The Fish Rots From The Head: The Crisis in our Boardrooms: Developing the Crucial Skills of the Competent Director

by Bob Garratt

corporate governance must be a necessary element in creating a healthy civil society. To achieve this it must apply to all organizations within that society – private, public and not-for-profit.

the majority of people who become legal (statutory) directors of their organizations have no formal induction process to explain the different knowledge, skills and attitude required in the role, nor is there a rigorous development and regular performance evaluation process to ensure they devote the necessary amount of time, care, skill and diligence needed to become an effective director. So most directors are directors in title only.

the recent banking crisis and subsequent global credit crunch have shown only too starkly the short-term, mission-orientated mindsets and behaviours of executives are often in

direct opposition to the long-term legal duties of the directors.

in the short term directors need a crash course in understanding both the financials and the political, economic and ecological – both the short-term bottom line and the long-term trend lines – what needs to be in the hearts, minds and behaviours of those elected or selected to provide effective direction and prudent control of our organizations.

do most organizations have the systems of fast learning to see whether the broad deployment of their scarce resources is achieving their purpose?

At the centre of the model is the director’s irresolvable dilemma: how to drive the organization forward whilst keeping it under prudent control. The balancing and frequent rebalancing of this dilemma is the essence of effective directing.

In an unstable and fast-changing environment, direction-givers need honest feedback on both changes in the external environment (the uncertainties) and the performance of the executive systems controlling the deviations (the risks) in the day-to-day operations of the organization. That is why effective organizations have monthly board meetings.

Policy is the highest level of organizational thought and action to achieve the fundamental purpose of the enterprise. The board must lead in the formulation of policy as it, not the managers, is legally responsible for this – pointing the ship in the direction required given the many uncertainties that are beyond the horizon.

Policies are the core of the business. They both set the purpose – why the organization exists – and allow the development of rational strategies and appropriate cultures.

Policies are not, as taught in some business schools, the rules of the organization.

strategy is the broad deployment of scarce resources to achieve a purpose. This is the role of the board of directors. This is a concept based on having a suitably varied group of independent thinkers around the board table capable of scanning the murky horizons of continuous change in the political, physical, economic, social, technological and trade environments and then linking the data in broad deployment terms to deliver the organization’s fundamental purpose – the reason it exists.

Strategies are flexible. They are not set in concrete. The uncertainties shown through continuous horizon scanning must allow for fast learning and the consequent adapting, or rejection, of the current strategy. Directors rarely understand this, especially if they have become overinvolved with the executives in micromanaging their operational plans. It is always difficult for a board, especially if full of executives from other organizations, to not micromanage the executives. It requires a strong and confident chairman to ensure this does not happen.

Strategic planning is an oxymoron, a dangerous contradiction in terms, which frequently leads boards into confusing two distinct and separately important processes: the prime board roles of policy formulation and its associated strategic thinking; and the executive roles of planning and delivery. If they are combined, little real strategic thinking is done systematically because human frailty means that any strategic planning process degenerates quickly into an interpersonal power fight as to who gets which projects, budgets and formal organizational power.

reinforce my argument for systematic and detailed induction of directors so that they at least know what they are getting themselves into. This is the chairman’s role, as is the subsequent personal development and annual evaluation of all directors.

Even such titles as finance director, HR director or director of production carry the same liability because individuals are ‘holding themselves out to be a director’ if they do not have statutory status. Thus a great number of directors sail through life oblivious to the large potential liabilities they have and that they have exposed their personal wealth to risk, for which they do not usually carry any liability insurance. If you want to be a director, get elected to the board as a statutory director and in the UK sign your form 288A or AP01 (or its equivalent elsewhere), and make sure that there is a suitable and valid directors and officers liability insurance.

The acid test of whether an executive director will ever become a true director is if the individual can take an independent stance on a board item and be seen to disagree with the chief executive.

However, there are ways of achieving this. Executives who become statutory directors must have two employment contracts: one for, say, 80–90 per cent of their time as an executive under a normal contract of employment; and one, a contract for services as a director, for the other 10–20 per cent of their time, including the development of the necessary care, skills and diligence needed to deliver their independence of thought, primary loyalty and fiduciary duty. Some boards have achieved this through rigorous induction, appraisal and development processes. The beauty of such an approach is that all directors join the board as equals, with the same contract for services, which allows them to behave as equals as required by law.

The chairman needs to come down heavily on any chief executive found guilty of taking action against an executive director who speaks against him or her in a board meeting. Executives are there in part to add diversity to board debate through their detailed operational experience. They are not there to act as ciphers of the chief executive.

Executives need more than a simple induction programme to turn them into effective statutory directors. They need a six-month minimum conversion programme.

It can be hard for someone appointed a statutory director by an investor, minister, local council or interest group to come to terms with the fact that, no matter who elected them, at the moment of their election their primary loyalty must switch away from those electors and to the company itself as a legal entity.

Or take a nominee director, that is, a director of a company who is nominated by a large shareholder to represent his interests. There is nothing wrong with that. It is done every day. Nothing wrong that is, so long as the director is left free to exercise his best judgement in the interests of the company which he serves. But if he is put on terms that he is bound to act in the affairs of the company in accordance with the direction of his patron, it is beyond doubt unlawful.

Never let politicians near corporate governance practice as their only tool is legislation and they always add too much to their prescription, as we saw when the 2010 Dodd-Frank Act came into force.

directing from the boardroom is not rated highly in the US. This partly explains the huge problems at AIG, Lehman Brothers and GM. Managing, or being an executive, is much more important; so much so that over 90 per cent of US corporations have a combined role of chief executive and chairman. Many chief executives insist that they must have the chairman’s role as well as their own (and the double remuneration and perks that go with it) to do their job properly. Few US investors query this, so absolute power resides in the CEO/chairman and we know what absolute power does without sufficient critical directoral comment: it corrupts.

The chairman is the boss of the board of directors, not of the company. Many chairmen do not realize this and behave as if they control every aspect of the organization.

the chairman is ultimately responsible legally for the total performance of the organization. He or she is the architect of the board, leading the selection and induction processes, the annual appraisals of the board and directors, subsequent board and director development processes, as well as renewal and deselection. The chairman is also responsible for the board dynamics so will ensure open debate around the boardroom table, the declaration of any conflicts of interest, and the timely running and recording of meetings, working here with the company secretary.

The Chairman’s job is to listen and not to chatter.

THE ROOT CAUSE of the loss of power of many boards – indeed the reason the public is asking rightly ‘where was the board?’ – is their surrender to the executives.

There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.

the meaning of added shareholder value as: The economic value added after the board considers three interrelated issues – the reasonable short-term demands of the owners, the cost of capital, and ensuring the long-term health of the business.

each board member had to be visibly and emotionally committed to the decisions taken and had to be prepared to resign if the owners insisted on a course of action with which the board disagreed.

the codification of the Seven Non-exhaustive Duties, general duties section 171 (there are others but these are the key ones), pulls together centuries of case law into a simple, stark document: 1 To act within their powers – i.e. the company’s constitution 2 To promote the success of the company 3 To exercise independent judgement 4 To exercise reasonable care, skill and diligence 5 To avoid conflicts of interest 6 Not to accept benefits from third parties 7 To declare interests in proposed transactions. This is a fundamental document for any board. The chairman needs to ensure that each statutory director commits to it formally, and each senior executive acknowledges it as the framework in which they will work with the board.

directors should not try to micromanage the executives from the boardroom table. Theirs should be a literally thoughtful world from which they delegate authority to managers to design, deliver and maintain the operational control parts of the enterprise.

The four directoral balances are: 1 Organizational effectiveness. The external, long-term perception in the customer’s mind of the products or services of the business being desirable, reliable and good value for money. 2 Organizational efficiency. The internal, short-term focus on cost reduction and efficiency gain – but only until just before it negatively affects the customer’s perception of organizational effectiveness. 3 Board performance. The external focus of the board on policy formulation in relation to the external political environments; and on strategic thinking about the competitive positioning and broad resource allocation of the enterprise in relation to its policies. 4 Board conformance. The internal focus of the board on its performance to pre-set goals of accountability to its stakeholders; and to its business performance through its people.

What is often not mentioned is the parallel process of board inclusion. The sadly too common induction of ‘turn up and shut up, you’ll pick it up as you go along – and don’t rock the boat as there are some powerful people around this table’ is very strong. It takes a tough-minded new director to have enough self-confidence and independence of mind to immediately keep asking discerning questions until he or she gets satisfactory answers. So most directors self-censor, keep quiet and do not offer contrary information even when they know it is right.

Asking intelligently naive questions is what the directoral job is about, whether of the internal management and operational systems or of the external environment. The ability to use intelligence in asking fundamental questions, and not be put off by the functional specialists’ technobabble, is what directors are paid to do.

the biggest problem is that the majority are still passive boards. The notion that, often later in life, they need to develop new directoral skills and attitudes is difficult for them to grasp.

the bureaucratic division of organizations has often led to a sealing off of one managerial function from another, executive directors from within and without the business can have great difficulty understanding the roles and jargon even of the other executive functions, let alone the uncertainties of the external environments. They are reluctant to question these at board meetings because they do not want to seem ignorant, and because they want to encourage others not to question them too deeply in return. In doing so they miss the opportunity to rise above the single-function perspective and develop the crucial ‘helicopter view’ ability necessary for direction-givers.

The argument is that any one symptom will hobble the board but not sink it. But any three or more symptoms combined will cause collapse in the short to medium term: One-man rule A non-participating board An unbalanced top team A lack of management depth A weak finance function A combined chairman and chief executive role

As yet there are few ‘board dashboards’ by which a board can have confident oversight of the integrated workings of the executive system,

The classic studies by Irving Janis which led to the book Groupthink6 looked not only at the observations of boards in action but also at the fast learning that occurred in the J.F. Kennedy Cabinet between the disaster of the Bay of Pigs invasion and the success of the Cuban missile crisis negotiations. Janis isolated eight key factors that block the use

of sufficient diversity around the boardroom table and lead inevitably to the blocking out of any information that is contrary to the existing assumptions of the board: The illusion of invulnerability.

Collective efforts to rationalize.

Unquestioning belief in the board’s inherent morality.

Stereotyped views of rivals and enemies.

Direct pressure on dissident board members.

Self-censorship or deviation from apparent group consensus.

A shared illusion of unanimity.

The emergence of self-appointed ‘mind guards’.

‘both the cream and the scum rise to the top.’ This latter must be fought against strongly.