Advisory boards play a key role in good corporate governance, and as the author points out, they offer advantages and disadvantages compared to full legal boards. Advisory boards can and do add value, provided the circumstances are right. He then describes the best uses of advisory boards.
Advisory boards have played an important role in the evolution of corporate governance. The roles and range of these boards, or advisory councils or committees as they are sometimes called, have increased dramatically, and if the current trend continues, they will come to play an even greater role in corporate governance.
There are several different arrangements under which boards are involved in the affairs of public companies. One arrangement sees a conventional regular board supplemented by either a single, national advisory board or by several concurrent regional advisory boards. Another arrangement in public companies is also, in my view, an undesirable one. It is the use of advisory boards comprised of external members, operating concurrently with a regular board comprised, to the greatest extent legally possible, of internal directors. For obvious reasons, the minority shareholders are not well served.
At least in Canada, advisory boards are more frequently used in private companies. The following three scenarios are the most common.
SITUATION NO. 1
A wholly owned subsidiary of a foreign corporation often needs and wants independent advice from knowledgeable, well-informed people. The advice could be on domestic politics, usually national but sometimes provincial, or even occasionally municipal, and/or on expected economic conditions and markets. Sometimes it wants door openers.
Sometimes it simply wants public association with “names” –high-profile business leaders or perhaps even celebrities of one kind or another.
What a global corporation does not want or need is what it view as “meddling” with the strategy of its wholly owned Canadian subsidiary. Such a strategy is almost always designed to mesh and integrate completely with its global strategy, which is, of course, almost invariably determined and monitored by world headquarters. And as the sole shareholder of a Canadian subsidiary, the parent corporation should and does rely on its own management and staff for crucial functions like setting goals, vetting performance, downsizing, and the placement or displacement (i.e., termination) of senior subsidiary management.
SITUATION NO. 2
A Canadian company that is private is contemplating going public. This is often a young company with aggressive growth aspirations and pressing needs for new capital. In this situation, it is far-sighted and fairly common to put an advisory board in place to help steer the transition. Subsequently, a regular board is elected with the head-start advantage of having a cadre of suitable directors already in place.
SITUATION NO. 3
Finally, there is the example of the private company, owned either by an individual, a small group or another company, that has every intention of remaining private. This can be a very large company or it can be more of a family enterprise. Regardless of size, the controlling shareholder, or shareholders, recognizes the need for independent counsel on an ongoing basis, but wishes to minimize the “rigmarole” of full and formal governance, i.e., the inconvenience and cost of all the bureaucratic trappings.
Turning to the specific uses to which advisory boards are put, I find that these are wider today than ever before and include the following:
a) Well-known and respected business (and women) on advisory boards bring credibility, contacts and the ability to facilitate an introduction and a hearing.
b) By recruiting people who might be unconventional candidates for regular boards, companies can often gain fresh insights and “outside the box” thinking on emerging, unfamiliar or especially intransigent issues.
c) Experience without the baggage of any controlling or judgmental aspect can be brought to bear on a broad array of situations and issues.
Here are a few examples of situations and issues that can be dealt with by advisory boards:
- A company is re-evaluating its basic vision, mission, and/or strategy.
- It is considering a major restructuring or it wishes to reposition itself.
- It wants to engage in a new business or introduce a new product or enter a new market or even go global.
- It needs to introduce and cope with new technology.
- It is facing a looming competitive threat.
- It seeks advice on national or regional political, economic, market issues.
- It wants the fresh, unbiased views of women, minorities, and/or relevant special interest groups on matters of ongoing importance to it.
As I mentioned earlier, an advisory board can be a preparatory stage for a regular board. Where an advisory board and a regular board co-exist, the former can provide a candidate pool for the latter. Incidentally, this is a good place to underscore the point that an advisory board is not a single-purpose focus group brought together for a limited time to deal with one specific, well-defined problem.
For both companies and individuals, there are, of course, advantages and disadvantages to advisory boards versus full legal boards. For companies, the pluses include these:
- Management is not constrained by the requirements of a regular board with full oversight responsibilities. The focus is on non-binding advice, not on control, approvals or governance. Remember, however, that this narrowed focus is entirely inappropriate for public companies with minority shareholders.
- The all-in cost of an advisory board is almost always lower than that of a regular board. Advisory boards are lower than that of a regular board. Advisory boards are usually much smaller; also, the annual fees paid to each member are usually between a third and half of what’s paid to directors of regular boards.
- Furthermore, advisory boards often provide valuable advice at a much lower cost than that provided by consultants. This assumes, of course, the right membership: independent thinkers, creative strategists, people with extensive knowledge of, and experience, in the relevant industry.
- The format is flexible and can be easily tailored to the specific needs of a given company. How it’s structured is crucial. As always, god (or the devil) is in the details.
- It’s easier to change or add members. Usually, appointments are for a one-year or, at most, two-year term. By contrast, regular board members may be re-elected annually but, with precious few exceptions, both the custom and the common expectation are that they will carry on until normal retirement.
The two largest disadvantages of advisory boards are:
- Where there is both a fully independent regular board and an advisory board, there is the potential for overlap, competition, and confusion, or at least ambiguity. This can largely be controlled if the ground rules are clear and well maintained.
- The creative tension and separation of roles between a board and management, which accompany a fully independent regular board, are, of course, lost. This is of no consequence and is fully acceptable with either a wholly owned subsidiary or with a family-owned enterprise. But it is reprehensible and the worst sort of governance for a public company to combine an advisory board with a regular board that does the absolute minimum to satisfy the legal and regulatory requirements to protect minority shareholders.
With respect to the individual, the advisory board entails far fewer, if any, legal liabilities. It provides an opportunity to offer advice in a freewheeling, more flexible, less structured format, with emphasis on the big picture, not on the minutiae with which even the best regular boards are inevitably saddled. The time commitment is less but so is the compensation, not only per annum but also in dollars per hour committed.
To summarize, under the right circumstances, advisory boards can and usually do add value. In private companies, they can provide all of whatever input is wanted from independent directors, without the need to worry about governance issues.
In public companies, advisory boards can be useful adjuncts to regular boards. But to reiterate, replacing a regular board, that has a strong representation of independent directors, with the combination of an advisory board and a regular board comprised, to the greatest legal extent, of insiders and functioning at the minimum level required by law, is ill-advised. It encourages governance of the worst kind.
I’d like to offer four actual and personal examples of some of the uses of advisory boards.
Consider, first, Royal LePage, where I have chaired three consecutive iterations of a commercial real estate advisory board. In the early ‘90’s, the company concerned itself with the Greater Toronto Region. From about 1996 on, it broadened its scope to cover all of Canada. And from mid-2000 forward, it has re-narrowed its focus on Ontario.
Until a little more than a year ago, Royal LePage, as a public company, had a regular board with several independent directors. But in 1999, Trilon, which became the controlling shareholder in 1984, bought out the public’s minority shares and disbanded its regular board. However, this had no impact on the commercial advisory board.
This advisory group has several purposes:
- to open client doors at senior levels
- to provide advice from time to time on commercial real estate strategy
- to encourage, via various business/social functions, the mingling of well-known business leaders who sit on the advisory board with the Royal LePage commercial sales force and sales management.
My second example is Monsanto Canada. For many years, the company had a regular board with full responsibilities, three board committees and four independent directors as well as two directors from Monsanto Corporation and the two senior officers of the Canadian company. I chaired this board for about seven years.
In 1997, the regular board was replaced with an advisory board, consistent with my earlier comments about the nuisance created by regular boards meddling in some or other aspect of global strategy.
There were four roles assigned to this advisory board. These were:
- to open doors at the federal—and provincial—government levels with both politicians and senior bureaucrats
- to help provide a better understanding of the Canadian and regional environment and economy
- to provide an unbiased and independent reaction to new product initiatives, especially in the pharmaceutical and biotech sectors
- and finally to help deal with such controversial public relations issues as the use of BST to stimulate milk production from cows or the use of genetically modified foods.
As a matter of incidental interest, Monsanto eliminated its advisory board and all outside representation at the end of 1998. At that time and since, there were a lot of major changes taking place in Monsanto globally.
Earlier this year, Monsanto Corporation of St. Louis, Mo., was acquired by Pharmacia Upjohn. This came after Monsanto’s earlier, unsuccessful attempt to merge with American Home Products.
My third example is more recent and quite different. A group of bright, energetic, young entrepreneurs with excellent technical backgrounds decided over a year ago to start a new business.
The concept is simple. Many U.S. catalogue companies sell to Canadians. Why not build a large fulfilment centre north of the border to serve as many of these U.S. retailers as possible? The advantage for them is better service and lower cost through outsourcing to an on-site facility in Toronto, where a good segment of the market is located.
The new enterprise intends to hold goods on consignment and then fill orders faster and more efficiently than any one U.S. catalogue house can service Canadian orders that involve customs paperwork, duties, sales taxes, the need for prompt delivery, and the ability to handle returns expeditiously.
These young entrepreneurs are smart enough to realize that they need advice and counsel on a wide range of business issues from older, experienced directors. And so they’ve recruited six or seven greybeards, including myself, to form an advisory board.
Their plan is to take the company public, when feasible, and to convert the advisory board to a regular board at that time. The job of recruiting directors for a public company board will, of course, have already been done.
Recently, I had a call from an old friend about the possibility of joining the advisory board of an enterprise in the dot-com industry.
This company, currently private, has been operating for a few years. And it recently developed a unique software system. The sales forecast for the next four or five years can best be described as explosive: a 12-to-15-fold increase in revenue from a high-seven figure base this year.
The method planned for compensating its directors is, I think, interesting and somewhat akin to how high-tech companies tend to pay their executives. That is, there are no directors’ fees, only expenses. The attraction is a generous option allocation at a very low price.
Each of these four cases illustrates, I think, some aspect of what I discussed earlier in more general terms. So theory and practice match, at least for the most part, unlike that rather cynical line that goes: “That may work in practice, but it will never work in theory.”