The fiduciary duties of members of corporate boards are usually invoked in connection with directors’ potential liability exposures. However, in their January 2015 Harvard Business Review article entitled “Where Boards Fall Short” (here), Dominic Barton, global managing director of McKinsey & Co., and Mark Wiseman, President and CEO of the Canada Pension Plan Investment Board, invoke directors’ fiduciary duties as a guidepost to help boards fulfill their “core mission” of “providing strong oversight and strategic support for management’s efforts to create long-term value.”
As the article’s title suggests, the authors believe that boards currently on falling short on this core mission. It isn’t just the authors themselves who think this; according to the authors’ survey of over 600 executives and directors, company officials think so, too. According to their survey, the most frequently identified source of pressure most responsible for their organizations’ over-emphasis on short-term financial results, cited by 47% of respondents, was the company’s board. An even higher percentage of respondents (74%) who identified themselves as corporate board members “pointed the finger at themselves.”
The answer to the short-termism problem, the authors suggest, is not “another round of good-governance box checking and hoop jumping.” A better starting point, they suggest, would be “to help everyone firmly grasp what a director’s ‘fiduciary duty is.” The law in most jurisdictions stresses two core aspects of fiduciary duty, loyalty and diligence. Nothing, the authors note, “suggests that the role of a loyal and prudent director is to pressure management to maximize short-term shareholder value to the exclusion of any other interest.” To the contrary, “the logical implication is that he or she should help the company thrive for years into the future.
If directors can keep their fiduciary duty firmly in mind, “big changes in the board room should follow.” If directors are focused on their fiduciary duty
They will spend more time discussing disruptive innovations that could lead to new goods, services, markets, and business models; what it take to capture value-creation opportunities with a big upside over the long-term; and shutting or selling operations that no longer fit. And they will spend less time talking about meeting next quarter’s earnings expectations, complying with regulations (although that must, of course, be done), and avoiding lawsuits.
In order to facilitate the “mental discipline of keeping long-term value creation in mind,” which would “help clarify choices and reform board behaviors,” the authors suggest four areas where “change is essential.”
First, the authors emphasize the importance of selecting the right people as directors. In particular, the authors suggest, “too many directors are generalists.” Boards all too often do not think about “attracting the right business expertise.” Boards that “combine deep relevant experience and knowledge with independence can help companies break through inertia and create lasting value.”
Second, boards should spend more quality time. The starting point is here is to first spend enough time. The authors suggest that public company directors “need to put in more days on the job and devote more time to understanding and shaping strategy.” Directors of large, complex firms should spend at least two days a month, or 24 days a year, on board responsibilities, in addition to attending regular board meetings. But more than the precise number of days, what “matters most” is “the quality and depth of strategic conversations that take place.” The example the authors give involves a company whose board members traveled to China before the company launched its Chinese initiative several years later. The board, the authors suggest, was anticipating and exploring directions that the company might later go.
In addition, the authors suggest that boards should develop nonfinancial metrics that will help guide strategy, particularly when the financial statements do not tell the entire story. Metrics the authors suggest include keys for gauging progress on key development activities, such as “implementing capital spending plans; achieving environmental, health and safety goals; and maintaining a healthy, well-funded balance sheet.”
Third, the authors suggest should engage with long-term investors, whose ownership position makes them “a counterforce” to the marketplace forces that encourage a short-term outlook. The survey respondents suggested that regularly communicating long-term strategy and performance to key long-term shareholders “would be one of the most effective ways to alleviate the pressure to maximize short-term returns and stock prices.”
Finally, the authors suggest that companies should restructure the way directors are compensated for their board service. The authors recommend a move toward “longer-term rewards.” The authors suggest that the way “to really get directors thinking and behaving more like owners, ask them to put a great portion of their net worth on the table.” The authors suggest a combination of giving directors incentive shares that only vest some years after the directors step aside, and requiring incoming directors to purchase equity with their own money. The goal is to insist on a material investment that more directly ties a director’s financial incentives to the company’s long-term performance.
I found the authors’ analysis interesting. I was particularly interested in the author’s use of fiduciary duty principles as a way to encourage better board performance. Fiduciary duty principles are invoked only as a potential source of director liability. (Ironically, the authors suggest that if directors spend more time focused on their fiduciary things, among the things that boards will spend less time worrying about is “avoiding lawsuits.”) The authors’ creative use of fiduciary duty principles can help to “bring about a deep shift in culture, behavior and structure of public company boards,” to help companies to “deliver the kind of sustained value creation that long-term shareholders expect and that our society deserves.”
The Little Prince: From the web page of Jim Gelcer: