Savvy directors are the fulcrum on which companies balance tensions between shareholders, who own the company, and management, who operate the company. “Good” governance requires well-constructed processes to facilitate good decision-making. While there are many aspects to good governance, three matters regularly hit the board’s agenda: the CEO and the board, strategy, and crisis management.
Sometimes, shareholder derivative actions are used to try to effect governance changes. These approaches are not common in private companies and are certainly more common in public companies. Nevertheless, some of the lessons from those cases are instructive: the board has control of the company as fiduciaries of the shareholders and is responsible to the shareholders to provide oversight of the CEO and the company as a whole. To quote Harry S. Truman: “The buck stops here.”
Companies need to engage with their investors, and this is of course a bigger concern for public companies. But small companies can still engage with investors. Boards and CEOs can and should meet with investors or regularly communicate with them. Remember that Reg FD applies to public companies, and Rule 10b-5 applies to all communications (and non-communications) from the company to investors just the same as it does to traditional public filings.
CEOs and the Board
Many people have described the job of the board to hire the CEO, decide strategy, and supervise the performance of the CEO in executing the company’s strategy.
A CEO usually serves on the board by custom, and in many companies the CEO is also the chair of the board (even though that title seldom has any legal significance). While some commentators have pushed to separate these roles, there is no substantial legal reason to do so – only custom and a lack of understanding of fiduciary duty leads directors to defer to a chair in the absence of actual authority.
While the board ultimately approves a strategy on behalf of the shareholders, it is the CEO’s duty, and privilege, to propose a strategy to the board. As I’ve told multiple CEO clients: “Just because the board votes doesn’t mean you lose your voice and can abdicate your responsibility. You’ve got the conch.”
In hiring the CEO, it’s also necessary to establish an appropriate compensation mechanism. Equity compensation for the CEO is often the starting point, with the goal of aligning the CEO’s incentives with the shareholders. The metrics for CEO compensation – because the essence of equity compensation is pay for performance – are complex. Boards have to be sure to establish sufficiently long-term metrics. It’s preferable to start that way, but when boards create clawback mechanisms, they often fail to follow through (unless the SEC “forces” them). Fine-tuning incentives is hard because *incentives work.* Misunderstandings about equity compensation confuse many people: stock buybacks don’t trigger bonuses and options aren’t free to anyone.
Supervising the CEO’s execution of the strategy can be complicated, if you’re doing it right. Not only does the board need to decide, or at least approve the strategy, but the board also needs to understand and again, decide or approve, the way that it will measure achievement — how and when.
Strategy is the other significant component of the board’s role in a typical company. The board must understand the company, its business model, its markets, and its competitors well enough to evaluate strategies, choose one, and monitor the company’s progress along the chosen path.
In selecting a strategy, the board must consider the risks it is accepting – in other words, what does the board assume will be true to make the chosen strategy successful? One method that boards use to help them avoid too many assumptions is scenario planning.
What I’ve found across all my experience is that too often, management will propose strategies, and the board will discuss and debate them – and even approve them – but nothing happens. The strategy is never elevated from “this is a good idea we could follow” to “this is the plan we’re going to execute and make happen.” Too often, the governance structure doesn’t push for a plan, the road that leads the company from goals to outcomes.
The board oversees the company’s performance on a regular and periodic basis (at least annually, often quarterly, and preferably monthly meetings). But occasionally, circumstances demand additional attention from the board: a traditional crisis in the business (e.g., product liability problem, major lawsuit, or natural disaster). In those situations, the board has the responsibility of approving the CEO’s response and ensuring that they take a long-term view regarding preserving shareholder value. Hiring and firing senior executives is another common problem period.
The other kind of crisis is the kind that is an opportunity: a UFO (an “unsolicited flattering offer” to buy the company) or a chance to buy a new company. Strategic financial transactions (M&A, raising equity, or raising debt) all have substantial risks to the company, and boards need to oversee these transactions so that the company can actually achieve the potential gains these kinds of transactions promise.