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Does your start-up need a board?

So you are the founder, you had the idea, you probably are the best to know where your  company needs to go…why should you involve anybody else in managing your company?

Particularly at a time when big and successful companies like Facebook and others have kept voting rights in excess of their economic stake after an IPO, isn`t it justified to avoid granting control to strange people?

Johanne Bouchard recently depicted how boards are at Unicorns, (1) these powerful but still at an early stage in their life companies. According to her, they use to be smaller, usually made of (relevant) investors and founders and other executives, (equity ownership at the board usually high), so that its leadership style adopts the shape below; these boards spend their time in value creation and growth related issues, which is perhaps their most relevant difference with mature or consolidated companies,  where (broadly speaking) compliance topics may reign. So, why should a founder have a board at all, particularly when the company hasn`t received large amounts of VC or early funds yet, when only you, your family and friends have contributed to launch the project? Read more…

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Visionary Board leadership. Stewardship for the Long term.

December 11, 2013 Leave a comment

What are the areas where boards need to focus on to help the company increase its long-term value?

In this post we will comment the article by the CFA Institute “Visionary Board leadership. Stewardship for the Long term”, by Matthew Orsagh, CFA, CIPM. (1)

They try to describe Visionary Directors: directors that are “committed to working with management to make a company successful in the long-term”. In other words, a Visionary Director does not allow for “corner-cutting strategies to meet fleeting short-term expectations”. Directors, (if properly embedded in visionary boards) strengthen leadership and foresight to fight against the short-termism reigning in the boardroom.

There are some areas in which a director can make a difference; (i) for instance, if he/she develops and appropriate role in strategic planning and oversight; (ii) if they correctly define the risk appetite of the firm, if they ensure an Enterprise Risk Management system is in place and they oversee its execution; (iii) if they establish Compensation systems that push employees and managers to long-term value creation; (iv) or if they define the correct long-term culture of the firm. Read more…

Who should sit on Corporate Boards (I): Industry Experts

Industry expertise provides a better understanding of risks, opportunities, regulatory environment, and competitive landscape. It is a general belief that directors should provide the boards with industry experience, perhaps only second to financial knowledge.

But, does it really improve board effectiveness? What else is necessary, or when is that assertion correct?

Faleye, Hoitash and Hoitash find evidence that industry expertise enhances firm value, while taking companies to better innovation results, by facilitating and bettering organic investments results, (on the other hand, there is not a correlation of industry expertise and firm value generated from acquisitions).

Industry expertise also provides a higher connectedness, through the directors`s connections and relationships in the industry and the regulatory bodies, which can be of a certain firm value relevance in certain industries, where regulation is demanding and local activities are predominant.

Dr Richard Leblanc, in his “Banking directors need to be at the top of their game” post, highlights the fact that directors in Lehman Brothers were well past their retirement age, so probably outdated on the complexities of the new financial products. So, when assessing the capacities of directors, “current experience” is also needed, not just “experience”. Just taking the example of the Online Display Advertising”, as a fast-changing industry, we will recognize the absolute need for this updated directors`expertise. Please look at the enclosed video by the industry association IAB, and be aware of the changes that took place in just ten years. Past experience would have become irrelevant in that time. (http://www.iabuk.net/video/the-evolution-of-online-display-advertising).

Dr. Richard Leblanc in his Corporate Governance blog points out that lack of industry expertise is one of the reasons why boards lack the courage needed to “do what is needed”, however disruptive it is to the company history or management. Just think of Kodak, and so many other firms, that failed to see what seemed to be evident for many others, except for management, and perhaps to a complacent board lacking industry expertise to be opposed to that of managers, who obviously somehow captured the board.

“People/director of one listed company should not be independent director of another listed company, and it should be clearly defined in the corporate governance guidelines,” Dr M Baki Khalili, the research director of Centre for Corporate Governance and Finance Studies (CCGFS) of Dhaka University, told bdnews24.com: “Experts alone should be independent directors, otherwise the whole purpose of having independent directors will be defeated,”.

Gregory Pratt, a President of the Capital Area Chapter of the National Association of Corporate Directors, says”The role of industry expertise in determining proper governance is a central piece of the puzzle going forward”.

But, what`s the real life of boards regarding this particular point? There are several studies on this subject, and for instance, one made by GovernanceMetrics International outlined that in each of the US largest companies, at least two directors had outstanding industry experience. Regulation should probably not go further than that, for several reasons: first, diversity could be hit by a general industry expertise requirement; second, a board could turn to be “parochial”, or forced into the kind of “groupthink” that so much harm causes to companies; third, not introducing members from nearby industries, or from industries with similar features, (regulatory pressure, growth path, etc), condemns the firm to lose that part of the picture; fourth, a board is charged with decisions not always connected to the industry strategy or facts, but also to accounting, law and regulation, crisis management, and a board only made of industry experts would eventually fail to satisfactorily comply with its duties.

As Richard Levick points out in Forbes: Whom would you need on the board in an accounting scandal, in a product recall, in a FCPA (Foreign Corrupt Practices Act) probe? How much actual knowledge of your specific markets will your directors need in such eventualities? Alternatively, how much of a broader world view would be needed?

To end up with, let me cite a McKinsey & Co. 2006 report saying: “…in our work with boards we find that too many simply lack directors who have industry expertise to participate effectively in shaping strategy… We believe that on a board of, say, a dozen directors, a litmus test of strategic energy is the presence of at least three or four members who have deep industry expertise in the core business and market conditions the company faces……… Once that expertise is in place, other board members can be screened for deep functional or geographic expertise” (Carey and Patsalos-Fox, 2006).

Bibliography:

Faleye, Hoitash and Hoitash: Industry Expertise on Corporate Boards.

Richard Leblanc: Why Corporate boards lack courage?, in his blog: http://rleblanc.apps01.yorku.ca/

Richard Levick, on http://www.forbes.com/sites/richardlevick/2011/11/10/icahn-oshkosh-and-a-persistent-question-should-board-members-be-industry-experts/?goback=.gna_3834048

Shaping strategy from the boardroom, by Carey and Patsalos-Fox, 2006, McKinsey Review.

The risk oversight function of the Board

December 9, 2012 Leave a comment

The number of yearly bankruptcies (generally low), shows that management-led enterprise risk models are not always effective, if they exist at all. But in many other cases, underperformance and loss of shareholder value are the consequences of that failure.

 

Traditional Corporate Governance models establish that “the board cannot and should not be involved in actual day-to-day risk management. Directors should instead, through their risk oversight role, satisfy themselves that the risk management policies and procedures designed and implemented by the company’s senior executives and risk managers are consistent with the company’s strategy and risk appetite, that these policies and procedures are functioning as directed, and that necessary steps are taken to foster a culture of risk-aware and risk-adjusted decision-making throughout the organization”.

 

What is the objective of the Risk oversight role of the Board:

 

We can identify the following two:

 

  • Preserving the viability: the bankruptcy case, even if it needs to be considered, is not generally in the path of most companies.
  • Improving shareholder value, is what really should bother directors. This is the main risk oversight role of directors.

 

Where does the oversight risk role of the board come from?

 

This board`s task comes basically from regulations on the role of directors:

 

a)      Directors`fiduciary duties: directors comply with their obligations by assuring the risk management oversight adequate systems are in place. Provided this is in place, the level of risk-aversion adopted by a company, is covered by the business judgement rule, which means directors are not responsible for the effects of risk, but only for a “sustained or systemic failure” to exercise oversight.

b)      Other: Other laws, listing requirements, sector-specific regulations.

 

What is the role of a board? Is that role the same, whatever the risk?

 

It is generally agreed that Boards are responsible for:

 

  • Determining the company`s approach to risk, the risk appetite or tolerance, and its relationship with expected rewards for the company, and for managers.
  • Setting the right culture throughout the organisation,
  • Assuring the material risks the company faces are identified, (dynamically) reviewing the risk categories and their interrelationships.
  • Assuring the company has risk strategies tailored to the company`s risk profile, strategy, and the kind of material risks confronted.
  • Reviewing with managers: the independence of the risk management function, the risk policies in place and their implementation, and all external reports, as necessary for the risk function.
  • Assuring risk is integrated into business decision-making throughout the organisation, and the adequate information flow systems are in place.
  • Transferring relevant information on risks to managers and committees.

 

Nevertheless, there are certain areas where a deeper role is recommended. In particular, where managers cannot be relied on to do a good job, for different reasons, as in the case of risks associated with leadership and strategy, for instance.

 

Strategic Risk: it can be defined as that risk that may most severely affect shareholder value, prevent the company from reaching its objectives, and even from surviving. Thus, directors need to challenge managers about the risk to the proposed strategy, particularly coming from external factors. The first step is a continual strategic risk assessment. There are several steps to properly deliver it, (understanding strategy, obtaining data, prepare risk profile, develop strategic risk management action plan, communicate both, and implementing the second), and it should be embedded in the management team. The second step is integrating risk management in strategy setting and measurement processes, (following Kaplan and Norton`s “The Execution Premium” could help).

Leadership: it is understood the board is responsible for assessing the performance and leadership capabilities of managers and particularly the Ceo.

 

How should the Board execute its oversight function?

 

Many boards delegate the function to the Audit Committee. Separate Risk Committees are not common out of the financial industry. Sometimes, several committees are responsible for the risk oversight role, (when different relevant risks are present), which requires some kind of coordination. In any case, the board should engage annually in a review of the risk management system, probably with external help.

 

Flow of information

 

The board needs to assure there is enough information flow about risk and risk management procedures, and gather this information from managers directly, if necessary.