In the Classroom II
A Call for Courage: Governing the Board in Troubled Times
The collapse of some of the oldest and most respected U.S. financial companies has given directors around the world pause for thought. “Systemic risk in the case of financial services is far more powerful or significant than we had appreciated,” says Professor Michael Useem, who is on the faculty of Corporate Governance: Fresh Insights and Best Practices for Directors. "In protecting the interests of shareholders, boards have their work cut out for them. Governance and leadership have never been more important. Assets are larger, so the consequences of failure are much greater. There are risks from globalization and intensifying competition. All these factors are putting a premium on good governance."
With such dramatic changes, even experienced board members need fresh insights. "The role, duties, and best practices of boards of directors are evolving and changing every year," says Thomas P. Gerrity, professor of management and academic director of the program. Originally created for new directors, the program has been redesigned due to growing interest from experienced board members. "With new external issues and internal changes, it is healthy to always think of yourself as a new director," Gerrity says. "Serving on a board continues to be just as personally rewarding as an important service and trust, but the job to be done is ever more complex and changing at a faster rate."
Governance and leadership have never been more important. Assets are larger, so the consequences of failure are much greater. There are risks from globalization and intensifying competition. All these factors are putting a premium on good governance.
–Michael Useem, The William and Jacalyn Egan Professor; Professor of Management; Faculty member, Corporate Governance: Fresh Insights and Best Practices for Directors
An Enormous Trust
In looking at recent corporate failures, many board members are considering how they may need to change their own behavior. "This makes a lot of board members nervous," says Julie Daum, practice leader for the North American Board Services Practice for Spencer Stuart, who worked with Wharton to develop the program. "They’ve all abided by Sarbanes-Oxley. The board members of these companies were very smart; they deserved to be there. Directors are now concerned about trying to be as good as they can be, to learn from other directors and leading governance experts. to keep themselves current and improving."
Useem says that in reviewing the actions of the Enron board before the company’s collapse, the directors could have made a difference. "The record is unequivocal; the board had ample opportunity to force management to do what management should have done," he says. In contrast, the board of Boeing played a very effective and critical role in the development of its 787 aircraft and in its change of two CEOs. "Directors need to be preemptive without micromanaging. They need to be proactive and take steps to intervene when things are not going the right way."
This proactive stance requires courage. "The major thing that has become obvious is that directors need courage and they need to ask tough questions,” says Daum. “The best directors have good judgment. They can get right to the salient points and are strategic."
The director’s role is crucial to success. "Directors have a calling, a sworn obligation," Useem says. "When they take a board seat, an enormous amount of trust is placed in their hands. In some cases, that trust did not get fulfilled, and small stockholders' lifelong earnings were sent up in smoke. Whether you are a veteran director or coming on for the first time, being vigilant and savvy about your role as director could not be more important."
New Challenges: Compensation and Risk Management
The changing economic environment has imposed multiple new demands on directors. Among the areas that have become more important are compensation and risk management. "The work of the compensation committee is much more carefully scrutinized," Gerrity says. "Committees are digging deeper and working hard to pay for effective performance without inordinate risk, in order to serve the interests of the company and the shareholders, and still attract and hold the best people for the firm."
Enterprise risk management has also taken more center stage for the board. "A few years ago, the focus was more upon financial risk, but now more attention is being given to all sorts of risks, including reputation and operations — from extreme weather to terrorist acts," Gerrity says. "The current financial and economic crisis further underlines the need to assess external and broadly systemic financial risks." he adds. Directors also need to understand the implications of the move to new global accounting standards and anticipate new regulations that will be passed as a result of Washington's response to the world financial crisis.
"You can't anticipate every '1,000-year storm,' but ensuring that management is thinking through broad options helps position you to do the right thing," Gerrity says. "One thing this financial crisis taught us is to examine multiple scenarios going forward and to shock test our response plans and strategies with true crisis events."
Research-Based Knowledge
In this environment, research-based knowledge is particularly valuable. Studies show, for example, that board size affects performance. The ideal size is "like a breadbox — not too big or too small," Useem says. Boards should be roughly 9 to 12 members, dominated by independent, non-executive directors. They should be "smart and savvy, and knowledgeable about the industry as well as how to run a company," Useem advises.
But some conventional wisdom about boards is not supported by research. Separation of the chairman and CEO positions does not seem to make much difference in performance, at least in the short run. "There is an enormous amount of conventional wisdom, in magazines and conferences, and much of it is extremely helpful. But a certain amount of conventional wisdom is not backed up by research," Useem says. "Our program is evidence-based."
In addition to research, the program draws upon the knowledge of experienced directors and other experts. "We glue together an academic understanding with practical engagement," Useem says.
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