What’s a typical independent director’s worst nightmare? My guess is that while a poor balance sheet might cause restless sleep, it’s the thought of an incorrectly reported balance sheet that brings on night terrors. It’s not surprising. Remember the public shaming – and heavy sentences — heaped on Enron and Worldcom for their accounting (and more importantly, ethical) failures?
In the years that followed these and other corporate lapses, our networks of C-level executives report that many boards have become far more focused on minimizing risk than on seizing opportunity. This is not surprising: Growing regulation, increased investor focus on governance issues, and scary new categories of corporate risk (e.g. cybersecurity) create two notable challenges for the modern board. First, directors face a real challenge in making sure that protection and alignment of key governance and risk management issues doesn’t crowd out equally important dialogue around strategy and operations. And second, they need to ensure that – even with respect to strategy and operations – board scrutiny doesn’t result in an over-emphasis on conforming to benchmarks and industry norms.
I’m not against benchmarking and norming. In fact, since our business is a global leader in assembling rich data sets that allow companies to benchmark almost every imaginable driver of corporate performance, we’d argue that there is too little analytic rigor in most areas of corporate management – particularly those which involve teams and people. Most boards would benefit from richer data sets that compare their company to others. But in an era where governance and risk agendas are driving board conservatism, there is real risk that these data sets will be used to drive conformity, not evaluate strategy.
The best companies do things differently by using data and benchmarks not to aspire to the median, but to ensure radical deviations that are consistent with core strategies.
Let’s take pay. While benchmarks are useful inputs for compensation decisions, they shouldn’t be a straitjacket. Applying them broadly without reference to your talent strategy could make it impossible to source or retain the people you need to achieve goals. If your strategy relies heavily on aggressive M&A, for example, do you really want a CFO who doesn’t command a salary higher than the norm? Or if your success relies heavily on IP protection or patents, it may make sense for your general counsel’s pay to be the highest in the C-suite.
And what about tax rates? If you have a stated strategy of growing in the government sector, or a vocal commitment to social and civil society vital to your brand, it may make strategic sense to have an effective tax rate significantly higher than the norm. Letting your ETR slip to the benchmark could risk your customers’ trust. But a relatively unknown, unbranded intellectual property company – with far less to lose – might be much more aggressive in minimizing taxes.
Benchmarking and norming won’t always lead to the right decision. Company strategy – and what makes the organization distinctive – has to come first.
Now is the time for directors and executive committees alike to re-balance the strategy-governance scale. They need to ensure that the right decisions are being made and that every director can defend those decisions when investors come calling with strategies of their own.
The understandable growth of risk management functions and their ascendancy in influencing strategy is important, but only part of the story here. Something more basic is at play, highlighted by Larry Fink’s annual Blackrock shareholder letter, where he called for better partnership between corporate leaders and their boards in setting a viable long-term course together. While this may seem like something that should be table stakes for any competent C-Suite and board, anyone who has sat in on a “strategic planning session” knows how often these sessions get derailed into short-term, operational discussions focused on the current “fire.”
I think the reason this happens is a misunderstanding over what constitutes the biggest threat to a company’s future. Obviously, no one wants to miss a short-term forecast or sales goal. More costly, however, is diverting resources to overcorrect near-term headaches at the expense of the time and energy needed to plan for the long term. In fact, investors are far more likely to assert themselves when they sense a lack of a coherent long-term strategy rather than a single missed sales forecast.
To keep their leaders centered on this reality, the strategy team at a prominent software and technology firm does the legwork upfront to educate its executives on the nature of long-term, strategic planning. By developing a protocol that allowed executives to evaluate their own proposed agenda items against a checklist of strategic goals (one-year-plus time horizon, relevance to major strategic initiatives, cross-functional impact, etc.) the firm measured a 75% increase in time spent on relevant subject matter during long-term, strategic planning meetings. Our research found companies with effective long-term planning processes are three times more likely to perform in the top 20% of their industry.
While boards have an opportunity to partner with executive teams to position for the long-term success of a company, unfortunately data show that directors are often more persistently focused on short-term issues than even the most assertive investors. Forty-six percent of executives and directors surveyed by the think-tank Focusing Capital on the Long Term noted that the board was a major source of demands for short-term results, more than 2.5 times those who mentioned investors in the same manner.
For an organization’s governance model and its business strategy to be in lock step, CXOs need to help directors understand and meaningfully engage in setting the company’s strategic direction. This means the C-suite must be able to develop productive relationships with board members—even have the skills to ‘coach’ directors on how to manage conversations with shareholders. Directors in turn need to monitor the company’s operational heartbeat closely so they can make informed decisions about when to play it safe and when to dare to deviate.