Are Corporate Boards Effective?Tuesday, February 17th, 2015
At its core, the purpose of a company’s board is to provide strong oversight and strategic support for management’s efforts to create long-term value. The board’s effectiveness in this role is a crucial part of a firm’s long-term success. Unfortunately, many boards are failing to serve their desired function, resulting in an overemphasis on short- rather than long-term performance.
BWFA is not unique in holding this view. In 2013, only 34% of the 772 directors surveyed by McKinsey & Company (a global management consulting firm that serves leading businesses, governments, non-governmental organizations, and not-for-profits) indicated that their board fully understood the company’s strategies. In 2014, McKinsey asked 604 C-suite executives who – in their opinion – were responsible for their company’s overemphasis on short-term financial results. Of the respondents, 47% identified the company’s board of directors as the source of the problem. An even higher percentage (74%) of the 47 respondents who identified themselves as sitting directors on public company boards pointed the finger in their own direction.
What can be done to improve board quality, strengthen boards’ knowledge and increase the emphasis on the long term? To start, everyone should have a clear understanding of what a director’s “fiduciary duty” really is. From a legal perspective, the two key elements are loyalty (the company’s interests come before the individual’s) and prudence (applying proper care, skill and diligence to business decisions). In no way do these factors give rise to the idea that a loyal and prudent director has to pressure management to maximize short-term value to the exclusion of any other interest. A more logical interpretation of a director’s responsibility is that he or she should help the company thrive for years into the future.
By keeping their fiduciary duty in mind, directors should spend less time talking about next quarter’s earnings expectations and avoiding lawsuits and more time discussing potential new products, services, markets and business models. This should increase the potential to capture value-creation opportunities with high upside.
There are four primary areas that need to change in order for boards to improve:
- Select the right people. Board members should be independent thinkers with industry-specific experience.
- Devote meaningful time to corporate strategy. Board members should put in more time and dedicate themselves to understanding and shaping strategy.
- Engage more with long-term investors. Much of the pressure placed on companies to deliver short-term performance comes from financial markets. Boards can take a more active role in engaging with long-term shareholders.
- Increase director pay. Directors should sit on fewer boards and be paid more to do so. Their compensation should also be structured in a way that favors longer-term rewards and puts a greater portion of their net worth on the table.
At BWFA, we believe corporate governance is important. We primarily use Institutional Shareholder Services (ISS) to vote shareholder proxies on behalf of, and in the best interest of, BWFA’s clients. When analyzing companies for investment, we also pay attention to the composition of a company’s board and the experience and other activities of its members.