Thursday, March 21, 2013

Clear Eyes. Full Hearts. Best Practices for Boards and CEOs


It’s Not Where You Start…
In 1973, lyricist Dorothy Fields teamed up with composer Cy Coleman to pen what would soon become one of Seesaw’s signature numbers, “It’s Not Where You Start, But Where You Finish.” These lyrics could not ring more true as I reflect on the completion of my MBA nearly one year later. While stepping out of a career in nonprofit management, the curriculum that I was introduced to was certainly new and thereby initially quite challenging for me. Possibly greater than the detailed terminology, theory, and frameworks that I was exposed to in business school, the MBA program at Boston College enabled my world view to evolve. 

This evolution could be detected as early as the first quarter of business school.  Shorty after the start of the first semester, I attended the Boston-area premiere of Lucy Prebble's play ENRON, a modern day morality play set against the events of the recent corporate scandal. As I turned to my friend at intermission expecting to bash the production's pacing and shoddy blocking, he, a very intelligent undergraduate theater and political science major at Boston College, admitted that he was having trouble following the plot. I, unaware at the time of my pedagogical path, began to explain this human tragedy in terms of a balance sheet equation. With less than four weeks of accounting under my belt, I was describing plot by using terms like assets, liabilities, and accounts payable. While this story couldn’t make Professor Pete Wilson more proud, I am almost positive legendary New York Times critic Brooks Atkinson is rolling over in his grave. Alas, I have not been able to view the world the same way since.

Boards and CEOs, an elective open to second-year MBA students, played a key role in contributing to this trajectory. While management curriculum generally examines organizational structure from the bottom up, this course taught me to see corporate America from the top-down – through the eyes of the CEO and c-suite. As such, the means in which I can interpret and analyze business media has changed. While the on goings captured within Column One of The Wall Street Journal once seemed mysterious and indecipherable, they now read as palpably as the content behind a prime time soap opera. Here in lies the frame of this essay. While completing the weekly readings for this course, I was also in the midst of watching, Friday Night Lights, a critically acclaimed serial drama following the trials and tribulations of protagonist Coach Eric Taylor as he spearheaded a high school football program in the fictional-town of Dillon, TX. Parallels could certainly be made between this community engulfed in politics, cut-throat competition, and melodrama and the challenges facing corporate governance today. While using some of the strategic and ethical decisions made by Eric Taylor throughout the series as parallel illustrations, this essay will highlight some of the best practices  for creating a stable and effective board structure and a strong corporate culture. The following essay will focus on best practices learned pertaining to a board’s most important functions – the hiring, firing, and executive compensation of the chief executive officer.[1] 

In the Line of Fire: CEO Termination & Ethical Violations

As early as the second season of Friday Night Lights, this simple phrase “Character is who you are when no one is watching” overlooked Eric Taylor’s shoulders as it hung on the cinderblock wall of his basement-level office.[2] Themes of character, integrity, and ethics are ones that run through this series as well as the board room. In his 2010, biennial letter to Berkshire Hathaway managers and directors, Warren Buffet wrote, “We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation. We must continue to measure every act against not only what is legal but also what we would be happy to have written on the front page of a national newspaper.”[3] Mr. Buffett communicates his vision and expectations to his managers clearly as he understands that a CEO helps define and form a strong corporate culture. And in short, “culture, more than rule books, determines how an organization behaves.”[4]

“Nobody’s above the rules on this field”[5]
Coach Taylor, like Buffett, understands that high-standards are key in preserving trust amongst key stakeholders. Whether it is the fans amongst a downtrodden community or the employees and shareholders of a publicly traded company, those below and on the sidelines look toward the top for direction and follow suit given what they see.  In season five, Taylor laid down the rules with his team as he declared, “Anyone, and I mean anyone who breaks our standards will be off the team and THAT is a promise.”[6] This promise was kept as be preceded to dismiss several teammates and bench the star quarterback as a consequence of their questionable ethical behaviors. Nothing sent a stronger message to his players about his expectations for the culture and community he set out to establish for the newly formed East Dillon Lions.

Board of Directors should take note of Taylor’s actions. Given the fallibility associated with human nature, it is not surprising that even a CEO is capable of making decisions that fall below the ideals of a corporate culture. In fact, several CEOs have recently met their fate due to ethical breaches. For example, Radio Shack CEO, David Edmondson resigned shortly after it was discovered that he had misrepresented his academic records while Boeing Co. CEO, Harry Stonecipher was fired following an affair with an employee.[7] Board members often find themselves in a quandary when deciding whether or not to preserve the post of their wayward leaders.  The pre-mature decision to find a new CEO is never an easy one. Jeffrey Sonnenfeld at the Yale School of Management has stated, “Board members are often uncomfortable pushing aside a chief executive they chose and like […] The devil we know is better than the unknown.”[8] While sticking by the side of the current CEO, especially one that has lead the company through healthy financial performance, may be the easier, least cognitive dissonant option for board members, but  it certainly does not adhere to Mr. Buffett’s aforementioned advice.  In the end, actions taken by the board to preserve the corporate cultures and values of the company will speak volumes in communicating the integrity and priorities of the company to both internal and external constituents.

‘Face Values’
Much like the value of character that Taylor must face every day as he walks into his office, a board must be prepared to review and uphold the core values of its company. As board members, they have an obligation to employees, shareholders, and customers that these values are upheld by all members of the organization, most notably those at the top. If a CEO’s behavior stands in opposition to these values, a board should, in the vast majority of cases, seek new leadership. For better or worse, a CEO is the public face of a company. His or her behavior, both as a professional and public citizen, becomes inseparable with the corporate identity and reputation. To maintain a corporation’s good standing reputation, it must be supported by the actions of its employees from the top down. When looking to protect the long-term returns for shareholders and the enduring reputation of the company, one must remember that “financial results are not sustainable, but culture and values are.”[9]

Reinstating Trust 
Much like the players who broke the bond of trust between Taylor and team, a CEO who chooses to act unethically creates the same breach of trust between himself and the board. In addition to preserving reputation and corporate culture in the eyes of employees, stockholders and the general public, the firing of a disreputable CEO may be necessary for preserving trust on a board. The most effective boards have honest, transparent lines of communication with the company’s CEO. In fact, those CEOs who have behaved unethically or dishonestly in one area of their careers or lives, lead board members to question how much they can trust “any report to the board or investors.”[10] It has been noted that failure to keep directors properly and objectively informed can increase liability for the company.[11] Given this risk, it is the responsibility of boards to ensure they are working with individuals who they trust and who will uphold the values and reputation of the company as reflected in all areas of their lives. Coach Taylor describes character as the following; “It’s about striving to be better than everyone else.” A good board expects management to not only do their utmost for the best possible returns for its shareholders but to do so in an ethical manner that categorizes them as leaders with integrity. While firing a CEO has never been easy, it has also never been a more important duty for a board if it feels its culture, reputation, and future performance is being threatened by questionable behaviors.

Put me in, Coach.
In the pilot episode of Friday Night Lights, Coach Eric Taylor’s chances for a state championship ring look grim as his Notre Dame-bound star quarterback suffers a severe spinal cord injury while successfully tackling a defender in what would have been a game-ending touchdown. Spending most of the first season, getting underclassman and green QB2 Matt Seracen up to speed on technique and strategy, Taylor never forgot the importance of having a strong succession plan in place for future seasons. In fact, when Saracen later begged Taylor to move him to wide receiver after having been benched during his senior year in favor of the more talented newbie J.D. McCoy, Taylor refused because he needed him safe and in prime condition should anything happen to the QB1. This philosophy is very similar to that of P&G’s former CEO, A.G. Laffley who viewed one of his prime responsibilities to be developing as many potential CEOs as he could – “leaders who would be ready and able at any time to lead P&G under any circumstances they faced.”[12]

Planning for Hire
One of the board’s most important responsibilities is the hiring of a company’s CEO. As such, it is essential for boards to have a sound succession plan in place for such instances when they are forced to bring on a new CEO. Surprisingly, two-thirds of all corporate directors admit that they don’t give succession planning enough energy. And, according to Corporate Board Member, nearly half of all board members are dissatisfied with their companies’ succession plans.[13] The sad reality is that most boards don’t begin to think about succession planning until the last year or two of the sitting CEO’s term.[14]

The most successful companies not only have a formal succession plan in place but pride themselves on their internal leadership development programs. One might argue that the boards of healthy companies are more apt to devote sustained time to the work of leadership development and succession because “they’re less busy putting out fires.”[15] But at the very least, one must give them credit for not merely relishing in the rewards of the present but instead having the foresight to be prepared for future. In fact, research suggests that these companies have the most reason for grooming future leaders as insider picks for CEO are generally the wisest when the company is performing well.[16] Though, when a company is in crisis, an outsider with fresh perspective and turn-around competencies often fare better.[17]
 
Both Campbell’s Soup and the previously mentioned Proctor & Gamble are companies who value sound succession planning. Denise Morrison, the current CEO of Campbell’s Soup, was groomed by former CEO Douglas Conant prior to her appointment while she served as President of Campbell USA. The two found “kindred spirits” in each other and had relatively similar strategic visions – even to the extent of being noted as peppering their speech with similar vocabulary such as “empowerment” and “engagement” in their addresses.[18] The board at Campbell’s admitted that its goal was to hire from within from the beginning.[19] In fact some companies, such as EMC, whose boards take leadership development and succession planning seriously as well will go as far to declare, “If the next CEO doesn’t come from inside, we have failed and our leadership development plan has failed.”[20]

Perhaps no company organizes leadership development better than Proctor and Gamble where Laffley devoted the first meeting of every year to CEO succession and executive leadership development. Through the creation of a list of criteria and a multigenerational tier of candidates grouped by the relative promise they showed at various stages in their careers, P&G created a safe and sure path to a smooth succession. With access to the company’s top talent, board members were able to identify and evaluate talent on a regular basis. Laffley’s commitment elevated leadership development to the same level of importance as business strategy and it clearly serves as some of the best practices in the industry as it pertains to succession planning.[21] While Taylor and his team were able to pull their season together on the back of a hard working second-string quarterback with heart, boards owe it to shareholders not not leave smooth transitions up to chance, but they must oversee a practical, well-though-out plan of succession.

Getting Your Skin in the Game
In Season 4 of Friday Night Lights, following a political turned personal fall-out with the West Dillon Boosters, Coach Taylor, accepts a coaching position at the under-funded East Dillon High. Facing a team in need of new uniforms, Taylor writes a personal check for $3,000 to obtain new gear for his players.[22] This gesture puts Taylor’s skin in the game as he becomes both personally and professionally invested in helping realize the future long-term success of this at-risk team. Boards should take note as the most efficient way to promote long-term returns for stakeholders is to tie the compensation rewards of the CEO and the board to those of the shareholders. Bruce Blessington, Chairman of Flight Landata, Inc., advises that deferred compensation is the most effective means of to pay executives.[23] He believes that this model puts their “skin in the game” and forces them to think like owners with equity. In turn, executives will be more likely to properly assess risk before taking action. Too often, managers take risk hoping for big short-term rewards paying complete disregard for those shareholders in it for the long-term. Blessington suggests that when restricted stock prices tank, executives should be given more stock instead of cash.

Laffley who was given credit earlier for his contributions in the realm of leadership development also takes a similar position as Blessington. He believes that every element of a pay package should strengthen the CEO’s stewardship of the firm, providing incentive to consistently create value over the short, medium, and long term. Laffley, and not surprisingly so after what was revealed in the last section, would go as far to say executive pay should not only align the CEO with the company when he is active but also in retirement, because “the surest measure of his contribution is the quality of succession and the business’s performance in the year or two after he hands over the reins.”[24] Given this philosophy, he too believes that equity should make up the “lion’s share” of a CEO’s retirement package. To emphasize a company’s commitment to long-term success for shareholders, a firm should also require an outgoing CEO to hold a meaningful portion of their company-awarded equity into retirement.

Much like the directors on the board of Berkshire Hathaway who hold major stakes in the company, executive compensation, too, should be tied to the long-term success of a firm. Warren Buffet cites the following bottom line for his directors: “You [shareholders] win big; they [directors] win big. You lose, they lose big.” [25]  This same philosophy should be adopted by compensation strategists in the board room.

 
Building Up Your Roster
Throughout the series, you see Coach Taylor, often with the gregarious Booster President Buddy Garrity, making his way across the state to recruit the next best running back for his team. As a coach, he needs his deck stacked with a strong offense and an equally strong defense. Much like a football team with clearly defined positions that need to be filled, it is also most necessary for a board to fill its roster strategically as well.

While our speakers this semester often disagreed on issues surrounding compensation, independence, and regulation, very rarely was their dissension regarding the qualities that make an effective board member. Our guests would probably agree unanimously with Kranhold and Lublin’s advice that “a board should ensure that it has the proper expertise and its members consists of persons with sufficiently diverse backgrounds.[26] Well-known Harvard Business School professor, Robert Pozen, laments that board members today “frequently lack sufficient expertise in the relevant industries.”[27] As such, most directors of large companies struggle to properly understand the business and thus a huge knowledge gap exists between the directors and the executives. Without industry knowledge and operational proficiencies, independent directors don’t have the expertise to properly evaluate the information they get from managers. Perhaps most important for directors is their ability to know what questions to ask about information they are not getting.[28]

Joe Petrowski, CEO of Cumberland Gulf, warned against the blind “check the box” approach to filling a board but advises boards to make sure they have all bases covered as they relate to the business and its core-competencies.[29] Flight Landata Chairman, Bruce Blessington also offered similar advice: “Review your strategic plan. You should have someone on your board who can contribute to each of the pillars of your strategic plan.”[30] Pat Gross, a director at three public companies told The Wall Street Journal that before accepting an invitation to join a board he asks himself, “Is there something about my background and experience that will allow me to add something to this company.”[31] More now than ever, board members who come with industry experience and can offer a “Been there. Done that,” perspectives are the most valuable board members.[32] 

Since the regulations that have followed the scandals surrounding WorldCom and Enron, we have seen corporate boards stacking their decks with directors with substantial experience in audit, accounting, and finance.  Corporations have formally recognized the importance of having the guidance and advice of members who possess expertise in these functional areas. It is now time for boards to “check another box” and recruit individuals to their boards with professional experience in other pivotal areas such as human resources and compensation – an area of corporate governance that the previous sections on succession planning and compensation suggest needs critical evaluations from deeply invested members.

“Clear Eyes. Full Hearts. Can’t Lose.”[33]
Boards & CEOs has taught me to think critically about the basic responsibilities of board and c-suite relations. In doing so, I have been able to find parallel applied best practices even within the dramatic frame of a prime-time soap opera like Friday Night Lights. Coach Taylor expects his players to give 100% on the field and corporate shareholders should expect nothing less from directors in the boardroom. Today’s boards “need individuals who can roll up their sleeves and get into detail much more than they used to.”[34] To be committed, they need to express a willingness to be informed (Clear Eyes), to do their homework, and to dedicate more hours than what might have been expected from them in the past. Simply put, Warren Buffett states the requisite for board membership should be “business savvy, interest in the job, and owner orientation (Full Hearts).”[35] At the core, it is the board’s responsibility to support and challenge management in a way that steers the company in the direction that allows the firm to remain true to its culture, values, and mission. It is with these intangibles that shareholders have consciously contracted. From here, responsibilities of compliance will follow, strategic input will be shared, and a board of directors will be able to focus on securing the long-term success of their company for its shareholders (Can’t Lose).



[1] J. Burns, Everything you wanted to know about corporate governance, WSJ, August, 14, 2002.
[2] Friday Night Lights, Season 2: Episode 4: “The Backfire”
[3] Warren Buffett, “Letter to Berkshire Hathaway Managers and Directors, July 26, 2010
[4] Warren Buffett, “Letter to Berkshire Hathaway Managers and Directors, July 26, 2010
[5] Friday Night Lights, Season 5: Epsidoe 9: “Gut Check.”
[6] Friday Night Lights, Season 5, Episode 3: “The Right Hand of the Father”
[7] Erin White & Thaddeus Herrick, “Ethical Breaches Pose Dilemma for Boards: When to Fire a CEO?”, The Wall Street Journal, February 16, 2006.
[8] Joann S. Lublin, “For Boards, Firing or Keeping a CEO Can Be a Tough Call”, The Wall Street Journal, October 22, 2007.
[9] Juan Enriquez, Class Lecture: The Role of Ethics, Trust & Integrity in Business, February 6, 2012
[10] Erin White & Thaddeus Herrick, “Ethical Breaches Pose Dilemma for Boards: When to Fire a CEO?”, The Wall Street Journal, February 16, 2006.
[11]Kaja Whitehouse, “Why CEOs Need to Be Honest With Their Boards”, January 14, 2008.
[12] A.G. Laffley, The Art and Science of Finding the Right CEO, HBR, October 2011
[13] A.G. Laffley, The Art and Science of Finding the Right CEO, HBR, October 2011
[14] A.G. Laffley, The Art and Science of Finding the Right CEO, HBR, October 2011
[15] J.M. Citrin and D. Ogden, Succeeding at Succession, HBR, November 2010.
[16] J.M. Citrin and D. Ogden, Succeeding at Succession, HBR, November 2010.
[17] J.M. Citrin and D. Ogden, Succeeding at Succession, HBR, November 2010.
[18] D. Brady and M. Boyle, Recipe for a CEO, Bloomberg Businessweek, June 27, 2011.
[19] D. Brady and M. Boyle, Recipe for a CEO, Bloomberg Businessweek, June 27, 2011.
[20] Win Priem, Class Lecture: How Boards Select CEOs and Measure Performance, January 30, 2012
[21] A.G. Laffley, The Art and Science of Finding the Right CEO, HBR, October 2011
[22] Friday Night Lights, Season 4: Episode 3: “The Skin of the Lion”
[23] Bruce Blessington, Class Lecture: Executive Compensation, March 12, 2012.
[24] A.G. Laffley, Executive pay: Time for CEOs to take a stand, HBR, May 2010
[25] Warren Buffett, The Essays of Warren Buffett: Lessons for Corporate America, Durham, NC ©2008
[26] K. Kranhold and J. Lublin, What Does a Director Do Anyway?, WSJ, March 3, 2005
[27] R. Pozen, The Case for Professional Boards, HBR, October 2010
[28] R. Pozen, The Case for Professional Boards, HBR, October 2010
[29] Joe Petrowski, Class Lecture: Improving Boards, April 2, 2012
[30] Bruce Blessington, Class Lecture: Executive Compensation, March 12, 2012.
[31] C. Hymowitz, How to be a good director, WSJ, October 27, 2003
[32] Ed Grady, Class Lecture: The Role of Directors, Independence, and Board Leadership, January 20, 2012
[33] Friday Night Lights, Episode 1, “Pilot”
[34] C. Hymowitz, How to be a good director, WSJ, October 27, 2003
[35] Warren Buffett, The Essays of Warren Buffett: Lessons for Corporate America, Durham, NC ©2008

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