What’s Wrong With Director Selection at Public Companies?
Every Criteria is Used Except for Those That Would Make Boards Great
The public company governance model in regard to company performance and value maximization is at best suboptimal. This includes, but is not limited to, director selection criteria.
The recent debacle with General Electric is a case in point. While myriad issues fueled the decline of GE, at the core of this downward spiral was the board of directors. The GE board was populated with captains of industry, had gender diversity and ticked a number of other “good governance” boxes. Yet only two of its 18 board members, Ed Garden, who only joined the board in late 2017 and Jonathan Tisch had strong capital allocation skills and track records. In any company, capital allocation is important, but at GE, with its conglomerate structure, it should be a non-negotiable core competency.
In today’s public company governance model, the primary selection criteria for boards is “independence,” based on mandates established after a handful of scandals including the collapse of Enron around 20 years ago. By all accounts, this focus on independence originated with benevolent intentions; however, it has devolved into “independence for independence’s sake,” creating boards that underperform relative to their potential. I talk about this and the context — the underperforming public company governance model — in my book, Governance Arbitrage: Blowing Up the Public Company Governance Model to Maximize Long Term Shareholder Value.
The late iconic venture capitalist Tom Perkins summed it up well in The Wall Street Journal: “It is not practical, you see, to have a retired employee on his or her former employer’s board these days, even though such people might have great strategic insight into corporate problems. Why? Because they aren’t independent. So where can good directors come from? Easy! A Compliance board director can come from anywhere!” And, as Warren Buffet recently pointed out, most independent directors are not really independent. Paid substantial board fees and hoping to obtain additional board roles, these board members are not going to rock the boat because if they do, the CEO is not going to recommend them for other board seats.
What is glaringly missing from public company board selection criteria is competence and the right mindset related qualities But this is not just any competence or mindset For example, just because an individual is or has been a CEO does not mean that he or she has the right experience and track record to serve on a particular board. Instead, if the intent is to maximize the asset value of the board rather than it serving as an underperforming oversight body, then the competence needed for public company boards is far more specific. And for each specific category, the right candidate should not just have experience. He or she should also have an extensive track record of performance increases and value creation in the particular category. For clarity, the intent is not for each director to have the experience and track record in all three categories. Instead, one or more directors should fall into the “industry” category, one or more into “specific value drivers” and so on. The following, at minimum, are the categories for director selection:
● The Company’s Industry –This should be recent experience and track record. The pace of change is too rapid for value to be derived from roles in the distant past.
● Specific Value Drivers — Look for directors with experience and track record in a field or discipline that is critical to the company’s value maximization plan (assuming it has one — that is another story also related to the shortfalls of the current public company governance model). On most boards, there will likely be a need for different directors that have the talent needed relative to the company’s major initiatives and value drivers.
● Sophisticated Investors/General Value Creation — As an example, the best private equity professionals have experience and track record of value creation, including capital allocation, across multiple businesses and industries, and that is one of the many reasons why the private equity portfolio company governance model is so robust. PE executives are not the only individuals who have this talent but provide a good example of this essential director competency.
Moreover, two characteristics should be expected of all board members regardless of which of the categories they fill:
· High Performance Mindset & Ownership Mentality — If you took a survey and it was answered honestly, how many board members would say that the primary reason they joined a board was to help maximize the value of the company? Yet, that is the only reason that is rational for joining a board and it is automatic with individuals with these qualities.
● No Nonsense Mental Toughness — Mental toughness is required to hold management accountable for targeted results both short and long term. (Done right, the short term will be a stepping stone toward the long term.)
As long as current regulations remain in place, independence will remain a required criteria for director selection at public companies. And, likely, there will continue to be a push for criteria not necessarily defined by competence that have entered into the process of late: gender and age diversity. But none of this should supersede the primacy of competence. Further, in the context of the competencies needed, the search processes should be wide open with absolutely no restrictions related to gender, race, ethnicity etc. Otherwise, the pool of candidates may not align as closely as it should with a company’s needs.
And keep in mind: Selecting directors based on competence neither guarantees nor precludes gender or any other “balance” on boards. Recently, I was involved with the selection of directors for two new boards. The first was for a company that was seeking outside capital for the first time. We clearly defined the specific competencies needed and launched a search. The end result? The new board was comprised of 60% women and 40% men, and I was the only board member over 50 years of age. The second board was for a public company that had been taken private. Using clearly defined competencies as the only selection criteria, this board ended up 100% men, and half were over 50.
Will selecting directors based on competence fix public company boards? No. It is a part of a much larger puzzle. To piece it together, investors (and boards) must first recognize that the current public company governance model is suboptimal in regard to optimizing capital allocation and maximizing company performance and long-term shareholder value. The former GE board is the poster child for this model albeit an extreme one. What is needed is not just an improved selection process but a radically new governance model that maximizes the full asset value of the board resulting in the development of the full potential of the company being governed.
