The Rise of the Independent directors

Independent directors now dominate the boards of public companies, holding over 80 percent of board seats. Only independent directors can serve on three key committees: audit, compensation, and governance.

An independent director can only fulfill her duties—legal and practical—if she resolves to be truly independent as well as candid and constructive.

 

Independent. Corporate boards used to be composed mainly of company executives and professionals who served them, such as bankers and attorneys. This was good in terms of directors' knowledge of the company and their ability to come to agreement and get things done. It was often not good in terms of directors putting their own interests (jobs, compensation, and benefits for inside directors, professional work and related fees for outside directors) above those of shareholders. It also hindered tough-minded monitoring and dismissal of underperforming CEOs. Relationships were too cozy and reciprocal.

The shareholder value revolution of the 1980s had profound consequences for board focus, size, and composition. Total shareholder return (share price plus dividends) became a key measure of board performance and effectiveness. A vigorous market for corporate control was reflected in acquisition and merger activity.

As a result, the human makeup of boards changed dramatically. Independent directors came to dominate public company boards. Boards became smaller: nine to twelve directors is customary now instead of fifteen or more. The chairman and CEO roles, previously united, are now frequently divided. The board's agenda, once the exclusive domain of the chairman/CEO, is now set in consultation with a lead independent director. Executive sessions of the independent directors occur regularly whereas previously they were rare and almost always signaled that the CEO was in trouble. Board compensation is now substantial because independent directors are no longer paid indirectly through legal and consulting fees and banking relationships.

The rise of independent directors has created an important question: What does independence really mean? It's useful to draw a distinction between technical independence and real independence. Technical independence, as required by the SEC and stock exchange listing standards, increases the odds of, but does not ensure, real independence.

In my experience, real independence is rooted in a director's attitude and state of mind combined with a willingness to speak up and, if required, act in ways not in one's immediate self-interest.

Independence requires a director to

 

• be curious, with a big appetite for facts, concepts, insights, ideas, and people from whom the director can learn so that independent thinking is well-informed;

• question and challenge, especially traditional practices, conventional wisdom, and majority views;

• trust but verify, one of President Ronald Reagan's favorite phrases;

• have perspective that puts current issues and events in context: past and future, related matters, and relative importance. This is sometimes called the helicopter view; and

• be creative, offering novel and innovative solutions to problems with which the board and management are wrestling.

 

Hallmarks of independent behavior are

 

• asking questions more than broadcasting;

• drilling down when warranted;

• precipitating conflict when required;

• tolerating discomfort;

• speaking truth to power;

• searching for common ground and solutions around which the board can unite; and

• resigning from the board if legal and professional duties or the dictates of conscience cannot be fulfilled.

 

The independence of a director is of little value unless it is combined with two others qualities: candor and constructiveness.

 

Candor. Candor is a fiduciary duty in addition to care and loyalty.

Directors are selected for their judgment, above all. The board, senior management, and the company only benefit if directors are candid, that is, speak out honestly about what is on their minds. They call things as they see them. They raise questions, including uncomfortable ones.

Of course, directors have to be selective. Is the issue worth addressing? Has someone else already made the point? Are they talking just to hear themselves speak? The most valued directors listen a lot and speak selectively. It's important to protect the value of your verbal currency.

Being candid sounds easy, but it's not. I served on the board of a small, family-owned company with a long history. The family CEO had done a good job with the company on his watch. But it was a difficult, cyclical business, and he had weathered several recessions with requisite cost cutting, including layoffs—always a difficult task.

One day I got a call at the office. I could hear the emotional distress in the CEO's voice. "I have to see you," he said. "I want to sell the company. I'm talking with each director."

I was shocked. There had been no warning of this, and the company had been in existence for many decades. I agreed to meet with him that afternoon.

When he walked in, I could see the stress on his face. He saw bad times coming and did not—did not—want to be at the helm through another recession. He had put out some feelers and found a buyer willing to purchase the company for a particular sum. He asked what I thought.

The answer he was looking for was obvious. He was seeking support to do what he desperately wanted to do. Providing it would have been easy. I had no ownership stake in the company, I served as a director at his and the family's pleasure, and the modest directors' fees were of no great consequence to me.

Yet with several hours to consider the matter, I had decided what I thought and was candid with the CEO:

 

I understand. I had to lay people off at Cummins, and it was the hardest thing I've ever done professionally. So I empathize. But I cannot in good conscience advise you to sell the company or support your doing so. This is a family business built over generations. I believe its market value is exceptionally low right now because you're not the only one who believes a recession is coming. A fire sale of the company today at a low point in its value would be wrong—for you and the family. I urge you to lead the company through this downturn and use the time to fix everything that will increase its value when volume returns. Then, reconsider whether to sell the company at a value that reflects the work that you, your father, and others have done over so many years to make it what it is today.

The CEO was disappointed and disagreed. We all like to hear what we want to hear, not necessarily what we need to hear. One of a director's most important duties is to be candid and honest, especially when doing so challenges a consequential direction that management or the board wants to pursue but with which the director disagrees.

The end of this particular story is a good one. Other directors expressed views similar to mine. The CEO led through the recession. Three years later, revenues and profits were strong, and he sold the company with the full support of the board and family for four times what he had been offered just thirty-six months earlier. That's the difference directors can make at a critical time in a company's and an executive's life. Candor is required, even if it is uncomfortable or inconvenient.

 

Constructiveness. I have found there is a big difference between quality academic research and successful leadership and management. In their search for truth, faculty must be analytical and deconstruct what they examine. Leaders and managers should be analytical, but they must also take constructive action in order to create value and move their organizations forward.

I have enormous respect for the scientific method and the value it brings to a world drawn to fashion, fads, false correlations, and fatuous theories. But I also deeply appreciate that leaders and managers must go beyond analysis and understanding to action and results.

This is the reason for a culture gap between academics and leaders/managers. Academics are inclined to be skeptical of leadership slogans such as "The Way Forward," a recent theme and name of a restructuring plan at Ford Motor Company. They can also be skeptical of their colleagues whose work appears to be longer on inspiration than evidence.

The need for constructive action is why I sometimes say to executives considering a change, "Remember, you need to be right twice!" It's usually not hard to figure out what you want to stop doing when a person or course of action isn't working out. The harder part is figuring out what to do next, such as recruiting the right person or embarking on a new strategy.

Good directors understand this. So they push themselves when opining on a situation about which they are concerned to share not only their analysis but also what might be done to make things better. As a director, when I'm concerned but can't come up with good alternatives, I will simply describe the communication of my concern as "sharing agony" and admit I don't know what to do about it. This is better than either of the alternatives—worrying in silence or offering a lame suggestion in which I'm not confident.