Amid high-profile board scandals the goal of assembling a strong board has never been more elusive.
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Amid high-proﬁle board scandals, regulatory demands, activist investors, and constant media scrutiny, the goal of assembling a strong board has never been more elusive. Directors now face heightened pressures, complicating the role and obscuring the path to success.
What are the challenges and areas of opportunity in this changing landscape? What are the implications for today's CEOs and boards of directors? What is the state of regulation and what are the impacts? How can boards thrive under these circumstances? These questions loom as companies, CEOs, and boards work to navigate today's corporate environment and achieve success.
The Board of Directors and the CEO
The relationship between the board and the CEO is one of the most important determinants of a company's success. To forge a successful relationship, both the board and the CEO should have a clear understanding of each party's role, requirements, and limitations.
This ﬁrm division of responsibilities will only be successful if the CEO and the board have shared goals. The two parties must agree upon their priorities and the timing of those priorities, leaving the board to accomplish the strategic element and the CEO to execute on the managerial component. To reach a state of shared goals and agree upon corporate priorities, the CEO and board must engage in candid, constructive communication marked by mutual respect.
Past Scandals and Management Overextension
In the instance of Enron in the early 2000s, management played an outsized role in running the company and the board offered insufﬁcient oversight and guidance. The management employed schemes to hide the company's losses and feign proﬁtability. Soon, analysts began to question Enron's earnings and transparency practices, leading to downgraded earnings, SEC investigation and, later, a ﬁling for Chapter 11 bankruptcy protection.
In the 2002 WorldCom scandal, management similarly overreached while the board retreated. WorldCom's revenue had begun to decrease as companies cut spending on telecommunications services and equipment. To hide its losses, WorldCom enlisted irregular accounting practices, later revealed by an internal audit.
While high-proﬁle fraudulent corporate accounting activity was rampant in the early 2000s, similar scandals have emerged over the past couple of years. In 2015, Volkswagen (VW) was accused of rigging emissions software to enable diesel cars to pass strict emissions tests. In the wake of the news, the company's stock price plummeted, causing the share prices of other car manufacturers to fall as well.
The cases of Enron, WorldCom, and Volkswagen demonstrate the risks associated with management overextending and boards of directors playing relatively minor roles in overseeing corporate performance.
Resulting Regulation and the Modern Model
Following the corporate scandals of the early 2000s, regulation was introduced expanding the requirements of public companies' boards of directors, management, and public accounting ﬁrms. These new regulatory frameworks were designed to ensure the board's independence and protect against the management overreach that occurred in the scandals.
In addition to regulatory changes, such as those introduced by the Sarbanes-Oxley Act in the U.S., other types of changes have further broadened the responsibilities of boards of directors. "Amid these changes, board service is no longer constrained to meeting once every two months or so," explains Cindy Baerman, CEO at Executive Advisory Services. "Rather, board members are now almost always on call and engaged in continued communication and feedback."
In this era of constant ﬂow of news rapidly affecting public perceptions, boards of directors must be ready to act quickly. Since breaking news can change perceptions in an instant, boards are tasked with continually considering the reputational risks that arise on social media, the company's strategy for mitigating these risks, and tactics for monitoring references to the company on social media.
Activist investors, often collaborating with pension-fund managers, leverage trillions of dollars and shareholder proposals to address corporate governance practices and strategies that are thought to inhibit growth.
The growing inﬂuence of activist investors has vast implications for boards. Traditionally, they rarely interacted directly with shareholders. Beyond meeting the largest shareholders at annual meetings, boards of directors typically relied on reports from the company's investor relations department to understand shareholders' primary concerns.
Implications for Today's Board of Directors
Following the corporate scandals and subsequent regulatory changes, and amid social media's constant news stream and mounting pressure from activist investors, board members' responsibilities have steadily expanded. Boards must now exercise broader oversight, enforce compliance with stricter regulatory guidelines, and remain constantly aware of the landscape in an environment of heightened exposure. While there is wide consensus over the ways in which these changes have fundamentally shifted the role of board members, opinions vary over the ideal state of regulation and the most important functions of the board.
The Increasing Importance of Board Skills and Composition
While opinions vary over the appropriate levels of corporate regulation and the impacts on boards of directors, there is wide agreement that with the appropriate skills in place, boards can ultimately self-regulate. It is therefore imperative that board members possess the ability to communicate clearly, conﬁdently and effectively, in a manner that invites discussion and elicits feedback and varying opinions.
While there is little consensus over the appropriate level of corporate regulation and the implications for boards of directors, there is broad agreement that directors must bring a range of skills, experiences, and ideas that invite discussion, dissension, and opposition. In voicing these opinions and engaging in meaningful conversations, boards will inherently regulate themselves, calling issues into question and examining ideas from all angles. Functioning as a healthy and active governing body, boards will ultimately arrive at the most promising, innovative, yet compliant solutions.
Throughout the world, corporate boards function according to varying structures and models. As a result, some meaningful differences exist in board structure from one country to the next. The United States uses a one-tier model, where a single, uniﬁed board executes managerial and supervisory responsibilities. The CEO often sits on the board of directors, serving as the sole representative of the company's executive team.
Many European and Asian countries, however, use a two-tier structure, including both a management board and a supervisory board. Led by the CEO, the management board meets frequently and handles operational decisions. The supervisory board, on the other hand, oversees the management board and handles strategic planning. Members of the supervisory board are elected by shareholders, and a chairman presides over the board. The two-tier model is designed to prevent conﬂicts of interest and distribute power across many parties.
The Future of Boards and Regulation
In recent years, the role of boards of directors has further expanded amid the growing pervasiveness of social media and heightened pressure from activist investors. Perspectives vary over the impact that these changes have had on the nature of the board, with some arguing that current regulations and pressures have ﬁnally ushered in an era of effective board oversight, and others contending that these changes leave directors vulnerable to scrutiny and liability, making the role less desirable and thus harder to ﬁll.