By Marsh & McLennan Companies
Corporate boards are dynamic social systems. While each board is unique, there are similar challenges that boards face as a natural consequence of being teams, composed of individuals charged with doing important work in a very specific legal, economic, and social context. Effective boards, similar to effective teams, need to be built and maintained over time. In our work with boards, we have found that board effectiveness is shaped by a number of key factors including:
• Clarity of the role of the board—the work it needs to perform and how it adds value.
• Backgrounds of the individual directors (their knowledge, experience, skills, and diverse perspectives), and their ability to work effectively with others.
• Content of the board’s agenda, driven by the potential value added of the board.
• Quality of the information the board receives about the company.
• Dynamics that develop among directors as they work together as a whole, with other directors separately, and with members of management.
• Leadership that enables and supports all of the above.
None of these elements is static. Effective boards are always assessing themselves and engaged in what we call “board building”—working on the factors that drive board effectiveness.
1. The board’s role in strategy. Surveys continue to indicate that directors consider engagement with management around corporate strategy as one of the most valuable elements of their role. Yet directors repeatedly report that they are not satisfied with how that process occurs today. Boards and management need to design ways to effectively engage directors in the development of strategic direction and key strategic decision-making in a way that adds to, but does not interfere with, the role of management. This is critical to the core questions: What is the role of the board, what is the role of management, and how does the board add value? In our view, strategic work at the board level needs to move beyond the “concurrence” model, where management proposes a strategy and the board is simply left with a choice of concurring with or rejecting the proposal.
2. Understanding the drivers of the business. In our observations, boards frequently do not understand the drivers of the business—the core causal factors that drive profitable growth, create competitive advantage and can result in unexpected volatility in earnings. Without that understanding, it becomes difficult (if not impossible) for a board to engage on strategy and to understand key risks that must be managed for the business to succeed. Critical to the understanding and knowledge of the business is a steady stream of useful information. Ultimately, it requires forward-looking (vs. backward-looking) information that helps the board to understand performance patterns and trends. Too often, boards are inundated with data about what the performance of the company has been. Not often enough are boards given information that can provide insight into the trajectory of the enterprise.
3. Enterprise risk management. More than a decade after the concept of risk-return management became popular with the rise of enterprise risk management, or ERM, few companies include risk management in their financial and strategic decision-making. Yet, most of the critical variables that companies consider in their strategic planning process have become more unpredictable. As outlined in the yearly report of the World Economic
Forum—the Global Risks Report—in which Marsh & McLennan Companies participates, the pace and scale of events introducing uncertainty into corporate earnings is increasing. Far too often, however, a firm’s underlying risk management process has little connection to the firm’s strategic or financial management. Risk management needs to be integrated into the strategic thinking of the company supported by a top-down, strategic examination addressing the drivers and core material risks of the organization. This approach enables management to examine the impact of different scenarios involving multiple risks on financial statements easily, quickly and accurately, and to keep the board informed of how critical emerging events, such as the recent Greece crisis and associated effects on the European economy could affect the company’s financials. The NACD Blue Ribbon Commission Report on Risk Governance, published several years ago, provides a useful blueprint for effective engagement of the board in understanding risk and ensuring the effective management of risk.
4. Board succession. While management succession continues to be an evergreen challenge, there is another succession issue that many boards face. With the extension of age limits, many boards are aging. In the short term, this is mostly positive—boards have been able to benefit from the wisdom and perspective of experienced people. However, we see a bit of a demographic time bomb ahead as boards will need to replace and replenish their ranks with talent over the coming years. Given the evolving role of boards and the complexity of the problems that companies face today, thought needs to be given to the type of director that is needed. Clearly, diversity is critical— gender, racial ethnic, and geographic. But there is also a need for a diversity of skill sets and experiences. Planning for director succession needs to become more strategic.
5. Board leadership succession. A related but separate issue is how boards plan for the succession of their own leadership. The age of independent board leadership has arrived, whether in the form of independent non- executive chairmen or lead directors. These roles are very real and very critical. How the independent leader of the board fulfills his/her role, relates to fellow directors, and shapes the relationship with management can all have a tremendous impact on the functioning and effectiveness of a board. Given how critical the role is, boards can no longer just hope that an effective leader will emerge once the current leader retires or leaves the role. Boards will need to understand the requirements for independent board leadership. Based on those requirements, recruitment and succession planning will be needed to ensure that the right candidates are available and being developed.
6. Surfacing and managing conflict. As social systems and teams, the dynamics of boards are as important as the mechanics, and perhaps more so. A recurring problem for boards is related to raising and resolving conflicts. Many boards have not created a culture, an environment, and a process for surfacing disagreements. When disagreements do arise (whether they be around strategic issues, quality of management, or how directors work together) boards do not have the processes in place to constructively work through and resolve conflicts. Issues frequently simmer beneath the surface and either never get raised or boil up to the point of a painful and destructive conflict. Board leaders, senior management, and individual directors need to become more comfortable with raising issues and working them through in a constructive manner.
Building Boards That Are Prepared for the Future
The underlying theme of our list of issues is board preparedness. The future is, by definition, uncertain, and increasingly more so. Boards need to prepare to face that future by having the right agenda, the right people, the right processes, and the right leadership to deal with what may come down the road. Good leadership underlies the obligation that boards have to their long-term shareholders and other stakeholders of the corporation.