1 What do you DO when you get there? The Activities of a Value-Adding Board Dr. Ivor Francis “Activating Intellectual and Investment Capital” [email protected].

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What do you DO when you get there?

The Activities of a Value-Adding Board

Dr. Ivor Francis

“Activating Intellectual and Investment Capital”

[email protected]

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What do you DO when you get there?The Activities of a Value-Adding Board

1. Activities, not Structure

2. The System is the Star

3. A System of Value-Adding Governance

4. The Process Part: The Essential Functions of a Company & Board

5. The People Part: The Structure of Boards

6. Quality in the Boardroom

7. Separation of Powers

8. Resolving the Independent Director Dilemma: Three Options– The Expert Board

– Compound Boards

– An Assuring Board: the Value-Adding Board

9. Assessing a Competitive Board - A Business Capability Audit

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Justice Owen, HIH Royal Commission: The problem behind dysfunctional boards -

Activities not Structure

• "adherence to an appropriate governance model will not in itself guarantee the success of the corporation."

• "There were defects in HIH’s model but I suspect that HIH would have measured up reasonably well if its corporate governance system were checked off against most of the codes I have seen.“

• "The identification of the background, skills and experience of the people who will walk into the board room is a good start, but it is what they do when they get there that is critical” - essential functions of a board

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1. Activities not Structure

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Talk of the Town (1620)

• mismanagement at the biggest companies• insider trading• misstated profit & loss accounts• excessive remuneration of executives• the need for accounting standards• the role of hedge funds• the need for independent directors• shredding of internal documents• directors and officers liability insurance• socially responsible investing

Paul Frentrop, A History of Corporate Governance, 1602-2002, translated by Ted Alkins, Deminor, Amsterdam 2003

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Galileo: Founder of Modern Science

• Theory

• Deduction

• Observation

• Induction

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In the wake of corporate disasters of recent years

• “A crisis of corporate governance”

• Guidelines for enhanced structures for boards

• Independent directors

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Corporate Governance Guidelines

• Some version of structural guidelines is– necessary, but not

– sufficient

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So, more important than the guidelines is the accountability for adhering to them, e.g.

• Adelphia• BHP Billiton

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Justice Owen, HIH Royal Commission: The essential functions of a board

• "The identification of the background, skills and experience of the people who will walk into the board room is a good start, but it is what they do when they get there that is critical”

• To identify what he called "the essential functions of a board" Justice Owen pointed to the catalogue of "Functions of Directing" on page 78 of my book, Future Direction: The Power of the Competitive Board.

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To Govern = To Steer (a Ship)

• Two Objectives: to steer the ship– away from dangerous waters, AND– towards a desired goal

• In other words– conformance with regulations (external perspective),

AND– performance (internal perspective)

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2. The System is the Star

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The Power and Accountability of Directors

• A successful large Australian company launches a major strategy

• A non-executive director states: “the board really doesn’t have a lot to say in corporate strategy other than to say ‘yes’”

• The company incurs billions of dollars in losses stemming from the failure of this strategy

• Who, if anyone, is held accountable to shareholders?

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The Talent Myth

• Promoted by McKinsey and Company

• Adopted by Enron - they believe in stars

• Enron’s failure exposed the myth

• Companies work by other rules

• In successful organisations the system is the star

• Organisations make people smart

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A Company as a System

• Dr. W. Edwards Deming saw a company’s operations as a system

• The foundation of the quality revolution

• Toyota Production System - “The Machine that Changed the World”

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3. A System of Value-Adding Governance

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A Complete System of Governance consists of two parts, encompassing:

• Process– Outcomes and required activities

• People– Who is to do What

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4. The Process Part: The Essential Functions of a

Company & Board

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The Company as a Living System

• What outputs (and inputs) are required of a company in order that it can prosper?– Shareholder Value– Customer Value

• What activities, therefore, must necessarily be performed?– Corporate Activities– Operational Activities

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Six Generic Outputs of a Company

• Shareholder Value– Growth of Assets– Strong & Healthy Organisation– Profitability

• Customer Value– Value to the Community– Quality Products & Services– Innovation in Products & Services

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Six Generic Activities of a Company

• Corporate Activities– Provide Direction and Oversight– Manage (External Partners) Relationships and Compliance

with Providers and Regulators– Plan and Coordinate Operations, Finance, and Performance

• Operational Activities– Provide Operational Capacity and Capability (including

engineering, human resources, R&D, product development, and information services)

– Conduct Marketing, Sales, and Customer Service – Execute Operations

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The Six High-level Functions of Directing

1. Set policies in regard to purpose, partnerships, and ethical behaviour.

2. Manage the directors' agenda, (executive) appointments, accountabilities, and communications.

3. Determine strategic and tactical directions and alliances.

4. Assure the capability of the company's operational and financial management functions.

5. Constructively oversee the company's operating performance and improvement.

6. Ensure corporate learning, renewal, evolution, and succession.

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“Because directors are bound to exercise ordinary care, they cannot set up as a defence lack of the knowledge needed to exercise the requisite degree of care... Directors are under a continuing obligation to keep informed about the activities [sic] of a corporation.”

The NSW Supreme Court (Court of Appeal, Judgement, 15 May 1995)

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The Value of Sound Board Processes?

• $3.2 billion at BHP

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5. The People Part: The Structure of Boards

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The Fundamental Dilemma

The more independent a director is, the more ignorant that director is.

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Get rid of Non-Executive Directors

Lord Young,

President of the Institute of Directors, London, April 2002:

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6. Quality in the Boardroom

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Crisis in quality in 1970-80

• Old QC methods guaranteed waste

• Needed to “Get it right the first time”

• New methodology: instead of inspecting the finished product, improve the processes that produced it - the Quality Imperative

• Now, Quality Process Management is known as “Six-Sigma” Management System

• Now, Quality in the Boardroom

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The Quality Imperative

• (Process) To improve results, look upstream to improve the process that produces them

• (People) Hold whomever owns the process accountable for improving the process (and therefore

the results).

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7. Separation of Powers

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James Madison, re U.S. Constitution:

• “The latent causes of faction are sown in the nature of man”

• “The CAUSES of faction cannot be removed; relief is only to be sought in the means of controlling its EFFECTS”

• “No man is allowed to be a judge in his own cause.”– [Self-regulation - an invitation for corruption]

• Solution: checks and balances, and separation of powers: legislative, executive, judicial

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8. Resolving the Independent Director Dilemma:

Three Options

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1. The Expert Board

8. Resolving the Independent Director Dilemma: Three Options

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8. Resolving the Independent Director Dilemma: Three Options

1. The Expert Board

2. Compound Boards– German Supervisory Board– Spanish Watchdog Board– Japanese Board of Statutory Auditors

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8. Resolving the Independent Director Dilemma: Three Options

1. The Expert Board

2. Compound Boards– German Supervisory Board– Spanish Watchdog Board– Japanese Board of Statutory Auditors

3. An Assuring Board– Value Adding– Process Management

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The Assuring Role of Directors (1)

• The big changes that have to occur are for the board to understand the role of processes and to make sure that you are taking a process approach to work;

• to ensure there are [management] processes in place and then to have [board] processes to monitor that they are being followed

– John Ralph

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The Assuring Role of Directors (2)

• Boards should allocate tasks to two or three directors to be responsible for a certain element of the business -- retailing, marketing, strategic direction, where the business is going;

• they should work with the person that's got the responsibility for the key value drivers, so they can give full support to the submission to the board

– Don Argus

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The Assuring Role of Directors (3)

• More than ever directors need to be able to argue, to challenge and to work hard to find the reality of what is really going on in their business.

• Often this means not accepting at face value what is being presented at board meetings, of forming teams of directors to really delve into operating areas of concern

– Don Argus

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The Assuring Role of Directors (4)

• A 'business capability audit' is simply examining the decision-making processes within the company...We, as shareholders, should not tell our managers what the processes for their particular company should be. But, we can certainly insist that processes exist

– Richard Koppes, Deputy Chief Executive Officer and General Counsel of CalPERS

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9. Assessing a Competitive Board - A Business

Capability Audit

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Business Capability Audit of Essential Functions of a Board

• a Business Capability Profile of a board's processes used to carry out its essential functions, for both current and target capabilities;

• an identification of accountabilities of individual directors and executives for these functions;

• a Business Capability Index - an overall index of capability for projecting the company’s future

performance.

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• Independent consulting firms like ours are assessing and enhancing a company's competitiveness in governance

• Combining active investment with value-adding governance and engagement

• Investors will reward companies that provide evidence

that their board processes are sound

Activating Intellectual and Investment Capital