The value that a board can bring a small to medium sized company is to:
- assess the context and environment within which the company operates
- provide independent evaluation of management
- access to important relationships not otherwise available to management
- drive strategic planning, and
- verify the execution of plans
Directors need to give valuable insights, assessments, contacts/networks and leverage to bring about results not otherwise available to the company or they need to be able to get those things or they should get off the board.
Get the Basics Right
Getting the board and management structure right is tricky. Boards must set the goals (desired results) and strategy (approach to achieve results) for the company whilst ensuring that the necessary resources to execute the plans are available to management. Management has the responsibility to plan and execute but both management and the board need to verify that what was planned to be done was done and that the right decisions were made when changes were needed. That is, the planning process is left to management, but the board describes the desired results toward which plans are directed.
It is the duty of a board to hire and fire the CEO and to properly evaluate the performance of the company. But who evaluates the board’s performance? Because the board has to evaluate itself it must do so transparently and hold itself accountable to shareholders, management and staff. However this is more difficult because in most small companies the shareholders, management and staff often have common membership.
Shareholders, as the owners of the company, appoint the directors to act on their behalf to be responsible for the company’s overall business performance and to ensure that the company complies with all its legal obligations. The following table (developed from an idea by Robert Tricker International Corporate Governance 1994) sets out the functions of the board.
|Hire/fire work with and through the CEO||External||Ensure accountability and that the company complies with all legislation and obligations it has with the outside world.||Develops high level goals and aspirations of the company and through the CEO formulates the strategy and ensures that the necessary resources are available to execute the plan.|
|Internal||Monitors and verifies that the CEO has systems in place for achieving the goals in the business plan within the approved budgets.||Sets the perimeter within which the company operates and approves all necessary policies for the operation of the business.|
|Looking backwards||Looking Forwards|
A board exists to govern the company not to manage it. That is the board is formed to provide the accountability link between owners and operators (CEO and the management team). But in addition to providing the link between owners and operators the board also provides the link between the broader society and the operators, meaning that the board is responsible for governing the company so that it meets the expectations of society especially those expectations codified in law. The board’s job is fulfilled only if it properly defines expectations and demands achievement. Whilst the board may advise management and the chairman may coach and mentor the CEO, in the end those things do not matter. The central challenge is can the board command (not the same as dictate) in such a way that management is optimally empowered and challenged at the same time? Proper accountability comes from the board having the authority as well as the obligation to demand results.
To perform its duty the board can delegate authority to committees and to the CEO. A board needs a chair that is responsible for the board itself proceeding successfully just as the CEO is responsible for the company proceeding successfully. It is important to clarify the different roles:
- The board is accountable to the shareholders for the company achieving what it should (such as profit, Return on Equity, long term company value, etc.) and avoiding what is unacceptable (such as excessive risk, illegality, unethical conduct, etc.).
- The board must be able to define success and failure for the CEO and then assess the CEO against those measures.
- The chair is accountable to the board for chairing the process so that directors fulfil their commitment that they made when becoming a director of the company. The chair is not the “boss” of the board, but its empowered servant whose task is tied to board, not CEO performance. (If the chair is accountable for CEO performance, the chair becomes the de facto CEO.)
- The CEO is accountable to the board for fulfilling the board’s definition of business achievement and avoiding the board’s prohibitions (as in point 1. above). The CEO is not accountable for board performance, nor is the CEO accountable to the chair. The board cannot direct the CEO in how to do their job, only what results they must produce and what policies they must follow.
There is a fundamental dilemma here because a responsible board must maintain control over the CEO but a responsible board will also want to provide the CEO with all the managerial power and latitude possible. The board has to achieve optimal board control while granting the CEO optimal CEO/management freedom.
How is this achieved? The board sets out the desired results in an affirmative, prescriptive way (what must be done) whilst only controlling corporate “means” in a limiting, proscriptive way (describing what cannot be done). Elaborating this further:
- Controlling results in an affirmative and prescriptive way by expressing to the CEO its performance expectations with respect to company profit (EBIT), share price (or company value), or whatever the board’s judgement is in relation to appropriate benchmarks of corporate success from the shareholders’ perspective.
- Controlling means in a limiting and proscriptive way by expressing to the CEO their boundaries around acceptable managerial decisions. This approach preserves great ranges of managerial prerogatives yet keeps that range within the board’s “limits of acceptability.” The board is not telling the CEO how to run the business but constructs an arena, directing the CEO to work within it.
Consequently the ultimate impact of the board on the way the company is run is by their choice of CEO and if they are not happy with how their choice is running the company they have the power, authority and responsibility to replace the CEO.
No single director, including the chair, has any authority over the CEO. The board jealously guards its wholeness and its authoritative voice as a group. The CEO should not be confronted with a list of various directors’ individual wishes, but only with the expectations of the board as a group. Getting to that point calls for diversity and dialogue within the board and on many issues will require extensive input from others (such as management, auditors, shareholders, investment bankers, etc.). Management is included in this dialogue, but should not steer it or be responsible for it.
Getting the Right Directors
Selecting independent directors with the skills and experience to effectively govern the company is the key. What skill gaps exist in the current board? Does the company intend to expand the shareholder base, raise capital or undertake a series of acquisitions? Look for directors with knowledge in the industry or an upstream or downstream industry or who understand the market.
In addition there are personal qualities that every director needs to have – commercially savvy, good judgement, personal integrity, credibility, good reputation, able to work collegiately, strategic thinking, a working knowledge of finance and accounting, good grasp of governance, good communicator.
The board and stakeholders
It is important that the board defines the relationship with each of its “significant others” so as to preserve the wholeness of the board as the single, authoritative position as the owner’s representative.
Shareholders Directors represent shareholders so it follows that directors must act on shareholder concerns and wishes. But by law the director must act in accordance with the best interests of the company itself and not any one particular shareholder.
Board/Chair The board has the responsibility to govern the company. The role of the chair is to ensure the board process is conducted well. The chair is an instrumentality of the board and great care must be taken to prevent the board from becoming the instrumentality of the chair. The chair exists to aid the board in being accountable to its stakeholders particularly the shareholders and it is not the chair’s role to supervise the CEO. That role belongs to the board collectively.
CEO The board is the CEO’s superior, not the chair; hence, the CEO is not supervised or instructed by the chair. (Directors individually may relate with the CEO and their subordinates in whatever ways they find mutually acceptable but such relationships have no authority. Only the board and CEO have that relationship.)
Committees Committees can be created by the board but they are always under board control. To preserve the board-CEO relationship, they cannot be given authority over the CEO and should not be allowed to fragment directors’ sense of whole board responsibility. While board committees can be given a task to help the board with some aspect of its job, it is interfering with management when a board committee is assigned to help or advise management on some topic. A committee’s charge, then, can only be derived from some decision area that the board has retained to itself. For example, shareholder relations, audit, and CEO compensation are such topics; human resources would not be.
Executive directors There is an inherent conflict in being, at the same time, a director and an executive working for the CEO who works for the board of directors. Board access to the wisdom and knowledge of upper management does not require them being directors. Appointment of executive directors should be done with great care and avoided if at all possible.