Why Boards Need to Keep an Eye on Value Creation

It's easy for directors to lose sight of top corporate objectives in a downturn. Here's a reminder of where priorities really lie

U.S. business is in a perilous time. Some companies, especially in the financial services, auto, and retail, are fighting merely to survive and are focused primarily on preservation of capital. However, many companies in other industries are not as hard pressed. The conservative approach they have taken to managing their balance sheet puts them on the verge of significant strategic opportunities. At such companies, the role of the board is to create the right environment for a CEO to get the job done, but that entails more than cutting costs to regain wealth-producing potential. CEOs need to position their companies for recovery and building value. In helping CEOs plan, boards need to be sensitive to the recession but not fearful. In that respect, this economic meltdown is reinforcing four governance lessons.

• Companies need a compelling value-creation strategy.

Boards should not forget that creating value is what companies should be doing and is the standard against which leaders should be measured. Recently one of us visited executives from a heavy-equipment manufacturer who feel their company is better positioned now than during the last major recession. These leaders believe their company will have significant advantages when the downturn ends. The manufacturer has financial staying power that several of its competitors lack and a strategy to expand. Competitors will shrink, be absorbed, or disappear, leaving a larger market space for this company. The firm still holds to its forecast that it will double in size over the next 10 years.

While this company and its board are using the recession to advantage, many boards are not spending enough time on creative strategic considerations. Some directors are being reactive to external pressures. For example, they are examining CEO compensation in a defensive way. They are caught up in the processes of governance and searching for guideposts to navigate into the future.

It is easy for boards to be distracted by the current economy. The present downturn is, according to most economists and commentators, historic in scope and based on a global shift in savings, investment, and consumption. However, boards should be encouraging CEOs to grapple with strategic issues. Directors should be urging management to take prudent risks to achieve value creation. Eliminating all risk is inconsistent with making appropriate bets to capture value. There is always a chance the environment and bad luck will destroy the best plan, so sensitivity analyses need to be extensive. The question for a board and CEO is whether the CEO's fallback plan protects the organization's ability to survive and thrive.

• Boards should encourage management to explore opportunities this recession presents.

If a company has a strong balance sheet, the board should ask the CEO how he or she could take advantage of competitors' difficulties. Experienced directors should spend a good deal of their time working with management on the exploration of strategic acquisitions or mergers, on enhancing value to customers and strengthening human capital.

Now is a time for CEOs to shop for depressed assets among competitors who are poorly capitalized and vulnerable. It is a time for CEOs to consolidate an industry and to improve supply-demand dynamics. Most important, it is a time for courage and insight. Boards should be asking about the vulnerabilities of competitors but understand that the state of individual competitors can change quickly and other companies can enter the marketplace. Most companies won't know when a market will hit bottom, but directors can help CEOs identify prudent risks with attractive upside potential and limited downside risk. Given the "buyer's market" for assets, it may be possible to command incredibly attractive terms.

• Boards and CEOs need a positive attitude.

Directors need to be sure CEOs are doing what they say they are going to get done. Boards need to conduct continuous due diligence and improve their understanding of company operations.

They should consult outside experts and management to test their concerns. However, boards should do their homework with a positive attitude. They should project confidence in their CEOs and feel good about supporting them. An atmosphere of suspicion diminishes cooperation at a time when CEOs and directors should be working closely together. CEOs, in turn, should welcome greater involvement because the deeper directors' understanding is, the better the counsel directors can provide.

CEOs need to be pragmatic but optimistic. We talked with one CEO who was drained from the challenge of having to implement a major layoff, but he was keeping his task in perspective. He was leading his team to do the difficult and unpleasant tasks that are necessary for the greater good. He says he will get his company through the recession, and he sees his job as preserving the company's ability to create value.

There is a great deal of pressure on boards and leadership, and it will continue, but there is no reason to concede defeat. True leaders will emerge in this challenging environment at every level of the organization—including the boardroom. The impact a board member can have by demonstrating support—"walking the halls" after a meeting and keeping a level head—should not be underestimated.

• Boards need balanced judgment.

There are multiple levers boards and CEOs must consider as they evaluate the dimensions of a company's performance. While prudent management of financial resources must be top of mind, the effective board will be capable of assessing operational drivers of company performance. We find that strong boards are a blend of directors who bring both financial and operational expertise. During challenging times, there is a real premium on recruiting directors with strong operating skills who can contribute insight about what it will take to guide a company through a business cycle. These directors intuitively know how to ask the right questions and to sort through the key metrics, which will be leading indicators of a company's trajectory.

Shareholder panic and activism are soaring, especially when it comes to CEO compensation. There is a strong move now to put limits on CEO pay, some of which we consider ill-advised. It is a board's responsibility to get incentives aligned with shareholders' interests and focused on longer-term value creation. However, directors must remind themselves that compensation is one issue among many that they must address in helping a CEO lead a company back to growth. Boards need a feel for the details of how a business works and where its vulnerabilities are, but they should not let themselves be stampeded by shareholder pressure.

In a recession of this magnitude, boards need strong business judgment and leadership more than ever. However, sitting CEOs, arguably the best qualified to bring such expertise to boards, today have limited capacity or appetite to serve as directors. They sit on one board at most, and 33% have no outside directorships at all. Responsive boards have turned to recently retired but still active CEOs to fill critical board seats previously held by sitting CEOs. Other backgrounds that have helped fill the gaps include experience in areas such as operations, financial expertise, international markets, and consumer/customer knowledge.

No matter how they assemble the needed perspectives, boards need to harness their insights in a way that goes beyond navigating the business turmoil of the moment. They need to be remain focused on ensuring that companies can create value over the long term.

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