How can you make a Board of Directors an effective element of corporate governance? How should meetings be organized? What is the role of the chairman of the Board? George Abdushelishvili, Senior Partner at Ward Howell, will answer these, and other, questions.
The history of collective management of a business goes back over 400 years. Starting at the beginning of the 17th century, when the first Board of Directors was recorded in Amsterdam, shareholders, consultants, bankers, and regulators developed an institution of collective supervision for effectively managing companies in the interest of the owners and general society.
Today, the practices of Boards of Directors are written in detail and tested in different countries, cultures, and socio-economic spheres. Has one single method for an effective Board of Directors been cultivated? No, and it’s unlikely that one exists. We’ll emphasize several areas, systemic work that can help maximize the functional effectiveness of your Board of Directors: its composition, agenda, the role of the chair, and the Board’s purpose.
Board of Directors Composition
This is probably the most thoroughly researched topic in academic literature – the research results displayed a significant correlation between the composition of a Board of Directors and their decisions (for example, a Board predominantly made up of investment bankers led to a growth in mergers and acquisitions and banking transactions – a growth in the volume of credit).
Traditionally, the Board of Directors will be filled with industry experts, representatives from finance and the investment community, experts in law and regulatory activities, strategy and HR experts. This makes it possible to comprehensively review the issues on the agenda, and minimizes the risk of making the wrong decision. That said, in modern business, it is fundamentally important to have a variety of parameters that you use to choose a director: sex, location, industry, function – thanks to professionals with different backgrounds, the Board of Directors enjoys an expanded viewpoint and helps avoid tunnel vision.
But what if we want more? Specifically, to adopt the best and most innovative solutions to strategic issues, that maximize the value of the company. Ideally, the target result of the Board’s work should be to make collective decisions that are better than those of the most intelligent Board member. For that, the composition of the Board of Directors should include members who are diverse in terms of discipline, and also work effectively as a team. Unfortunately, finding these skills when selecting directors is far more difficult than identifying professional competencies. A group of highly qualified professionals, gathered into one boardroom, could be useless if the directors’ work styles don’t complement each other (for example, if the Board of Directors consists exclusively of critics or pacifists).
Understanding group dynamics, familiarity with the role (or roles) that we assign during a Board meeting, and overcoming the so-called “traps” substantially increases the work effectiveness. Here are some examples of “traps”:
- Anchoring. A tendency to formulate a judgment based only on accessible and understandable information. It is important to comprehensively analyze diverse, contradictory, and not always easily accessible information. Board members should be able to find their own information, and not just rely on the information provided by management.
- Confirmation. The involuntary attempt to confirm your own thoughts and conclusions. It is important to listen to the thoughts of others and, when necessary, change your opinion.
- Self-righteousness, which develops in the overconfidence in oneself, and in hasty judgments about events and people.
- Sunk Cost. The phenomenon of trying to justify past wrong decisions occurs often, which leads to additional and ineffective wasted spending.
Once you’ve attained the most effective composition of Board members, you then must address what keeps them busy, how they spend their time, and what are the meeting agendas.
An analysis of agendas allows you to determine what type of Board you have. Generally, all Boards of Directors can be divided into five types (See Fig. 1)
This isn’t to say that one type of Board of Directors is better than another – depending on the context, it can and should serve different functions. However, for large companies that operate in the modern world, the Board of Directors should play a strategic role, not just be a supervisory body. It should move from analyzing the past to planning for the future, from monitoring abidance to procedures and standards to developing strategy and mitigating risk, from analyzing management’s proposed decisions to developing them together, from confirming CEO candidates to actively engaging in succession planning.
In order to be considered “strategic,” a Board of Directors should, at minimum, pay attention to the following:
- Leadership: Who manages the company today, and who will manage the company in the future? How can we best motivate management?
- Strategy: What will be done with the company in the future, and how? Or, more importantly, what shouldn't be done?
- The structure or composition of the company: Which of the company’s acquisitions are strong, and which ones should we get rid of?
- Risks: What level of risk is acceptable for the company, and how can we realize our chosen strategy while taking risk into consideration?
- Finances: How can we preserve the financial well-being of the company and its shareholders?
- Stakeholders: Who influences the success of the company, and how do we interact with them?
Paying attention to strategically important questions, introducing them to the agenda, and preparing for their discussion ensures the effectiveness of a Board of Directors, and guarantees the well-being of the company.
Chairman of the Board of Directors
In practice, this role is often filled by a shareholder, his representative, a prominent public official (unless the government is a shareholder), or an independent, but always publicly respected professional. Whether or not this person is accountable is frequently considered more often than whether he can be effective in his role.
In the modern world, the role of chairman of the Board of Directors is complex and important: he determines the agenda of meetings, manages conflicts and disagreements between members, summarizes ideas and statements that have been expressed and creates understandable and achievable solutions from them, provides support and feedback to the members of the Board, interacts with key stakeholders on behalf of the Board, determines and introduces codes of conduct and standards of behavior for the members of the Board, supports and, simultaneously, monitors the CEO. These responsibilities clearly require developed communication skills and a high level of emotional intelligence.
The chairman of a Board of Directors, first and foremost, should be an experienced facilitator, not a strict authoritarian leader. This role should be performed professionally, and must be learned. But I’d like to point out that this doesn’t mean that a shareholder can’t be the chairman. It means that when he crosses the threshold into the cabinet for Board meetings, he plays a different role, and should fulfill it effectively.
What are the primary mistakes that a Board of Directors chairman makes?
- Manages the work of the Board in the interests of a particular shareholder, forgetting that even if he representing that shareholder as a Board member, as chairman, he should ensure that the work of the Board is done in the interest of all shareholders.
- Focuses on supervisory functions more than strategy.
- Controls the loyalty of the CEO, instead of providing support for business challenges.
- Interprets the role of chairman as a leading role, and not a facilitating one.
- Sees members of the Board of Directors as narrow specialists and/or advisors, without motivating them or helping them develop.
Purpose of the Board of Directors
Another important task of the chairman of the Board lies in ensuring that all directors are well aware of the Board’s mission, and know the answers to questions such as “What are we working for? For whom are we working? What are we trying to achieve?” The chairman of the Board should determine the standards and codes of conduct of the Board of Directors, specifically – what level of risk to accept, certain things the Board of Directors will never do.
Frequently, members of the Board of Directors don’t fully understand the difference between the purpose of the Board and that of management: the primary goal of the CEO and company management is to create value and maximize results. The Board of Directors should be accountable for maintaining value and minimizing loss. Only then will the interaction between management and the Board of Directors be balanced and beneficial for shareholders.
Every member of the Board of Directors should understand that he simultaneously fulfills five roles: that of an expert (that is, has professional knowledge in some kind of function and/or industry), that of a strategist (capable of long-term thinking), that of a mentor (capable of motivating and developing management and other directors), that of a team player (realizes, that the value of the Board is in their combined abilities). Most importantly, he must have the ability to put himself in the owner’s place and make decisions, thinking “If I were in the owner’s shoes, would this be beneficial for me?”
This article was published as part of the eighth issue of Talent Equity Newsletter "Effective Corporate Government".
To read all other journal issues, please follow the link to TE Newsletters page.