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For Boards to Work, They Need to Work Hard

A recent survey conducted by McKinsey and the Canada Pension Plan Investment Board (CPPIB) discussed by the Harvard Business Review found that directors globally were the greatest source of pressure and were most responsible for their organizations’ overemphasis on short-term financial results and under emphasis on long-term value creation, with an overwhelming 74% of responses from those identified as board members actually pointing the finger at themselves.

An earlier McKinsey study in 2013 found that only 34% directors surveyed fully comprehended their companies’ strategies. In addition, “only 22% said their boards were completely aware of how their firms created value, and just 16% claimed that their boards had a strong understanding of the dynamics of their firms’ industries.”

Ineffective public boards are increasingly the targets of activist investors with the number of interventions by activists increasing 88% from January 2010 to September 2013 according to Activist Insight. Stephen Murray, the president and CEO of CCMP Capital claims that “the whole activist industry exists because public boards are often seen as inadequately equipped to meet shareholder interests.”

Directors need to remember their fiduciary duty. They have made a commitment to help drive value throughout the company and position it for future growth. In order to do so, McKinsey highlights key critical components to formulating an effective and successful board:

  • Selecting the right people. In short, companies keep appointing directors who aren’t independent thinkers and whose experience is too general.
  • Spending quality time on strategy. Most governance experts would agree that public-company directors need to put in more days on the job and devote more time to understanding and shaping strategy. While McKinsey recommends that board members dedicate at least 35 days a year to the job, the precise number of days a board meets or the mix of field trips isn’t the main issue. What matters most is the quality and depth of the strategic conversations that take place.
  • Engaging with long-term investors. While boards may be guilty of pushing executives to maximize short-term results, we have no doubt where that pressure really originates: financial markets. That’s why it’s essential to persuade institutional investors, whose ownership position makes them the cornerstone of our capitalist system, to be a counterforce. Boards can and should be far more active in facilitating a dialogue with major long-term shareholders—and many investors would welcome such engagement.
  • Paying directors more. Good capitalists believe in incentives. There is a growing consensus that directors should sit on fewer boards and get paid more. McKinsey fully agrees, but the even more important issue is to structure that pay toward longer-term rewards. To get directors really thinking and behaving like owners, companies should ask them to put a greater portion of their net worth on the table. This could be achieved by giving them a combination of incentive shares, a portion of which vests only some years after directors step aside, and requiring incoming directors to purchase equity with their own money.

Remarking on the findings McKinsey’s Dominic Barton and Mark Wiseman say that, “Over time, nothing else will do more to ensure that these core institutions of our capitalist system deliver the kind of sustained value creation that long-term shareholders expect and that our society deserves.