When boards work well

The end of every boom-bust cycle during my lifetime has included a fin de siècle scandal:  insider trading punctuated the ’87 crash, accounting irregularities (think Enron and Worldcom) helped pop the tech bubble of the ’90s, and our most recent bust was characterized by lax governance at Fannie & Freddie and more than a few banks.

We all understand the business cycle, and we all understand human nature… but what about all those good governance measures that get implemented in the wake of each meltdown?  Why do they inevitably fail to prevent the *next* crisis?

Presumably, those companies and regulatory bodies have boards comprised of accomplished and highly intelligent members, with personal wealth at stake.  Weren’t they paying attention to, and paying consultants to implement, best practices in good governance?  Ethics codes, audit and compensation committees,  Independent Directors, regular meetings, well constructed board packages…

Yes, they did.

So what gives?  Why did all that wealth have to get destroyed in such spectacular fashion?  It’s conceivable that a board member here or there could be corrupt or asleep – but entire boards?  Across multiple companies and regulatory agencies?

Unlikely.  It’s more likely that they were following the current and best practices for strong and effective board oversight.  So, if *all* boards have similar formal systems in place, something else must be at work.

Jeffrey Sonnenfeld explains in “What Makes Great Boards Great” in the Harvard Business Review that great boards are ‘robust social systems’ in which the members’ informal  modus operandi ensure that all those well-designed systems function properly.

Create a climate of trust and candor. If you’re CEO, share important and difficult information with directors in time for them to digest it—not the night before a meeting. If you’re a member, insist on receiving adequate information. To discourage members from creating back channels to line managers in pursuit of political agendas, give them access to company personnel and sites—then trust them not to meddle in day-to-day operations.

Evaluate board performance. No group’s performance is assessed less rigorously than boards—yet no group learns without feedback. To conduct a full board review, a governance committee can evaluate the board’s understanding and development of strategy, the quality of board meeting discussions, the level of candor and use of conflict, and the credibility of reports. It can evaluate individuals by examining initiative, preparation for and participation in discussions, and energy levels.

Foster open dissent. The willingness to challenge one another’s assumptions and beliefs may be the most important characteristic of great boards—indicating bonds strong enough to withstand clashing viewpoints. Don’t punish dissenters or forbid discussion of any subject. Probe silent board members for their opinions and the thinking behind their positions.

If you’re asked to join a board, say no if you detect pressure to conform. Blind obedience puts your—and your company’s—wealth and reputation at risk. An ideal board member, Home Depot chairman Bernie Marcus has said, “I don’t think you want me on your board. I am contentious. I ask a lot of questions, and if I don’t get the answers, I won’t sit down.”

Use a fluid portfolio of roles. Don’t let directors get trapped in typecast positions—the peacemaker, the damn-the-details big-picture person, the ruthless cost-cutter. Push everyone—including the CEO—to challenge his or her roles and assumptions. Require a big-picture person to dig deeply into the details of a particular business, or a peacemaker to play devil’s advocate. Results? Wider views of the business and its available alternatives.

Ensure individual accountability. The most effective enforcement mechanism is peer pressure. Give directors tasks—for example, meeting with customers, suppliers, and distributors, or visiting plants or stores in the field—and require them to inform the rest of the board about the company’s strategic and operational issues.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entrepreneurs are almost always surprised how much value a good board can bring to their companies, and the best boards are a function of both the quality of the people involved and, just as importantly, how they operate.

UPDATE:

(12/04/09)

Jeff Bussgang, general partner at Flybridge Capital in Boston – and coincidentally, a classmate of mine from business school – suggests three specific examples of best practices that we believe also touch on the aforementioned ‘robust social systems.’  Here’s Jeff, writing at BusinessWeek’s New Entrepreneur.

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