Time for Boards to Get Serious

A new study suggests that boards must be more engaged, better advised, better informed and — in a word — feistier.

At one time, Lehman Brothers was the fourth largest investment bank in the world. But when it filed for Chapter 11 bankruptcy in September 2008, it had racked up $7 billion in losses — a casualty, and one of the precipitants, of the global credit crisis. Most observers were incredulous. Every major news outlet and business blog asked the same question: Where was Lehman’s board?

Lehman’s board was there, all right, said corporate governance expert Nell Minow, but it was “a risk-management committee that didn’t understand or manage its risk.” Incredibly, only a few Lehman board members had any financial industry experience, and those that did, said Minow, had spent “most of their working lives tied to a different era — the one before massive securitization, credit-default swaps, derivatives trading and all the risks those products created.”

As the scope and depth of the crisis was revealed, it became clear that Lehman’s was not the only board that had gone AWOL. In company after company, such as AIG, J.P. Morgan and Goldman Sachs, similarly ill-equipped or passive boards had been unable or unwilling to recognize and stem a tide of outrageous risk taking and questionable ethical behavior.

Boards have come under a good deal of scrutiny in past decade, contributing to the passing of regulatory legislation such as Sarbanes-Oxley in 2002 and Dodd-Frank last year, as well as a number of so-called “bright-line” standards instituted by regulatory agencies and stock exchanges. However, the focus on regulation and process controls may have overlooked a larger systemic problem. “There is too great a gap between the popular notion of what boards do and the reality of what they are capable of doing,” says Frank Zarb, senior advisor at Hellman and Friedman, and a veteran of many corporate boards. “The existing system limits the depth of board oversight. We must either change the system or change expectations.”

To address that gap, Zarb chaired a recent study, along with co-chairs Glenn Hubbard, dean of Columbia Business School, and Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. The study assembled a 20-member all-star panel, including former Chairman of the SEC Arthur Levitt, former Secretary of the Treasury Paul O’Neill, and other governance leaders from major corporations and academia. Their resulting report, “Bridging Board Gaps,” took a critical look at what boards currently can and can’t do and what they should do going forward.

Most boards, the report suggested, are mired in detached, advisory roles, focused on process and compliance. As a result, they lack a sense of their own purpose. “A singular focus on sustaining long-term shareholder value is the necessary guidepost for boards,” said panel member Ken Bertsch, president and CEO of the Society of Corporate Secretaries and Governance Professionals. “Without such clear purpose, directors and boards are more likely to lose their way.”

A defining mission alone is not enough, however. Many boards are simply too passive in their oversight and monitoring. They are disengaged and complacent because of their part-time service and overextended tenures and are often handicapped by a lack of relevant expertise, a dearth of information and an aversion to real debate, both in and outside of the boardroom. “Directors are not a full-time board of managers, nor [do we] suggest they should be,” the report stated. “Yet directors must be on the front lines for the constructive oversight of public companies. To this end, it is worth considering how to empower part-time boards to a greater extent.”

First and foremost, the report’s authors urged boards to expand their expertise. Given a limited number of seats, they said, it is unrealistic to expect even the best-composed board to bring to bear all the expertise necessary for every situation. Therefore, boards should regularly seek the perspective of outside advisors. The authors made it clear that they do not envision a board meeting in which each director has his or her own expert advisor, nor do they advocate checking every statement made by the CEO. However, as panel member Ken Daly, president and CEO of the National Association of Corporate Directors, put it: “Directors can’t offer perspective in a void. They need the support of knowledge and perspective from qualified advisors, as required in specific situations.”

Along the same lines, boards have to start soliciting more and better information. “Boards only know what the CEO and CFO tell them. Nothing more. This is a significant problem,” said one panel member. “If one looks at all the failures of the last four years, and it is a long list, the boards were not aware of the risks the companies were taking, because no one was telling them about the risks.” Ideally, then, a board would reach out beyond the company’s senior management to a variety of external and internal sources, such as analysts’ reports, the company’s non-senior managers and, especially, shareholders. The report strongly recommended that boards make liberal use of technology such as sentiment analysis, which tracks attitudes, to continually take the share-holders’ temperature, based on proprietary documents such as email, surveys and call center logs, as well as public-domain documents such as blogs, forum posts and tweets.

Finally, the report concluded that boards need to drop the gloves and mix it up. Too many boards, said the authors, make too great an effort to achieve consensus. According to panel member Paul Washington, former chairman of the Society of Corporate Secretaries and Governance Professionals, “Poor boardroom dynamics cause most of our problems. Authority is concentrated among too few, and there is too much deference to authority.” The best boards, the report contended, will actively foment debate and dissent among themselves, as well as with company managers.

Despite the report’s disclaimer that boards cannot and should not do everything, it painted a compelling picture of an ideal board that is strategically involved and continually engaged and challenging. While several of the authors’ recommendations might be perceived as blurring the distinction between board members, the CEO and other C-suite executives, that may in fact be exactly what is needed to curb the abuses of power and ignorance of risk that can instantly sink companies and even whole financial systems in today’s hair-trigger environment. Such a model may prove to be a far better solution than regulation and standards alone, which allow for little situational adaptability.

Panel member Damon Silvers, who sits on a number of advisory and oversight committees for both the U.S. Congress and the U.S. Treasury Department, summed it up this way: “Managing corporations is complicated. Strong boards are much better at managing complexity than regulators or courts or shareholder votes are — but history shows that without regulators and courts and shareholder votes, we won’t have strong boards.”