How can the the board of directors create value? update

I have added a 4th article to the “Further Reading Section” of my article “How can the board of create value?” https://koorandassociates.org/points-of-view/how-can-the-board-of-directors-create-value/

This 4th article suggests enhancing the board’s role in value creation three ways: assessing the full suite of options for value creation; evaluating how strategic options affect total shareholder return; and understanding long-term shareholders’ views on value creation.  The authors are from: Norton Rose, BCG, and RBC Capital Markets http://www.nortonrosefulbright.com/knowledge/publications/137271/beyond-governance-a-canadian-perspective-on-preempting-shareholder-activism-through-value-creation

 

 

 

Long-term value growth demands a talent driven board and C-Suite.

Business competition is intense.  It is competitively differentiated board and C-Suite talent which develops differentiated strategies, business models, plans, and successfully executes them.

 Few companies survive the competition.

Most public companies will not survive. A

  • A Fortune 500 company will survive an average of 16 years.
  • The typical half-life of a North American public company is 10 years.
  • Global public companies with $250 million+ market cap have a typical half-life of 10 years.
  • 50% of all U.S. companies survive for 5 years.

Most venture-backed start-ups will fail.B

  • Three quarters of venture backed firms in the U.S. don’t return investors capital.
  • 30-40% of high potential start-ups lose all of the investors money. Many start-ups do not have any venture-backing. The overall start-up failure rate is very high.

 Few companies generate significant value.

  • McKinsey analyzed the world’s 2,393 largest corporations from 2010 to 2014. The top 20% generated 158% of the total economic value (i.e. profit after cost of capital) created by those corporations.  The middle 60% generated 16% of the total economic value.  The bottom 20% lost 74% of the total.C
  • Mark Leonard, CEO of Constellation Software, his final annual CEO letter. “Qualified and competent Directors are very rare, and not surprisingly, the track record of most boards is awful. According to the 2017 Hendrik Bessembinder study of approximately 26,000 stocks in the CRSP database, only 4% of the stocks generated all of the stock market’s return in excess of one – month T-Bills during the last 90 years. The other 96% of the stocks generated, in aggregate, the T-bill rate over that period. This means that 4% of boards oversaw all he long-term wealth creation by markets during that period. Even more disturbing, the boards for over 50% of public companies saw their businesses generate negative returns during their entire existence as public companies.”  http://www.csisoftware.com/wp-content/uploads/2018/04/Presidents-Letter-April-2018-Final.pdf

 CEO and leadership development programs are ineffective.

7% of CEOs believe their companies are building effective global leaders.  Only 10% of CEOs say their leadership development initiatives have a clear business impact.  Just 11% of global executives agree that their leadership-development interventions achieve and sustain the desired results.D

 Board direction selection and development processes are broken.

A McKinsey survey of board directors revealed that “Only 16 percent said directors strongly understood the dynamics of their industries, just 22 percent said directors were aware of how their firms created value, and a mere 34 percent said directors fully comprehended their companies’ strategies.”E

 Boards must also consider the company’s role in society.

Larry Fink articulated the challenge in his 2018 letter to the CEOs of Blackock’s investee companies. “Furthermore, the board is essential to helping a company articulate and pursue its purpose…..Companies must ask themselves: What role do we play in the community? How are we managing our impact on the environment? Are we working to create a diverse workforce? Are we adapting to technological change? Are we providing the retraining and opportunities that our employees and our business will need to adjust to an increasingly automated world? Are we using behavioral finance and other tools to prepare workers for retirement, so that they invest in a way that will help them achieve their goals?”F

1981 US Business Roundtable Statement on Corporate Responsibility: “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part.  The well-being of society also depends upon profitable and responsible business enterprises.”G

 External talent must also be part of your talent pool.

No company has all of the talent it requires.  External talent can include: your personal network, advisory board, strategic advisors, consultants, lawyers, accountants and other experts.

 What do you do about it?  

  • Determine the talent needed over the next 5-10 years on the board and in the C-Suite, in order to grow long-term value and beat the competition.
  • What’s the talent your company has (both internally and externally)?
  • How do you close the gap with a combination of internal and external talent?
  • What talent and processes need to go in place to ensure the gap does not reappear?

This sounds easy, but incredibly difficult to do in practice.

 Footnotes

A “Corporate Longevity”, Credit Suisse, February 7, 2017

B “The venture capital secret : 3 out of 4 start-ups fail”, Deborah Gage, Wall Street Journal Small Business, September 19, 2012  discusses research by Shikhar Ghosh, Harvard Business School

C Chris Bradley, Martin Hirt, and Sven Smit, “Strategy to beat the odds”, McKinsey Quarterly February 2018, https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/strategy-to-beat-the-odds , Tom Koor analysis

D Claudio Feser, Nicolai Nielsen, and Michael Rennie, “What’s missing in leadership development?”, McKinsey Quarterly August 2017, https://www.mckinsey.com/featured-insights/leadership/whats-missing-in-leadership-development

E Eric Kutcher, “Corporate Boards need a facelift”, McKinsey May 4, 2018, https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-strategy-and-corporate-finance-blog/corporate-boards-need-a-facelift

F Larry Fink, “Larry Fink’s Annual letter to CEOs.  A sense of purpose”, Blackrock,  https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter

G Ralph Gomory and Richard Sylla, “The American Corporation”, April 2013, page 6, The Wall Street Journal http://online.wsj.com/public/resources/documents/50b74ca9c91e6TheAmericanCorporation11292012.doc.pdf

 Further reading

My website has several points-of-view relating to value growth and talent.

Survey – how do board directors impact long-term corporate value?

This report contains the high-level findings from my survey regarding ” How do board directors impact-long term corporate value?”  A PDF with more detailed data is available for download here. (How do board directors impact long-term value?) People I know from three groups (7 CEOs/Presidents, 8 directors, and 10 major investors) responded to my two questions.

The survey findings are intended to help discussion among your board, C-Suite, and major investors.  You should do a similar survey, focused just on your company.  My survey findings are not conclusions regarding the overall views of all directors, CEOs, or major investors.  The sample size was too small.

What follows are:

  • Summary observations
  • Summary data
  • A link to the spreadsheet with detailed data

Summary observations

Question #1  What are the three board of directors decisions (or actions, behaviours) which have the greatest impact on long-corporate value?

Most major investors believe CEO selection is one of the top 3 value impacting decisions made by directors.  A minority of directors and CEOs responded this way.  Investors believe that the talent of the CEO has a massive impact on value growth.  80% of investors responded that CEO selection was one of the top 3 decisions.  Only 38% of directors, and 43% of CEOs responded that way.

Major investors and CEOs, unlike directors, believe that directors should challenge and approve the strategy, resource allocation, and major initiatives. Investors and CEOs want directors to help with the creation of robust plans and resource allocation.  Several investors told me that the allocation of capital and talent by the board has a major impact on long-term value.  One director was quite blunt – the board does not get involved with talent allocation. 50% of investors and 57% of CEOs responded.  Only 13% of directors responded directors should challenge and approve the strategy, resource allocation, and major initiatives.

Many CEOs want to have a both a deep and challenging discussion with directors.  50% of directors responded only to approve the strategy. No CEOs or investors responded that only approve the strategy was sufficient involvement.

Question #2 In order to make those three decisions, what skills, experience, values, morals, and ethics must each director have?

Every CEO and most investors (70%) responded that directors should have skills relevant to the company.  Only 50% of directors responded this way.  I wonder how directors are able to make decisions which impact long-term corporate value if they don’t have skills relevant to the company.

Most directors, unlike CEOs and investors, perceive that values, morals, ethics, and courage to make tough decisions are required to make the top 3 decisions.  63% of directors responded with some or all attributes of values, morals, ethics, and courage to make tough decisions.  Only 29% of CEOs and 30% of investors responded.

Each group provided similar responses regarding diversity i.e. about 30%.  No-one mentioned gender diversity.  One interpretation is that the requirement for board gender diversity in 2018 is a given.  Thus, it no longer appears as a critical director requirement enable the three major value creating decisions.

Independent of management had a 0% response from investors, only 14% from CEOs while 25% from directors.  My interpretation is the perception that independence does not drive value growth.

I was surprised by the low response regarding the need for a broad personal network. All three groups had similar responses – approximately 12%.  No-one has a perfect and complete set of skills.

25% of directors responded with the ability to work together on the board.  No CEOs or investors responded.  I suspect that this an issue only for directors.

Overall observations

  • Directors, CEOs, and investors often have very different points of view as to:
    1. how a board can enable long-term value creation.
    2. what a director has to bring to the table in order to make those long-term decisions.
  • There was a extremely broad range of responses.
  • Some people saw a direct link between directors’ actions and the types of directors required for those actions (e.g. decision making on succession planning require experience in senior executive succession planning). Others did not see a link.
  • The words “strategy”, “strategy planning”, etc. mean very different things to different people. Cleary each company requires a written definition of the terminology they use, given that directors will come from different backgrounds where the words had different meanings.
  • Directors without skills relevant to the company will have difficulty in value creating challenges and approvals of strategy, resource allocation, and major initiatives.
  • At first it might look good that 63% of directors responded with some aspect of values, morals, ethics, and courage. This will actually have limited impact on the company because only 13% of directors will challenge the strategy, resource allocation, and major initiatives.  Only 13% of directors responded with establishing the right culture.  Although the directors may have high moral, values, and ethics, it’s not clear those beliefs will be reflected in management.

Summary Data

Question #1  What are the three board of directors decisions (or actions, behaviours) which have the greatest impact on long-term corporate value?

CEO Selection” – 56% The individual group rankings were:  Investors 80%, CEOs 43%, directors 38%

Strategy approval” – 56% The individual group rankings were: Directors 63%, CEOs 57%, Investors 50%

“Strategy approval” has two sets of responses:

Response #1 was only “Approve the strategy”.  The individual group rankings were: Directors 50%, CEOs 0%, Investors 0%

Response #2 was some or all of “Challenge and approve the strategy, resource allocation, and major initiatives”. The individual group rankings were: CEOs 57%, Directors 13%. Investors 50%

Set the long-term direction or management goals”– 36% The individual group rankings were: Investors 70%, Directors 25%, CEOs 0%

Ensure the right talent in management and staff – 20% The individual group rankings were: Directors 38%, CEOs 14%, Investors 10%

Set compensation for CEO and C-Suite” – 12% The individual group rankings were: Investors 20%, CEO 14%, Directors 0%

Challenge and validate what management says -12%  The individual group rankings were: Investors 30%, CEOs 0%, Directors 0%

Establishing or ensuring the right culture – 8% The individual group rankings were: CEOs 14%, Directors 13%, Investors 0%

Ensure management meeting objectives” – 4% The individual group rankings were: Investors 10%, CEOs 0%, Directors 0%

There were three other sets of replies, each with a total of 4%:

Ensure C-Suite and succession plans in place; establish the culture; and ensure management meeting objectives.

Here were 13 unique replies which I did not put into any of the above groups.  Those replies are listed in the detailed findings PDF.

Question #2 In order to make those decisions, what skills, experience, values, morals, and ethics must each director have?

Skills relevant to the company” – 72% The individual group rankings were: CEOs 100%, Investors 70%, Directors 50%

“Skills relevant to the company” was comprised of distinct sets of responses, as shown below in terms of total respondents: 44% – “up-to-date industry and ecosystem knowledge”

4% each for the following 7: operational skills in the company’s industry; public company directors have public company experience; understand how the director can enhance the company’s long-term value; skills relevant to the company’s long-term value creation; understanding the impact of technology; and relevant to the company.

Values, morals, ethics, and courage to make tough decisions (some or all of these) – 40%

The individual group rankings were: Directors 63%, Investors 30%, CEOs 29%

Diversity – 28% The individual group rankings were: Investors 30%, CEOs 29%, Directors 13%

Respondents identified 3 different types of diversity: skills; opinions; industry and society backgrounds.

C-Suite experience – 12% The individual group rankings were:

Directors 25%, Investors 10%, CEOs 0%

Respondents identified 3 different types of C-Suite experience: Been a CEO before; Retired CEO or C-Suite executive; significant C-Suite experience

Independent of management – 12% The individual group rankings were:  Directors 25%, CEOs 14%, Investors 0%

Experience in succession planning for senior roles – 12% The individual group rankings were: Investors 20%, Directors 13%, CEOs 0%

Broad personal network, relevant to the company” – 12%  The individual group rankings were: CEOs 14%; Directors 13%; Investors 10%.

4% of the replies were very specific “Every director must have a personal network relevant to the company”.

Ability to work together on the board – 8% The individual group rankings were: Directors 25%, CEOs 0%, Investors 0%

Ability to engage in constructive conflict – 8% The individual group rankings were: CEOs 14%, Investors 10%, Directors 0%

Here were 19 unique replies which I did not put into any of the above groups.  Those replies are listed in the detailed findings PDF.

How was input gathered?

The two questions were asked. Question #1 focused on what was most important.  Question #2 focused on what was necessary to achieve the responses in Question #2.  This approach was designed to capture top of mind thinking, without the guidance of a check-the-box survey.  I had to interpret the responses and many times seek clarification.

I did not use a check-the-box survey because

  • I wanted to understand the breadth of what people were thinking. A check-the-box survey constrains the breadth.  In term of question #1 I was surprised by some of the responses. I would never have guessed at some of them.
  • Question #2 was based on the response to question #1. This would have required a massive list of options.
  • I wanted top-of-mind responses. g. what are the first things that come to mind when you think about director decisions which impact long-term value.

Your next steps

This report draws no conclusions or observations regarding the overall views of directors, CEOs, or investors.  You must conduct your own anonymous survey with your directors, C-Suite, and major investors. You must ask open ended questions to obtain top-of-mind responses, rather than a guided check-the-box survey. In the course of this you must define the terminology for your company e.g. what exactly is meant by the word “strategy”. You can then have a discussion specific to your company regarding the findings, observations, and conclusions.

You can download here the PDF containing the detailed excel spreadsheet showing the results.

How do board directors impact long-term value?

How can the board of directors create value? (Major revision)

Long-term value growth and preservation demands a competitively differentiated talent driven board and C-suite.

 Overview

  • Boards are ultimately responsible for the long-term success of their organizations.
  • What is the company’s ecosystem?
  • What is the purpose of the corporation?
  • What is governance?
  • What is the purpose of governance?
  • What is value?
  • What is the board’s decision-making model?
  • What decisions, actions, and behaviours have the greatest impact on value?
  • What are the implications for individual director requirements?

The purpose of this article (supported by a one-page slide) is to provide a framework, process, and facts to enable discussion and action planning among owners/shareholders, boards of directors, CEOs, and advisory boards as to whether or not directors should have a role in creating value, and if so, what that role is. There is no one-size-fits-all answer.  The approach and action plan will be unique to the specific situation of each corporation.

Boards are ultimately responsible for the long term success of their organizations. 1

The entire discussion around boards creating value assumes that boards are accountable for creating value.  If this is not the case for your corporation, there’s no need to read further.  Many discussions regarding the value of directors use words such as “oversight”, “noses in, fingers out”, and other vague definitions of board accountability.  It’s critical to be absolutely clear regarding board accountability.

What is the company’s ecosystem?

You need to understand the environment within which the company must be able to succeed i.e. the company’s ecosystem.

The company’s ecosystem is the network of people and organizations, including stakeholders and third parties, directly and indirectly involved in the operation of the business through both competition and cooperation. The idea is that each entity in the ecosystem will affect and is affected by the others, creating a constantly evolving set and nature of relationships in which each entity must be flexible and adaptable in order to survive, as in a biological ecosystem. The actions and behaviours of the ecosystem vary, depending upon what attribute of the company is considered. For example, the ecosystem has different behaviours when regarding the second to second corporate delivery of products or services versus when the company is dealing with CEO succession.2

What is the purpose of the corporation?

What is the purpose of the corporation?  Is it solely to make money for shareholders and the C-Suite?

Why have societies and governments put in place the legal and regulatory framework for corporations?  Is it to enable the creation of financial wealth for shareholders and the C-Suite?  Is it so a “business can thrive and sustain growth while enhancing the wealth of its stakeholders and the well-being of societies in which it operates?”3

The U.S. perspective on the relationship between the corporation and society has changed radically in the past 37 years, as shown below by publications from the U.S. Business Roundtable.

 In 1981: “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part.  The well-being of society also depends upon profitable and responsible business enterprises.”4

In 2016: “Core guiding principles: The board approves corporate strategies that are intended to build sustainable long-term value.”5 There is no mention of responsibility to society.

Peter Drucker said: “Because the purpose of business is to create a customer, the business enterprise has two–and only two–basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs. Marketing is the distinguishing, unique function of the business.” 6

What is governance?

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders, other stakeholders, and third parties.  Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”7

Based on the above definition, there are four aspects to corporate governance:

  • The focus is on relationships among different types of people.
  • Setting objectives. People set objectives.  The board directors, company management, shareholders, stakeholders and third parties all have different interests and personal objectives.  The conflicts of interest need to be understood and managed to agree upon objectives for the board and for management.
  • Determining how to meet objectives. People have to develop plans which reflect what they will do to achieve the objectives.  Both the board and management have objectives and plans.
  • Monitoring performance. The performance of people (the board and management) is monitored. Everyone needs to understand the personal consequences of not achieving objectives.

The board and management have two way communications with the ecosystem to enable mutual understanding and hopefully support for the company’s (i.e. board and management) objectives.

What is the purpose of governance?

Governance is the mechanism by which the purpose and objectives of the corporation are achieved.

A critical challenge of board governance is understanding and managing the broad range of conflicts of interest.8 These conflicts need to be addressed when determining: the company’s ecosystem, the purpose of the corporation, defining what is value, and how to allocate value (both the benefit and cost components) among stakeholders, third parties, and society. A company’s management, its board, shareholders, stakeholders and third parties all have different interests, which impacts both objective setting and allocating value.

The four tiers of conflict of interest are:

#1 between a board member and a company.  For example, in a company sale, the directors should not give any consideration to the impact on their future roles if the company is sold.

# 2 compromising the director’s duty to act in the best interest of a particular stakeholder (e.g. in Canada – the corporation, in U.S. – the shareholder).

#3 between: stakeholders and the company; between different stakeholders; and within the same stakeholder group.

#4 between the company and society e.g. when a company acts in its own interests at the expense of society.  What should a director do when the company’s purpose is in conflict with the interests of society?

What is value?

Is value (or wealth) simply the financial returns to shareholders and the C-Suite? Ecosystem members may have varying and conflicting interests regarding benefits and costs they incur.  Value may be more than only financial value.

The corporation can create value (both benefits and costs) throughout its ecosystem. How are benefits and costs allocated among the directors, management, shareholders, other stakeholders, third parties, and society?  For example, if an unprofitable facility is shut down in a region with no other employment, who should bear the cost of keeping the former employees fed and housed?  Should the corporation focus on shifting as many costs as possible onto society and minimize the benefits provided to society?

Determining what value is based on the purpose of the company, and considering the interests of different members of the company’s ecosystem.

 What board decisions, actions, and behaviours have the greatest impact on value?

This is a discussion for the board and management.  I have often heard that these include: a) the appointment/termination of the CEO b) the approval of the strategy and strategic plan.  The board may decide how to allocate value (benefits and costs) among: directors, management, shareholders, other stakeholders, third parties, and society.  Many directors and shareholders believe the focus should be on increasing shareholder value, and subject to laws & regulations, minimizing benefits to others and maximizing costs to others.

Value creation (or destruction) by director can occur by: the decisions they make, the nature of their relationships, if any, with the members of the company’s ecosystem, the behaviour which demonstrates to the ecosystem the values, morals, and ethics of the board.

What is the board’s decision-making model?

There are several types of decision-making models, including:

  • The jury – 12 non-experts make a decision.
  • The parliamentary or congressional model – non-experts make decisions, which may be based in whole or in part on advice.
  • The judge model – a expert in making decisions based upon rules & principles.
  • The meritocracy model – an expert making decisions based on personal experience and skills.
  • Or some combination of the above.

 All of the above models have a degree of subjectivity to them, and are influenced by conscious and unconscious biases.

 Sometime there is confusion between a fiduciary or decision-making board vs an advisory board.  The advisory board asks the CEO questions and challenges their thinking in order to help the CEO.  The decision-making board asks the CEO questions and challenges their thinking in order to make decisions which impact the long-term value of the corporation. If the decision has no material impact on the long-term value of the corporation, why are the directors making that decision?  If laws and regulations require directors to make decisions which have no long-term material value impact, the directors must put in place processes which minimizes their time while still being legally compliant.  Sometimes boards fall into the trap of spending the bulk of their time on compliance.

What are the implications for individual director requirements?

All directors must share a common set of VME (values, morals, and ethics) in order to be nominated and to remain as directors.  These VME are the company’s VME.  VME are a framework and input for making decisions, behaviours, and actions.

The traditional skills matrix must be transformed to the long-term value growth matrix.  What are the decisions, actions, and behaviours which have the greatest impact on long-term value growth?  What experience must directors in achieving long-term value for each of these?  How many directors must have this experience?

The following is an illustration of the process each board should use.  What if the board considers CEO appointment or termination as one of the biggest impacts on long-term value growth.  Must a director have experience in and accountability for: the appointment and termination of CEOs? Or C-Suite members? Or middle management?  Or is any experience at all required?  If experience is required, how many directors of those voting on the CEO appointment/termination must have relevant experience?  All directors?  Majority?  One?

What do you do if you are a SME?9

You need to determine the scope of your ecosystem.  e.g. are you a small manufacturing company, with a handful of customers within 50 kilometers or are you a small fin tech operating globally with millions of users.  The broader the scope of the ecosystem, the greater the implications to your company.

 Conclusion

You need to define what value is and which director decisions, actions and behaviours have the greatest impact on value.  This can only be done once you understand the company’s purpose, ecosystem, and how to allocate value (both benefits and costs) among the different components of the ecosystem.

Your next steps

To enable discussion with your board of directors, CEO, and advisory board, download the following one-page slide:

How can the board of directors create value?

Questions for your board and CEO/management to consider?

Ask the following questions and document the agreed upon answers, as well as points of disagreement.  Remember, the Supreme Court does not always have a unanimous point of view.

  • Is your board ultimately responsible for the long term success of your organization? If not who is, and what is the board accountable for?
  • What are the components of your company’s ecosystem and how do impact your company?
  • What is the purpose of your company? Define the relationship between the company and society.
  • What is your company’s definition of governance? What are the relationships among the board, management, shareholders, other stakeholders and third parties including society?
  • How are the objectives for the board and for management set?
  • How is the performance of the board and of management monitored?
  • What is the purpose of governance? How are the conflicts of interests among directors, management, shareholders, other stakeholders, third parties and society managed?  What are the VME (values, morals, and ethics each director requires?)  Are the directors VME aligned with the company’s VME?
  • What is value?
  • What board decisions, actions, and behaviours have the greatest impact on value?
    1. Do you have a one paragraph description of each decision, action, and behaviour? For example: i) what do you mean by strategy?  ii) does appointing the CEO mean meeting with the short list of candidates prepared by the search firm and picking one?
  • What are the implications for individual director requirements? What experience in achieving long-term value do directors need in order to make decisions?  How many directors, of those voting, need to have the necessary qualifications?
  • What is the action plan, if any?

Footnotes

1 Professor Didier and Estelle Metayer, “Does your board really add value to strategy?”, IMD, Global Board Center, https://www.imd.org/research-knowledge/articles/board-strategy/

2 Adapted from Investopedia 2018 May 11

3 Dr. Didier Cossin, Boon Hwee Ong, Sophie Coughla, “Stewardship fostering responsible long-term wealth creation”, IMD, Global Board Center 2015, https://www.imd.org/globalassets/board-center/docs/stewardship_2015.pdf

4 U.S. Business Roundtable, 1981 October  “Statement of Corporate Responsibility”,

5 U.S. Business Roundtable,  “Principles of Corporate Governance 2016”, https://businessroundtable.org/sites/default/files/Principles-of-Corporate-Governance-2016.pdf

6 Jack Trout , “Peter Drucker on Marketing”, Forbes, 2006 July 3, https://www.forbes.com/2006/06/30/jack-trout-on-marketing-cx_jt_0703drucker.html#3495ded7555c

7 based on “G20/OECD Principles of Corporate Governance”, 2015  I added the concept of “third parties”, https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf

8 Professor Didier Cossin and Abraham Hongze Lu, “The four tiers of conflict of interest”, IMD, Global Board Center, https://www.imd.org/research-knowledge/articles/the-four-tiers-of-conflict-of-interest-faced-by-board-directors/

9 Industry Canada definitions (2018 May 9): Small business: < $5 million in revenue, < 100 employees; Medium business: between $5 million and $20 million in revenue, 100 to 499 employees.

Further reading

What will be the board and C-Suite talent requirements?

Overview

  • Future corporate leadership (board and C-Suite) talent requirements will drive talent selection, development and succession planning.
  • Corporate leadership must deal with stakeholders and third parties.
  • What is the purpose of governance?
  • What are your strategy and strategic plan?
  • How will the future corporation be different?
  • Describe the future roles.
  • Outline future talent requirements.
  • Make talent management sustainable.

This article (supported by a one-page slide) is intended to enable discussion and action planning among owners/shareholders, boards of directors, CEOs, and advisory boards. The approach and action plan will be unique to the specific situation of each corporation.  There is no one-size-fits-all answer.

Future corporate leadership (board and C-Suite) talent requirements will drive talent selection, development and succession planning.

For-profit corporate leadership includes: the board of directors, CEO, advisory board, and C-Suite.  Shareholders, if they make major decisions, such as in a private company with a shareholders agreement, would also be part of corporate leadership.

Future talent requirements are based on:  your strategy (i.e. what your successful company will look like in the future) and your strategic plan (i.e. what is the plan to build and achieve the strategy).

Succession plans often start with the current situation as a given and try to move forwards.  I recommend you start with a successful future and figure out how to get there.

The advisory board plays a key role in the future success of the corporation.  The advisory board relieves the board of directors from devoting time to coaching the CEO, and helps the CEO think through the recommendations before going to the board of directors.  The advisory board also contains people with skills and expertise who are not appropriate for, nor required on, the board of directors.

Corporate leadership must deal with stakeholders and third parties.

Corporate leadership must have relationships with, or deep understanding of, the following stakeholders (those who have an economic interest in the company):

  • Shareholders;
  • Non-equity capital;
  • Customers/users; (Dominic Barton, McKinsey’s global managing partner, meets with two CEOs a day.1)
  • Employees/unions; and
  • Suppliers, partners.

Corporate leadership must also have relationships with, or deep understanding of, third parties who can impact future success:

  • Politicians;
  • Regulators;
  • Third-party standard setters (e.g. proxy advisory firms, accountants, lawyers); and

Corporate leadership must make a conscious decision as to whether or not to have relationships with, or deep understanding of, society.  Not making a conscious decision is actually making a decision.

What is the purpose of governance?

What is the purpose of the corporation and why does it exist?

Is the only purpose of the corporation to create wealth?  Is there a higher purpose, either to a community or to society?  Or you may conclude the only purpose is to create wealth for shareholders and the C-Suite.

Peter Drucker said: “Because the purpose of business is to create a customer, the business enterprise has two–and only two–basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs. Marketing is the distinguishing, unique function of the business.”2

 What is your written definition of corporate governance?

Corporate governance is often talked about.  What is your written definition?  I use the OECD definition: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders.  Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. “3

 What is the purpose of corporate governance?

Now that you have a written definition of governance, what is the purpose of corporate governance? Is it only to grow and preserve the value of the corporation?  The OECD governance definition starts with relationships: within corporate leadership, as well as stakeholders and third parties.  Any relationship has the potential for conflict of interest, because parties may have different or conflicting interests.  For example, how should the potential to generate value be allocated among: CEO, C-Suite, shareholders, employees, other stakeholders, and third parties including society, especially in cases of poor profits or losses.  The concept of potential to generate value addresses conflicts such as: whether to replace employees with lower-cost offshore staff or retain the employees in order to sustain local communities.

The U.S. perspective on the relationship between the corporation and society has changed radically in the past 37 years, as shown below by publications from the U.S. Business Roundtable.

 In 1981: “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part.  The well-being of society also depends upon profitable and responsible business enterprises.”4

In 2016: “Core guiding principles: The board approves corporate strategies that are intended to build sustainable long-term value.”5 There is no mention of responsibility to society.

There are many conflicts of interests between the corporation and society.  For example, should the corporation lobby to put in place laws which benefit the corporation but harm the broader society?  Should the corporation be extracting value from society (i.e. causing harm in the short- or long-term), be neutral, or provide value to society?  The point-of-view adopted by corporate leadership illustrates their values, ethics, and character.

Managing conflicts with society is not the same as CSR (Corporate Social Responsibility).

CSR often has a business case, which links doing-good with a combination of building reputation and supporting the wealth creation aspects of the strategy.  Sometimes a senior person in corporate leadership has a pet personal cause which the corporation then supports.

Managing conflict of interest with society requires dealing with situations where benefiting society reduces the wealth created by the corporation in the short-term (i.e. 5-10 years).  There is no business case.  The general public will have little awareness of what the company is doing, because there may be no advertising about what the company is doing.  The employees should be aware.

What are your strategy and strategic plan?

My definition of strategy: What will a successful future look like? What does future success look like to: customers, shareholders, other stakeholders, and society? What will be the future business model? What are your facts, assumptions, and scenarios?

An integral part of this strategy definition is: What will be the roles and capabilities of corporate leadership, i.e. board of directors, CEO, advisory board, and C-Suite?

My definition of strategic plan: What is the plan to build and achieve the strategy?  This includes the plan to build the future corporate leadership.  What will be the process, roles, and principles used to define the roles, appoint people to those roles, develop or recruit those people, and exit those who are not appropriate?

The CEO and board chair each have a part of the strategy and strategic plan and must co-ordinate their integration.

 How will the future corporation be different?

The strategy describes a future corporation different from today.  What are some of the issues corporate leadership must deal with during the timeframe of the strategy?  What will be the:

  • Major accomplishments?
  • Major changes?
  • Major challenges?
  • Major risks and uncertainties?

Describe the future roles:

What roles will be required in the future, and on the way to the future?

You need to understand (and document) the value of each role within the corporate leadership.  This is different from the typical job description. What roles will have the greatest impact on achieving the strategy?

Which roles make which decisions? What are the decisions made by each role which have the greatest impact on long-term value growth and preservation?  For example, which votes by each member of the board of directors have the greatest impact on the corporation’s long-term value growth.  Is it the appointment (or termination) of the CEO?

Which roles will have relationships with other roles?  Relationships among the corporate leadership are key to the smooth operation of the corporation.  Relationships with stakeholders, third parties and society can be critical for long-term success or even survival.

How will your corporate leadership roles be differentiated from your competitors’ and enable you to win against competitors?  Or will you have similar roles, and your competitive advantage comes down the to talent in each role?

Outline future talent requirements:

At this point, you have developed an understanding of:

  • The strategy (excluding future corporate leadership).
  • The strategic plan and associated challenges, changes, and risks.
  • The roles within corporate leadership, and how the decisions and relationships associated with each role are necessary to achieve future success.

All of the above then enables a discussion of what type of people are required for each role.  What should be their ethics, values, character, skills, experience, etc?

Let’s use an example.  Perhaps you’ve concluded that one of the decisions made by each board director having the greatest impact on long-term value growth is the appointment (or termination) of the CEO.  What capabilities must each director who votes on the CEO have in order to make a sound decision? What ethics, values, character, skills, and experience must each director have? What level of person, if any, must the director have terminated in the past?  What decision-making process did each director use when appointing someone in the past, e.g. approved a recommendation by a third party; or assessed several candidates and selected?

How will your corporate leadership talent be differentiated from your competitors’ and enable you to win against competitors?

If your corporate leadership roles and talent are weaker than the competition or have fatal flaws, how can you expect to win against the competition?

Make talent management sustainable:

  • Integrate corporate leadership talent management into the process for developing and managing the strategy and strategic plan.
  • The most important question is: “Who sets the strategy?” Sometimes, the board of directors sets a high-level strategy. Then using this high-level strategy, determines the type of CEO required.  The CEO can then flush out the strategy. Sometimes, the board expects the CEO to set the strategy, with some input from the board. In either case, the board is also involved with the development of the CEO’s strategic plan.

What to do you if you are a small company?

If you’re less than $3 million of EBITDA, your corporate leadership might be a handful of executives with no board of directors.  You have very limited talent and resources.  The three most critical actions are:

  • Being crystal clear on your strategy. You don’t have the resources to head off in a vague direction or pursue multiple directions.
  • Having a network of ad-hoc advisors (i.e. people you can ask who don’t charge money).
  • Having an advisory board, who understand your business in greater detail. Your ad-hoc advisors will have limited time and will have limited understanding of your company.

Conclusion

Corporate talent management is the pre-requisite for long-term success.  The corporation will not succeed if it has poorer talent than the competition.

Corporate leadership will develop and achieve the strategy.  The roles and characteristics of the people in each role must be defined. The people will both grow and preserve the value of the corporation, and also manage a broad range of conflicts of interests, including conflicts of interest with society.

Your next steps

To enable discussion with your board of directors, CEO, and advisory board, download the following one-page slide:

What will be the board and C-Suite talent requirements?

Understand and assess the current situation:

The action plan begins with the description of the future state of corporate leadership. Then you outline the steps to get there.

  • How does your business performance compare against your competitors’ (market share, growth, return on capital, etc.)?
  • List which corporate leadership decisions, stakeholder relationships, and third-party relationships are most important and enable you to win against the competition.
  • Review your formal corporate leadership governance documents. This includes board approved position descriptions, mandates, and policies.  There could be informational documents (i.e. not board approved) which provide additional clarity, e.g. who makes recommendations.  A crucial document is the Delegation of Authority.  Often the board delegates all authority to the CEO but reserves specific decisions for the board.  This document is called the Delegation of Authority.  Note that it is not called Delegation of Accountability.  The board still retains ultimate accountability for the performance of the corporation.
  • Based on the document review, list who makes which decisions and has which relationships.
  • Compare the two lists.
  • What are the differences and gaps?
  • What are the implications?

 Footnotes

1 “McKinsey’s head on why corporate sustainability efforts are falling short”, Harvard Business Review, 2018 March 13

2 “Peter Drucker on Marketing”, Jack Trout, Forbes, 2006 July 3

3 “G20/OECD Principles of Corporate Governance”, 2015

4 “Statement of Corporate Responsibility”, Business Roundtable, 1981 October

5 “Principles of Corporate Governance 2016”, Business Roundtable

Further reading

 “The four tiers of conflict of interest”, Professor Didier Cossin and Abraham Hongze Lu, IMD Global Board Center

“Beyond corporate social responsibility: Integrated external management”, McKinsey, March 2013

How can M&A create value?

Overview

  • More than half of all deals destroy value for investors.
  • M&A has three value creation approaches, based on the buyer’s strategy and future business model.
  • Customer-focused growth is key, supported by business model improvements.
  • Accountability for results must be assigned. Results relative to targets must be reported on
  • Small private companies have a unique opportunity to create value.

More than half of all deals destroy value for investors.1

The root causes of M&A failure at the deal stage are:

  • The M&A target does not fit the business strategy and future business model
  • Synergy estimates (both revenue and costs) are optimistic. Relevant external benchmarks are not used. No bottom-up analysis.
  • Weak due diligence.
  • Those accountable for delivering the benefits are not involved at the deal stage.

The root causes of M&A failure at the integration stage are:

  • Taking too long to put in place the leadership accountable for delivering results.
  • Poor change management.
  • Poor planning and execution.
  • Limited ongoing communications with stakeholders.
  • Losing customers.

M&A has three value creation approaches, based on the buyer’s strategy and future business model.

The buyer must have a strategy (i.e. who the future customers will be, and why those customers will deal with the buyer rather than a competitor), as well as the future business model (i.e. how the buyer will profitably sell and deliver to future customers).  Without a strategy and a future business model, it’s hard to determine how the acquisition fits with the future direction of the company.

The value of the integrated company must be greater than the value of the standalone companies.  There are three value creation approaches:

  • Fill holes in the buying company’s strategy and future business model.
  • Fill holes in the acquired company’s future business model.
  • Create a new or revised future business model.

Customer-focused growth is key, supported by business model improvements.

Focus on retaining and growing profitable customers.

Current products and service can be delivered to new customers, via new distribution channels, in new geographies.

For both current and new customers:

  • Improve or develop new products.
  • Improve product/service development.
  • Improve sales process.
  • Improve sales team.
  • Improve customer service
  • Change pricing

Accountability for results must be assigned. Results relative to targets must be reported on.

Only 58% of acquiring companies publicly announce synergy targets.  Of those that do announce synergy targets, only 29% update investors regarding progress against targets. Successful acquirers have higher internal targets than what is externally communicated.1

The leaders who will be accountable for driving results should be appointed as soon as possible after the deal is done. Synergies which are not achieved within 18 months are not likely to happen.

Small private companies have a unique opportunity to create value.

A privately owned company with less than $3 million of EBITDA may find it difficult or impossible to raise capital or sell the company.

Successful acquisitions increasing EBITDA to $3 million or more will make it easier to raise capital on favourable terms or sell the company at a better multiple.  Companies of this size will also be able to afford a strong C-Suite, with owner/founder successors, which all contributes to easier and more favourable terms for raising capital.

Conclusion

  • M&A sounds easy, but many companies don’t heed the lessons learned.
  • Your strategy (who the future customers will be and why they will be buying from your) and your strategic plan (how you build the future business model to achieve the strategy) may include M&A.
  • Conduct a fact based, sanity checked due diligence. The CEO’s advisory board should challenge the CEO’s thinking regarding the deal and its attractiveness.
  • Know up front what you’re willing to pay and don’t pay more than what value justifies. You may look at many opportunities before you close a deal.
  • Be clear on the principles or decision-making criteria before looking at a deal.
  • If multiple M&A is part of your growth strategy, create a standard M&A process and team (consisting of both internal and external resources).

Your next steps

There are 5 key questions to ask as you think about M&A.  The focus is on achieving a long-term business strategy and future business model, rather than targeting short-term, one-time potential cost savings.

  • What is your business strategy and future business model to increase sales, market share and profitability?
  • What gaps in your business strategy and business model need to be filled: by organic growth and by M&A?
  • Why will the acquisition be more effective than organic growth?
  • How will you be able to generate sufficient value from the acquisition to finance it and pay a premium for the acquired company?
  • How will you be able to generate more value from the acquisition than other bidders?

To enable discussion with your board of directors, CEO, and advisory board, download the following one-page slide:

How can M&A create value?

Footnotes

1 “The real deal on M&A, synergies, and value”, Boston Consulting Group, BCG Perspectives, 2016

Further reading

“The six types of successful acquisitions”, McKinsey, 2017 May

How can restructuring grow value?

Restructuring is often focused on short-term cost reduction, with workforce shrinkage playing a major role. There is the risk that restructuring addresses short term issues but does not position the company for long term value growth and preservation.

Step #1 Establish a common understanding of what success and business value will look like in the future.

Step #2 Set out the restructuring objectives, based on step #1.  These objectives will be broader than short-term financial targets and consider things such as: reputation, customer retention, employee morale & ability to attract employees in the future, and the need for long-term investments, etc.

Step #3 Assign accountability for achieving objectives to specific members of leadership.

Step #4 Assemble a plan, which includes both short-term options (e.g. terminating current and planned consulting projects, eliminating discretionary spending, staff reductions) and longer-term options (e.g. continuing to investment in projects with clear business cases to grow and preserve value, continuing with select innovation and trials, reviewing and revising the organizational structure.)

Step #5 This may well be the hardest step.  Determine the root causes of the need for restructuring.

  • What changes to the board of directors and board oversight processes are needed?
  • What changes to the executive team and the executive recruiting & development processes are required?
  • What changes to the resource allocation process are needed? Can resources be better allocated to value growth and preservation initiatives? What is the right blend of long-term and short-term resources to provide the agility to adapt to changes in the external environment?

And don’t forget the foundational questions:

  • Who are your target customers?
  • How do your target customers, in their hearts and minds, perceive your competitive differentiated value proposition?
  • What are your internal competitively differentiated delivery capabilities?

 

To enable discussion with your board of directors, advisory board and management, download the following one-page slide:

How can restructuring grow value?

How do you grow your company’s value?

Growing the value of the company requires growing the number of customers.  Depending upon your situation, you may focus on customers who are profitable in the short term or longer term.  There are four steps you can take, starting with growing customers and leading to growing shareholder value or value to the owners.

Step #1 Start by focusing on the customers.

Recognize that you are competing for customers. Agree on your company’s customer metrics e.g.

  • Target customer market share?
  • Customer recommendations?
  • Customer satisfaction?
  • Customer retention?
  • Customer perception of your company’s differentiated value proposition?

Also consider what internal capabilities need to be competitively differentiated in order to impact customer growth.  For example, having the best financial processes (rather than “good enough”) may not impact customer growth for every company.

It is critical to listen to customers.  If you don’t listen to customers and understand customers, then you won’t have customers who understand your company.  The 2017 Edelman Trust Survey for Canada showed that only 36% of people believed that companies listen to customers.  What an incredible opportunity for your company to differentiated itself and grow,

Step #2 Don’t forget to look at what is happening to the overall size of the market, and customers’ ecosystem.

It can be hard to grow the number of customers if the overall market is shrinking.  Blackberry may have 100% market share of customers who desire a physical keyboard, but that that does not help grow the total number of customers.

Step #3 Determine what the appropriate financial metrics are for your company.

Private Equity may be focused on free cash flow.  Other companies may be looking at asset value.

Step #4 Define how value is realized by the owners (often referred to as Shareholder Value)

Depending upon the company, owners may realize value via:

  • Dividends and share buybacks;
  • IPO;
  • Sales of the shares;
  • Compensation; or
  • Products and services provided to the owners.

Have a common understanding of over what time frame value must be achieved.  E.g.

  • 3 years for a high-tech start-up;
  • years for private equity buying an existing company;
  • 30+ years for a pension fund; or
  • Indefinite for a family holding company.

There can be risks in focusing on growing shareholder value.

  • The board and CEO may take actions which grow shareholder value in the short term but do not grow the number of profitable customers.
  • The perception of analysts and investors impacts shareholder value.
  • There can be actions which improve the financial metrics in the short term.
  • It can be easy to overlook customers and customer metrics.

To enable discussion with your board and management, download the one page slide How do you grow your company’s value?