“The directors of such (joint stock) companies, however, being the managers rather of other people’s money than of their own, it cannot be well expected, that they should watch over it with the same vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.”
Adam Smith, The Wealth of Nations, 1776
In the wake of scandals such as Livent, Royal Trust and, more recently, Enron, boards are have become much more wary of managers. The lack of a need for trust has been replaced by a lack of trust itself. Faced with the possibility of personal liability, board members are now probing deeper and deeper into the actions of managers to ensure that operations are proper. Boards are no longer “rubber stamps”; in fact, they have become “roadblocks.” Senior managers are being forced to spend more time preparing for board meetings, as well as locating and documenting information for the board. This takes them away from their prime responsibility of running their businesses. There is a fear that, with scandals such as Enron, the pendulum of due diligence has swung over too far, to the realm of mistrust. The real fear is that boards are so concerned with protecting themselves and the interests of the stakeholders that they are constricting senior managers to the point that corporate performance may be adversely affected.
This article suggests seven ways for striking a balance between the board as a “rubber stamp” and a “roadblock.” The role of the board is to act as a steward for the owners of the firm and to ensure that senior managers are fulfilling their roles, while at the same time provide advice and counsel to those same managers. If the board does not question enough or, questions too much, it is not fulfilling either of its roles. In the following sections I will suggest steps that can foster trust between boards and their senior managers and allow both groups to fulfill their responsibilities. If these steps are followed, the board and senior managers will be able to work effectively to improve firm performance.
Seven steps to building trust
1. Align the vision: A firm’s vision is articulated by its shareholders, who hire managers to enact their vision. Board members must share that vision, and they must not impose their own vision on the firm or attempt to change the shareholders’ vision. The board acts on behalf of the shareholders, not instead of them. Hence, if a board member does not share the same vision as the shareholders, it is incumbent upon him or her to resign. Although the CEO must be a visionary, if he or she does not have the same vision as shareholders, the board must replace that CEO. Only when the board and senior mangers have the same vision can they trust each other and begin to develop the goals and strategies to realize that vision.
2. Clearly define the roles of the board, the chair and the CEO: If the board and senior managers are going to trust each other, it is crucial that each knows the limits of their roles. For example, the board should not be making the day-to-day decisions the CEO should make, and the CEO should not ask it to do so. Some of the main roles of the board, board chair and CEO are outlined below.
The role of the board (Adapted from “Where were the directors?” Guidelines for Improved Corporate Governance in Canada: Report of the Toronto Stock Exchange Committee on Corporate Governance in Canada, 1994.)
- Establish corporate policies
- Approve operating and capital budgets
- Review senior management’s performance and authorize the selection and compensation of the CEO
- Prepare strategic succession and development plans
- Determine dividend policies and procedures
- Ensure the integrity of internal controls and governmental compliance
- Identify significant risks and appropriate responses
- Act as the steward of the company’s assets and the liabilities, and as a representative of all shareholders
- Appoint committees that configure and perform their duties to the best of their abilities
- Monitor safety and environmental programs
Role of the board chair:
- Build a strong, effective, well-balanced and representative board and committees
- Set the board agenda, and schedule and chair directors’ and shareholders’ meetings
- Manage the affairs of the board
- Ensure that all committees are working effectively
- Head the evaluation of the CEO and the review of corporate performance
- Act as adviser and sounding board to the CEO
- Provide a link between management and the board, and the board and shareholders
- Ensure that the board is receiving timely and appropriate information before, during and after board meetings
- Appraise the board’s performance
Role of the CEO:
- Senior management person responsible for achieving the goals approved by the board
- Build/increase shareholder value
- Provide leadership for the corporation
- Develop the corporation’s mission, strategy, policies and management processes
- Recommend corporate financial targets and investment projects
- Create a strategic plan to meet financial goalsEnsure that annual business plans are aligned with financial objectives
- Monitor financial performance
- Select senior management and monitor their performance
- Recommend appropriate rewards and incentivesSet annual objectives for the CEO and senior management team
- Be responsible for shareholder relations, regulatory conformance, internal communications and all public reporting requirements
- Deliver essential corporate services in a cost-effective way
- Work with divisional presidents to foster customer relationships
3. Build a strong board: A board must be constituted of members who are committed to the firm. In selecting the “right” members, a list of criteria must be established. Although, there is no list of criteria or specific criterion that is appropriate for all corporations (each member must be selected on a firm-specific basis), the following criteria are, generally speaking, important for all boards.
- Independence: Each member must be able to—and be perceived as being able to — exercise independent judgment. Director independence means that the director is not dependent on management for any source of revenue, remuneration or the like, and is free from any undue influence over his or her actions. Any special relationship with the business or senior management that could interfere with the director’s ability to act in the firm’s best interest compromises independence. An important aspect of this independence is the separation of the CEO and the board chair or lead director. Although the CEO should be on the board, independence is compromised if he or she is also the board chair. How can compensation and evaluation be undertaken independently when the CEO is the chair and will be involved in both areas? The board itself rather than management should decide who is independent. Being a shareholder does not necessarily mean a director is dependent.
- Members: Nominations to the board should be made by independent members. New members should receive an orientation to the board and corporation. Board members should be expected to commit several days a year to the board. Additionally, processes should be in place to evaluate the performance of each member. The board size should not be too unwieldy. Too many members may slow the governance process; too few may result in oversight or lack of insight. Compensation should reflect the responsibility and commitment of the board members. If the board member is going to take a high risk and commit to do a lot of work, he or she should be compensated appropriately. This will also ensure that high-calibre talent is attracted and retained. Membership should be based on the skills an individual brings to the board. Skill redundancy and overlap reduces the effectiveness of a board. Part of the purpose of the board is to provide senior managers with additional resources. Technical expertise, influential connections, industry experience and commitment are the best criteria for board membership, not notoriety or patronage.
4. Build a strong management team: Part of the role of the board is to select the firm’s CEO, who in turn selects the senior managers. Since the board is supposed to choose the CEO, it does not make sense that they would not trust the person they install. However, this situation does occur. At a minimum, boards should select experienced, technically competent CEOs. Beyond that, the CEO needs to be a visionary, and capable of transferring this vision to the management team. The board can assist in selecting the senior managers by providing contacts, guidance and advice. What is important is that the management team, including the CEO, sees the board as a tool that can be used to improve the firm’s performance, not as a body that is unresponsive and oppressive. The board must recognize the talent and autonomy of the management team. They are the ones who run the business, not the board, and this responsibility must be respected.
5. Recognize the importance of evaluating the directors (see article in this issue by Conger and Lalwor): Performance evaluation should not be considered a negative activity. Further, it should be focused to ensure that both the CEO and the board are fulfilling their roles. It is, of course, the board’s role to evaluate the CEO, but the CEO evaluates the senior management team. The CEO must have a clear understanding of the expectations of senior management performance based on directives from the stakeholders, issued by the board.
Although the board is not evaluated by senior management, its members still must be evaluated. A true, introspective and objective evaluation is hindered by executive board chairs or by a predominance of related directors. However, several firms exist that specialize in board self-evaluation processes. Each board member and committee must be evaluated based on their contribution and effectiveness. Along with a valid evaluation system, processes for remedial assistance or removal of members who have subpar performance must be in place.
A culture of open self-evaluation with the goal of continuous improvement gives senior managers who will be evaluated by the board a strong indication that the expectations are high, but will be adhered to at all levels. A trusting relationship cannot be built if the senior managers feel that their actions are always being evaluated, while the board gets away with poor performance. There can be no incentive for a manager to come to the board with problems if he or she feels that they will be the scapegoat. If senior managers are aware that board members are under the same pressure or evaluation process, they will be more forthcoming with information, and the board can provide better advice and counsel.
6. Encourage a climate of constructive challenge: In order for a board to be more than a rubber stamp, it needs to be able to challenge the senior managers. A culture in which pointed, direct, serious and important questions are asked and answered is a good way to ensure that there is trust between the board and senior management. Board members must not hesitate to ask tough questions; managers should anticipate those questions and be prepared.
In order to foster trust, however, the inquiry needs to be constructive. The board should ask questions to keep management accountable, but not to embarrass or exercise its authority. If action taken by board members when asking tough questions is constructive, senior managers will provide honest answers. If the stance is adversarial or malicious, managers will be less forthcoming.
Further, if board members trust their managers, they should be more accepting of honest answers, and be open to opinions that may be different or unexpected. A culture where there is two-way, open, constructive communication will help the board and managers fulfill shareholders’ goals.
7. Ensure a timely flow of information: Board members are often overwhelmed by the amount of information they are required to digest and interpret; much of the information does not necessarily help them in their task. Senior managers may also be required to produce reams of information for board members in order to be seen as being accountable. This preparation takes the managers away from their roles as leaders and strategists. There may be an assumption on the part of management that the board requires voluminous information when in fact it doesn’t. There are also cases when board members are not provided with enough information, or are provided the information with little time to understand it before an important decision needs to be made.
Knowledge is indeed power when it comes to stewardship of a corporation. In situations where boards and managers do not trust each other, boards often request more information, while managers are willing to provide less, and not in a timely fashion. The board is dependent on managers for the information it needs to make accurate, informed decisions. Even the most effective board can be rendered powerless and make grave errors when it is forced to act with improper information. Thus, as a protective measure, boards will sometimes require managers to provide very detailed information. From an agency-theory perspective, control of information is one of the best ways a CEO can secure his or her position. Boards can be manipulated by the information they are given. If boards are to be effective, they should be quite concerned that the information they receive is accurate. However, if the board is not independent of management, this is not even a concern. Since the CEO will have the board stacked in his or her favour, there is no need for deception.
The upshot of this agency fear is that boards and managers will spend too much time requesting and accumulating information that may not be pertinent, and not enough time governing the corporation. If the board only requests information that it really needs, it signals that it trusts its managers. If the managers match the board’s request with timely, accurate, easy-to-interpret information, they signal that they can be trusted. Trust does not suggest a lack of accountability or an easing of responsibility. The board and managers should still fulfill their fiduciary duties. However, when the board signals that it trusts management, and management provides the proper information, both parties can reduce the bureaucracy and focus on running the business.
In an uncertain environment, trust between the board and senior managers is more crucial than ever. Nimble decision-making and decisive action are required to pre-empt competition and capitalize on opportunities as they arise, rather than endless discussion and actions by committee. Such action is impossible if the board does not trust and believe in managers. Thus, the board will never fulfill its role. For a manager to act, he or she must have the support of his or her board and not be second-guessed, and have the freedom to create strategic directions for the corporation, or, to do his or her job. To this end, I have suggested seven steps that will foster trust between a corporation’s board and its senior managers.
1 The members of the board must share the vision of the shareholders.
2 The roles of the board, board chair and CEO must be clearly defined and adhered to.
3 & 4 A strong board and management team must be created.
5 The importance of evaluation must be recognized and undertaken to ensure that each board or senior management team member is effectively fulfilling his or her role and responsibility.
6 Create an environment in which directors and senior managers can constructively challenge each other.
7 Ensure that appropriate information is made available in a timely fashion.