies need to resolve if they are to compete effectively in the digital economy:
Then, Woerner spoke about digital savviness, making two points along the way. First, 62% of directors claim to be 'digital savvy' (and, presumably, ready to tackle emergent challenges), but only 24% are indeed savvy. Second, the presence of three digital savvy directors is sufficient to drive improved [financial] performance outcomes. With that, I sat up. How might a quantitative analysis be a reliable predictor of a contingent outcome? A person at the table I was seated at was similarly exercised. She interjected, asking what the term 'digital savvy' meant. "Great question. We used the experience and qualifications of board members as a proxy." Woerner went on the explain how this has been arrived at: a keyword analysis of resumés (searching for words such as technology, CIO, disruption, software). The presence of such words on a resumé was deemed sufficient to categorise someone as being digitally savvy. You could have heard a pin drop.
While Woerner's assertion (that boards need to be knowledgeable of emerging technology trends) is intuitively reasonable, the underpinning research appeared to be flawed. Others seemed to agree, suggesting it is more important for directors to have a curious mind, read widely and ask probing questions. Notwithstanding this, Woerner's core point was on the money: boards need to get up to speed with technological innovations and the opportunities they present.
Making a difference, from the boardroom
I spoke second, the task being to both build on Woerner's comments and add some insights of my own. I started by acknowledging today's reality, that change seems to be the only constant. Woerner set a great platform so there was no need to labour the point, except to say that directors need to work hard to keep up. Importantly, contemporary recommendations including so-called 'best practices' provide little assurance of better board practice much less improved firm performance.
An important duty of all boards is ensure the future performance of the governed company. If boards are to make a difference, they need to make informed decisions about the future direction of the company, and verify whether desired performance outcomes are actually being achieved or not. Four crucial questions that boards need to ask were tabled, these being:
After suggesting some practical considerations, I introduced the strategic governance framework, an option for more effective contributions (as revealed from my doctoral research and subsequently lauded by both practicing directors and scholars around the world).
The seminar presented two perspectives, namely, that directors need to become a lot more digital savvy if they are to contribute effectively in the boardroom, and that effectiveness is a function of director capability, board activity and underlying behavioural characteristics of directors, not what they look like.
Board readiness to lead well in the emerging 'digital' world is a concern—made worse given boards tend to pay much more attention to historical performance than wrestling with the [largely unknown] future. This is the elephant in the room. 'Digital' is but a symptom, I suspect. If boards are to have any hope of influencing firm performance, what they do in the boardroom (i.e., corporate governance) needs to change.
In a couple of weeks, I'll be in England and Europe, for the third and final time this year. The schedule includes attendance at two conferences, delivery of two keynotes and a bevy of meetings, as follows:
While the schedule is fairly full, some gaps remain for additional meetings (in London).
If you would like to meet, please get in touch. I'd be glad to discuss any aspect of boards, corporate governance or effective board practice; explore a research idea; or respond to (future) speaking or advisory enquiries.
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.
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.
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.
Thoughts on corporate governance, strategy and effective board practice; our place in the world; and, other things that catch my attention.