Restructure and reignite the spark in your company with ‘Rethinc’

Blog post - 2-1

We come back to the question we posed earlier: How do we make boards more effective? We need a serious RETHINC here. Merely compiling a checklist of dos and don’ts for boards won’t suffice. We must change the way boards are constituted. We need far greater diversity in the boardroom than we have today. How do we go about ushering in these changes?

To begin with, we must abandon the pretence that directors chosen by management or the owner can act independently of them. We can have truly independent directors only when directors are selected independently of management or the promoter. In other words, we need diversity in the selection of directors. This can happen only if the stakeholders in the company, other than management or the promoter, have a say in the selection process.

These other stakeholders—institutional shareholders, retail shareholders, lenders with large exposures to a company and employees—must all be given a say in the selection of independent directors. We must introduce what’s called ‘proportional representation’ whereby all shareholders can nominate directors in proportion to their shareholding in a company. There should be a separate provision for large creditors (with exposures over a prescribed minimum) and employees.

None of this is as novel as it sounds. In Sweden, large shareholders are part of the nomination committee for listed companies. In Germany, workers sit on the supervisory board of companies. (Germany has a two-tier board system, a supervisory board and a management board.) In India, lenders sometimes include a covenant that gives them the right to appoint directors to the board. In Indian public sector banks, officers and staff both have one representative each on the board.

Independent directors needn’t be employees of any of the other stakeholders. Management may not like institutional or retail investors, lenders or workers to get to know some of its decisions before the rest of the world gets to know these. It’s better that these stakeholders choose persons from outside their own groups to represent them on the board. We need people of stature and competence in the board. Let all stakeholders—not just management or the dominant owner—select such people.

Once we have at least a few directors who are chosen independently of management or the dominant owner, we can expect to see instances of genuine independence in the functioning of boards. When the director doesn’t owe his selection, re-election or fee to management or the dominant owner, he’s well placed to act in the interests of the larger body of shareholders. These independent directors would be answerable for their performance on the board to their particular stakeholders, whether employees, institutional investors, lenders or retail investors. Allowing stakeholders other than the dominant shareholder or management to select directors will bring about not just greater independence in board members but greater accountability as well.

Involving multiple stakeholders in board selection will also force companies to step out of the narrow pool from which directors are now chosen. It will create genuine diversity in the boardroom. Diversity’s not just about gender or having more women on the board, although that’s certainly necessary and useful. It’s about having people from different walks of life and different strata of society contributing to decisions. We have seen in Chapter 3 that diversity of views improves managerial decision-making. The same goes for boards as well.

I can see hackles rising in the corporate world. CEOs and owners will argue that if they don’t have control over who sits on the board, the board won’t be able to function ‘harmoniously’.

The short answer is that there’s too much sweetness and harmony in the boardroom today, too much back-slapping and bonhomie. We could do with injecting a healthy dose of disharmony into the proceedings. We need people who will actively challenge management proposals. We need directors to tell the CEO it’s time to pack up and leave. We could use much tighter scrutiny of executive pay and compliance.

Robert Pozen, senior lecturer at Harvard Business School, makes out a case for building a specialist cadre of ‘professional’ directors. Pozen argues that today boards are too large (the average number of directors on the American board in 2009 was eleven), that directors sit on too many boards and often do not have domain expertise. He wants boards that are smaller (say, seven directors), and have adequate domain expertise. He suggests that board membership be viewed as a primary, not ancillary, vocation.

Pozen suggests that professional directors would ideally not serve on more than two boards. They would spend at least two days a month at the company, apart from board meetings. Since they would be expected to work a lot harder, they would be paid better. Most of the pay would be in the form of longterm stock options. Since this sort of time commitment would be beyond working professionals, the choice of professional directors would be restricted to retired persons. Pozen thinks this pool is large enough to meet the requirements of companies.Regulators could make professional directors mandatory for banks. Institutional shareholders should push for professional directors in other companies.

There are obvious flaws in Pozen’s proposal. Spending an additional two days at a company may not make a big difference to a director’s contribution. Domain expertise is useful, but it’s hard to match the firm-specific expertise that management possesses or the superior information that management has. A director may have expertise in the fast-moving consumer goods sector, but that doesn’t mean he would be deeply knowledgeable about the specific suite of products that a company has for, say,soaps, detergents and beauty products.

There’s a bigger problem with Pozen’s proposal: it rests on several notions about the board. Being on a board requires abilities that are not commonly found. Board membership calls for high-quality managerial experience, wisdom and maturity of the sort that only those in the corporate stratosphere possess. A great board is one that’s packed with people of ‘eminence’.

Somebody needs to scream from the rooftops: Every one of these notions is a myth. It’s certainly useful to have people with knowledge of a sector or functional expertise (finance, marketing, production, etc.) on the board. But effectiveness on the board has less to do with expertise than with asking basic questions. Why are we losing market share? Why has the budget not been met? Which divisions have fallen behind and why? Are succession plans in place at all levels? Why has the attrition rate amongst employees gone up? Why is the CEO spending so much time out of the home base?

Asking these questions, indicating that one’s not satisfied with the answers and demanding accountability doesn’t require great expertise. It requires commitment and a willingness to rock the boat. These are, of course, qualities that are rare anywhere. But we’re most unlikely to find them on boards where directors owe their seats to management or the promoter. When we have a truly diversified board—with various stakeholders bringing in directors with differing backgrounds and strengths—there’s a better chance of seeing commitment and active dissent.


Get the ‘Rethinc’ by T.T. Ram Mohan here:


The Penguin India Blog

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