Blame directors for failure, CEOs for success

Fairfax (Reuters) belatedly opines that Directorships are not a reward, but actual work. It’s an article based on US companies, but is applies to every jurisdiction.

I absolutely agree – a directorship is a very serious obligation.

I propose a simple philosophy

  • Blame the Board of Directors for failed companies
  • Credit the CEO and management team for successful companies

The Board is responsible to shareholders for the performance of the company. Their ultimate power is to take out the CEO and replace him or her with someone else. If they fail to exercise this power in time then value is destroyed, and (in a reasonable jurisdiction) they are opening themselves up for shareholder lawsuits and more.

The CEO on the other hand is there to do the best job he can do to increase the value of the company – and a smart board steps aside a bit and lets a successful CEO go for it. A smarter board will keep challenging the CEO with questions on strategy, implementation, culture and succession. They will also make sure the legal and fiduciary obligations are up to date and keep a very jaundiced eye on what could go wrong.

And plenty has gone wrong recently, often in companies ruled by a strong CEO/founder/majority shareholder.

So here are a few starter Q&A’s for existing and prospective board members

What should you do if you do not agree with the company’s strategy?

Voice your concerns. Your responsibility is to the shareholders, and you are their representative. So if you don’t like the strategy, then get the discussion going. You are on the board because your voice needs to be heard. If it is a matter of degrees, or if it is big but you can live with the alternative, then a good discussion (with well researched inputs, and a constructive atmosphere) is the right thing to do. If the strategy is wildly different from your beliefs then perhaps it is time to make a stand, or get out. More on that down the page.

What should you do if you think the CEO is “off”

CEO’s can go off – they may get stale, not grow with the company or change with the times. You may have employed the wrong person in the first place, or they may have out-grown the role and want to move on. Firstly talk to the other board members, and see if your concerns are shared. Then constructively engage with the CEO to help him change his ways or move aside for a successor.

However if the CEO is really going off the rails, or if you think there is fraud involved, then you need to get down and dirty. Call or meet with the other board members, or with the non-executive board members only. Agree on a course of action, which may be asking toe CEO to resign, issuing him with firm instructions or demands (or else) and/or shopping for a new CEO. It’s important to move together, and firmly.

What should you do if someone makes an offer for the company?

If they are serious, then you have a duty to the shareholders to maximise the value of their investment. This is a duty to all shareholders, not just the majority, and it is a duty taken very seriously by courts (at least in the USA). You should consider the company “in play” and the  independent directors need to step up to make sure that the interests of the executives and/or major shareholders do not come first.

Next you should retain professional advice (a great way to CYA), and seek to maximise what you can sell the company for. You firstly need  to have a very clear understanding internally of what you believe the company is worth – actually this is something that you should always have. If the offer is within reach of your internal range (or above your share price) then it’s time to create and run an auction process, whether public or not.

Should you accept board positions when the founder has a majority share?

Yes, But. Yes you can accept these, but the founder has to understand that you are putting your reputation and more on the line. That means he needs to accept that the board has a certain amount of “veto” power, and even more specifically that the independent directors have a de-facto veto over any major decisions. If they do not have this power then the board cannot represent the interests of all shareholders, and is a powerless advisory board only.

What should you do if the founder/majority shareholder/CEO/rest of the board doesn’t take your advice?

If it persists, then resign. You are not a figurehead, and if they demonstrate time and time again do not want to listen, then go gently into the night. After all you may be wrong, but like it our not as a board member you will be responsible for the failure of the company, and if you strongly believe they are going the wrong way, then you need to get off the ship. Of course this is a drastic action, but you have to keep your integrity.

What should you do if you see illegal activity happening by the company/founder/majority shareholder/CEO?

Resign, and quickly. This is the main power that you have, and you should also report any illegal behavior to the relevant authorities. Illegal behavior is a huge indicator of impending financial disaster, and so as a board member you should treat it with utter seriousness. It’s also, well, illegal, and you can go to jail yourself if you do not react appropriately.

On occasion the CEO (say) may have stepped out of line a bit, but not too  far, and the Board can place controls and mandates to bring things back into control. However as a board member your reputation and freedom are on the line so these will be treacherous waters.

What do you do if the board meetings unproductive or simply do not happen?

Step up and make the changes required. Boards that do not meet are asking for trouble, while poor board meetings will rubber stamp poor decisions. If you see this happening then it is your duty to shareholders to make sure that meetings happen and that the board it doing the right thing by shareholders. Once again it is your reputation and even perhaps freedom on the line.

How many boards should you be on?

Up to as many as you can cope with – and this is a function of what else you have on, but more importantly on how efficient and effective you are, and what else you have on your plate. It’s the old adage t0 give the busy person things to do and they will get done.

Should I recruit a “professional director”?

Rarely I say, and even then maximum one person. I’m defining a professional director as someone who is only doing directorships for income, they are usually older and retired from direct involvement in business. To me this risks losing perspective, as the professional directors are not engaged at the right level. It may make sense to have one elder statesman of this type for the history and network – but the majority of the board should be dynamic and involved. This doesn’t mean don’t get people that are experienced, but please make sure you have a mix of youth and experience.

I’m a founder/CEO – what sort of people should I have on my board?

People you respect, can learn from and will listen to – they have to hold you to account after all. People that are different enough from each other so they bring different points of view – be it from their skill set, industry experience, age, gender or ethnicity/country of origin or seniority. They are there to work, are are underpaid, so genuine interest and passion for the company is really important.

I’m a founder/CEO – how many people should I have on my board?

From 3 to 12, and it varies by the size of the company and the complexity of the business. The EBRD has a live-in board of 23 Directors and 20 alternates, along with a Board of Governors 126-strong (2 from each country). Somehow it works. I’ve also seen a board of 3 people work well for Lingopal. It’s the skill-set and the engagement around the table that is important, and you should get the minimum number that works.

How should you compensate board members?

Some research I saw (part-directed) at McKinsey was equivocal on a lot of board behaviors, but very clear on one. The more money on the table when the board meets, the better the results to shareholders. That means the major shareholders should be there, and that board members should have their own money at stake. It’s true for the 3 people Lingopal board meetings, and it is true for Microsoft and the EBRD. Let the non-investors accumulate shares, by earning them or buying them at a good price, (preferably not by options as it encourages risk taking) helping them pay for those shares with a loan. Pay them a bit in cash as well to help make ends meet.

That’s my take – Do you agree with these answers? What other questions are important?

About Lance Wiggs

@lancewiggs
This entry was posted in Business, Investing, NZ Business and tagged , . Bookmark the permalink.

9 Responses to Blame directors for failure, CEOs for success

  1. Andrew says:

    Hi Lance,

    Another great article, thank you again. I agree with what you are saying. I do have one comment/question where you say to a director “Your responsibility is to the shareholders, and you are their representative.”

    I would say instead a directors responsibility is to the company, and to act in the best interests of the company. And, even though they are appointed by the shareholders, they are not on the board to represent the shareholders, nor to represent the interests of the shareholders.

    I think this is an important distinction particularly when a company is making decisions that may have a day-to-day impact on a shareholder. The duty is for the directors to act in the best interests of the company, and this is specifically stated in the Act. (Companies Act 1993 Section 131)

    http://www.legislation.govt.nz/act/public/1993/0105/latest/DLM320657.html

    Having said that, this is no way takes away from the duty to maximise shareholder value. In the long term, all decisions should increase the value of the company.

    This can be very apparent with startup companies who begin with a board appointed as “shareholder representatives”, quite often the shareholders and founders themselves. As the company matures, the board will transition to a more professional board where the directors are appointed for their specific skills and experiences in areas the board requires.

    Keep up the great writing.

    Andrew

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  2. Nik says:

    Thanks Lance – a great explanation for us laypeople.

    I’m wondering, at what stage of a company should you begin looking for directors, or start having a board?

    Once the shareholding passes beyond just the original founders? (Once you take money?)

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  3. Lance Wiggs says:

    Andrew – you raise an excellent point:
    I would say instead a directors responsibility is to the company, and to act in the best interests of the company.

    the reply I was writing got out of hand – so expect a blog post soon.

    Nik
    I feel you should always have a board (and it is a legal requirement), even if it is just the founders.
    The question of when you need external directors is a bigger one. Having just one external director means that you should be having regular meetings, and that you will should keep your internal reporting and plans up to date. My quick answer would be “as soon as you can see the viability and growth”.

    Once you start growing in earnest, then it is time to add directors that have skills and experience you require. A lawyer, super connected sales person, deal maker, accountant and of course people that really get what you are doing. These can be added progressively as you grow – after all at least some of them will expect to be paid.
    The directors can grow with you as well – I would not be afraid of tapping friends from universisty, peers at a junior level in a large law firm and so forth. They would leap at the opportunity to be on a board, and will early stage companies seriously.

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  4. You seem to be driving at whether the quality of the board. Odd but HIH’s former boss Rodney Adler defined the problem well this week.

    Many superstar CEO’s have enjoyed a period where they have received the rewards that have historically been reserved for owners of a business.

    They have done so without any of the risk that owners would have experienced and continue to face (i.e. shareholding, the pain of getting the business to a point of wealth creation, the possibility of bankruptcy in bad times).

    A lot of these superstar CEO’s are now becoming Directors so they still have little or no downside to their cushy fees paid for a part time job. So you have no incentive at governance or management to do right by your shareholders. It’s only down to best intentions.

    While this situation continues to excerbate you won’t have well run businesses and shareholders will get short shrift.

    So perhaps when choosing a board or CEO the best practice might be to have them assume more personal liability for poor performance. Start hitting their pockets and you are likely to have a good governance structure and excellent management.

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  5. lance says:

    Julian
    -the best practice might be to have them assume more personal liability for poor performance.

    I couldn’t agree more.
    The financial aspect is often meaningless for the directors, either because they are already made, or because they are compensated through cash or a one-way option on the company.
    So yes – directors need to feel committed and involved – on both the upside and the downside. It’s not merely financial – we need to hold directors from poor performing boards to “professional account”, which means they should take a meaningful reputation hit and struggle to get or retain other board positions.

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