According to Confucius, one should “study the past if you want to define the future.” With that in mind, President and CEO Ken Daly led the session to officially kick off NACD’s future-defining initiative with panelists that have a storied history in the world of governance. The panel comprised Raymond Gilmartin, former president and CEO of Merck & Co., lead director at General Mills, and the newest member of NACD’s board of directors, and Myron Steele, Chief Justice, Delaware Supreme Court.
Based on the observation that capitalism is undergoing a profound shift as a result of shareholder activism, technology, and regulatory activity, work to define and shape NACD Directorship 2020 has been underway for several months. Starting this spring, NACD held three events to discuss and hone the direction of research topics in New York City, Chicago, and Los Angeles. Three areas came to the forefront: information flow, performance metrics, and disruptive technologies. For recaps of these sessions, visit nacdonline.org/directorship2020.
Changes in the Boardroom
According to Steele, the most significant changes in the boardroom have been the shift in dynamic of ownership from retail to institutional investors, and the dominance of independence in the boardroom. In the past, the majority of investors were retail, now 60 to 70 percent of stock ownership is in the hands of institutional investors.
As a result of Enron and WorldCom, Sarbanes-Oxley required the board to become more independent than ever before. And yet, as Chief Justice Steele observed, without an empirical study to support this requirement, the legislation missed the mark. Of the 17 directors on Enron’s board, 15 were independent and it “still resulted in a massive failure of corporate governance.”
In his remarks, Chief Justice Steele stressed his belief that regardless of who comprises the shareholders, authority, balanced with accountability, rests with directors. “It is still fundamentally the responsibility of directors to manage the corporation with oversight, loyalty, and care. Also the underlying dynamic has changed, the authority and accountability of directors has not.”
TSR and Short-Termism
Continuing off a theme that began last night with keynote speaker Raj Sisodia, Gilmartin addressed the increasing focus placed on generating short-term quarterly results. Maximizing shareholder value above all else has reinforced practices that can be detrimental to society. Although some practices, such as laying employees off, are sometimes required, they are currently being used with a frequency that destroys long-term value and the future survival of an institution.
But directors have an opportunity to change this. NACD Directorship 2020, according to Gilmartin, “allows an opportunity to challenge the conventional wisdom that has developed over the last few years.”
Innovation and Risk Taking
Both Chief Justice Steele and Gilmartin emphasized the need for innovation and risk-taking in boardroom culture. In addition to using incentive systems that focus on the creation of long-term value, Gilmartin suggested using the company’s ability to innovate as a performance metric.
Chief Justice Steele addressed the increasingly litigious nature of directorship, which as Ken Daly noted has become, “not if you’ll be sued, but when you’ll be sued.” According to Chief Justice Steele, the business judgment rule is alive and thriving. Directors should feel free to take the necessary bold steps to create economic value. “Society is dependent upon a board being empowered to take risks on behalf of shareholders—that is what builds the economy.”
This year, NACD began a series of programs designed to address the changing nature of directorship. Intended to identify the board composition, processes, and resources necessary for the future board, the time frame lends a twist to this launch—no defined outcome has been chosen at this initial stage. Instead, with the awareness that the economy, and the boardroom, is in a state of unprecedented change, NACD Directorship 2020™is a multi-year initiative designed to help provide clarity to an uncertain picture regarding the future of directorship.
This initiative started with three exploratory meetings in New York, Chicago, and Los Angeles, the last of which concluded this week on the West Coast. In each city, feedback has allowed NACD to continually refine the program design, as well as re-think the questions posed to attendees. Perhaps mirroring the movement of the meeting’s locations from east to west, the conversations have become more focused on the processes directors can implement to meet the coming challenges.
At the SLS Hotel in Los Angeles, more than 100 directors attended the afternoon session to discuss two topics: the future state of information flow between the board and C-suite, and how to select performance metrics that will generate sustainable organizational profit. Sessions were led by NACD Managing Director and CFO Peter Gleason; Akamai Technologies Lead Director and Audit Committee Chairman Martin Coyne; Investor Responsibility Research Center Director and current NACD Director Richard Koppes; and former Bell and Howell CEO, current NACD Director, ContextMedia Non-Executive Chairman, and Northwestern University Professor Bill White. During the highly interactive sessions, each table was given a specific set of questions to discuss and provide thoughts among their peers. Takeaways from the event include:
Asymmetric information risk is inherent in directorship. If the board had the same level of operational knowledge as management, directors would be running the company.
An imbalance in information can occur within the boardroom as well. Boards are at a higher risk if one director is viewed as an expert in a technical area. In these situations, the rest of the directors may defer to his or her proficiency and not exercise the necessary skepticism. Further, board structure, with committees that delve deeper into technical areas, adds to the potential for information imbalance.
The risk of information asymmetry is not an issue, but a catalyst. Discussing the balance of information flow between the board and C-suite can expand into many interconnected topics, including board composition, culture, metrics, and leadership.
Board portals may be “greener,” but they encourage information dump. Attendees agreed that their board books have largely grown in length, due to the ease of transferring files rather than creating physical board books. Today, it is more important than ever for the board to communicate what information it needs from management.
By bringing more viewpoints to the boardroom, directors that are diverse in skill set and experience are more likely to explore all sides of an issue. Diversity of directors will change the dialogue in the boardroom going forward.
Boardroom culture should welcome constructive challenges from directors.It is necessary for directors to ask probing questions on issues without fearing negative repercussions. A culture that welcomes constructive criticism will enable more effective individual director evaluations that address problems head on.
There is no one-size-fits-all solution to addressing the current and future challenges posed by legislators, regulators, and stakeholders. While the underlying principles are consistent, application of new processes will be tailored to each company.
As a result of the rapid pace of marketplace change, directors need to adopt a mindset that their business is going to be disrupted. This adjusted mindset will allow for continuity planning to be built into the strategy to help offset future disruptions. As Bill White observed: ”If you have the mindset, the metrics will follow.”
In the year 2020, metrics will increasingly focus on speed and agility. Attendees largely agreed that there is no such thing as a competitive sustainable advantage, as a result of disruptive technologies. Speed and agility not only apply to the operations (speed of execution, acceptance of new products), but also to talent (willingness to change, ability to adapt).
In the era of big data, you can “metric yourself to death.” Directors should not look at metrics and dashboards blindly, but instead they should view them in a broader context, including what implications they may hold. It is also important to counter internal metrics with data that shows how the company is viewed externally.
NACD Directorship 2020 will officially kick off next month at the 2013 NACD Board Leadership Conference. Until then, NACD’s blog will feature viewpoints and research from our NACD Directorship 2020 partners—Broadridge, KPMG, Marsh & McLennan Cos., and PwC—that will take a deeper look into the emerging issues and trends that will redefine directorship in the years to come.
Last year, NACD launched its fourth Advisory Council on Risk Oversight—the first of our councils not dedicated to a specific key board committee. In fact, less than 10 percent of public companies even have a committee dedicated to risk oversight. This advisory council was formed as the result of a simple observation: the responsibility of risk oversight has expanded significantly in the last several years. This council is not lacking for discussion topics—the nature of potential risks to an organization is evolving seemingly by the day. Directors need to know the strategies in place to not only mitigate but capitalize on the risks currently facing the company, and those predicted to present challenges in the future.
But that just accounts for what is on the board’s radar. At the second meeting of NACD’s Advisory Council on Risk Oversight held in collaboration with PwC and Gibson Dunn, the discussion went beyond current and predicted risks to the challenges of disruptive technologies and innovation. Increasingly, the most severe shocks have been largely unpredictable: extreme weather, the confluence of multiple events, or innovation that upturns the industry. As one delegate observed: “We haven’t spent much time on the [risk of] ‘I will eat your lunch with a completely different approach.’ Companies don’t sit down and think about who is going to attack from a completely different angle.”
In their oversight capacity, directors cannot constantly monitor the more detailed aspects of the business. Nor can “you anticipate what you don’t know.” Nevertheless, several delegates suggested that the appropriate risk oversight processes in place, coupled with a resilient culture that efficiently reports risks up to the board, can support directors in mitigating known and unknown risks. The meeting, captured in the 2013 Advisory Council on Risk Oversight Summary of Proceedings, focused on areas critical to effective risk oversight processes. These include:
Board processes and people. It is critical that the board not only has the right talent, but engages it fully. Directors should have a “real and thorough” understanding of the business to be able to effectively discuss both strategy and risk with management.
Recognizing asymmetric information risk. While the board has to be comfortable with the reality of information asymmetry, directors should establish tolerance levels for the level of asymmetric risk they are willing to bear, and look for signs of when this risk has become too high.
Engaging with management involved in risk reporting. For companies with a chief risk officer (CRO), that person can keep an “inventory” of risks throughout the organization. Additionally, directors can ask internal audit to identify what it believes will be “hot-button” risk areas.
Linking strategy to risk. The board’s oversight of risk should begin with an assessment of the company’s strategy and its inherent risks, which necessitates understanding and agreeing on the risk appetite, or the amount of risk the company is willing to accept.
Allocating the work of risk oversight. The significant increase in risks facing the board necessitates defining who will act as an “air traffic controller”—allocating risk oversight responsibilities.
Leading practices for risk oversight—including allocation of work and the development of a risk strategy document—will continue to be the focus points not only for this advisory council but also NACD’s Directorship 2020 initiative. To download the full summary of proceedings, click here.