One of the most important tasks for any board of directors is to understand when it is not performing adequately and must change its membership, says Ken Daly, chief executive of the National Association of Corporate Directors, based in Washington. The NACD recently completed its annual 2007 survey of 790 directors and top executives. Edited excerpts from a conversation with him follow.
How can a board know when it is not doing its job?
That's a great question. It can be as simple as the company having a change in strategy, doing things in a different way, perhaps more virtually than before. Or maybe they're expanding international operations or going into a new industry. A committee of the board, typically the nominating committee or the governance committee, would evaluate what they think is required on the board and then reach conclusions about whether they have the right skills mix. Our thinking is that to be effective, especially in the post-Sarbanes-Oxley environment, boards need the right people who look at the right issues with the right information.
But chief executive officers, who arguably have the best understanding of where the business is going and what skills need to be represented on the board, have been largely marginalized in shaping their boards, haven't they?
The CEO certainly has a role, and an important one. But I'm not sure there would be unanimous agreement that the CEO needs to drive this particular process. In fact, highly effective boards are looking to their nominating and governance committees to take the leadership role in making these decisions.
In the past, it seems that CEOs and boards looked for new members who were distinguished and had a few gray hairs, but do you think that today there's a greater emphasis on recruiting directors who actually have skills?
You put your finger right on the issue. The way to ensure that the board is in the best position to help develop shareholder and other constituency value is to seek the right skill set to make that happen. For example, information technology (IT) is going to become even more important, but there is a huge dichotomy in that the great majority of boards do not really have anyone who has the skill set to help oversee the risks associated with IT. The folks with gray hair often don't have that technology background, which is one reason why board members are getting younger.
How exactly are boards making up their minds on the issue of their own performance?
Our recent poll showed that the average tenure of a director was 7.6 years. That's down from the survey results from the previous year and way down from the results of five years ago. For a variety of reasons, boards are becoming more evaluative in their processes. One of the interesting data points is that 85% of boards are doing board evaluations. I'd be willing to bet that number was a lot smaller a few years ago. And 46% of them are doing evaluations of individual directors. That's a massive change. Boards today are evaluating whether the right skill sets are there.
Which are more effective: self-evaluations or third-party evaluations?
Only about 4% of the board evaluations are being done by consultants. Typically, they are self-evaluations, which is what a third of our correspondents do, or peer evaluations, which is another third. People tell me that peer evaluations are the toughest.
An outsider can be helpful, but if you have an outsider whose primary purpose is to generate additional business, maybe that's not as good as someone who isn't. With that caveat, the outsiders are bringing a different perspective. They don't have a lot of luggage or personality quirks.
However, if a consultant reaches the conclusion that Director A is not doing a good job, usually it's not the consultant who's going to have to deliver that message. It's the lead director. The tough love conversation still has to occur. So some boards are a little concerned about losing control of the process.
What goes wrong on a board as we saw famously at Hewlett-Packard (HPQ) or more recently at Sprint-Nextel (S), where Chief Executive Officer Gary Forsee quit without the board having named a successor?
I can't comment specifically on either case, but there is often an issue of collegiality that can go too far. The culture is too collegial. On the other side, and this may have happened at HP, there are people on the board who decide they want to be lone wolves and do things that are not very helpful. The root cause of a dysfunctional board is that they are not united on their conclusions about matters. A faction goes out and does something that is not smart. Things get leaked. That's what causes the angst.
Don't board members hash out the business strategy and reach agreement on that?
That is a lightning rod we hear about. The No. 1 thing boards have to get better at is the company's strategy, and understanding what risks emanate from that strategy. Sometimes boards have difficulty articulating precisely what the company's strategy is. McKinsey did a study not that long ago and came to the conclusion that only 12% of the directors they interviewed understood their companies' strategies. That's a curious number. How can a board do its job if it doesn't know what the risks are and who is responsible for the risks?