Category: The Value of Questions and Curiosity

Why Your Board Needs to Prioritize Its Discussion of Technology Disruption

Published by

Erin Essenmacher

Our mission at the National Association of Corporate Directors (NACD) includes continuous learning for directors. In pursuit of that mission our staff also seek out the most exciting events across the country to learn more about the disruptions that will impact members’ boards. I caught up with Erin Essenmacher, NACD’s chief programming officer, after her appearance at SXSW to discuss takeaways from the conference and how corporate directors can continue the conversation on technology disruption.

Erin moderated a panel, in partnership with KITE, titled “Innovation: the Board Director’s Cut,” featuring leadership representatives from Spredfast, OurOffice, and Capital Expert Services. The panel discussed the strategies directors should take in order to best manage technology disruptions at their companies. Highlights from our conversation follow.

Katie Swafford: What led your panel to discuss technology disruption? What do you see at NACD—or among NACD’s members—that surfaced this particular topic for the panel?

Erin Essenmacher: Across the spectrum of industries, companies are being disrupted because they are not focused on how new technologies, paired with shifting trends, are completely changing business models. My first major takeaway from the panel was the need to focus on disruption. I don’t even like to say technology disruption, because I think that makes the issue sound too small and prescribed, which it is not. While technology is a big driver of disruption, so are issues like social and demographic shifts and other market-shaping forces as they intersect with technology. Disruption is a huge challenge to navigate for boards at companies of all sizes. We are reaching the point where the swift changes are blurring the lines between industries, and directors should be raising questions with managers about what is on the horizon for their companies, and if their companies are thinking sufficiently about the big picture and the nature and impact of those changes.

In terms of the discussion here at SXSW, the panel was really focused a lot more on flipping the script. A lot of the folks in the audience were on the boards of early-stage companies, and the panel really looked at how boards can add value to companies of all sizes. The panelists brought many perspectives—some are involved on the inside of early-stage companies, some are making investments in start-ups, and they all serve as directors at companies of various sizes, so it was a really interesting discussion.

Swafford: Are there specific skills gaps that NACD has seen when it comes to handling technology disruption or innovation?

Essenmacher: I would say the biggest skill gap is very low tech, but critically important: a sense of curiosity and a willingness to be a continuous learner. When you get to the top of your career and you’re on a board, you’re extremely seasoned and experienced. You’re an expert in many things that relate to the company business model or to the industry you serve, and it’s easy for that expertise to make you complacent. When you have a business environment like ours where things are changing so quickly, I think the most successful boards are the ones that acknowledge that disruption is happening. Most importantly, they acknowledge that because the environment is new, they will not have all of the answers. They are willing to get serious about what’s happening, they are willing to get curious about the gaps in their own knowledge, and they are willing to challenge the management team to evaluate the existing assumptions and expectations of the company culture and business model.

Swafford: Is there an ideal board composition that’s best able to navigate disruption? Is there a leading practice when it comes to board composition?

Essenmacher: I wouldn’t say that there’s an ideal board composition, because every company is different. Composition is going to vary widely depending on industry, company size, and many other factors. An overarching leading practice is to continually consider the board’s composition compared to your long-term strategy as a company. It’s not just about bringing in people that have the latest and greatest technology expertise. There is a critical role on any board for business judgment and experience. We need all of that in our boards. Once you start to dig into how you can think differently about your business model in the face of disruption, you can start to think differently about your board composition. It’s also not just about defaulting to a former CEO or CFO. Boards need to think critically about how diversity of experience, perspective, and expertise can help elevate their strategic discussions to map to where consumers and the market are headed.

Swafford: Where do you foresee some of the topics that came up in the panel flowing over into the Global Board Leaders’ Summit? I would think diversity, board composition, and growth, among other topics, will really flow into the conversations you will be having at Summit.

Essenmacher: We need to challenge ourselves to learn about new trends from the ground-level up. Our panel here at SXSW discussed topics that are important for board members to engage in, so how can we extend this conversation? At the NACD 2018 Global Board Leaders’ Summit we will be hosting the third annual “Dancing with the Start-ups” pitch competition. This event allows us, as board members, to hear what the leaders of start-ups are creating from the ground level—how they are using technology, how they are leveraging or setting trends, and how their ingenuity is disrupting the industry of the company on whose board you might serve. Yes, it’s a fun format and very exciting, but there is also a lot of great content. I think of it as a “meet the disruptors” session. It’s really an opportunity for directors to see the earliest stages of the next iteration of products, services, and trends that are disrupting their industry.

Our Summit theme this year is transformation. The theme provides a wonderful opportunity to keep engaging in this conversation on disruption, but to also look at disruption through a proactive lens. How can we take what we know about the shifting business landscape and leverage it for strategic advantage? On the risk side, we will learn from people who are experts on the important issues of technology and privacy, enabling us to delve into what those issues mean for public trust. We will discuss how new regulations are shifting what disruption means, including the European Union’s General Data Protection Regulation (GDPR). I believe this shift in how companies market their products and how business models are changing is creating an opportunity for large and small companies to learn from each other.

There will be a lot of opportunity to discuss disruption at the 2018 Global Board Leaders’ Summit happening September 29 through October 2 in Washington, DC. Don’t miss out on our early bird pricing through March 31 to save on registration.

Dynamic Governance: Rethinking the Purpose of the Corporation

Published by

Edward Waitzer

In his classic treatise on the Wealth of Nations, Adam Smith noted a discrepancy between the interests of owners and the managers who are handling those “other people’s money.” In the twentieth century, Michael C. Jensen and William H. Meckling—citing Smith as well as Adolf A. Berle and Gardiner C. Means’s The Modern Corporation and Private Property—gave new urgency to this issue by introducing the concept of agency costs—the costs of aligning the incentives of these different corporate actors. This led to more than four decades of searching for the best way to align the interests of shareholders and managers.

At first it seemed that the solution would be stock price, since shareholders and managers alike want to optimize that. The advent of the efficient market hypothesis reinforced the focus on market pricing as the arbiter of corporate performance, and of short term shareholder value as the purpose of the corporation. We have learned, painfully, that neither of these ways of thinking about governance issues is adequate.

Meanwhile, corporate law has been overwhelmed by the advent of a litany of corporate governance norms. This has spawned an active governance industry and a variety of new analytical models for framing corporate law, including:

  • shareholder primacy, in which boards are accountable above all to shareholders;
  • the stakeholder model, in which the interests of all stakeholders are to be considered and mediated by the board of directors;
  • the team production model, in which the inputs of various stakeholders are acknowledged; and
  • the nexus of contracts theory, director primacy, and others.

What has become clear is that there is no “right” corporate governance model. Governance is highly contextual, and is dependent on what a particular company does, its ownership structure, and the markets and political frameworks in which it operates. The focus on corporate governance reflects a move from a simple legal view of the corporation to one that has become increasingly complex and dynamic, constantly responding to societal expectations. Governance is messy because that is life.

One of the consequences is that there seem to be new controversies and consequential regulatory proposals every year. We have spawned a corporate governance reform industry (private sector and regulatory) that has become adept at generating activity to feed itself. A related oddity is the fact that many of the regulatory proposals are symbolic—they certainly cannot be explained by their relevance to improving corporate governance or performance.

To take a current example, think of say on pay. We now have several years of data resulting from the legal ability of shareholders in the US to cast an advisory vote on executive compensation. Rhetoric aside, shareholders have typically approved compensation with votes in favor, typically exceeding 90 percent.  There is a double irony here. First, executive compensation is paid mostly in equity with a value based mostly on short-term stock prices. Second, shareholder support for executive pay also appears to be highly correlated with a company’s short-term stock performance. To the extent that the say on pay vote has heightened executives’ incentives to focus on short-term stock price at the potential expense of creating sustainable value, this regulatory initiative would appear to be counterproductive.

Another recent example is last year’s shareholder resolutions asking companies to report on their exposure to climate risk (and related regulatory, technological, legal, and meteorological forces). In spite of proclaimed commitments to engagement on environmental, social, and governance issues, both executive management teams and investors seem indifferent to such proposals. Management typically recommends a vote against the measure, claiming that the company’s reporting is already thorough, and shareholders vote thumbs down accordingly. Preventable Surprises, a self-described “think-do” tank in the United Kingdom, reports that only one of nine such resolutions at the major U.S. utilities received majority support. Three of the largest institutional investors (owning, on average, close to 20 percent of the shares of the nine companies) voted against each of the resolutions. Equally surprising is the lack of disclosure by these investors regarding the impacts of climate risk on their portfolios and investment strategies.

It is unlikely that the explanation for this lies in false perceptions. The actors we are talking about are among the most sophisticated and influential in our society. A more likely explanation is that governance is often viewed as a moral crusade that is tapping into broader public sentiment without regard for materiality or the difficulty of effecting fundamental change. The exercise of governance then becomes largely symbolic and political and, as a result, it is often conservative and self-serving. One systemic danger is that such reforms dull the desire for deeper introspection and more fundamental change.

Might there be a more nuanced and constructive way to think about corporate purpose? Tamara Belinfanti and Lynn Stout begin to develop one such approach in their recent paper “Contested Visions: The Value of Systems Theory for Corporate Law.” They first describe two basic principles of systems theory:

  1. That systems are integrated (i.e., more than the sum of their parts), and
  2. That systems are fractal (i.e., they are comprised of subsystems which in turn are comprised of other subsystems on so on).

A third principle flows from the first two: that the overall health of the system depends on the continued health of each of its essential subsystems, as well as of the larger systems in which it is embedded. They then reflect on how each of these principles applies to corporations.

Well-managed corporations achieve resilience through positive mechanisms such as economy (i.e devoting the appropriate level of  resources based on current conditions), homeostasis (i.e., information and feedback loops that allow a system to adjust to disturbances in its environment and stay within the parameters necessary for its continued functioning), and self-organization (i.e., the ability of a system to learn, diversify and evolve in response to shifts in its environment that might otherwise threaten its survival).

By contrast, poorly managed corporations remain vulnerable due to negative mechanisms such as redundancy (i.e., devoting more resources than needed for a given purpose); imbalance (e.g., information asymmetry between management and directors); and rigidity (doing the same thing over and over and expecting different results).

In systems, multiple purposes are the rule, not the exception. What we observe about a system’s purpose or purposes, actual or apparent, will depend on our level of analysis. The relevant lesson that systems thinking offers on corporate purpose is that the overall goal of a corporate system should not be subordinated to the goals of any one of its subsystems (such as the share ownership subsystem). A critical, ongoing role of effective boards should be to mediate these competing interests.

Systems theory suggests that corporate purpose can be viewed from different perspectives, including the expectations of the state whose laws made incorporation possible. This doesn’t offer a definitive answer to the difficult question of corporate purpose. Indeed, one of the primary insights of systems theory is that the purpose and functions of a system is often the least obvious part of the system, especially to outside observers who pay attention to only a few events or to rhetoric or stated goals.

Where does this thinking lead? First, systems theory counsels against focusing on any single metric. To take the obvious example, short-term profitability is not so much an objective as a constraint a firm may have to meet in order to remain in business. Metrics such as profits, employee turnover, customer satisfaction, and so forth are not ends in themselves. Rather, they are a source of information about whether the corporation is relevant, resilient, and sustainable. Sustainable value creation is the singular goal boards should be focusing on and to which managers should be held accountable.

A related lesson is the need to develop new tools and techniques to measure system-level effects. Increasingly the focus will be on the ability of corporations to generate and account for positive externalities. The work of one organization, The Investment Integration Project, may provide guidance for corporations as well as institutional investors. The organization’s work looks beyond financial metrics to consider system-level events and the integration of the United Nations’ sustainable development goals, for instance.

A third lesson from systems theory is that, given multiple purposes and the complexity inherent in systems analysis, the three branches of government—courts, lawmakers, and regulators—will rarely be well positioned to judge corporate performance. (It is fortunate that the U.S. Securities and Exchange Commission has not yet finalized the proposed Dodd-Frank rule on pay versus performance, which defines performance as no more or less than three years of annualized Total Shareholder Returns (TSR) .)It will also be difficult for academics or the corporate governance profession to identify “one size fits all” reforms that can reliably improve the performance of all companies. Attempts to impose such silver-bullet solutions are more likely to result in what Roberta Romano has described as “quack corporate governance” that often does more harm than good.

This suggests the exercise of restraint by regulators—assuming positive intent and encouraging adaptive responses rather than imposing rigid and formal compliance requirements. In this manner, we can ensure that our corporations can continue to function as dynamic systems that foster the wealth of nations and the globe.

 

Edward Waitzer is a partner and head of the corporate governance group at Stikeman Elliott LLP. All thoughts are his own. 

CES Tour Reveals Trends and Innovations That Will Reshape Business

Published by

Shelly Palmer guides directors through the show floor.

At the conclusion of day two of NACD and Grant Thornton’s board-focused experience at the 2018 Consumer Electronics Show (CES), my feet are throbbing, my head is spinning, and I have a clearer picture of what the future holds thanks to a much sought-after spot at Shelly Palmer’s breakfast lecture on innovation and future trends, which was followed by an exclusive, small-group tour of this colossal show—some 3,900 exhibitors in all.

According to Palmer, the next-generation automobiles displayed by Mitsubishi, Nissan, Ford, and so many other companies raises the following question: How will we move—or want to be moved—from point A to point B?

“What does it mean to get from here to there? Uber is already self-driving. I push a few buttons and the car shows up,” Palmer said as he took us through the North Hall of the Las Vegas Convention Center—home to what has been dubbed the world’s largest auto show.

Among the flashier electric vehicles on display was the Mercedes-AMG Project ONE Showcar, an electric hybrid Formula 1 race car. While only 275 of these cars will be made, the technology applied in its engineering eventually could end up in your self-driving car. AI might also sneak its way in. (To see more about the implications of AI, watch Erin Essenmacher’s interview with data scientist J.T. Kostman.)

Palmer also highlighted the following provocative insights to the directors in our tour group:

  • Smart speakers are among the fastest-adopted technologies, having achieved 50-percent penetration in U.S. homes in just three years.
  • Any device powered by electricity will be voice-controlled.
  • While Amazon is not exhibiting at this year’s show, its presence was abundantly visible through some 30,000 examples of apps compatible with its Alexa device.
  • Companies that may be considered old-line—Blackberry, Honeywell, ADP—have reinvented themselves through their understanding and embrace of technology that makes us more secure. “Security,” Palmer said, “is the gateway drug to home systems.”
  • At Honda’s booth, spectators were charmed by an adorable three-foot robot. The Japanese automaker discovered after the devastating tsunami in 2011 that children responded to the robot, which is capable of expressing empathy. “Americans have no interest in this,” Palmer said, adding this nugget: “Robotics are way ahead of anthropology and sociology.”
  • Chinese companies are the world’s leader in artificial intelligence. Google and Facebook lead in America. The presence of Chinese companies exhibiting at CES was a quantum leap over last year.
  • Some 15 million American homes have cut the cable cord and instead have roof antennas for TV service. So how can Comcast expect to flourish? The broadband giant will provide its customers the ability to connect various Internet of Things technologies that can be controlled through its voice remote.

More insights from CES and directors’ impressions of the governance implications raised by some of what they experienced will be covered in the January/February 2018 issue of NACD Directorship magazine. You can also watch the video below of NACD Chief Programming Officer Erin Essenmacher discussing AI with data scientist J.T. Kostman.