To Advise and to Govern
By Nicola Rowe
The boardroom! The name conjures up a circle of grave-faced, silver-haired businesspeople in suits, meeting in exclusive conclave to exercise two broad sets of functions: to advise and to govern. What kind of boards exist? What is best practice in how they are structured? And what are their core roles?
The Informal Board of Advisors
Perhaps a firm is just starting out, and is run by a sole trader. Or maybe the owner runs it in partnership with others. In general, these arrangements won’t need a formal board unless the owner/s want to list the company but, unless they’re bent on making all their mistakes alone, they’ll still need the advice – and the Rolodex – that a board can provide.
New Zealand entrepreneur and doctor Miriam Martin founded her hugely successful medical personnel recruitment agency Kiwisstat/Ausstat in 1999. As a private company, hers doesn’t need a formal board, but Miriam has found it invaluable to have an informal board of advisors, whom she pays by the hour. She says:
“It’s been really good to have people critique our decisions every couple of months. It’s added a dimension of robustness to the business.”
How do companies choose advisors? James Currier, who founded the social networking company Tickle (and sold it to Monster Worldwide for $US100m) said:
“My selection criteria were based on several factors. Number one was personality fit – meaning can we get along. Number two was does he or she have relevant experience…. Number three was can this person introduce me to people I want to work with and/or do business with. That is a sub category of personality because if your personalities match, it is likely that the people they introduce you to will also match. But, it is also a matter of how big their Rolodex is.”
The Formal Board of Directors
A listed company needs a formal board of directors. When going public, the company’s founders need to decide who should be on the board, where they should come from, and how many appointees there should be.
1. Executive directors and non-executive directors
Ideally, the board will comprise both directors who are executives in the company (for example, the chief finance officer) and directors who come from outside its ranks. The former type are referred to as executive directors; the latter are called non-executive directors, external directors or outside directors. If you’re intent on becoming a director, the route you take will depend on whether you intend to be an executive director or an independent. If the former, you’ll be aiming for a C-level role with board representation; if the latter, you won’t necessarily be on a corporate track, but may, for example, be an accounting or legal professional.
There is an increasing trend towards non-executive directors. Their presence is perceived to strengthen the board: while no director should be beholden to a particular constituency, non-executive directors are seen as less likely to bow to anyone’s will. Venture capitalists, who represent investors with a particular time horizon, and executive directors, who tend to side with their boss, the CEO, can be seen as less independent.
Research has found that the incidence of fraud decreases as the number of non-executive directors rises 2, and the New Zealand Securities Commission recommends an “appropriate balance” of executive and non-executive directors for New Zealand companies 3.
2. No one size fits all
It’s not just who sits on your board, but how many you have alongside you at the table that counts. In the US, the size of boards has shrunk from an average of 16 in the 1980s to a mean of ten last year, while a recent Egon Zehnder survey of North American and European directors determined that 14 seats at the table were thought ideal. No one size fits all, and any decision on size means weighing competing considerations: too small a group, and you foster group-think and close off a wider range of opinion; too large, and discussions become unwieldy and factions form.
3. The chairman of the board
The CEO will always be on the company’s board; should he or she also be that board’s chair? National practice varies widely. In the US, the roles are usually occupied by a single person; in the UK, the reverse is the case. Here, the Securities Commission takes a dim view of joint responsibility, stating that “[n]o director of a publicly owned entity should simultaneously hold the roles of board chairperson and chief executive (or equivalent).” 4
Structure of the Board
To discharge its functions effectively, the board should have at least three committees.
- audit committee: responsible for liaising with the internal and external auditors and promoting integrity in financial reporting
- compensation committee: responsible for setting and reviewing the CEO’s total compensation package
- nomination committee: responsible for nominating new directors to the board
Further committees may also be adopted as appropriate to enable the board to work effectively.
The Securities Commission recommends that the audit committee consist only of non-executive directors, that at least one member be “a chartered accountant or [have] another recognised form of financial expertise”, and that its chairman be an independent director who is not also chair of the board itself.
The compensation committee’s remit is simple: set and review the CEO’s total compensation package. That package has up to six components: base salary, salary bonus, stock grants, stock options, pensions and perks (such as the Gulfstream jet that Apple gave CEO Steve Jobs). The last quarter-century has seen a breathtaking rise in the package value, especially in the US. A CEO’s earnings as a multiple of an average factory worker’s rose from 42 times in 1980, to a whopping 531 in 2000. Much of that increase came through stock options – paper pay, perhaps, but pay nonetheless.
The compensation committee typically sets the CEO’s goals for coming year, with compensation tied to them. As the review period approaches, it asks the CEO for a written self-appraisal and list of desired compensation changes. In parallel, the committee reviews the CEO’s performance against past goals and researches CEO market salaries. It then presents its findings to the wider board. Finally, it meets with the CEO to share the performance and salary review outcomes.
Not all boards have a nomination committee, but research has found that formalising the selection of directors through a nomination committee, rather than informal shoulder-tapping, increases the chance that the board will appoint foreign and independent directors. This does not, alas, make it more likely that women will be appointed to the board.
To Advise and To Govern
The board has one advisory function: it offers expert advice to management, enabling management to run the company better than it could on its own.
Next, it exercises four governance functions.
First, it hires top management, especially the CEO. When Hewlett Packard was searching for its penultimate CEO, it was looking for a change manager who could make the numbers. Carly Fiorina, who had been just that at Lucent, fit the bill. But hiring the CEO is only part of the task: the board must evaluate the CEO and, if necessary, fire her – and you can read about Carly Fiorina’s perspective on that aspect of her tenure at HP in her autobiography, Tough Choices.
Secondly, the board votes on major operating proposals – capital expenditures, for example, or mergers and acquisitions. If you’re familiar with Carly Fiorina’s tenure at HP, you’ll remember that her board split over her proposal to merge with Compaq in 2002.
Thirdly, the board must vote on major financial decisions, such as issuing stocks and bonds, and determining dividend payments and stock repurchases.
Finally, and importantly, the board must ensure that the firm’s activities and financial condition are accurately reported to its shareholders.
There’s not one answer to what you, as a new director, might find on your first agenda. In part, it depends where in the year you come in and also on what issues the board happens to be examining. One thing you should not see are topics and tasks that should be carried out by management. The distinction between governance and management is a vital one for any new Director to grasp, but it’s too wide a topic to cover here.
- Michael Roberts, William Sahlmann, Sasha Novakovich, How Serial Entrepreneurs Build and Manage a Board of Directors in a Venture-Backed Start Up, HBS Case 9-808-163, Rev. July 1, 2008.
- Board Composition and Corporate Fraud”, Hatice Uzun, Samuel H Szewczyk, Raj Varma. Financial Analysts Journal. Charlottesville: May/Jun 2004. Vol. 60, Iss. 3; pp. 33 ff.
- Corporate Governance in New Zealand – Principles and Guidelines. A Handbook for Directors, Executives and Advisers. Securities Commission, March 2004, section 2.1.
- Ibid, section 2.5.
- The Determinants and Effects of Board Nomination Committees” Winfried Ruigrok, Simon Peck, Sabina Tacheva, Peder Greve, Yan Hu. Journal of Management & Governance. Dordrecht: 2006. Vol. 10, Iss. 2.
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