Tag Archive: culture

Building a Strong Board Culture: Perspectives From Fortune 500 Committee Chairs

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This blog post is one installment in a series related to board oversight of corporate culture. The National Association of Corporate Directors (NACD) announced in March that its 2017 Blue Ribbon Commission—a roster of distinguished corporate leaders and governance experts—would explore the role of the board in overseeing corporate culture. The commission will produce a report that will be released at NACD’s Global Board Leaders’ Summit, Oct. 1–4.

In a recent study by Stanford University’s Rock Center, less than half of directors surveyed strongly believe their boards tolerate dissent, and 46 percent expressed concern that a subgroup of directors has disproportionate influence on boardroom decisions. A 2015 survey cited by Heidrick & Struggles reflects similar concerns about culture in companies as a whole: 87 percent of organizations listed culture and engagement as a top challenge, with half of business leaders ranking the issue as “urgent”—a 20 percent increase from the prior year.

Sound, ethical culture in the boardroom sets the tone for the rest of the organization.

In light of the importance of the culture issue for boards, NACD, Heidrick & Struggles, and Sidley Austin LLP cohosted a meeting of the Nominating and Governance Committee Chair Advisory Council on March 28, 2017. The session and a related conference call brought together nominating and governance committee chairs from Fortune 500 corporations to discuss how boards can improve their own cultures and, by doing so, reinforce the elements of good culture in their corporations. The discussion was held using a modified version of the Chatham House Rule, under which participants’ quotes (italicized below) are not attributed to those individuals or their organizations, with the exception of cohosts. A list of attendees’ names are available here.

The council meeting resulted in the following takeaways:

1. Recognize and implement characteristics of a strong board.

Council delegates at the meeting listed a number of indicators of productive boardroom culture:

  • Extensive and thorough preparation on the part of every director, without exception. “Every board member needs to have an in-depth understanding not just of the company, but its peers, competitors, and the broader industry. Passive reliance on management presentations for information is no longer sufficient.” Another director added, “Intellectual curiosity and learning agility are essential ingredients of good board culture.”
  • Directors are able to strike the right balance between collegiality and directness, challenging one another―and management―constructively. “Attack the issue, not the individual,” said one director.
  • The board has well-functioning continuous improvement processes, including regular evaluations, director and committee succession planning, and review of needed skill sets in light of current and future strategy. This includes the notion that board service is not a guarantee, but subject to the needs of the board and the strategic direction of the company.
  • The board should model the culture that the corporation as a whole desires: “Walk and talk the culture you’re expecting.
  • The board has a healthy relationship with management and can speak with candor.

Holly Gregory, partner at Sidley Austin, added that the notion of teamwork as an element of productive board culture goes beyond semantics. “Boards are teams in the legal sense,” she said. “The board’s authority is as a body, and board decision making is by collective action.”

2. Use inflection points as opportunities to address board culture.

Directors agreed that changes in board leadership—such as a committee chair, lead director, or nonexecutive chair—can be good opportunities to reevaluate board culture and performance. According to one delegate, “How are you challenging yourselves? Your board may be working fine today, but maybe you’re missing a chance to take the board’s performance and culture to an entirely different level.

Council members also suggested a number of other inflection points to use as opportunities to examine board culture:

  • Patterns of breakdowns or concerns regarding compliance and ethics—“If we see two or three ethical violations and we don’t do anything about it, what does that say about our strategy and the performance of the board?
  • Major transactions“After a large acquisition, [a culture-consulting firm] came in to work with management. Then [the firm] came back and did a session for the full board. We got a much better understanding about how our culture was aligned with where the company was going.” Another director observed, “Creating the culture for a spin-off board was easy compared to [changing culture on] an established board. [In either case], team-building on the board is actually a good idea.
  • CEO successionThe previous CEO had a very strong demeanor in the boardroom and [held strong control] over strategy. After he stepped down, the lead director was in a position to take a much more active leadership role that coincided with a significant regulatory change. The board was much more challenged and became much more engaged in strategy and more productive and useful to the company.”

3. Proactively examine board culture at scheduled periods.

Although the inflection points described above can be useful opportunities to review board culture, council meeting participants agreed that boards should be proactive about assessing and molding their cultures. “You don’t know the culture you have before you hit a bump in the road,” one director said. “Be that person that says, ‘maybe we can improve by doing XYZ.’ If our major shareholders had been listening to the process we just went through, how would we feel about that?” Theodore Dysart, a vice chairman at Heidrick & Struggles, observed, “It’s important for boards to be able to rally after a crisis, but how can that cohesiveness of purpose be made more routine? We are seeing a growing number of boards making use of tools and processes to embed cultural assessments more deeply, but it is not yet a widespread practice.”

Directors provided a number of examples where their boards took a proactive approach to evaluating culture:

  • Board succession planning“On one board, we initiated a self-examination of our culture in anticipation of some turnover coming up due to director retirements. We realized it was an opportunity to clarify what we stand for as a board, how we want to operate, and the elements of board performance we want to evaluate.”
  • Reviewing key management reports—“We use the review of the company’s sustainability report as an annually scheduled inflection point [to review culture]. It has extensive statistics on environmental, safety, and other issues, as well as key stakeholders and the firm’s interactions with them. It helps us see the cultural underpinnings of the company and also drives deep discussion about our own culture as a board.”
  • Risk appetite discussions—“Our board’s discussions about risk appetite led us to a conversation about culture. It emerged that we were not all on the same page with respect to the level of risk we felt was appropriate for the strategy. Some directors were gung ho; others were more reserved. The work we went through to gain alignment highlighted some important aspects of our board culture and dynamics.

Board evaluations provide another opportunity to assess the current state of boardroom culture and identify opportunities for improvement. See the Report of the NACD Blue Ribbon Commission Report on the Strategic-Asset Board for specific guidance and tools to help conduct evaluations and elevate board performance.

Council delegates emphasized that both measuring and changing culture can be extremely challenging, but the benefits are significant. As one director observed: “The board can have a culture and interact with senior management to form what you believe is the tone at the top. It takes a different curiosity to see if that trickles down into the institution. There’s no magic here; this is really hard work, but directors can have enormous positive impact when they model and reinforce the company’s desired cultural attributes.

Additional Resources

Driving Behaviors Through Incentives and Risks

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The following blog post is one installment in a series related to board oversight of corporate culture. The National Association of Corporate Directors (NACD) announced in March that its 2017 Blue Ribbon Commission—a roster of distinguished corporate leaders and governance experts—would explore the role of the board in overseeing corporate culture. The commission will produce a report that will launch during NACD’s Global Board Leaders’ Summit Oct. 1–4.

CompensationCulture

Incentives can reward performance—and create tension and unintentional risks.

One element that helps define an organization’s culture is the set of incentives motivating employees to act. While incentives can effectively reward performance that benefits the enterprise, the compensation committee—and the board more generally—must factor in the tension and unintentional risks that incentives can create.

NACD, along with Farient Advisors, Katten Muchin Rosenman, PwC, and Sidley Austin, last fall cohosted the first-ever joint meeting between the NACD Compensation Committee Chair Advisory Council and the NACD Advisory Council on Risk Oversight. Committee chairs from Fortune 500 corporations joined governance stakeholders for an open dialogue on incentives and risk taking.

The discussion was held under a modified version of the Chatham House Rule, under which participants’ quotes are not attributed to those individuals or their organizations, excepting cohosts.

Six questions emerged that boards and compensation committees should consider:

  1. Do we have an appropriate balance of metrics?
  2. Are we calibrating goals and upside opportunity appropriately?
  3. Are we considering the quality of performance?
  4. How robust are the controls on data that is used as inputs to the compensation plan?
  5. How are our board’s committees collaborating on developing and monitoring incentive plans?
  6. Are we actively exercising discretion?

Below are details for three of those questions. More information is available for download in NACD’s complimentary brief, Incentives and Risk Taking.

Do we have an appropriate balance of metrics?

The Report of the NACD Blue Ribbon Commission on Performance Metrics states, “Corporate leaders must select metrics that encapsulate the company’s strategy, the balance of risk and reward, and the milestones along the way.” Management chooses appropriate metrics for the company. The board’s role is to decide if those metrics help create long-term value for shareholders—and also to ask management the right questions to ensure that risks associated with compensation plan incentives are being mitigated.

“Our responsibility is to understand the business and the industry,” said one director at the meeting. “The more we understand the business, the more [any] red flags will become apparent.” Meeting participants added that just as there is no silver bullet or single perfect metric to use when developing incentive plans, there is no one-size-fits-all approach to finding a satisfactory balance of metrics.

“There’s no perfect performance measure because every one of them can be gamed either deliberately or not deliberately,” said Dayna Harris, vice president at Farient Advisors. “In addition, it’s important to factor in trade-offs—for example, between metrics related to earnings and those related to revenue or returns—in order to get a combination that works.”

Thomas J. Kim, partner at Sidley Austin, said, “Performance metrics for compensation should be consistent with how management and the board think and talk about the business, both internally and externally. Qualitative metrics are generally more appropriate for, and tailored to, specific individuals, rather than for management as a whole.”

Are we calibrating goals and upside opportunity appropriately?

In addition to selecting performance measures, compensation committees must ensure the pay plan keeps the firm’s risk appetite in mind. The goal is to avoid unintended consequences that might compromise the enterprise’s reputation or its long-term viability. At one council delegate’s company, “the chief risk officer does a risk analysis of the executive compensation plans and shares it with the board. We can assess where it nets out on the risk spectrum. The analysis is repeated at the end of the year to look at incentive payouts and whether any business area took undue risks.”

Participants highlighted two areas for compensation committees and boards to consider:

  • Incentive thresholds. “Stretch goals are great and often important to strategy execution. But the board needs to ask whether high incentive thresholds may encourage bad behavior,” one participant said.
  • Slope-of-the-payout curve. Harris advised, “Make sure the upside [payout] opportunity is not excessive, especially for annual incentives. Three hundred to four hundred percent payout ranges can be dangerous.”

Are we considering the quality of performance?

Council delegates also emphasized that it is essential for compensation committees—and, indeed, for all board members—to ask probing questions about the way in which management achieves results, not just whether or not a particular performance target has been met: “How you get there makes all the difference: we have to look at the quality of earnings,” one delegate said. “If our incentive plan is heavily weighted toward rewarding revenue, did we end up with a bunch of low-margin or bad deals?”

One compensation committee chair reported, “To make sure that our results are sustainable, we’ve introduced strong metrics around employee satisfaction and engagement, along with customer satisfaction. These can count for as much as 25 percent of the CEO’s annual bonus.”

Questions about the quality of performance have risen to the top of many boards’ agendas in the wake of criticism over the consequences of aggressive incentive plans at companies such as Wells Fargo and Mylan. Reflecting on what has been publicly reported about these two situations, participants identified the following takeaways for directors:

  • Exercising skepticism is essential in times of good performance—when it is often most difficult to do. “It can be hard for directors to push back when they’re in the boardroom of a high-functioning organization and hearing lots of great stories from management,” observed one participant. Several delegates pointed out that executive sessions can be particularly useful in this regard.
  • Question over-performance as closely as underperformance. “If it looks too good to be true, it probably is,” a director said. “Wells Fargo’s cross-selling numbers were significantly above industry standard. As directors, we need to look very closely at outlier-level performance—it might be a red flag.”
  • Reputation risk can be material, even when financial losses are relatively small.

By incorporating into board discussions the above-listed questions, directors can strengthen responsible oversight of incentives. “It’s our responsibility as directors to understand the business and the industry in depth—trends, competitors, pricing models,” one director said. “That gives us a much deeper understanding about what is possible and what we’re asking management to do when we set goals and targets. It will also help us see potential risks and red flags much earlier.”

Through the Boardroom Lens

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Directors attending the recent NACD Directorship 2020® event in Denver, Colorado engaged in group discussions about how boards can anticipate and effectively respond to environmental and competitive disruptors in the marketplace.

The half-day symposium at the Ritz-Carlton on July 15 was the second of three NACD Directorship 2020 events this year addressing seven disruptive forces and their implications for the boardroom. Summaries of the Denver speakers’ main points are available here.

Following each speaker, directors developed key takeaways for boards. Those takeaways fell within the parameters of the five elements of effective board leadership defined at last year’s NACD Directorship 2020 forums: strategic board leadership and processes, boardroom dynamics and culture, information and awareness, board composition, and goals and metrics.

Environmental Disruptor Takeaways

Strategic Board Leadership and Processes

  • Crisis response plan. Ensure that the company has a contingency plan in place that takes into account a potential environmental crisis. The plan should include how the company will respond to disruptions in the supply chain and production cycle, as well as to employees, customers, and investors.

Boardroom Dynamics and Culture

  • Culture. Boardroom culture should reflect that directors are ready and willing to be held accountable for environmental or climatological issues that arise for the company.

Information and Awareness

  • Engagement. The company should have an established communications plan to use in response to requests from shareholders and stakeholders regarding environmental matters.

Goals and Metrics

  • Green metrics. Becoming a sustainability-focused company requires adopting a long-term commitment to the cause. The board can communicate that commitment by establishing environment-related performance metrics that align with the corporate strategy.

Competitive Disruptor Takeaways

Strategic Board Leadership and Processes

  • Board agenda. Set aside time on the board agenda to discuss forward-looking strategy, so that the board’s focus is not limited to reviewing the company’s past performance.

Boardroom Dynamics and Culture

  • Culture. Fostering innovation requires risk. The culture throughout the organization should support failure and risk taking within the company’s tolerances. Also invite outside experts—or “white space” teams—to help trigger new, innovative thoughts.

Board Composition

  • Composition. Board composition should reflect a diversity of thought and experience. Regardless of background, directors should be willing to ask probing questions and stay aware of marketplace trends.

Goals and metrics

  • Understanding the marketplace. Management should be able to answer who future competitors might be and what trends might gain traction.