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Beyond implementing reforms and best practicesMethods or techniques of running a corporation or business to realize superior results., boards are being counseled to become more involved.See, for example, Felton and Pamela Fritz (2005); and The State of the Corporate Board, 2007—A McKinsey Global Survey (2007, April). Rubber-stamping decisions, populating boards with friends of the CEO, and convening board meetings on the golf course are out; engagement, transparency, independence, knowing the company inside and out, and adding value are in. This all sounds good. There is a real danger, however, that the rise in shareholder activism, the new regulatory environment, and related social factors are pushing boards toward micromanagement and meddling.
This issue is troubling, and clear evidence that the important differences that separate governance from management—critical to effective governance—are still not sufficiently well understood by directors, executives, regulators, and the popular press alike. And regrettably, faced with the need to be more involved, the most obvious opportunity (and danger) is for boards to expand their involvement into—or, more accurately, intrude into—management’s territory.
The key issues are how and to whom boards add value.Carver (2007, November), pp. 1030–1037. Specifically, the potential of directors to add value is all too often framed in terms of their ability to add value to management by giving advice on issues such as strategy, choice of markets, and other factors of corporate success. While this may be valuable, it obscures the primary role of the board to govern, the purpose of which is to add value to shareholders and other stakeholders. John Carver, well-known governance consultant and author, does not mince words:
Governance is an extension of ownership, not of operations. Directors must be more allied with shareholders than with managers. Their mentality, their language, their concerns, their skills, their choice of interactions are subsets of ownership, not of management. As long as we view governance as übermanagement—focusing on management methods, strategies and planning—finding a new balance between micromanagement and detachment… will be hard to come by.Carver (2007, November), p. 1035.
A greater arms-length relationship between management and the board, therefore, is both desirable and unavoidable. Recent governance reforms focused on creating greater independence and minimizing managerial excess while enhancing executive accountability have already created greater tension in the relationship between management and the board. The Sarbanes-Oxley Act, for example, effectively asks boards to substitute verification for trust. Section 404 of the act requires management at all levels to “sign off” on key financial statements.
This is not necessarily bad because trust and verification are not necessarily incompatible. In fact, we need both. But we should also realize that effective governance is about striking a reasonable accommodation between verification and trust—not about elevating one over the other. The history of human nature shows that adversarial relationships can create their own pathologies of miscommunication and mismanaged expectations with respect to risk and reward. This makes defining the trade-offs that shape effective governance so difficult. Is better governance defined primarily by the active prevention of abuse? Or by the active promotion of risk taking and profitability? The quick and easy answer is that it should mean all of those things. However, as recurrent crises in corporate governance around the world have shown, it is hard to do even one of those things consistently well. What is more, a board trying to do all of these things well is not merely an active board; it is a board actively running the company. This is not overseeing management or holding management accountable—it is management. Therefore, the corporate governance reform agenda risks becoming an initiative that effectively dissolves most of the critical, traditional distinctions between the chief executive and the board.Macavoy and Milstein (2003).