Effective boards move from cheerleading to groupthink through a conscious process.
At the 2010 OECD-Asian Roundtable on corporate governance, co-hosted by the China Securities Regulatory Commission and the Shanghai and Shenzhen Stock Exchanges, there was an emerging consensus that “the board is the ‘nexus’ for improving corporate governance and that there is a need to focus on board nomination and election as one of the key factors impeding its performance and effectiveness.”
The discussions honed in on five common weaknesses that the boards commonly suffer from:
# Limited search process with an over-reliance on existing network and known candidates.
# Limited due diligence on competence and qualification of candidates with undue emphasis on box-ticking checks on candidate “independence”.
# Insufficient regular review of skills, knowledge and experience of boards in order to determine appropriate profile of new directors needed.
# Lack of a systematic evaluation of director performance.
# Inadequate disclosure of relevant information on director candidates and lack of shareholder challenge in the context of concentrated ownership to boards to justify candidates proposed for election and re-election.
These weaknesses are only symptoms of a deeper malaise that has its genesis in the inadequate attention and significance attached to the composition and design of the boards, and more significantly in the management-centric view of the organisation. According to this view, the board is a necessary component of a corporation and it exists to fulfil legal requirements. The overt and un-declared supremacy is that of the management over the board for, in the final analysis, the management alone is supposed to know the organisation more intimately than the board of directors who do not spend more than 18 hours in a year with the organisation. In such organisations, it is the internal members of the board, including the chairman, who matter more than the external, independent ones. When this happens, the boards engage in a type of “window-dressing” when appointing independent directors. They are selected more on account of their connections, networking or perceived ornamental value and are overly sympathetic to management, while still qualifying as technically-independent according to regulatory definitions. The external members of the board then become cheerleaders of the chairman and management. Instead of providing constructive evaluation and feedback of organisational strategies and policies at the board meetings, they become their supporters.
More than becoming dysfunctional, such cheerleader boards are by and large ceremonial in nature. They perfunctorily perform the compliance role; the directors serve for the prestige, attend board meetings diligently and speak in generalities. By not being critical about the policies, they do a disservice to the chairman and the organisation by acting as negative external monitors. Such boards are more pronounced in the state-owned enterprises in which the chairmen have short tenures, usually not exceeding three years.
Very often, the cheerleader board allows the chairman to pursue policies and implement strategies that seem to be populist, positively aggressive, politically correct and that aid in reaping short-run benefits — the impact of which lasts at least till the end of the chairman’s tenure. Charisma and media savviness act as catalysts to the zeitgeist strategies to enhance the popularity of the chairman and the policies. But once organisations have cheerleaders for the current management on the boards, there is a strong possibility that these organisations will engage in more potentially questionable activities for shareholders. One of the questionable behaviours that is both well-documented and established in the literature is earnings management. That is where the support of the auditors and accounting policies are enlisted to provide justification and sanctity.
The Financial Reporting Council is the UK’s independent regulator responsible for promoting high-quality corporate governance and reporting to foster investment. One of its professional operating bodies, the Auditing Practices Board, has brought out a discussion paper that emphasises the importance of scepticism to audit quality. The paper advocates for the “right” level of scepticism to be applied by auditors and the conditions that foster appropriate sceptical behaviour. Professional scepticism, the paper argues, is a crucial component of a high-quality audit that pervades every aspect of the auditor’s judgment. In cheerleader boards, professional scepticism is deliberately silenced and the auditors are often led to certify questionable accounting policies that positively influence profitability in the short run.
There is one other noticeable tendency in cheerleader boards. A new chairman when appointed (again for a short-term) often tends to act as a “new broom” to sweep away the cobwebs and ushers in a new regime that may be radically different. Since the tenure of the chairman is short and there is a strong desire to leave a footprint, there is palpable eagerness to be different and a sense of one-upmanship. Leadership transitions in organisations are not always easy. Enlightened organisations with progressive and enlightened boards, even if the organisations are large in size, have a way of managing these transitions. Examples abound as in the case of GE, Pepsi, Microsoft, the Tata group, the TVS group, Infosys and ICICI. Very often there could be a J-shaped curve in terms of discovery of “skeletons in cupboards”, discovery and attribution of errors to the previous regime and there is likely to be a period of poor results before things get better. But things can become difficult when the tenure of the new regime is short and uncertain. It may not necessarily be that there is a conspiracy behind the difficulties. It is more of a case of a botch-up piggy-riding on a built-in systemic inadequacy and information asymmetry, which get exacerbated by the fact that the board comprising cheerleaders is not in a position to act as the bedrock for the organisation and offer the necessary support.
“Recent theory suggests that board independence is unlikely to have a uniform effect across firms, and that the effectiveness of independent directors may depend on the information environment of the firm. Perhaps as a result of these issues, many studies fail to find a strong relation between board independence and firm performance” (2008, Cohen, Frazzini and Maloy; www.nber.org). Notwithstanding the above, underlying the Indian and global regulatory requirements about board composition and independent directors is the argument that the independent directors, are the custodians of shareholder interests, whose presence on the board helps reduce agency problems, conflicts, enhances quality of decision making and improve performance. Under this view a board with a majority of independent directors acts as good monitors.
Overhauling the nomination process for directors and focusing consciously on improving the quality of nominations by selecting directors only for their depth of knowledge, breadth of experience, integrity and independence is the starting point for improving the quality of governance. This will avoid the GIGO (garbage in / garbage out) from occurring in the boards. The other ways to improve their knowledge and skills would include: training and development programmes and setting up appropriate board evaluation processes. Together, these will help the boards transit from being cheerleaders to purposeful boards — boards that deliver.
The author is former executive director of Sebi and is currently associated with the IFC’s Global Corporate Governance Forum of the International Finance Corporation and the World Bank. These views are personal
