Putting Together a Board of Directors

An effective Board of Directors is a significant component of an effective corporate governance framework. Effectiveness can be represented by quality and robustness. I define quality as the Board being fully engaged and actively fulfilling its mandate. I define robustness as having individuals on the Board with complementary skill sets and a majority of independent Board members.

As a former auditor, I attended countless Audit Committee and Board meetings. Some meetings were crisp, lively and energetic. Management came to the meeting prepared and ensured their Board was prepared. Issues were discussed and debated and consensuses emerged. I left these meetings feeling inspired and energized.

Most meetings I attended left me yearning for the local pub. Materials were hot off the printer and rushed to the Board as the meeting was in progress. Management awkwardly read the slides shown up on the wall while Board members checked their Blackberries.

These companies typically had a string of poor investment decisions and middling financial performance. Rarely would these issues be discussed. Management would hold their breath and hope that the meetings would end without incident. Or worse, management would steamroll through yet another change in strategic direction.

If a Board is to be fully engaged, management needs to fully inform them with quality materials circulated on a timely basis. Those materials can include details monthly management reports on performance and detailed materials to cover meeting agenda items. With those materials in hand, Board members will understand the business and be prepared in advance of meetings. Allowing time to analyze the business and develop opinions is important to soliciting feedback from each Board member. Board members become engaged by having the opportunity to actively guide the company; management benefits from receiving thoughtful guidance and feedback on performance and strategic direction.

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Before I write about individual Board member skill sets, it is important to cover the overall composition of the Board. To maximize the chance of being effective, I believe the majority of the members ought to be independent. Management and significant shareholders (or their designates) are not independent. The issue with non-independent Board members is that they can bring biases to the discussion. They can also bring ignorance and a lack of critical thinking.

As an example, let us assume the Board is comprised of the CEO, the two largest shareholders and an independent member who has a longstanding relationship with the largest shareholder. The business is quite technically complex; while the shareholders have invested in the type of business in the past, they do not have the underlying technical expertise to challenge management. The independent member has a financial background but is not overly familiar with this particular type of business.

This type of Board will struggle to be effective, especially if management does not provide a quality set of materials for meetings. The CEO will obviously support management’s proposed future activities proposed. To the extent the company has been successful, the other shareholders will likely trust management’s judgment and break out the rubber stamp. To the extent results have been poor, the shareholders are still in a tough spot: they may be skeptical of management’s proposal, but lack the knowledge to identify flaws or suggest an alternate course.

This issue can be addressed by having a majority of independent directors who have the ability to challenge management’s thinking.  The key is ensuring the Board members understand the business sufficiently to add value to the discussion.

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If you are involved in putting together a Board, it is important to consider the mix of talent appropriate for your company. For an oil company, the company is going to have an Audit Committee (”AC”), Reserves Committee and Compensation Committee (“CC”). The company will need some financial literacy, an engineer with reservoir engineering experience and someone with expertise on compensation matters. It the company’s reason for being is to conduct business in South America, having a Board member with experience in the region is invaluable. Having some legal expertise is useful, whether it is a board member or by having your counsel act as corporate secretary.

Typically, Board members will sit on a couple committees which will have three members. Assuming the AC and CC have a majority of independent directors, the company needs a good three or four independent Board members. The bigger and more complex the company, the more members are required. Coke, for example, has seventeen board members to help oversee its worldwide operations. If a Board is going to be useful, they need enough members to divvy up the oversight responsibility to a manageable workload.

As part of the Board selection process, it is important to look at the skill set of the management team. If the company has a first time CEO seat, the company may have a couple Board members with extensive CEO experience to provide advice, support and mentorship. If the CFO has little capital markets experience, an investment banker on the Board can help fill the gap.

At the end of the day, it is up to management to manage the business. By matching up our Board skills with management’s skills, we helped fill potential management blind spots while also making the work a little more interesting for the Board. If a company is to be a success, the Board’s input is going to be integral.

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