FindingThe Right Board Mix Harder Than It Sounds

Wednesday, June 15, 2005

Russ Banham, Abstracted from: Boards That Can Shoot Straight, http://

Treasury & Risk Management - April 2005, Pgs. 16-23

Board Reconstruction 101.
Ask the experts at high-profile consulting and search firms such as Mercer Delta Consulting and Spencer Stuart, and they will confirm it: no easy or scientific way exists to construct a board that will rate exemplary marks for corporate governance. These firms are increasingly being drawn into the search process to fill vacancies in corporate boards. Negative publicity from boards gone awry at Enron and WorldCom has ushered in a new era of governance and responsibility, replacing the golf-centered, cigar-smoking boardroom of years past. Russ Banham illustrates the new paradigm in board governance with Apria, which had committed just about every corporate sin in the book before it asked shareholder activist Ralph Whitworth to become CEO and reform the company and its board. His first order of the day was to split the offices of CEO and chair. Next he replaced most of the board­five directors in one fell swoop­with independent experts in finance and accounting. Finally, he added an evaluation system to keep the new members on track. Apria’s board is now rated among the ten best in America.

Being ombudsmen for shareholders and others.
Because they are not involved in daily operations, directors have the luxury­and the duty­to review the business from a unique perspective and take a stance against fraud, self-interest, and power-hungry executives. Taking their responsibilities seriously, directors have become strong advocates for the shareholders. Yet, the author cautions, constructing the ideal board, with just the right mix of talent and personalities to fulfill its mandate, is a tricky proposition. Recruiters have learned the hard way (think Enron) that a superb résumé and strong qualifications do not always guarantee a good board member. In the past, CEOs were the favorite board candidates. Many thought that only a CEO could stand up to his or her peers and challenge them on corporate issues. Today’s executives are limiting the number of boards they join, given the hours involved (many more meetings and more preparation) and the personal liability. Few CEOs have the time to take on board memberships outside their own company, and too often now they seem unduly deferential to their peers.

Diversify, diversify, diversify.
As in investing, diversification is the key to a board’s success. The right mix of business, financial, operating, marketing, and other skills will put the board on the track to success. Sometimes, this means reaching lower in the ranks to tap the head of a business unit or division. It is also a good idea, the author notes, to have a few directors with major equity stakes in the company. With the help of consulting firms, some companies are drawing up competency or skill matrices for their boards. Nexen, a Canadian-based global oil-and-gas exploration and production company, used this process to construct an eleven-armed matrix identifying the areas of competency for its board. GovernanceMetrics International has rated Nexen’s board a perfect ten, despite the fact that it has no women members. Nexen’s high marks for governance are the result, in some part, of a Canadian law requiring companies to adopt a formal process for assessing board needs and evaluating the competency of its members. One 2004 study by Institutional Shareholder Services found that 96% of S&P 500 companies regularly review their board’s performance.

What’s in a name.
Setting up criteria for selecting and evaluating directors is only part of the process, the author points out. Nominating committees are now becoming more aware of the source of the names that are nominated. The old-boy network is being replaced with a more open nominating process by using sitting directors and employing search firms­rather than the executive management team­to identify names for open seats. The SEC now requires companies to disclose how the board identified a candidate. With this rule in effect, the names submitted by the current CEO are no longer automatically chosen, since they may represent a vested interest. D&O insurers are also taking a hard look at board composition and the loss experience of individual members, which helps the board avoid candidates who have been defendants in class actions. For their part, candidates are demanding that the company get separate insurance protection for independent directors.

No guarantees.
The extra work, evaluation process, and stricter compliance still do not guarantee a board that truly meets corporate governance standards or that protects shareholder interests. The author reminds us that the Enron board looked good on paper. In retrospect, it appears that Enron’s board did not probe some of the controversial issues deeply enough. A board and its outside advisors must be willing to ask pointed questions and not be cowed by the apparent success of the company’s operations. In Enron’s case, an independent chairman would have helped. One solution to the dilemma of true independence is to install a lead independent or a presiding director, who will coalesce and advocate for the views of the outside directors.

Abstracted from Treasury & Risk Management, published by Wicks Business Information, 52 Vanderbilt Avenue, Suite 514, New York, NY 10017.

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