A recent survey of CEO attitudes to their boards by respected commentator Jeffrey Sonnenfeld and his colleagues, shouldn’t' surprise anyone:
CEOs complain that boards often lack the intestinal fortitude for the level of risk taking that healthy growth requires. “Board members are supposed to bring long-term prudence to a company,” as one CEO says, but this often translates to protecting the status quo and suppressing the bold thinking about reinvention that enterprises need when strategic contexts shift.[i]
Consensus is growing that public company boards are too focused on compliance and are ignoring their role as creators of enduring value for the firms they direct.
But it's not for lack of will on their part.
The board’s role in strategy is considered the biggest issue for 67% of respondents to the 2012 Spencer Stuart US Board Index[ii]. PwC also report that three quarters of directors want to spend more time on strategy[iii]. Despite this, according to Heidrick & Struggles, 84% of directors of the top 2,000 largest publicly traded companies in the United States thought “they are now spending more time on monitoring and less on strategy” [iv]. This has resulted in only one-third of respondents to a 2013 McKinsey & Company report saying they have a complete understanding of current strategy.[v]
If directors have their eyes on value creation why is it that their feet are still pointing in a different direction?
It's because the system is not designed to create value. The set of corporate governance principles and practices we call "best practice" is producing too many “governors” focused on protecting value and not enough directors focused on creating it. Public companies have become over governed and under directed because corporate governance regulation and education is designed to ensure the "correct" board structure, process and composition rather than ensure "imagination, creativity, or ethical behavior in guiding the destinies of corporate enterprises"[vi].
This paper argues that in order to create enduring value, public company directors must go beyond governing and governance and also embrace “directing” and “directorship”.
Governing and Directing: Are they Different
Governance and directorship are two distinct systems of thought and action in the boardroom. Their difference lies in their attitude to value.
Governance protects value. Directorship creates it.
Think of governance and what comes to mind are thing like structure and process. The focus is on protecting and preserving financial value through maintaining control and managing risk. In contrast, directorship involves bold choices that create risk. Directing involves designing the ways in which all forms of value are created, making decisions of consequence and inspiring CEO's to lead their organizations into strength, resilience and endurance.
Here are four tests to help you decide where you stand on the question of governing and directing.
Governing for Shareholder Value Vs Directing for Firm Value
Corporate governance is described as the system by which companies are directed and controlled. But these definitions fail to mention who their directed and controlled for.
Sovereign wealth fund, Oslo based Norges Bank Investment Management, recently came out with a Note that should leave no one doubting the practical reality of what corporate governance means:
NBIM's goal is aligned with a commonly accepted definition of corporate governance, namely the way that suppliers of finance assure themselves a return on their investment.[vii]
Compare this position with Apple Inc’s attitude to suppliers of finance (shareholders) under the chairmanship of Steve Jobs.
Apple was directed and controlled for Apple.
Despite regularly being marked down on corporate governance, Apple was directed into market leadership, with no debt and a bank balance that made activists green with envy.
Put simply, Apple prioritized stakeholders based on their contribution to Apple's success.
This applied to everyone including shareholders. Apple ceased declaring dividends when Jobs returned to the Board. He also rejected calls to buy back Apple's shares. According to Warren Buffet: "He didn't want to repurchase stock", he continued "although he absolutely felt his stock was significantly under priced at two-hundred and whatever it was then". What Buffet knew is that neither he nor Jobs would "buy dollar bills for 80 cents" for as long as Apple and Berkshire Hathaway owned the mint. Though you can't blame Buffet for trying.
It wasn’t that Apple’s board was anti-shareholder – there were several lucrative share splits. Apple's directors put Apple first.
Jobs directed more than he governed. We even know what Jobs thought of governance types. When Jobs discovered that former SEC Chairman, Arthur Levitt, was a governance true believer, Apple’s board promptly retracted their invitation to join them.
Measuring Value Vs Creating Value
Governance traditionally measures value in dollars. The conservatives in the corporate governance community think of value in terms of the share price, whereas the liberals are more inclined to consider more sophisticated financial measures.
Nonetheless corporate governance is focused on cash value. Creating cash, measuring it, reporting on it and redistributing it in the form of dividends and increasingly buy backs. The audit committee and strong financial literacy are the backbone of good governance and the growing financialization of corporate governance.
But here’s the rub. A financial statement is a backward indicator. It will show historic revenues and costs but it won’t tell the board how to create the 5 other forms of capital a company needs to grow and prosper.
Directorship takes all forms of capital into account:
First, cash is not a synonym for value. Tom Graves reminds us value doesn’t mean cash. He goes on:
It’s utterly crucial, in all business contexts, to understand that money is only one subset of value – and that whilst all forms of value may interact, and may often be convertible from one form to another, not all forms of business-critical value can be converted to monetary form.[viii]
Second, financial statements are not a synonym for a business model. A business model describes the rationale of how an organization creates, delivers and captures value[ix]. That means all forms of value that a firm needs to prosper and grow. Key to this is that the more successful a firm becomes the less cash becomes business critical and is over taken by non cash forms value such as information, relationships, culture etc.
To create value, a director must first understand the difference between cash and value. Then she must be able to direct through the business model. That means that the decisions made, the support and help given to the executive and the organization are aligned with the objective of generating financial capital, intellectual capital, human capital, produced capital, social capital and natural capital needed to survive a hostile market.
There’s a good reason why Apple only raised capital once. After that, there were better ways to make financial capital.
Governing for Transparency Vs Directing with Discretion
Governance demands an open book when it comes to communicating the company’s ideas and strategies to shareholders. Information is the lifeblood of the investors business model.
Directing for value demands discretion. Again under the chairmanship of Jobs, Apple was notorious for its tight control of information and Apple prospered. This was no quirk of genius. The harder it is to see within a firm the harder it is to imitate its success.
Managing Risk Vs Creating Risk
From a governance perspective, risks are best managed. Deloitte's go as far as to put risk at the core of their proprietary governance framework:
Risk intelligence is at the center of an effective framework for corporate governance - and it lays the foundations for everything the board and management do to properly govern the corporation[x]
Governing for risk involves formulas and processes; setting risk appetite, formulating risk tolerances, adopting standards, delegating responsibilities, establishing risk committees, implementing risk programs and embracing the boards role of chief monitor of the corporation's strategic, operational, financial, technological and compliance risks etc.
From a directorship perspective, risks are best made by the board deliberately, consciously and focused on the return on the risk.
Every bold choice that is designed to create value also creates risk. Whether appointing a new CEO, acquiring a new business or pivoting the strategy, directing requires conscious and deliberate risk making.
Directorship embraces the best possible risk. Relying on a foundation of commercial intelligence to understand, negotiate, transfer, insure and price opportunity correctly, the director bakes the risk into all their decisions and choices. Risk and strategy are two sides of the same coin.
Risk management is necessary, but it is the second best solution to the problem of risk.
Governing For Value Creation
If you’re still wondering where you stand on the difference between governance and directorship, consider what happens when a governance expert sets out to create rules for creating value in public companies.
In August 2013, Professor Richard Leblanc, a popular commentator on boards of directors, published Forty proposals to strengthen: The public company Board of Director's Role in value creation; management accountability to the Board; and Board Accountability to shareholders[xi]. Following interviews with activist investors and private equity leaders, he formulated a series of reforms focused on addressing the “infirmities” identified by his respondents.
To the Professor's credit he accurately identifies that public company boards are too focused on compliance and are forgetting value creation and company performance. But what then follows are highly prescriptive recommendations of what director "shall", "should", "must" and "must not" do to create value.
And though the words "value", "value creation" and "value creation plan" are liberally applied to each page, what value really means is to be found in a footnote. In line with his peers, he reaches for a definition that describes value in purely financial terms.
The Professor's recommendations to create value are formulaic - Reduce the size of the board, Increase the frequency of board meetings, Limit director and chair overboardedness, Increase director work time, Focus the majority of the Board time on value creation and company performance, Increase director roles and responsibilities relative to value creation, Increase director compensation to long-term value creation and individual performance.
At one stage, he invokes bureaucracy when he proposes the "the Value Creation Committee":
"The mandate of the Value Creation Committee shall include the development of a longer-term value creation plan, which shall include non-financial performance metrics and holding management to account; integrated reporting; and oversight of all non-financial risks"
These are recommendations that only a manager could love.
The Professor had approached the question of how to create value as a manager might solve the problem. Creating processes, mandating policies and emphasizing accountability.
Reading all forty recommendations it became clear that not only did a managerial thread run through his work, but that managerial type thinking ran through corporate governance. Corporate governance sets a distinctly managerial "tone" at the top.
Has no one noticed the obvious similarities between the mindset expected of a good manager and a good governor? I don't mean the work of the manager but the work ethic and psyche.
Governing and managing are both about creating and following processes. They're both adverse to risk and promote control through formal structures and accountability. They're both more comfortable counting value than creating it. Governing is a variety of managing in the boardroom.
Not that governing is a bad thing. There is a time for managerial thinking in the boardroom. But it is an expensive and counterproductive mistake to think that a director can govern for value creation.
Directing For Value Creation
To create value for their organizations directors must approach their work not as managers, but as leaders. Directorship is a variety of leadership in the boardroom.
Great directorship approaches value creation with imagination and requires that boards design how their organization create, deliver and capture real value (including cash), make decisions of influence and inspires and motivates the CEO and their team to execute on their shared vision.
Value creation at the board level requires the characteristics of leadership, not management. To rephrase Kouzes and Posner five characteristics of leadership [xii], exemplary directorship requires that directors (a) model the way; (b) inspire a shared vision with the CEO and their team; (c) challenge the process; (d) enable the CEO and their team to act; and (e) encourage the heart of the CEO and their team.
New research supports the need for directorship:
Olubunmi Faleye and his colleagues suggest that the most favorable conditions for value creating innovation occur when boards do not govern intensely but instead focus on strategic advising.
Marc van Essen and his colleagues conclude in their paper Does “Good” Corporate Governance Help in a Crisis? The Impact of Country- and Firm-Level Governance Mechanisms in the European Financial Crisis, that the mechanisms of good governance proved dangerously restrictive during the global financial crisis. According to the authors "The tendency to respond to a crisis with more stringent rules may be counterproductive since such measures may compromise executives' ability to respond appropriately to systemic shocks. Practitioners are encouraged to optimize rather than maximize their governance choices".
Directing for value requires that the board does the right things. Governing for value protection is about doing things right.
Once again, Apple may yet provide the proof that governing and directing are different.
The Succession of Arthur Levinson to the chairmanship of Apple’s board, has seen Apple putting its shareholders first. Increasing dividends, retiring up to 60 Billion dollars of shares through share buy backs and raking up billions of dollars of debt in the process. Levinson and Tim Cook are also opening the book at Apple. Apple is now the only one of its major competitors to break down the sales of its product. This is radical corporate governance by any measure and only time will tell if governing under Levinson will create as much value for Apple as strong directing did under Steve Jobs.
The DLMA Matrix ™
To capture the similarities between directing and leading on the one hand, and governing and managing on the other, I’ve developed the following matrix.
The DLMA Matrix is made up of a horizontal axis that represents Value Creation ("do the right thing") and Value Protection ("do things right"). The vertical axis has the Board on the left and the Executive on the right.
Below the line:
Assurance, in the form of best practice, involves formulas and processes, monitoring and oversight, setting risk appetite, etc. From this point, the board and the executives share managerial characteristics. While not crossing the line into management roles, boards tend to approach their assurance work with a managerial mindset.
Above the line:
Directorship means leadership in the boardroom. The Board and the Executive have complimentary and collaborative leadership roles. They make different decisions, pull different leavers, but Boards that lead and Executives that lead share the same objective of creating the greatest possible value for their firm.
Here We Go Again
Drawing a parallel between leading and directing on the one hand and governing and managing on the other will no doubt evoke the tired old debate as to which is more important.
For my part, I respect the value of appropriate governance and I’m not suggesting that one is better than the other. Governing and directing though distinct, can still be complimentary systems of thought or action. Each has a vital role to play in its time. Strong directing and weak governing, though preferable to the reverse, can equally undermine or destroy value.
The challenge is that while a balanced approach to governing is not bad, the attitude of many within the corporate governance community is at best, unhelpful. The most vocal advocates for corporate governance stubbornly refuse to consider, let alone believe:
There is more to the boardroom than governing and governance;
Their single minded "shareholder takes all" approach is distorting capitalism in ways that have sadly moved beyond imagination and into our lives.
Until we see a change of attitude amongst these men, women and institutions, a great many boardrooms will remain locked into the contradiction of wanting to create value for their organization but spending more time protecting value for its shareholders.
But for those who don’t need permission from lawyers, activists or any other members of the corporate governance community to compete, the opportunity is there to embrace directing, directorship and the DLMA Matrix ™ to your firms enduring advantage.
Remembering Abraham
You may recognize the debt this paper owes to Abraham Zaleznik, the Harvard Professor who, in 1977 wrote Managers and Leaders: Are They Different? [xiii]
Though we take the difference between managers and leaders as integral to our understanding of management, the Professor’s obituary reminds us that this wasn’t always the case.
Zaleznik's analysis was so out of keeping with the common belief at the time that managers and leaders were one and the same that it evoked cries of disbelief from business people and academicians alike. In the years since then, however, the wisdom of Zaleznik's words has won acceptance, as companies scramble to fill their ranks with change agents. [xiv]
All that we need is fraction of the energy that Abraham Zaleznik released all those years ago, to start the debate about whether governing and directing are different.
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* This is a pre-print version of Governing and Directing: Are They Different. (c) 2013 Tunjic
** an updated version. Thank you to everyone for your suggestions and improvements,
[i] http://hbr.org/2013/04/what-ceos-really-think-of-their-boards/ar/1
[ii] http://content.spencerstuart.com/sswebsite/pdf/lib/spencer-stuart-us-board-index-2012_06nov2012.pdf
[iii] pwc.com/us/en/financial-services/events/assets/pwc-annual-corporate-directors-survey.pdf.
[iv] Heidrick & Struggles, “10th Annual Corporate Board Effectiveness Study 2006-2007” (Los Angeles, California: Heidrick & Struggles and USC/Center for Effective Organizations, 2007).
[v] http://www.mckinsey.com/insights/strategy/improving_board_governance_mckinsey_global_survey_results
[vi] Adapted from a comment by Abraham Zaleznik in Zaleznik A.Managers and leaders: Are they different?HarvBusRev2004;82(1):74-81
[vii] http://www.nbim.no/Global/Documents/Dicussio n%20Paper/2012/DiscussionNote_14.pdf
[viii] http://weblog.tetradian.com/2013/07/08/bmcanvas-beyond-startups-1/
[ix] OSTERWALDER, A., PIGNEUR, Y., & CLARK, T. (2010). Business model generation: a handbook for visionaries, game changers, and challengers. Hoboken, NJ, Wiley.
[x] http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/US_AERS_Governance_%20Framework_102412%20Final.pdf
[xi] International Journal of Disclosure and Governance advance online publication, 15 August 2013
[xii] KOUZES J, POSNER B. (2007) The Leadership Challenge. 4th ed. San Francisco, CA: Jossey-Bass
[xiii] Zaleznik A.Managers and leaders: Are they different?HarvBusRev2004;82(1):74-81.
[xiv] http://www.hbs.edu/news/releases/Pages/abrahamzaleznikobituary120111.aspx