Corporate governance received a lot of attention during the scandals that followed the tech wreck, specifically Enron, Worldcom and Tyco. Who was supervising these corporations? Where were the checks and balances for the corporate executives? The theory is that a board of directors is elected to represent shareholders, to support and challenge the CEO and to take ultimate responsibility for everything that happens in the company.
In practice, boards of directors have varying compositions and effectiveness. They don’t all see their role in the same way. Because each company is unique, every board needs to determine what role it should play and how it can best support the company. The most important role, that every board has in common, is to bring a long term perspective to management, who might otherwise focus solely on short-term actions and results.
A board is made up of directors who are selected by the shareholders and the existing board members, often with advice and support from the CEO. Some CEOs will set up a board that can act as a sounding board, listening to ideas and strategy in order to offer constructive advice and criticism. The CEO can benefit from feedback in order to consider all aspects and better match his plans to the needs of the company. Some boards are constructed as a network, composed of directors who are CEOs of other companies or representatives of key suppliers, clients and partners. In this way, the CEO has direct access to a network of people who can help to implement the company’s strategy.
A board of directors may include, or be composed entirely of, representatives of shareholders. This seems to happen especially with institutional ownership. For example, a mutual fund or, more likely, a pension fund will put forward candidates for directorship in order to have input and feedback on efforts to make a company more profitable. This is one way that a fund can have more control over investment outcomes. Boards often ensure that directors are shareholders by requiring them to buy stock in the company, but in some cases it is merely a token gesture. In the case of a proxy battle, however, large and influential shareholders can sometimes get an entire slate of directors accepted by shareholders.
The policy board seems to be very common. One of the difficulties that corporations sometimes experience is when a strong board tries to compensate for a weak CEO by meddling in management. Governance does not mean managing the company, it means supporting, helping and challenging the CEO, helping her to perform to her full capacity on behalf of owners. A policy board will formalize this distinction by clarifying desired outcomes, setting boundaries outside of which the CEO must not act, then leaving the CEO free to use her creativity and initiative to produce the outcomes.
While a policy board clearly delineates responsibility, it leaves the board at the mercy of the CEO for gathering information. The CEO may become a filter that only allows certain information and a particular perspective to bubble up to the board. Without meddling in management, a board needs to be curious and energetic, encouraged to “walk the shop floor” to gather insight and be able to help the CEO identify positive and negative situations and trends.
Corporate governance comes in many flavours. There isn’t a single right way to implement good governance, but the purpose of a board is to understand the corporations’ strengths and weakness, have insight on the environment within which it operates, and use this perspective to support and challenge the CEO to function optimally on behalf of owners.