Executive Leadership and Corporate Governance (Part Six)

As noted in my previous Blog, your company is proceeding with the governance process and the Board members have elected a fellow Board member who will serve as the Board’s independent Chairperson. This marks a positive step on the road to improving your company’s governance process, as now the inherent, unresolvable conflict that exists when the owner/CEO/President is also the Board Chair has been eliminated.

So at what monetary level should this individual be compensated for the services he/she performs?

First, I believe it’s important to note and to understand that the Chairperson assignment is time consuming, complex and requires a person with strong managerial skills, including an ability to “herd cats”. The cat herding skill is necessary because it is not the case that all directors (some of whom were elected at different times and under differing circumstances or who were “elected” because an equity investment/loan agreement specified that they would be) have the same agenda/reason for being on a company’s Board. So the management of what is likely to be a very diverse group is challenging on several levels to say the least.

Second, the fact that the Chair position IS time consuming should provide enough impetus to separate that responsibility from the CEO/President. I submit that a properly functioning Chair will spend on average three weeks a month in committee meetings, meeting with the CEO and other members of executive management on matters of strategy and execution, prepping for Board meetings, attending Board meetings, following up after Board meetings and doing external research/meeting with outsiders (e. g., audit firm, law firm, etc.). If the CEO is also the Board Chair, it is a given that one or both sets of responsibilities will not be effectively discharged. There simply is not enough time available for one individual to effectively discharge the requirements of both positions, no matter how good a manager or delegator he/she might be.

Many companies that have separated the CEO and Board Chair positions have experienced a failed governance process for a number of reasons. Those reasons include not electing the right person (e. g., the CEO of another company who will not have the time available to effectively discharge the responsibilities of the Chair (they have their own battles to fight!!), or a person who does not have the requisite background/skill sets) as Chair and undue attempts at influencing the Board’s governance process by management. There is a third reason that will create problems, and likely failure to do the job right, even if the above noted negatives do not occur, and that is inadequate compensation for the Chair.

So what’s the ideal situation? I believe the Board Chair should be an individual with broad business experience at a high organizational level who has the time to commit to the process requirements of being both an independent director and independent Board Chair – so not a high profile individual who is already committing 60 – 70 hours/week to his/her own company’s needs.

And what’s the ideal compensation for such a person? I believe (remember, cash only as stock should not be part of a director’s compensation package (see my last Blog)) this is a company’s investment in an asset that should create additional shareholder value, and this individual should be regarded as one of the most important positions in the company. Therefore the Board Chair’s compensation should be targeted at 75% of the CEO’s total compensation – assuming the CEO’s compensation is at least at market rate for a company in his/her industry.

This accomplishes several objectives. First it recognizes the value of the position in a company’s “pecking order”. Second, it may encourage the CEO to consider an appropriate level of compensation for the CEO position. And, finally, it properly compensates the Chair for the amount of time required to properly discharge the functions of the position.

Executive Leadership and Corporate Governance (Part Five)

As the company’s owner and CEO, you have made the choice to employ “best practices” with respect to corporate governance and have separated yourself from the position of Board Chair. Further, the Directors have been elected, committees formed and the Board is ready to commence the governance process on behalf of the company’s shareholders.

Obviously the following needs to be determined prior to putting the Board together, but since we have been dealing with the philosophy and theory of governance in the last few blogs, I have allowed the issue of Board compensation to fall a bit out of order, but it is a most important component of the governance equation – and one few companies seem to get right.

First, Board compensation is an investment in the creation of shareholder value. Therefore it must be meaningful, and like beauty, meaningful is in the eyes of the beholder. So, to clarify, by meaningful I am saying compensation that is fair for the risk (which is enormous) assumed, for the work required and for the value a Director creates for the shareholders via his or her expertise is required.

Let me give you an example of compensation that is not meaningful. A company with annual revenue of more than $100 million offered me a Board seat (subject to shareholder approval) for $2,000/quarter, based on the fact that there would only be four Board meetings per year and that each meeting would not last more than two hours and would require “minimal” preparation time. That offer was not adequate compensation. Why? It gave no consideration for the risk involved. It gave no consideration for the number of years of my Board service, or for my level of expertise based on my various committee assignments and the complexity of issues I dealt with. And, it didn’t adequately compensate for the time required, as there is no such thing as “minimal” preparation time, and I’ve never been in a regularly scheduled quarterly Board meeting in a company that size that lasted only two hours. There are simply too many issues to deal with for two hour Board meetings to be the norm. So in the case of this company, an offer of $10,000 per quarter would have been much more reasonable.

Second, Director compensation should be all cash and no stock. Stock options could possibly be appropriate, but should only be exercisable once the Director’s term has ended. Why no stock?

Most public companies have blackout periods to eliminate insider trading. That sounds good in principle. The reality is that Directors always, and I mean always, have more information available to them than any outside investor ever does. And that’s true for companies whose disclosures with the SEC are forthright and in full compliance with Regulation FD. A Director always has an investment edge over an outside investor in terms of knowledge. A no buying or selling policy eliminates that unfair advantage.

Another myth that needs to be dispelled is that if Directors hold stock of the company on whose Board they serve, their interests are aligned with the shareholders. Possibly not. There are hedge funds. There are short sellers in the market. There are day traders. There are management and possibly family holdings. I submit that it’s impossible for a Director to have the necessary knowledge to align himself/herself with all of the above and other groups whose interests may be in conflict with one another. And it’s certainly not a Director’s responsibility to adjudicate those conflicted positions. A Director’s responsibility is to govern the activities of the company through the CEO on behalf of all shareholders, to assure that all shareholders and prospective shareholders have the same timely information available to them, and that that information meets or exceeds all SEC disclosure requirements.

Having written the above, we are capitalists, and I have no problem with any Director acquiring a capital gain on stock he or she holds. Just do it with a company with whom you have no governance responsibilities in order to eliminate any perception or reality of conflict of interest.

My next Blog will discuss the proper amount of compensation for the Independent Board Chair.

 

Executive Leadership and Corporate Governance (Part Four)

This Blog explains how to get any company’s Board leadership configured to optimize the Board’s effectiveness.

In an earlier Blog on company leadership and effective governance, I noted the inherent and unresolvable conflict of interest created when the Board Chair and the CEO of the company are the same individual. This conflict arises because the CEO, when also acting as the company’s Board Chair, is controlling the very governing body that he/she reports to.

Think for a moment how many dysfunctional outcomes are likely to and do occur because of such a structure! And try to recall where else in your company a structure exists where a manager controls an organizational group within the company that he/she reports to. I submit the only place that dynamic occurs in the great majority of cases is at the CEO/Board Chair level. The message that sends to the rest of the company is “manage/lead as I say, not as I do”. Can you see how that type of “leadership” sows dysfunctional seeds in terms of culture and performance assessment within the company?

The pragmatic, ethical solution that exemplifies positive leadership is for the company’s CEO and Board Chair responsibilities to be discharged by separate individuals. (Note that some companies attempt to solve the “dilemma of separation” by creating the role of Lead Director. Following that path in no way resolves the inherent conflict, because the Lead Director still reports to the CEO who also serves as the Board Chair. The result is that the Lead Director “solution” is only a mask for separation, and governance is usually conducted in a fashion very similar to the way it was before the Lead Director was appointed.)

The “how to” of separation is fairly straightforward, and is a process that has become unmercifully complicated (in an effort to discredit the need for separation). As noted in an earlier Blog, the non management members of a company’s Board should be Directors who meet every criterion of independence (e.g., not relatives). Those independent Directors then elect one of their peers to serve as Board Chair. Can’t get any easier than that! Obviously the Chair should be an individual with extensive governance and operational experience.

The Board Chair then establishes functioning committees, appoints a Chair for each committee and charges the committees to develop charters that define each committee’s actions and accountabilities. The Board Chair then “manages” the Board’s governance activities on behalf of the company’s shareholders (the group to whom the Board reports and the group that elects the Directors) – whether in a privately held company or a publicly held company.

The CEO manages the company’s activities (strategies and operations) and reports to the Board on behalf of the shareholders in a non conflicted manner, meaning the CEO does not control the Board’s governance process.

As mentioned above, this process really is straightforward, but the strategies and the activities behind the process are complex and must be well thought out in order to arrive at the desired end point. For instance, there’s the key issue of Chair compensation and Director compensation (an issue that’s been poorly addressed to date by most companies), and my next Blog will delve into those issues, their resolution and how that resolution enhances both governance and company performance.

If you are a CEO who is willing to make the behavioral changes required in order to realize the benefits (read “competitive advantage”) of constructing a Board now for the upcoming post recession economy that is led by an independent Chair, and want to do so by benefiting from my 20 years of public and private company governance experience, I’m available to help you evaluate your current situation and to guide you through the steps required to achieve your governance goals.

 

Executive Leadership and Corporate Governance (Part Three)

My prior two Blogs dealt with the causes and ramifications of poor governance.  Today I will offer what I believe is the pathway to governance that helps an entity operate more than one standard deviation to the right of the mean, or in the top 15% of entities in its sector.  The observations I offer below are based on over 20 years of active governance participation that continues to this day – as an independent director on Boards of NFPs, privately held companies and publicly traded companies, so a rather broad sample.  The real world challenges and levels of risk exposure are different for Board participation in each of those groups, but the legal responsibilities are essentially the same for each group.

So, what steps should be taken to put your company or organization in the best possible position to have a high performance Board that, via a minimum of four scheduled Board meetings/year, helps create a measurable increase in performance and value?

First, as you might have guessed if you read my previous two Blogs on this subject, is to formally separate the top executive officer of the entity from the Chair position.  Having the Chair position filled by an individual who legally qualifies as an independent director eliminates the inherent conflict of interest that occurs when the Chair and the top executive officer are the same individual.  Also of importance is the fact that this is a great leadership move that signals ethics, transparency at the top of the entity and that true governance is likely to occur.

Second, select and elect directors so that a majority of the elected directors qualify as independent directors on a Board that will have from five to nine members.  The directors from the entity should be limited in most cases to the top executive officer and the top financial officer of the entity.  If the entity does not have a financial officer, one other senior member of the management team may serve on the Board, but that’s all, as Board meetings are not management/staff meetings, or worse yet, perks.  The directors that are selected for election should be selected based on needed silos of expertise, and diversity of all types should be encouraged so the Board is a microcosm of the entity’s customer/client base.

Third, establish formal committees.  The three mandatory committees should be audit/finance, nominating/governance and compensation.  Each committee should be chaired by an outside director.  Each committee Chair should lead his/her committee through the process of developing a committee charter that identifies the responsibilities and accountabilities of the committee.

Fourth, compensate the Board appropriately (i. e., treat as a value creating asset) and establish an annual budget that is specifically for the Board’s operations in the discharge of its governance responsibilities.  I will comment more on Board member compensation in a Blog next week.

Fifth, set up an entity wide whistleblower policy that is monitored by an outside agency.

Sixth, conduct annual reviews of each director’s performance, preferably through an outside firm whose specialty is providing that service.  This lessens internal politics and biases.

While there are several other steps to be taken to ensure that high performance of the Board is realistically possible, if an entity starts with these six, it will be light years ahead of most of the other organizations in its sector – specifically those privately held companies that need to position themselves for sale within the next five years.  After all, think how much more attractive (read valuable) a properly governed company is as an acquisition opportunity vs. one that’s poorly governed and whose performance is also substandard as a result.

Also, there’s a LOT of “how to do” for each of the above steps.  If you would like to have step by step guidance in implementing each of these steps, please contact me.