Corporate Governance: The Seven Habits Of An Effective Board

Corporate Governance: The Seven Habits Of An Effective Board

Rarely have corporate directors faced such a deep and widespread erosion of public trust.

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Corporate Governance: The Seven Habits Of An Effective Board

Rarely have corporate directors faced such a deep and widespread erosion of public trust. Boards are seen to provide weak oversight, or worse, to be complicit in allowing executive greed, rewarding underperformance and failing to prevent corporate excess and even fraud.

Predictably, the loss of trust in corporate oversight has produced two inevitable responses: lawmakers and regulators push stronger regulation, while activist shareholders strive to exercise greater influence over corporate governance. Restoring trust is essential, but each of these responses, however well intentioned, risks creating new problems.

A new era of regulation is consuming directors' attention, focusing them on issues of governance and the accuracy of the next earnings announcement rather than helping companies to build sustainable value. The defensive climate prompted U.S. Federal Reserve Chairman Alan Greenspan to comment recently that "a pervasive sense of caution" is influencing business leaders.

Empowering investors sounds good in principle, but it can backfire. Pressure from investor groups all too frequently engenders a simplistic "box-checking" mentality to complex governance issues. More importantly, are investors fit for a more active role? Institutional investors have become so focused on short-term stock performance and on stock trading rather than stock ownership, their interests no longer line up clearly with the business fundamentals that make companies successful over the long term.

The real problem is that boards cannot afford to be distracted from issues of performance. Collectively, corporate performance is mediocre: only one company in every eight achieves relatively modest targets for growth. According to Bain & Co. research, just 13% of companies post top- and bottom-line growth of 5.5% or better over a 10-year period, while also earning back their cost of capital. Companies like American Express, Dell, Lloyds and Vodafone, to name a few, have managed to exceed this standard by keeping company performance front and center. Effective boards focus on sustained value and how they can contribute to its creation.

What can directors do to affirm their role, drive board effectiveness and reclaim control over their own agenda? They can start by holding up a mirror to their own board performance, as measured against the "seven habits of an effective board." While these habits may seem straightforward, very few boards score well in all areas.

1. Own the strategy

Most boards convene special strategy meetings and retreats, but typically they sit through presentations of the executive team's plans. Effective boards ensure non-executive directors contribute to developing the strategy, and feel a sense of ownership of the strategy. The more a board understands and owns the strategy, the more responsive it can be to help seize opportunities such as major acquisitions when they arise.

2. Build the top team

Boards have a key role to play in selecting, developing, evaluating, and planning the succession for the executive team. Leading Private Equity firms view their involvement in building the executive team as a top priority—and a clear factor in creating market value. The challenge facing many directors is how to be effective in this role in the presence of a forceful CEO or CEO/chairman.

3. Match reward to performance

CEO remuneration is the most controversial issue for most boards: they want to attract the best talent, and yet the remuneration benchmarks just keep on rising. Part of the solution lies in ensuring that exceptional pay requires exceptional performance. Effective remuneration systems measure what matters—and only what matters. They pay for performance, with real downside for mediocre results. And they ensure that rewards are simple, transparent and focused on sustained value creation, balancing short-term and long-term focus.

4. Ensure financial viability

Sarbanes-Oxley has had its main impact here, focusing on the probity of financial reporting and the audit process. Yet beyond issues of process and compliance, boards have a role in taking key financial decisions, such as ensuring appropriate levels of debt leverage, and scrutinizing major investments and acquisitions for value. Directors must be able to understand as well as trust the numbers to provide a challenge where necessary.

5. Match risk with return

Boards typically have formal processes for assessing and managing operational risk that incorporate commercial, financial and legal considerations. Yet few boards understand the true risks inherent in their companies' strategies. This is critical: 70% of acquisitions fail to create value and 70% of moves into new markets away from the core business also fail.

6. Manage corporate reputation

Doing what's right for the board and the company means not succumbing unduly to outside pressures. If boards are to avoid the trap of "check-box" compliance and short-term focus, they need to take action to reclaim control over the agenda, and target those investors who are in for the long term. Transparency and effective communication are key.

7. Drive effective board process

An effective chairman, who values and upholds the role of the board, is vital. The chairman sets the tone from the top, ensures a governance model that works in practice, focuses the agenda on issues of performance, builds a team of directors with the right mix of skills and experience, and reviews board effectiveness regularly. A board's ability to add value depends heavily on how effectively directors can work with the chairman and CEO.

Directors must overcome diverse challenges and constraints if they are to perform their roles effectively. Some of these challenges are structural, some arise from wrong-headed external pressures, while others stem from poor team dynamics or shortcomings in values, capabilities and focus. What's needed is a robust blueprint against which boards can set their own aspirations and make progress towards enhanced performance. It will take as much to restore trust in boards and to ensure that pressures from outside the boardroom focus on the need to perform rather than conform.

Alan Bird is a vice president of Bain & Co. in London. Robin Buchanan is the senior partner of Bain in London. Paul Rogers is a Bain director and leader of Bain's global organization practice.


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