Questioning boardroom practices

When things go wrong in the boardroom, everyone wants to know what happened and why. Jonar Nader believes the answer is that independent directors haven’t asked enough infuriating questions.

He poses some questions, and seeks the views of four leading company directors. As a digital-age philosopher my job is to ask questions but, as a journalist, my job is to question the answers. By their very nature these two tasks can tend to infuriate those who would rather leave things as they are. It is also the task of non-executive directors (NEDs) on boards to ask the right questions and question the answers provided by management as to the state of affairs of their company. Unfortunately, the fear of infuriating the chairman or challenging boardroom solidarity shackles true independence. But leaving things as they are is not an option in a world where change is the only constant. Understandably, those on the gravy train frown upon anyone who pulls the emergency cord. When forced off the train and made to observe the world from ground-level, they soon declare that "the world has changed". In fact, nothing has changed. It's just that they have woken up to the reality from which they had cocooned themselves. Brought face-to-face with the truth, they are shocked at the contrast.

This applies equally to events in the boardrooms of companies such as HIH and One.Tel as it does to those who believe that the events of September 11 "changed the world". The same naivety continues to afflict on-lookers of the corporate jungle. All of a sudden, they are concerned about share options, executive bonuses, corporate governance, personal liability, the triple bottom line, corporate social responsibility, and, of all things, ethics. Who is there to question the CEO's obsession with the share price or whether indeed we need a stock market at all? What about shareholders? Do they not owe a duty of care to the company they have invested in? What about the very nature of boards? We spend a great deal of time pondering the role of boards but we never question the need for their existence, in the first instance. Many years ago, on broadcasts around the world, I said that "executives who daily monitor their company's stock-price, ought to be sacked on the spot. Their job is not to monitor the stock price, but to deliver on promises made to the customer." Much merriment ensued.

In March 2000 Australian Stock Exchange MD, Richard Humphry wrote to me saying he concurs that "a CEO should focus on the management of the business and not be distracted by the share price." He also said, "It is important that management pursues strategic and tactical objectives without necessarily being reactive to short-term movement in share prices." The issue of passive investors is also interesting. Yes, we need investors, but not if they are going to stand on the sidelines, able to withdraw as fast as a telephone call to the stockbroker will allow. Investors cannot call themselves shareholders if they do not understand the companies in which they are investing. They have no right to command attention if all that they are interested in is how to double their cash before the market crash. What right do investors have to say that senior executives ought to have long-term perspectives about corporate wealth creation, when they, as investors, chop and change their loyalty at the stroke of a pen? In my book, no investor can be taken seriously if they don't also invest time and energy into the company in which they put their money. If all they want is some sterile money-making machine into which they can plough their funds, then they do not understand the principles of ethical wealth creation, and I'd guess that they do not understand the essence of ethics – let alone the meaning of long-term business strategy.

How is it that investors can inject funds at arm's length, without any commitment whatsoever, yet expect directors to risk everything they have (including their freedom) should something not go according to plan? The complexity and burdens placed upon directors are so arduous that it is becoming rare to find directors brave enough, or foolish enough, to risk their family home for the sake of distant and ungrateful shareholders. The role of a good philosopher is to ask the right questions. The role of good students is to empty their mind, erase their strategies, discard their recipes, and start again. If they arrive at the same conclusion, or draft a new way, so be it. This is just like hitting the "reset" button. They need to flush the system regularly, or burden themselves with baggage in the guise of customs and traditions. Why do we expect directors to be personally liable? Why don't we expect shareholders to take responsibility? Historically, shareholders were immune because it was the only way to encourage them to inject much-needed capital.

That was a good reason back then. However, those who agreed with George W. Bush when he said: "Anyone who finances terrorists is also a terrorist", should think again about the similarity between that and the notion that anyone who finances corporate criminals is also a corporate criminal. What's the difference? Nations who financed terrorists did not necessarily know what they were doing. They financed people who promised to liberate their neighbourhoods. They supported community leaders who promised to structure a better life for the downtrodden. They were out to "do good". The financiers never approved the plans for terrorism, yet they are held accountable because they have a duty to know that money morphs into weapons. Similarly, corporate investors ought to know that money morphs into power, and power morphs into greed, and greed can easily become fraud. In any case, I do not believe that the penalties go far enough (regardless of who is responsible). If it were up to me to change the law, my wish-list would include the abolition of the notion of "voluntary liquidation".

I would remove tax rebates or tax exemptions for organisations, especially those whose CEO earns more than half a million dollars a year (in total). I would outlaw the notion of 30-day credit terms because monies should be paid the instant that they are due, thereby reducing bad-debts that afflict poor unsuspecting suppliers. I would not allow troubled organisations to be salvaged, because paying 10c in the dollar to creditors is the epitome of highway robbery and gives a savvy investor a clean slate and a cheap operation built on innocent blood. For US organisations that continue to trade while in Chapter 11, that too would be forbidden. Isolating creditors is the personification of unethical conduct. The most recent questions being asked relate to share option schemes. Ponder these: Is greed something new that we never knew about? Is fraud something new that we never thought about? Is malpractice so unusual that it did not cross our mind? Is creative accounting so innovative that we did not think about it? Was bankruptcy unheard of? Was the notion of collapse foreign to us? Well then, what's all the fuss about? Why is everyone so surprised? Why are the commentators and politicians now saying that they had no idea?

Sydney Morning Herald economic editor, Ross Gittins, had this to say about aligning company managers' interests with those of their shareholders by issuing them with share options: "What a disastrous (economists') brainwave that turned out to be." Why is it that commentators speak with hindsight? We need experts to advise us about the status quo. We need good advice now. It is all too easy to look back and write eloquently about magnificent corporate theatrics. Who has the courage to speak out? Commentators who do are singled out as loonies out of touch with the market. Insiders who speak up are discredited in ways that would make Shakespeare proud. Among the hundreds of people who were close to the disgraced corporations and their advisers, where were the whistle blowers? When Time asked consumer advocate Ralph Nader why we did not know about it sooner, he said, "What amazes me is that there are thousands of people who could have been whistle-blowers, from boards of directors to corporate insiders to the accounting firms to the lawyers working for these firms to the credit-rating agencies. All these people. Would a dictatorship have been more efficient in silencing them and producing the perverse incentives for them all to keep quiet? The system is so efficient that there's total silence."

Here is another prickly question: why do we have boards of directors? We can argue about what the roles and responsibilities of a board ought to be, but why can't we take a step back and ponder their very existence? Is the managing director not skilled enough to run the show? Is the senior management team so juvenile that it cannot command a tight and ethical ship? Or can no-one be trusted, to the point where directors are required to guard the guards? But who is keeping an eye on the directors? So how can we work with what we've got? In seeking sound practical advice, I spoke with four prominent corporate observers and asked them to enlighten us. Here is what they had to say:

On director independence

It is generally agreed that independence refers to a director who is: not a recent employee of the company; not a supplier or customer of the company; not a significant shareholder. However, William Kirkby-Jones, chairman of Landcom, Amber Group Australia, Community Housing Canberra, and the Kingston Foreshore Development Authority, goes one step further to insist on a director who is able to bring "independent thought and advice" not for the benefit of the majority shareholder, but "for the benefit of the hypothetical average shareholder."

Karen Hamilton, chairman of the recently formed Corporate Governance Council, says that directors need to ask themselves if they are unshackled to the point where they can "make a decision with a free mind and a free will. Where that is not possible, they must abstain from voting because there must be neutrality in decision making." Philip Higginson, managing director of PRO:NED, looks beyond material independence and says, "a director is only independent if that director has the personal financial freedom to be able to threaten to resign without being concerned about mortgage issues." In 1983, PRO:NED founder Guy Pease said it more succinctly, "If you need the money [board fees] from any one particular appointment, then you must seriously question your ability to be truly independent. Every non-executive director must be able to resign, if necessary, without losing the ability to maintain lifestyle." For Mervyn King, chairman of South Africa's King Committee on Corporate Governance, directors could only be deemed to be independent if they passed the "critical bystander test". Are they associated with the company, to the point where their judgment can be clouded? "Yet," King asks, "despite passing the test, does it follow as a matter of logic that directors will therefore display absolute intellectual honesty and always act in the best interest of the company?" He answers his own question, "Not necessarily. Sometimes, an employee elevated to the board can display greater independence of mind."

On board composition

"It matters enormously that the majority of directors should be independent non-executive directors," says Kirkby-Jones. "If you allow executives to be on the board alongside the MD, chances are they will be sycophantic, because outside the boardroom, they are at the MD's whim for their advancement and survival." Higginson concurs, "In all my experience, having sat on large and small boards, I have never ever seen an executive director ask a decent question of the MD. It is a complete waste of time. Executives would never challenge the MD with truly tough questions because they are beholden to the MD. For that reason, over 50 percent of board members should be independent non-executive directors." Higginson is in favour of an uneven number of directors. "I advise five, seven, or nine directors. If you have to have six, then four of them must be non-executive directors. Furthermore, it is advisable for the chairman to be a non-executive director. Incidentally, the PRO:NED survey shows that 57 percent of directors did not believe that former chief executives should sit on the company board. One quarter felt that they should be able to sit on the board, while 18 percent were undecided."

As for the MD also being a chairman, that is a recipe for disaster, says Higginson. "It's a bad mix because it gives absolute power. And we all know where that can lead." What of boards appointing non-executive directors for the first time? Higginson doubts the efficacy of only one non-executive director on the board. "It's very difficult. You would need a mate on the board, otherwise you will find that the wagons will circle in on you. If that happens, you must not give up too easily. If you smell something fishy, you need the courage of your convictions to act, and to lobby outside the boardroom. However, if after all that hard work you know that you are not wanted, then it's time to go. Leave it be. But I would expect that you would resign and say why." King sees major flaws in the US model that allows the CEO to be the chairman. "This is a problem that thankfully is not prevalent in Commonwealth countries." He thinks that an overabundance of non-executive directors also has its challenges. "Non-executive directors have asymmetrical knowledge of the workings of the company. The only one who really knows what's going on is the CEO. If the CEO becomes ill, who will know the detail? For that reason, it would be sensible to balance the board with executive and non-executive directors."

Despite this, King acknowledges the problems associated with having subordinates on the board. The PRO:NED Survey Report shows that 89 percent of boards now have non-executive chairmen. This is slightly higher than the finding for 1999 of 85 percent.

On individual contribution

Kirkby-Jones says, "Gone are the days when directorships were a handout. It is now a profession that requires integrity and demonstrable skill mixed with wide-ranging experience. Directors must be able to add value to the enterprise by assisting it to ride the business cycle and capitalise on the opportunities and minimise adverse impacts. "It is incumbent upon each director to know the business. It is no longer good enough to say, 'I did not know.' If you do not know, seek a fully-fledged brief, and go and get extra training." Kirkby-Jones is adamant about one thing. He says no matter how skilled you are, you would be lacking until you are financially literate. "Every director must be able to know how to ask the right financial questions," he said.

On CEO remuneration

"We have been aware for some time that many of Australia's senior business leaders have become increasingly concerned at the huge and sometimes unrealistic remuneration packages being paid to chief executives," says Hamilton. Higginson says: "The quantum of these financial rewards is often difficult to justify, particularly in the face of so many major business failures. It is therefore of special interest to note that a significant response to our survey was that 52 percent of directors now consider that the senior executive remuneration levels are excessive. This becomes particularly vexing when it is realised that these 'excessive rewards' are often paid regardless of disastrous results. There is a dichotomy here, considering that it is the board that approves these payouts."

On option schemes

According to Higginson, "There are as many arguments for having shares as there are against. The jury is out on that. However, in a widely held company, I see no problem for a director to have a small parcel of shares. On the subject of share options, I am dead against them. I think that options will go."

Karen Hamilton's view of options is that a balance is needed. "Options serve a useful role. The tragedy is that they are abused, so now we see companies walking away from them." She also notes that many directors perform their duties without too much focus on the fees because they "take a genuine interest in the corporate evolution to facilitate the growth of Australian companies." According to King, share options were supposed to focus the mind on the business but this did not happen. "We made a mistake with share options," he says. "What I think we need is a system whereby directors are obliged to buy shares with their hard earned cash. They need to buy a quantity that is significant in relation to their financial position. This will show their real commitment." Here King is referring to what Australians call, 'having skin in it'. He believes the granting of share options needs to be re-thought, because he is concerned about the "greed mentality".

On directors' fees

"Directors earn the money they are paid by being utterly diligent in their role," says Kirkby-Jones. "When directors take shareholders' money, they have a responsibility to perform their duty for the well-being of the company by performing their best for the hypothetical average shareholder, while keeping in mind the interests of creditors, and while ensuring that the issues of occupational health and safety are attended to."

According to the findings in the 2002 PRO:NED Survey Report, only 27 percent of directors felt it was not appropriate for directors to be remunerated with either share or share options. In fact, 72 percent did not believe that fees paid to non-executive directors partly in shares or options would result in directors focusing on short-term share price gains. As for fees, the survey shows that on average, an independent non-executive director earns $35,000 per year, whereas the average fees earned for chairmen is $70,000. Higginson does not think that these averages are acceptable. "I would prefer to see at least a 50 percent increase in earning to compensate directors for the long hours and the personal liability that they shoulder." Hamilton believes that we could do a better job at balancing the fees with the liabilities. She is not convinced that directors are paid enough for what they do: "Who in their right mind would want it? Due to the high media profiles of some executives, the public seems to think that directors are paid excessively."

King says: "It is absurd and ridiculous to think that all directors should be paid the same fee. Those days are gone. We will see more boards rewarding directors for their input. For the deals they bring to the table. We will see boards paying a retainer plus special fees for specialist expertise. I would have no hesitation in paying bonuses on input." The PRO:NED survey shows that we have a long way to go. The total time commitment, including all regular and ad hoc meetings, committee work, site visits and travel, averages 36 days per annum on board matters for chairmen, 32 days for deputy chairmen, and 26 days for non-executive directors. Just 22 percent of companies surveyed pay additional fees on top of the base fee, in return for committee work.

On the financial model

"The board would be neglecting its duties if it did not take a magnifying glass to the financial models that are presented," says Kirkby-Jones who expects management to disclose the assumptions that underpin the financial model: "I would insist on seeing every single assumption upon which the financial model is based. I do not want to see a digital document with numbers all over the place. I want to see a Word document that explains the assumptions in detail."

He expects the board to challenge the validity of the assumptions by engaging the MD and the GMs in a frank discussion. He does not believe in an adversarial environment, but he does expect management to be open and willing to challenge and be challenged.

On board papers

"The MD prepares the board papers after scanning the political, social, economic, and ecological environment, and after keeping an eye on the competitors," says Kirkby-Jones. "In the end, the MD has to be ready to answer one fundamental question: 'So what?' If the MD cannot say what impact the observations will have on the organisations, then it is all a waste of paper, and a burden on the directors. When board papers are presented, we need to know why they are presented." King strongly advises the chairman and all the directors to ask, at only 10 minutes' notice, a senior member of staff to be available to attend the board meeting to answer questions. "Ten minutes before a board meeting, it is not uncommon for me to ask someone to call John Smith to the meeting. No prior notice is given. This is the best way to conduct checks and balances to make sure that we all understand what is going on, and that the managers know that they could be called to account for their decisions."

Will this tactic make the CEO uncomfortable? Would this not signal distrust? "I have a duty to ensure that the information the board is presented with is factual. And I will do this by the best means possible," says King.

On moral conduct

Kirkby-Jones says, "It is vital that the board sets an example of high standards of moral conduct. If the board is busy trying to find ways to avoid paying tax or if it is trying to cover up a mistake, this sends bad signals to the troops. And you can be sure that no matter what you discuss behind closed doors, the troops will always get to hear about it." Hamilton is not a fan of hardwiring rules and regulations. "It is true that the general public is not satisfied with the status quo. There are community concerns and fears. However, additional hardwiring is not the answer," she says. "We have a good balance between regulation and peer persuasion. Of course, we need continuous disclosure to all investors. The existing Corporations Act sets out the duties and obligations, and it has worked well. We simply need continuous transparency and accountability so that organisations can perform and grow. It would not be a good idea to favour conformance over performance. Detailed prescriptive models are no good."

"None of us is a recording machine," says King. "We all have baggage. So it is not true to say that an independent director is someone who will be a pre-eminent director. We must take independent non-executive directors and employees, and consider them as threads whereby, through a balancing act, a fabric can be weaved."

On appointing managers

Kirkby-Jones believes that "it is the board's responsibility to not only appoint the managing director, but to also have a significant say in the appointment of the MD's direct reports, and their collective and individual performance." Does this not go against the grain of providing the MD with autonomy? "The board must set the strategic direction and then contribute to, and sign-off on, the corporate plan. It must also monitor progress and suggest remedial action. But don't forget that in the end, the board has the power to direct and control the corporation. "There is nothing to suggest that the board cannot run the mail room if it so chooses," says Kirby-Jones.

On accepting a post

Hamilton cautions directors to do their homework before they accept a directorship: "Make sure that you understand the skill mix on the board. Make sure that each fellow director is of high repute. Find out if individual board members will have their voice heard. Check about your rights to access external advice, and look into what established procedures exist to facilitate that. Chat with the chairman, the company secretary, and the CEO before you accept an offer. Find out if dissenting voices are minuted, because minuting practices differ."

On the role of the chair

"The role of the chair is to promote vigorous debate, when necessary, and to seek consensus," asserts Kirkby-Jones. "When you do this among people of goodwill who genuinely have the company's interest at heart, they will be prepared to be persuaded. It is the chairman's role to ensure that everyone on the board has equal standing and status, and to draw out intellectual capital for the benefit of the organisation." Higginson reminds us that the chairman is the chairman of the board, not the chairman of the company, and as such, holds no greater authority or power than any other director. Like all the directors, the chairman is responsible to shareholders.

"The chair is the voice box. The role is overrated in terms of power and position. There was a time when people did as they were told, and the chair had clout. Those days are gone. Yet, the chairman who is appointed by the majority shareholder sometimes does have more power."

On loyalty to the chairman

There is a school of thought that requires a director to never vote against the chair. Higginson says that any director who is so obedient to the chairman is either lily-livered and weak-willed, or just does not understand the role. "Anyone who cannot exercise their duties with independence of thought is of no use to the board," he says. "If we are debating a difficult decision, and we finally take a vote, I would worry if the vote is unanimous," says King. "If it is unanimous, I would point to a director at random and ask, 'Why do you say this should be done?' If the director cannot give me a good answer, I would know that he has not read the board papers. If he stumbles, I can assure you that he will never again come to a meeting without being ready."

On tough penalties

Kirkby-Jones would have no hesitation in dismissing any director who acts fraudulently or dishonestly. He favours tough penalties, saying: "Those directors who are lacking in their fiduciary responsibility to shareholders and creditors would do well to consider the statement, 'There is nothing that so concentrates the mind as the promise of a good hanging in the morrow'."

On blowing the whistle

What would Kirkby-Jones do if he smelled something fishy on a board? "If you believe that the company is transgressing, and you have taken every action to express your concerns and nobody seems to want to remedy the situation, you have no alternative but to report the matter to ASIC. However, don't forget that in many circumstances, you are at liberty to seek legal advice at the company's expense. Directors will not get into trouble if they act honestly, act with a good will, and engage transparently."

The final word

Those for whom philosophy is useless, are those who do not understand philosophy. Philosophers are trouble-makers, asking all sorts of questions people might not be ready to explore.

One question that has baffled many people is the purpose and function of "integrity". If you value integrity, remember that you speak volumes by what you do not say. You expose your integrity by what you refuse to accept. You highlight your conviction by what you refuse to believe. Astute people will determine your fibre by observing what you deem insignificant. They will construe your essence by what you overlook. They will interpret your actions by what you neglect. They will assess your grandeur by how low you stoop. They will examine your honour by what you hide. Shrewd people will scrutinise your nature by giving you whatever you ask for. They will examine your morality by tantalising your pleasures. They will probe your ethics by sponsoring your indulgences. They will unveil your principles by extending your authority. They will know your limits by replenishing your power so that you will be able to reach your destination. Leaders do not mind clumsy people, but they worry about polished yobs. The tiniest detail exposes impostors. Vulgarity seizes glamour. Rudeness usurps style. Indiscretion smothers elegance. Insensitivity extinguishes romance. Selfishness destroys love.

Of all the species, we humans seem to be the least co-ordinated. We amass wealth without purpose. We grow without reason. We consume without need. In the end, what starts out as a quest to provide our families with daily bread, ends up a mad dash for more. Do you want more? How much more? If you do not know what will satisfy you, you will never be satisfied with anything. There is something insanely brilliant about nature's revenge. It gives you all the freedom you can't handle just to remind you who's boss.

*Jonar C. Nader is chairman of consulting firm, Logictivity, and the author of How to Lose Friends and Infuriate Your Boss.

Disclaimer

The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.