Embracing a brave new world

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:

• Governance by walking about: Directors are actively encouraged to view the company "in the wild". This includes attending executive meetings (albeit in silence, as an observer), and the freedom to wander around the office, chatting and asking questions (but not offering guidance nor providing instruction).
• Pragmatic reports: Memos are both brief and insightful. They must be less than 30 pages long and, in addition to providing links to detailed information, they provide open access to all relevant data on the company's systems.

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:

• Proximity trumps distance: If boards are to govern effectively, directors need to  be adequately knowledgeable of the business and the wider operating context including emerging trends and technologies. Information needs to be elicited from multiple sources. Barton and Wiseman's report highlights this. But the Netflix case goes further; boards need to get a lot closer to managers, to establish and maintain a strong relationship founded on trust and expedite the flow of high quality and relevant information. My own research (here and here) provides supporting evidence. But don't be deluded, the recommendation comes with a warning: high levels of maturity are  required, to discern the appropriate proximity, and to minimise the chance of directors becoming 'captured' by managers.
• Real knowledge takes time to acquire: Conventional wisdom, supported by recommendations emanating from many consultants and directors' institutes, suggests that directors should allocate two hours in preparation for every one hour of board meeting time. Yet the evidence suggests that this is probably insufficient. Real, relevant knowledge (read: deep understanding, wisdom even) takes time to acquire. The Netflix case adds weight to this argument. And knowledge needs to extend beyond the business and ecosystem, to include emerging trends and technologies, and theoretical perspectives as well. Together, this demands that directors invest considerably more time than the two-to-one rule-of-thumb if they are to be well-informed and make meaningful contributions. When asked, I propose five hours for every one hour of board meeting time, and double for the Chair. Established directors, including those who happily describe themselves as 'professional directors' often baulk at this, saying they don't have time. This is not an adequate defence. 
  

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.