The Independents’ Challenge

Irving Olds, who was chairman of US Steel Inc in the 1940s, noted that non-executive or ‘independent’ directors of corporations were “like the parsley on fish – decorous but not useful”, notes David Beatty in a conversation with IEDP.

Beatty is a world authority on Boards and the governance of public corporations and currently holds the Conway Chair at the Clarkson Centre for Board Effectiveness at the Rotman School of Management, University of Toronto where he also leads the Directors’ Education Program which has graduated over 6,000 prominent Canadians since its founding in 2004.

Bringing value to an independent director’s role is really hard, stresses Beatty, but something that is increasingly important for corporations to ensure that their Board is adding value to the company. Most boards do well at their ‘policing’ and compliance roles but not so well in the value adding role. He highlights some critical points that need to be actioned to create such value.

The challenge can be illustrated by a picture of ‘The Grand Canyon’.  There is a 26-mile gap between one side and the other. On one side is the top management team – investing perhaps 3,000 hours a year in their work; often with a lifetime of experience in their industry and usually with a single-minded focus on the company. On the other side, 26 miles distant, is the board. Independent directors of large, publicly traded companies spend perhaps 250 hours a year on their duties. That’s only 8% of the hours invested by the management team. Most often the independent directors are accomplished businessmen with enviable track records of proven achievement. But in most cases, they are completely unfamiliar with the industry the company competes within. They are ‘gifted amateurs’. Finally, independent directors normally have a significant portfolio of other interests in their lives. This portfolio might include other boards, their own money, the Swiss ski holiday, the Caribbean yachting expedition… they do not have a single minded and dedicated focus on the company on whose board they sit.

These challenges create a large opportunity for the management team to lead the Board, rather than the other way around, says Beatty.

Beatty sees that this gap is essentially unbridgeable, so the Board side needs to arm itself with external knowledge to bring value to the management team. The Board has multiple advantages over the management team in being able to see the wood for the trees, not being bogged-down in the daily fire-fight of management team. They should lever this advantage to scan the horizon for alternative viewpoints and opinions. Beatty advocates Board directors to engage with three particular sources to gain this knowledge from:

1/ Current shareholders. Traditionally corporations’ ‘Investor Relations’ teams and the senior management have been the main interface with key shareholders (principally the institutional investors in the corporation). Beatty encourages independent Board directors to take part in these meetings, often without any management present.

This is a policy also being encouraged by the bosses of the world’s largest fund managers – the heads of both Blackrock and Vanguard groups have advocated Boards do this. Andy Bryant, the independent chair of Intel Group meets with four of the largest stockholders in Intel each quarter.

2/ Off-site strategy meetings are now regular fixtures on the calendar for all senior management and Boards. The agenda and presentations are most likely to be arranged and made by the senior management to the Board, with little Board input. Beatty recommends that Board directors seek third party opinions on any significant or contentious proposals or papers that management is proposing.

External experts who really understand the sector that can be brought in to help explore and stress-test new management ideas are going to be much more robust and reveal any potential flaws, than the Board can alone. This process need not be an antagonistic one, but positioned as supporting the new initiative to further improve it, while retaining the option to discard it if it unravels under closer examination.

3/ Activist investors. Beatty’s third source of external expertise is the most radical – and is to invite the lion into the den. All public corporations today exist under the potential threat of attack from activist investors. Beatty has identified over 500 activist firms that are permanently analysing potential targets – while predominantly located in the US, they are spreading around the globe and can mobilize trillions of dollars in funding very quickly.

Activist investors will often have spent many millions of their own money analysing potential target companies and will then share their insights with current passive institutional investors to try and persuade them a different strategy would be more profitable. These perspectives and analyses should be invaluable to Board directors, allowing them to look at their strategy through an alternate prism to the one that the executive team presents, and he encourages Directors to speak with activists to get their perspectives early.

Beatty notes that the CFO, who will not have any direct capital responsibility unlike other senior executives, should be relatively dispassionate about capital allocation and is therefore a key ally and link between the executive team and the independent Board to explore the activists thinking with afterwards.

The relationship between Board and executives should not be a cosy one; the Board is there to probe and challenge the executive’s thinking for the long-term benefit of the business. Beatty acknowledges that these three interventions may make the management team uncomfortable, but handled well they should also make for a much stronger strategy process.