UNLEASHING
THE POWER OF CORPORTATE BOARDS
The best thing
about Naresh Chandra committee’s report on Corporate Governance
released recently is the manner the committee has set about
in strengthening the Corporate Board and improving its effectiveness
by recommending that 50% of directors be independent.
The committee has
gone to great lengths in describing who can or who can’t be
a director. Like the Indian Constitution, it is most exhaustive.
Yet rules cannot cover all situations, as the following example
will indicate.
An Indian company
whose CEO wants to forge a strategic alliance with, or possibly
sell the company to, a much larger American firm has appointed
a director of the American firm to his board as a non-executive.
Clearly, were an offer to be made, the non-executive in question
could have no part in any discussion of bids or counter-bids.
However, his absence would reduce the number of independent
directors available to make recommendations to shareholders.
Furthermore, he would by that point be well known to fellow
directors, many of whom might have cause for gratitude to
him as a member of the remuneration committee, to which he
would no doubt have imported American notions of directors’
compensation. The argument that long-term shareholders interested
would be better served by rejecting the bid-because the sector
is currently on the down swing and the US company is highly
overvalued and poorly managed might not win the consideration
it deserves. In the example at the time of his appointment
the American non-executive appeared to warrant a tick in every
box, making him an exemplary independent director.
Another example
of apparently impartial, but in reality compromised, non-executive
directorships emerges when a ‘golden triangle’ is created-whether
by accident or design. These occur when a director of company
A sits on the board of company B, while a director of company
B sits on the board of company C. Once a director of C is
appointed to the board of A, the triangle is complete. This
is called a ‘golden triangle’ because non-executive appointed
in this way invariably turn up on remuneration committees.
WorldCom’s board
comprised an architect who had designed CEO’s house, the principal
of his daughter’s school principal and an actor friend. They
would all be termed as “independent directors”. All this brings
into process the irrelevance of a box ticking approach to
corporate governance which indeed have become disastrous for
US corporate governance.
Naresh Chandra’s
committee by and large has done an excellent job. It has not
succumbed to the pressure of auditing firms in prohibiting
non-audit work. It has not gone far enough in recommending
the US type oversight boards which is badly required in India
where the influence of Accountancy profession is no less than
what Arthur Levitt lamented about in the US.
What we must realize
is that Corporate Governance guidelines and rules only focus
on structural fixes and do not effect change below the surface.
Real change comes from choosing Boardroom Practices that focus
on how to ask tough questions, challenges assumptions, conventional
wisdom, probe assessments and broaden the perspective to ensure
collective learning that gives the company a competitive advantage.
The issues that truly board performances are the board dynamics,
quality of dialogue, flow of information, power play, schedules
and agendas for meeting and even the way seating is arranged.
These issues can create or destroy board’s competitiveness.
Few people realize
the untapped potential of corporate boards in creating value
for the company. It is unfortunate that the CEOs have so far
treated the boards as an interference in their work and something
that diminishes their power. As Jay Lorsch of Harvard Business
School and an authority on corporate governance asserts this
is a serious misconception. His studies of the companies where
directors have been empowered to monitor corporate and management
performance, there is no evidence that the CEO and other top
level managers have their power to lead the company diminished.
Instead they have found that directors are better informed,
communicate their ideas more effectively and provide better
advice. In this way they can make a good CEO perform better.
A board can be a true coach, counsellor and sounding board.
There is a general
feeling that involving board and especially the non-executive
directors shown the decision making. Regard, therefore, has
to be given to the recruitment of the directors. If independent
directors themselves have express of managing companies as
CEOs they would know the cost of procrastination. We are living
in a highly competitive world or radical change. Today’s chief
executives face a bewildering mosaic of wrenching change,
uncertainty, stiff competition in a world of unprecedented
opportunity for growth. His most important job is to manage
discontinuation. The margin of error in today’s markets has
been reduced to razor thin. A slightly wrong decision can
decimate stock price. Boards of today have to be proactive
and not pliant, intrusive and not quite, innovative and not
incremental, radical and not staid. Bausch & Lomb suffered
a $1 Billion loss in market value and a permanent decline
in its core contact lens business under CEO Daniel Gill when
the company lost to Johnson & Johnson’s drive into disposable
contact lens. Apple Computers failed to regain its dominance
in software driven competitive industry under 3 successive
CEO’s.
What we need is
an absolute transparency in the decision making process of
the board. These are issues of culture and law will not be
able to change such an attitude. The taboos against candor
and open discussion are so strong that we need to take some
heroined steps to break them. There are three major reasons
why boards even with independent directors, are not working:
(i) Failure to
recognize that failure to deliver profits every quarter is
not something to be ashamed of. Indeed it could have lessons
that are value enhancing and asset creating.
(ii) Failure to recognize the value in the board is created
by keeping it in diverse as possible and Conformity in the
brand is value destroying.
(iii) Failure to
recognize that the “independent outside directors” who owe
their appointment or reappointment to CEO and look upon him
for remuneration fee and travel allowance cannot be truly
independent.
The centrality
of Corporate Governance is transparency. In an economy driven
by innovation where companies have to constantly try out new
models and where you are hitting a revolutionary target, every
shot cannot be bull’s eye. Indeed successing turn should be
rejected without suspect. Indeed quality profits are not the
only parameter of a company’s success. But if you have wetted
shareholders appetite by managing earnings and showing profits
each quarter, you require tremendous courage to admit you
have failed this time. Our task is two fold, we have to educate
the board to have the pride in admitting mistakes and educate
investors to make them realize that in the innovation economy
results are bound to be volatile. Indeed anything other than
that my be deception. What we need is a culture where both
board and management freely admit failures and explain to
investors how, these have helped them change track and thus
crate value for the corporation.
The secret of world’s
most successful management innovation-ISO-9001 Quality Management
Systems – over a million companies have been certified against
the standard-is its recognition of failure and hence, focus
on self-audit and corrective action. The purpose of self-audit
is not simply to show the form but satisfy the auditors and
provide them evidence that the system is robust enough to
detect errors and take corrective action. The emphasis has
to be on the process and not result.
Secondly just as
conformance added value in the industrial economy, the value
in the knowledge economy stems from diversity. A diverse board
composed of a range of backgrounds and experience with gender,
age and ethnic balance is far more valuable today that the
board of former Stephenians of Free Masons. The best solutions
come to from clash of ideas and not through yesmanship. Recognition
of this concept has a transformational value for the whole
nation. There is a lot more value in associations, which are
heterogeneous than homogenous. We should not cling to our
caste, class or community. Never again we should defend a
villain just because he happiest be “our own scoundrel” simply
because he/she is from my caste/region or religion.
Independence of
directors is a truly complex subject. Independence lies in
the state of ones’ mind. Yet there is no denying that most
of us will hesitate to raise awkward questions in a board
meeting when we have to go to the same CEO to collect the
remuneration cheque or depend on him for reappointment. The
answer lies in having a separate agency, an appointment and
pay remuneration to the directors. The agency should have
its own pool of independent directors selected through an
elaborate proven. The directors would receive the fee directly
from that agency and will owe nothing to the company they
are working for. This is a radical solution for a problem,
but intricate problems such as these does require a radical
solution.
There is nothing
new about corporate greed. Problem of governance stem from
time immemorial. The only change is that the stakes today
are too high. Look at George Soros, paragon of corporate virtue,
having been fined $1.4 million for insider trading. This shows
how times have changed. Had this decision come 10 years earlier
it would have been different. All complaints of smoke ended
up being declared “without fire”. Take Lord Archer. 10 years
ago he was not only acquitted but held as a model of virtue
by the judge. Now he is languishing in prison and so are scores
of while collar criminals not only in the UK and USA but all
over the world. Messier the invincible corporate hero of Vivendi
of the 1990s had the police raiding his home in Paris. In
his recent book Arthur Levitt could not curtain the power
of investment bankers and big auditing firms. Today Eliot
Spitzer has brought them to their knees and got them to pay
a fine of $1.4 billion. The wrong doers are America’s banking
jewels – the Citibank and Merrill Lynch. Nixon lived all through
his years of US Presidency exhorting everyone “You can disobey
all the 10 commandments as long as you obey the 11th commandment:
Thou shalt not be found out”. In the uncertain times we live
today there is one certainty: “thou shalt sure be found out.”
Transparency, therefore, is the key for corporate survival.
In the words of Einstein “it is not the mistake that you make
that causes the damage, it is the mistake that you make of
defending the first mistakes that causes the serious damage”.
