How board involvement can improve corporate strategy

Both parties should maintain a relationship of ‘principled intimacy’.

The days of most boards rubber-stamping what the CEO wants, staying quiescent during meetings and letting the CEO dictate strategy are fading. Boards have woken up and become more involved in setting the company’s course of action, driven by a variety of factors.

Triggered by company failures, intensified by governmental regulations and spurred on by shareholder activism, boards are taking a more active role in developing strategy, reducing risk and working in concert with the CEO. A 2012 study by the Mercer Consulting Group notes: ‘Widespread recognition that active engagement in strategy is a critical obligation of any board is a relatively recent phenomenon.’ In the past, boards might review a strategic plan annually and then evaluate the CEO on the results of executing it, but now that isn’t enough.

Creating an atmosphere in which the CEO and the board can collaborate on strategy is tricky and is filled with more potential pitfalls than there are sand traps on a golf course. Indeed, the Mercer report notes that ‘successful board engagement in strategy is not easy and many companies lack a clear framework.’

Illustrating that point, a 2011 survey by consulting group RHR International which interviewed 210 board members and 22 CEOs revealed that only 47 percent of recently hired CEOs were aligned with the board on the company’s direction, and only 41 percent were clear on the board’s expectations of their performance. After three months on the job, 59 percent had a clearer understanding of the board’s expectations. To improve the relationship, CEOs asked for ‘more frequent, high-quality interaction with the board earlier in the transition and for more transparent and candid communication’ with the board.

The board as management team

The board of directors of San Diego-based AMN Healthcare Services has made a conscious effort to play an instrumental role in developing the company’s corporate strategy. When the country’s largest medical staffing company, with $887 million in revenue in 2011, considered acquiring Medfinders, a leading clinical workforce managed services provider, in 2010, CEO Susan Salka immediately consulted with her six-member board. If AMN purchased Medfinders, it could introduce new revenue streams such as adding home healthcare workers and providing management services for hospitals.

While some CEOs shun their boards, keep them at a distance or object to their interference, Salka saw her board as a resource. Relying on the board produces ‘a stronger, more enduring strategy’, she says. ‘Boards help ensure that we are looking beyond the next year, to five to 10 years down the road.’

Salka believes management often gets too caught up in short-term performance and quarterly results. The board has more distance from these matters and is often more focused on long-term strategies such as whether acquisitions can boost long-term results and spark revenue.

Salka enlisted the expertise of each board member to conduct due diligence on the potential deal, explains Douglas Wheat, chairman of AMN’s board and a partner at Southlake Equity Group. Wheat brought private equity expertise, and the board included a former PwC partner, a marketing and branding expert, and a general counsel with governance know-how. Salka peppered board members Michael Johns, former chancellor of Emory University, and Martha Marsh, retired CEO of Stanford Hospital, with questions about whether the increasing consolidation of hospitals would spark increased outsourcing of medical staffing from firms like AMN. Would the increase in larger, merged hospitals warrant spending $193 million on acquiring Medfinders and adding its specialties?
The board brings a broader perspective than the management team can provide, since members are involved in other companies. Salka says board members offered insights and perspectives beyond the ABN viewpoint. When the acquisition was heating up, she met with them weekly, not monthly or quarterly, to tap their expertise.

Though the board was concerned about AMN’s assuming $225 million in total debt for the Medfinders purchase, it decided that this acquisition positioned it for future revenue spikes and gave its approval. AMN completed the acquisition of Medfinders in September 2010.

The short-term effects of the acquisition were rocky. Investors were concerned about the heavy debt load and drove AMN’s stock down 28 percent in 2011. However, the stock rebounded and rose 58 percent by mid-August 2012. Wheat says the board made the right long-term decision. ‘People were critical of the debt, but we bought master services, which got us into hospital outsourcing,’ he explains.

Building relationships, solving problems

Salka established a constructive relationship with her board, but forging it required the management team to supply continual updates on changes in the business. ‘We provide details, narrative information, business metrics; we give them the good, the bad and the ugly,’ she says. Transparency with her board and shareholders fuels the close relationship. For example, on the first page of AMN’s 2011 annual report, Salka says that the stock had a rough year in 2011 and plunged 28 percent. Some CEOs would have buried that negative on the last page, and some wouldn’t even have mentioned it at all.

Often it’s the CEO that sets the tone with the board on solving problems. Suzanne Hopgood, former CEO of Furr’s Restaurant Group (a public company with $350 million in revenue) and ex-CEO of privately owned Houlihan’s Restaurant Group, notes that 90 percent of the time the CEO’s attitude determines and drives the relationship with the board. Having also served on nine boards, she’s seen a variety of CEOs that neglected their relationships with directors.

Some CEOs are threatened by the board and want to keep it at arm’s length, some see it as a resource that can help set strategy, and some control the board and see it as a deferential ally beholden to the chief executive. Other CEOs withhold information and share little with the board in an effort to minimize its influence, but Hopgood notes that boards can play an influential role in solving problems, particularly when the company is facing a crisis.

For example, soon after Hopgood was hired as CEO of the Furr’s restaurant chain in 1998, a major class-action suit arose which could have damaged the company’s reputation and threatened its financial stability. Hopgood had to keep the company’s operations running smoothly, so she knew she couldn’t devote herself to the lawsuit full-time. She enlisted the board’s help, identifying two board members – one a former forensic auditor with a Big Eight accounting firm and the other a former private equity leader who worked with distressed companies – and assigning them to handle the lawsuit. The two board members attended all the court hearings and ultimately negotiated a settlement that salvaged the firm’s reputation and kept losses to a minimum. While that was being dealt with, Hopgood got the company’s business operations back on track.

Boards can also restore a company’s reputation if it has been tarnished by legal action. When the CEO, CFO and COO of Point Blank Solutions, a body armor and bullet-resistant vest manufacturer and major military contractor, were indicted on malfeasance in Florida in 2007 and 2008, the board, which included Hopgood as a member, helped straighten out the company’s finances, restated earnings and restored shareholder confidence. ‘Each board member had a specific role; mine was doing the right thing, which is a standard that rises considerably when meeting regulations and compliance issues,’ Hopgood says.
Too often, boards get immersed in dealing with compliance issues and this can serve as a deterrent to focusing on strategy, says Hopgood. Corporate secretaries who assemble the board books and itinerary for board meetings can serve a useful role by moving strategic issues higher up on the agenda.

The board’s dual role

Boards develop their own communication styles, and these can determine whether they’re high-performing or dysfunctional. Internal rivalries can discourage members from contributing valuable information to the CEO. Boards can’t function effectively if members are ‘belittling each other or rolling their eyes’, Hopgood says. Mutual respect produces better results.
CEOs who encourage the board to ask difficult questions can obtain invaluable advice and information from those exchanges.

For example, Thomas Stanton, author of Why some firms thrive while others fail: governance and management lessons from the crisis, cites the case of TD Bank CEO Edmund Clark, who listened to his board’s feedback during the subprime mortgage crisis. While Bank of America, Citigroup and JPMorgan Chase lost millions due to the subprime fiasco, TD Bank’s board informed Clark that the subprime mortgages were increasing the bank’s risk portfolio. Bucking the prevailing wisdom that subprime mortgages were a cash cow, Clark reduced the bank’s subprime mortgage portfolio and thereby curtailed its losses. ‘The bottom line is that he was a CEO who was open to feedback,’ Stanton says.

Clark’s decision to elicit feedback from his board was part of his strategy of openness and corporate accountability. He said at a conference that good executives depend on a strong board that challenges the assumptions of the CEO, and he encourages his board to ‘wander through the organization, meet the executives and ask for any document you want. And if an executive refuses, I’ll let them know they have to let you have it.’ Indeed, at board meetings, Clark identifies the bank’s major problems and suggests topics on which the board can dig deeper for more data.

Stanton says that a CEO’s developing a strong rapport with the board is a complex and difficult endeavor, partially due to the board’s dual roles. The board fulfills two functions that can easily conflict. ‘One function is to assist the CEO in making good decisions for the company, and the other is to keep an eye on the CEO on behalf of the shareholders,’ he explains. Since the board is evaluating the CEO and could fire the CEO if the company’s performance declines, some chief executives keep their distance from the board and don’t always trust it.

Wheat says boards must juggle both roles, supporting the CEO by providing expertise that helps improve decision-making but ‘compartmentalizing’ its role of evaluating the CEO’s performance and tenure. For example, when AMN acquired Medfinders, the board tied management compensation closer to stock performance than it had in the past. The board didn’t want to pay excessive compensation if stockholders weren’t being rewarded, Wheat explains.

Control freaks and drinking buddies

Ego prevents some CEOs from establishing constructive relationships with boards, according to Don Rogers, attorney and president of business services at Shulman Rogers. ‘Some CEOs want total control,’ he says. ‘They aren’t interested in having people second-guess or criticize them.’ Hopgood says she has seen CEOs choose inexperienced boards primarily so that they can control them.

Boards that become too cozy and close to the CEO can fall into another trap. Stanton says boards must maintain a stance of ‘principled intimacy’, described as comparable to policemen on a beat who strike up relationships with the public but maintain some distance. A board that becomes too close to a dominant CEO ‘loses its objectivity and independent perspective,’ he explains. Therefore, boards and CEOs shouldn’t be golfing together and patting each other on the back. Boards must offer independent feedback, which is difficult to do with ‘your drinking buddy’, Stanton points out.

When CEOs ignore the sound advice of a board, the consequences can be dire. Stanton notes that the Lehman Brothers board warned CEO Richard Fuld that the investment bank was taking excessive risks, but rather than heed this warning, Fuld dismissed his chief risk officer in 2007. Lehman declared bankruptcy in 2008, suggesting that Fuld should have spent more time listening to his board.

For a board to work effectively with a CEO, Stanton says three factors must be in place.

1. The chairman of the board and the CEO should be separate and distinct. If the CEO controls the board and the board becomes a rubber stamp, little will be accomplished.

2. The board must be able to set its own agenda, explore uncomfortable territory and surface any issues affecting the business.

3. Operating independently and asking questions are crucial to a board’s effectiveness.
Stanton notes that sometimes asking a simple, straightforward question can minimize a company’s risk. Had a JPMorgan Chase board member in 2012 wondered why trading revenue was so abnormally high in London, it could have contributed to an investigation of derivatives trading, possibly cutting the firm’s losses.

How boards should work with the CEO

The PwC Center for Board Governance’s 2012 annual corporate directors survey, released in September, reveals that of 860 corporate directors polled, 75 percent said they intend to devote more time to strategy in the coming year. Providing directors with information about customers and employees is critical to helping them develop strategy. Nearly three quarters of directors were satisfied with information about employee values and customer satisfaction that they were receiving, although 20 percent said they didn’t receive these kinds of surveys. Mary Ann Cloyd, leader of the PwC Center for Board Governance, emphasizes that ‘Corporate directors are in the spotlight as never before.’

Here are Cloyd’s six best tips on how boards can form closer relationships to CEOs to design better corporate strategy.
1: Be clear about expectations. The first step a board must take is to be clear in communicating its expectations of management, Cloyd says. The CEO and his or her team must also provide the board with advice on key risks to avoid and required resources and strategic alliances that add the most value. Together the board and CEO can discuss how the long-term strategy can best be executed.

2: Provide consistent feedback. Based on the survey responses, Cloyd says a board’s ability to provide constant, consistent feedback to the CEO is critical for the joint agreement on and execution of corporate strategy. This can best be accomplished by the board’s asking relevant, probing and insightful questions in a positive and constructive way. The best boards interact collegially with the CEO, forming an effective working relationship.

3: Boards must do their homework. CEOs work full-time, and boards operate on a part

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