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The East African : Feb 23rd 2015
The EastAfrican BUSINESS FEBRUARY 21-27,2015 MANAG E R International Corporate Governance Network, most boards aren’t delivering on their core mission: Providing strong oversight and strategic support for management’s efforts to create long-term value. This isn’t just our opinion. Directors also believe boards are falling short, our research suggests. A mere 34 per cent of the 772 directors surveyed by McKinsey in 2013 agreed that the boards on which they served fully comprehended their companies’ strategies. More recently, in March 2014, McKinsey and the Canada Pension Plan Investment Board asked 604 C-suite executives and directors around the world which source of pressure was most responsible for their organisations’ overemphasis on short-term financial results. The most frequent response, cited by 47 per cent of those surveyed, was the company’s board. How can companies strength- en boards’ knowledge and help directors maintain a long-term mindset? A good first step may be to help everyone firmly grasp what a director’s “fiduciary duty” is. Most legal codes stress two core aspects of it: Loyalty (placing the company’s interests before one’s own) and prudence (applying proper diligence to business decisions). Nothing suggests that the role of a loyal and prudent director is to pressure management to maximise shortterm shareholder value to the exclusion of any other interest. To the contrary, the logical implication is that he should help the company thrive for years into the future. The mental discipline of keeping long-term value creation foremost in mind would help clarify choices and reform board behaviours. To see how, let’s look at four familiar areas where change is essential. Selecting the right people Public company boards of- ten do not think enough about attracting the right business expertise. Having a diversity of perspectives and deep functional knowledge is critical. But Research has shown that boards have fallen short on their mandate. Picture: File COMMENTARY DOMINIC BARTON AND MARK WISEMAN “The mental discipline of keeping long-term value creation foremost in mind would help clarify choices and reform board behaviours.” if our surveys are any indication, too many directors are generalists. And as Don Lindsay, the CEO of Teck Resources, a large Canadian mining company, told us: “One of the big problems with generalist directors who don’t have a natural interest in the business is that it can take a long time to persuade them to make important decisions.” That is indeed a problem. Former IBM CEO Lou Gerstner recently observed in the McKinsey Quarterly that the willingness to tackle outmoded orthodoxies decisively is crucial to sustained value creation: “In anything other than a protected industry, longevity is the capacity to change, not to stay with what you’ve got.” However, recent McKinsey research has shown that during a 20-year period, the majority of 1,500-plus US companies were content to maintain the status quo and dole out roughly the same amount of capital to business units that they did the previous year. These businesses moved forward in low gear as a result. By contrast, the most aggressive reallocators delivered 30 per cent higher total returns to shareholders. Boards that combine deep relevant knowledge with independence can help companies break through inertia and create lasting value. Spending quality time on strategy Most governance experts would agree that public company directors need to devote more time to understanding and shaping strategy. While we recommend that directors dedicate at least 35 days a year to the job, the precise number of days a board meets isn’t the main issue. If the aim is fostering the proper long-term view, what matters most is the quality of the strategic conversations that take place. Consider Interbrew (now part of Anheuser-Busch InBev). When the Belgium-based company decided to explore the China market in the early 1990s, it invited the entire board to join the executive team on a weeklong trip there. Chairman Paul de Keersmaeker made it very clear in the opening meeting that the intent was to have directors learn as much as possible about the country and the market. The reason: At some point in the next few years, Interbrew was likely to make an acquisition in China, and when that happened, there wouldn’t be much time for debate. The directors needed to develop views on the competitive landscape and operating environment before then so that when the time came, Interbrew could move quickly to acquire its target. Engaging with long-term investors While boards may be guilty of pushing executives to maximise short-term results, we have no doubt where that pressure really originates: The financial markets. That’s why it’s essential to persuade institutional investors, whose ownership position makes them the cornerstone of our capitalist system, to be a counterforce. Boards should be far more active in facilitating a dialogue with major long-term shareholders. Happily, this is an idea whose time appears to be coming. Organisations like Shareholder-Director Exchange have been working to ensure that public companies disclose how their directors interact with shareholders and have been compiling best practices for, among other things, preparing board members for such conversations. That trend underscores long-term investors’ growing interest in learning from and exchanging ideas Boa≥ds failing to delive≥ on co≥e mission B oards aren’t working. Despite a host of guidelines from independent watchdogs such as the 47 with smart, engaged directors. Currently, however, too much of this dialogue focuses on investor pressures to have a “say on pay” and similar singleminded governance issues. The more powerful discussions occur when companies strive to communicate their strategies for longer-term growth and their key metrics for it. Paying directors more If we are going to ask direc- tors to engage more deeply and more publicly, then we should give them a substantial raise. There is a growing consensus that directors should sit on fewer boards and get paid substantially more than the current average annual compensation of $249,000. We fully agree, but the even more important issue is how that pay is structured. To really get directors think- ing and behaving like owners, ask them to put a greater portion of their net worth on the table. This could be achieved by giving them a combination of incentive shares, a portion of which vests only some years after directors step aside, and requiring incoming directors to purchase equity with their own money. We’d favour encouraging companies to implement this requirement on their own rather than imposing it on them as a rule. That said, the overarching goal should be to insist on a “material” investment that more strongly ties a director’s financial incentives to the company’s long-term performance. While the thrust of each of these broad changes is relatively simple to articulate, none is easy to make. All of them must fit the company and industry context. But in total they could bring about a deep shift in the culture of public company boards. Over time nothing else will do more to ensure that these institutions deliver the kind of sustained value creation that long-term shareholders expect and that our society deserves. Dominic Barton is the global managing director of McKinsey & Co and the author of Capitalism for the Long Term. Mark Wiseman is the president and CEO of the Canada Pension Plan Investment Board Can legislation help tame exo≥bitant CEO sala≥ies? By GRAHAM KENNY Harvard Business School Publishing Corp Laws around the world seek to curb huge salaries for top managers. Picture: File SINCE COMPANIES can’t seem to solve the divisive problem of exorbitant CEO pay on their own, legislation may well turn out to be the best fix. In the US, entities that register with the Securities and Exchange Commission are required by the Dodd-Frank Act (passed by Congress in 2010) to conduct shareholder ad- visory votes at least once every three years on compensation for their board members and highest-paid executives. Shareholders in the UK have en- joyed advisory votes on pay since 2002 — but the British government recently tightened the rules even more. For a little more than a year, UK public companies have had to prepare annual remuneration reports, and shareholder votes on the policies behind them are binding. If a company fails a vote, it can’t implement any of the proposed compensation changes, and instead must revert to its last approved pay scheme. While many European countries — Belgium, France, Germany, Italy, the Netherlands and Switzerland — have their own say-on-pay regulations for firms within their borders, the European Commission has proposed increasing shareholder power across the board. Australia has gone even further: If 25 per cent or more shareholders vote “no” on a company’s remuneration report at two consecutive annual general meetings, it triggers a vote to “spill” the board. If this second resolution is passed, all company directors (except the MD) must stand for re-election within 90 days. This legislation is among the strictest in the world.
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