Selker Leadership

In our third segment in the continuation of our latest Leadership Interview with Dick Foster, he discusses the role of a board of directors in ensuring a company and its leadership actively engages in the process of challenging their conceptions of themselves and their competitive markets; and in evaluating the CEO and senior team.

Greg Selker: What is the best way that a board of directors can participate in making certain that both their leadership is adept at changing their mental models, or if not, that the members of the leadership team change?

Dick Foster: The board has a very important role to play, but we need to be clear that I think boards only have a very few functions, and they are there to govern, not to manage. But one of the acts of governance is, “who is the top guy? What should they be doing? How adequate are they and when’s the right time to bring on a new one?”

I think boards need to be thinking about just the kinds of issues you and I have been talking about in terms of how they are evaluating their own CEOs. If their CEO is not changing in tune with the times, then the direction the company ends up heading is not going to be pretty. The board is the one with this responsibility, which means they have to understand the business. They have to really know the people that are running the business. They have to have a perception of these things.

They presumably should know what the alternatives are and should be. And if they don’t have a little list in their pocket of possible replacements, I’m not sure they’re doing the right job. Not that they need to look at that list all the time but they should think about it all the time.

Greg Selker: It sounds to me like boards of directors need a major re-education.

Dick Foster: I know some companies are better at it than others. This should definitely be on a board’s agenda and boards need to understand how they are going to do this. Judging the CEO and the team at the top only by their operating efficiency will turn out to be both narrow minded and costly. They have to think about the ensemble of abilities at the top to create, operate, and trade at the pace and scale of the market without losing control, to go back to my favorite sentence.

Greg Selker: I would think another factor that needs to be added to this is to evaluate the degree to which the CEO and senior team are adaptable and flexible in their thinking. What are their mental models and can they change and adapt with the changes that are occurring with the times?

Dick Foster: Yes, it’s essential because if they don’t adapt and change, someone’s going to come along who’s going to be more competitive and it’s over, so that’s absolutely correct. I’m willing to listen to all of the arguments about how the pace of change is slowing down. I just don’t see any evidence of it and I’ve looked pretty hard.

Greg Selker: Given that this is one of the critical priorities, perhaps maybe even THE critical priority for a board of directors, what have you discovered are some of the best ways for an individual board director and for a board of directors to get their arms around this level of insight and data about their CEO and the senior team?

Dick Foster: I think first of all they have to talk about it collectively as a board, then they have to decide who has got the monkey here, and I think of several key committees. There’s obviously the comp committee, which is a key place for doing all of this. The comp committee has to figure out how to operationalize these things. The first question is, how do we evaluate and compensate the CEO? My own personal belief is the comp committee should look at the CEO, and at most two, three or four others in the organization, and make sure that the perspective on these people, the ways of measuring them, and the information is correct.

The audit committee is obviously another key board group. Their role is different. It is to ensure that all the information necessary to evaluate the CEO and the entire business is accessible. That this information is provided without errors of omission, or commission, it is provided in a timely fashion, and is accurate and forthright. So while the audit committee plays an important role, it is a very different role than that of the comp committee.

The nominating and governance committee also has a very important role in making sure that the processes of the board itself are working correctly. If anybody’s going to judge the effectiveness of the compensation committee, it’s the nominating and governance committee. They’re the ones that should be and that generally have the monkey on their back to say when a member of the board should move off, when a member of the board should move on, and what, by the way, are we looking for in new members for the board? What are their job specifications, and how do we compensate and evaluate them? All of this falls to the nominating and governance committee, so I see them playing a very crucial role.

Greg Selker: You’ve described the mechanisms in which the evaluation can occur. Do you have any comments about the evaluation itself, and what you believe are perhaps some “best practices” of making that determination on the caliber and quality of the CEO and the senior team?

Dick Foster: There are two schools of thought on this and I’m probably in the middle. One view is, if you can only get one measure of performance, pick it. Mid-income growth, return on invested capital, whatever it is. Hold their feet to the fire on that, and anything else is unnecessarily complex. It just gets in the way, and by the way, allows people too many escape hatches to get out of it. So pick one measure and make it right.

The other extreme has been pursued by a number of academics. This is multidimensional evaluations, corporate scorecards, and that entire sort of thing. These can have a lot of value, particularly further down in the lower operational levels of a corporation where you have a large number of departments, with entirely different functions and different performance parameters, all of which need to roll up to the top. However, if you do that at the CEO level, you can easily end up with 20 or 30 measures of performance and your chances of getting a little bit twisted in your socks with this kind of mechanism is pretty high. So I’m not an advocate of extending this methodology that far.

For me, a third key measurement is margins. Is the company’s margins increasing or decreasing? With those three measures I can have a pretty good sense of how the company is growing and therefore what the CEO is doing. I tend to favor a limited set of measures, more than one but less than five, and apply it to the top three or four individuals.

Greg Selker: But how do these measurements give you insight into the adaptability and the flexibility of the CEO and his or her willingness to break apart their own mental models and take on new ways of looking at themselves, their company, their business, and the world?

Dick Foster: There’s a stunningly good question. I think what happens is “life”. As you put these measures into place, life never works out like you think it’s going to work out. You’re given challenges against what you intended, and the CEO has to make tradeoffs. For example, our margins have been growing, but this year it doesn’t look like it’s going to be the case. If I keep the prices high enough and even push for price increases to keep the margins up, my growth is going to fall. By the way, I know that I should be spending more on marketing but if I do, I’m going to take my fixed costs up. I want to keep my fixed costs down, but that won’t let me grow, and if I keep my prices high I’m going to get killed. These are all tradeoffs.

You watch the executive team during the year identify these tradeoffs. By the way, nobody ever implements their plan exactly as they put it down on paper. So you watch how they react to the challenges they confront. And as a board, you have to have your own idea of what the best approach is given the circumstances.

What is our objective here? What are we trying to present?

You don’t necessarily want to protect shareholder value every day, every week, every month at all other expenses. There’s a misperception out there that the job of the board is to represent the shareholders. That’s actually not true, at least according to the American Bar Association, and I take them as a pretty good guide. The ABA’s Committee on Corporate Law produces The Corporate Director’s Guidebook, which I’m looking at right now which is why I’m able to recite it. I keep it on my desk because it’s really a good book. And it says, “the duty of the director is to the company, to the best operation of the company.” There are many times when that is synonymous with the shareholders’ best interest, but not always. Particularly, when the company’s long-term best interest is not synonymous with the shareholders’ short-term best interest.

The responsibility of the board is to the long-term health of the corporation. In order to evaluate whether the CEO is making the right tradeoffs, the board has to have its own sense of what these tradeoffs ought to be and how they would react to these circumstances. And the board has an obligation, therefore, in their governance responsibility and duty of care, to have those dialogues with the CEO and work out what they think is right. If the CEO goes in another direction, they need to express that in the compensation and evaluation of the CEO. Eventually, if they feel strongly enough about it, they need to replace the CEO. That crosses over the line of governance into management, but I think that’s the one exception.

That’s the ultimate judgment the board has to make and if they’re not doing that, it’s up to them to determine the options and to move on those options. I think it’s the one management act that a board has.

Greg Selker: What can a board director or a board of directors can do to better equip themselves to deal with these issues, not only of evaluation, but also governance and management?

Dick Foster: First of all, they have to educate themselves on it and I think they have to be clear of their own purposes. I’m a big fan of charters for each of these three major committees, and maybe a charter for the board itself. Write these things down so that there can be no misunderstanding about what the purpose and role of the board is within the individual corporation. I think that’s a very important but hard thing to do. I think that more and more corporations should do this over time.

I think executive session is a very important way to do this so the board can talk without management being present. You get different answers in executive session than when you’re talking with management there. I’m all in favor of periodic board retreats with thoughtful people about these issues. There are some very good people around the country, and, as you know, there are many board trainings. I think some of them are quite good. These all represent good opportunities for the board to get away and to consider these alternatives.

Finally, I think turning over the board itself is very important. What are the policies for staggering and bringing new people on? This is a critical way to bring new ideas and insights onto a board.