Board thoughtfulness, not just behaviour, in demand

What makes a board effective? There are dozens of books about it, hundreds of academic studies. There are laws, too: In America, Dodd-Frank has followed Sarbanes-Oxley down the route of specifying actions. In the European Union, the commission is gathering information through a green paper consultation aimed at deciding whether to create law. Much attention is being paid around the world to the issue of gender quotas, an idea made tantalisingly real through legislation in Norway, now being copied in other countries. There are codes of practice, too: In the UK the various iterations of the code of corporate governance have sought, among other things, to define what makes a good board. In 2003, the Higgs Review set out to give guidance on the effectiveness of non-executive directors. Its findings were incorporated, at least in part, into the Combined Code and then revised in 2006. With the drafting of a new UK Corporate Governance Code last year came a desire to revisit the Higgs guidance, updating it for changed perceptions. Where its emphasis seems to lie – as with the emphasis in the new code, is on thoughtfulness – an elusive commodity, one that will defy attempts of the governance industry from setting standards and calculating performance.

The new guidance was published with relatively little fanfare in mid-March. The Financial Reporting Council, the accountancy watchdog that oversees the governance code, published the report following research conducted by the Institute of Chartered Secretaries and Administrators. Baroness Hogg, the FRC chairman and a long-standing corporate director, introduced the guidance with these words:

Boards need to think deeply about the way in which they carry out their role and the behaviours that they display, not just about the structures and processes that they put in place. This change of emphasis is reflected in the most recent edition of the UK Corporate Governance Code, published in 2010, and also in this guidance. For example, boards are encouraged to consider how the way in which decisions are taken might affect the quality of those decisions, and the factors to be taken into account when constructing the board and reviewing its performance. The FRC hopes that this guidance will assist in those considerations.
But what does thoughtfulness entail? The guidance document suggests: "An effective board should not necessarily be a comfortable place. Challenge, as well as teamwork, is an essential feature. Diversity in board composition is an important driver of a board's effectiveness, creating a breadth of perspective among directors, and breaking down a tendency towards 'group think'," which is, of course, an example of not thinking. The actions and purposes of an effective board involve:

• Direction: Providing direction for management, that is.
  
• Leadership: Demonstrating ethical leadership, displaying – and promoting throughout the company – "behaviours consistent with the culture and values it has defined for the organisation". So behaviour matters.
  
• Performance: Creating a performance culture that "drives value creation without exposing the company to excessive risk of value destruction".
  
• Decision: Making "well-informed and high-quality decisions based on a clear line of sight into the business". Here it looks as though management-speak got the better of the authors. Whatever does that mean?
  
• Complying: Creating the right framework for "helping directors meet their statutory duties".
  
• Accountability: Particularly "to those that provide the company's capital"; and reading between the lines not exclusively to them.
  
• Thoughtfulness: Thinking "carefully about its governance arrangements and embraces evaluation of their effectiveness".

Independence of mind is an elusive quality that arises from thoughtfulness. It's what the framers of the code in its various iterations have sought, in different terms, over the past 20 years. This guidance illustrates the point in describing the role of the "senior independent director": In "normal times" the incumbent in this defined role becomes a "sounding board for the chairman", providing support and taking on roles the chairman couldn't without a conflict of interest, such as recruiting the chairman's successor. But when times are stressful, SIDs, as they are colloquially known, need to change their spots. The guidance puts it this way: "When the board is undergoing a period of stress, however, the senior independent director’s role becomes critically important. He or she is expected to work with the chairman and other directors, and/or shareholders, to resolve significant issues. Boards should ensure they have a clear understanding of when the senior independent director might intervene in order to maintain board and company stability." It then goes on to list a variety of such circumstances, including when the path followed by the chairman and CEO ignores the concerns of shareholders or other non-executives.

Thoughtfulness shows up, therefore, in the ability to change direction and even change roles. It shows up in not slavishly following the group direction, but not needlessly falling out with the group, either. Thoughtfulness in the boardroom should be easy to detect. From the outside, you will know it when you see it, by which point it may be too late. If board effectiveness is characterised by thoughtfulness, then investors will need to trust directors, though not blindly. Investment is, after all, a statement of trust.

Source document: The FRC report "Guidance for Board Effectiveness" is an 18-page pdf file.