Category: Starting a Business

The popular press, and sometimes even the business press, will refer to founding CEOs as if they remained the sole equity holders when, as the business grew, outside equity has been used to fund the growth and the founding CEO has retained only a small minority stake. This illusion of ownership persists after listing, the creation of an ‘independent’ board of directors, and recruitment of a professional management team.

Dangerously, the illusion may persist also in the mind of the founding CEO. This can cause many conflicts between the desires of the founding CEO and the expectations of the equity providers. In worst cases founding CEOs are ousted from ‘their own’ companies leaving behind an organisation divided into factions and reeling from the aftermath of the trauma such internal conflict always generates, or are found to regard the company’s property as their own, awarding themselves generous benefits or ‘investing’ in unnecessary such as penthouses for the CEO to reside in when visiting town, or corporate jets, boats and helicopters.

In the best cases the founding CEO provides guidance, keeping the company on track as it grows to fulfil the promises made when inviting investment. This delights investors and CEO alike.

What are the critical differences between the two cases?

Perhaps the greatest difference is the respect that the CEO has for the providers of the outside equity. This is most easily gauged when the first equity injection from beyond the founding CEO and his or her direct family occurs. At this point the company is generally not listed and a shareholders’ agreement is drafted to protect the interests of the outside equity providers. If this first agreement is balanced and respects the need of the external shareholders to have some control of their shareholding then the likelihood is that the CEO will perform well as subsequent shareholders join the organisation and introduce greater complexity into the investor relationship management.

A well written shareholders’ agreement will provide for the CEO to undertake management of the company, for some group to take the big strategic decisions using consensual decision-making, and for shareholders to vote their stock at AGMs and EGMs, or at certain crucial points such as a sale of equity above 15%, disposal of assets, mergers, acquisitions, sales and purchase of shareholdings, etc. Devices such as preferential shares or casting votes for the founding CEO are a bad sign. They work in practice but they subvert the fundamental rule that all shareholders are equal.

An independent board of directors, properly structured and constituted, is can assist in making the transition from entrepreneurial stages to corporate reality. It is important that the founding CEO selects directors who will not be “yes men”; in particular a skilled chairman with experience in taking a company from the current phase of activity to an investment-worthy stage. In selecting the board it is important that the founder recognize that this activity is be done under the guise of his or her shareholding rather than under the guise of their CEO role. Shareholders select the directors; CEOs manage the daily activity of the organisation.

Having a properly constituted board of directors will give confidence to investors and may prevent them from requesting a seat on the board of their own. A board charter, that defines the role of the board as representing the interests of all of the shareholders, will assist in this. The charter should make clear that even if a new investor is given the opportunity to appoint a director to the board that director will be bound by the terms of the charter and must represent the interests of all the shareholders, not just their nominator.

As the company grows the skills required of the CEO will change. At some stage the founder must consider relinquishing the CEO role whilst retaining the ability to influence progress through their board position. If this succession is not well planned there is a real risk that the board will remove the CEO. It is important that the founding CEO be aware of the needs of the company as it develops and recruit viable alternatives to him or herself. At this point, if the CEO has assumed well the role of a board member, it is not uncommon to the CEO to assume the chairman role.

This is an orderly and equitable way for a CEO to remain influential in the destiny of the company that they have founded without subverting the rights of the investors who had made that destiny possible. The other ethical alternative is to grow more slowly, using only the CEO’s own equity and the cashflow generated from operations and perhaps a combination of joint ventures, alliances and outsourcing arrangements that allow the founding CEO to retain absolute control over a part of the operations.

What do you think?

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Julie Garland-McLellan has been internationally acclaimed as a leading expert on board governance. See her website and LinkedIn profiles, and get her book Dilemmas, Dilemmas: Practical Case Studies for Company Directors.

Jeff Jarvis’ latest book ‘What Would Google Do’ envisions the ways in which running businesses the way Google is run would change industries. It is impossible to read this book without having a few innovative ideas of your own. It got me thinking ‘What would Google do if they regulated boards or designed corporate governance systems?’

Here are some ideas:

Give people control and they will use it – in theory this is what happens at AGMs. In practice the process stultifies the content and the voting rules and systems mean that the exercise is often an empty formality because the deals have been done long before the meeting took place. The Google algorithm would ruthlessly accept voting decisions, in real time over the internet. The AGM could be webcast and votes cast remotely after hearing the arguments for and against each issue. Chat rooms could allow shareholders to communicate with each other and the board on the issues as they were being discussed. A bulletin board could gather topics for discussion and the Chairman could allocate time to each topic depending on the number of shareholders who wanted to have it discussed. No more hijacking of meetings by vocal minorities; much more communication that shareholders want.

Life is a beta test – instinctively, when we make mistakes, we feel embarrassed. We shouldn’t. A board that truly values innovation or creativity should be out pushing the boundaries of what is possible and failing a little from time to time. (and how many companies have those two buzz words in their values statements?) Failing well means acting quickly to rectify mistakes and that means having the systems in place to know about the failures, fast, and to admit to them, openly. When Coca Cola Amatil implemented a system of ‘pre-nuptial’ agreements designed to help the whole board to eject any one member whom the rest felt was no longer part of the team there was a major outcry; shareholders want dissident voices to be heard in the boardroom not ousted from it. The Chairman apologised and the contracts were ripped up and never mentioned again. I don’t respect him less because of that issue; I respect him more!

Don’t be evil – Google’s founders wrote, before their IPO, “We believe strongly that in the long term, we will be better served – as shareholders and in all other ways – by a company that does good things for the world even if we forego some short term gains.” Wow! How many pages of social and environmental reporting does it take most boards to say the same thing? And why do we still see boards that countenance obviously bad behaviour for short term gain, whether we look at the sporting club that covers up a star player’s drug and violence problems, an asbestos producer that severs all ties to the people who may need compensation for the harm its products have caused, or the banks that allowed trading in instruments that were clearly not the creditworthy investment grade product they were held out to be?

Elegant organisation of data – When you type a search into Google you get back a simple list of relevant sources of the information sought. There is no clutter, no distracting graphic, and the sources are ranked in order of likely importance. Why aren’t board papers presented like that? Why don’t boards report to their shareholders like that? Imagine what an annual report would look like if the most frequently read information was on the front page. How good would accounts be if useful information, instead of being stuck in pages of small print notes to the accounts, was up front in the P&L and less useful information was hidden behind the summarised data and only sprang to view when you clicked upon it to expand it? Shareholders have voted against receiving paper annual reports. We don’t need a thick catalogue full of glossy photos to tell us about our company. We don’t want that replaced by a pdf file of the same thing. We want data that we can sort, cut and paste into our spreadsheets, condense and expand to suit our needs. So do boards. So why are we still in the trap of ‘doing what we did last year’ and creating thicker, more unwieldy, documents instead of taking a Google approach and providing interactive reports, with important information (that is what the recipients are most likely to want to see) first, and less important information later?

Meritocracy wins – in boardrooms it is often the sad case that directors are selected because of what they have done in the past and with insufficient real analysis of what they will provide to the board in the future. On Google data is realtime; imagine if we could constitute boards that had access to the best expertise on any topic, instantly, as required. How would that affect quality of data, independence of thought and speed of reaction? Of course there would be a cost in consensus building, responsibility for implementation and group decision making. I know some boards are using open source technology to run their agendas but what if they adopted the open source model for their committee structures and even the board itself, allowing executives and visiting experts to enrich the debate?

Well, those are the first five ideas that struck me on reading the book. What do you think?

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Julie Garland-McLellan has been internationally acclaimed as a leading expert on board governance. See her website and LinkedIn profiles, and get her book Dilemmas, Dilemmas: Practical Case Studies for Company Directors.

There are many attempts to define ethical standards for company directors.

It would be foolish to argue that there should not be an ethical standard or even that an ethical standard is as important as a competency standard. The problem is with identifying a suitable standard before making a board appointment. Whilst many boards have codes of conduct few request incoming directors to formally sign that they have read, understood, and agree to be bound by, these codes. Even fewer have an explicit statement of consequences for any breach of the codes.

This leaves boards in a difficult position when conduct is ‘unbecoming’. The offending director may state that they were unaware of the breach and of any possible consequences. When board members’ reputations are at stake this can turn into a highly inefficient ‘Mexican standoff’ where the board is reluctant to go to the shareholders and request a removal because the offending director may claim a lack of natural justice. If the offense is one that shareholders would obviously view as undesirable, such as theft, the case is usually resolved with a settlement and deed of separation where the director is rewarded for going quietly. When the offense is subtle, such as favouring the interests of a majority shareholder above those of other shareholders, the outcome of an EGM vote is less predictable and the offending director may defend his or her position sufficiently vigorously to deter the board from an attempt to oust them.

This, already unclear, environment is made more uncertain by the changes in social acceptability of actions and utterances. Different boards will react differently to similar actions.

In recent times we have seen:

• The audit committee chairman of a major retail bank refuse to resign after significant fraud and controls weaknesses were identified. This case was resolved by paying the director a settlement including retirement benefits.
• A CEO sanctioned for posting holiday snaps of himself on the beach (without a shirt) on the popular Facebook website.
• Directors of a multinational company caught having a shared business interest that they had not disclosed to the board and that created a conflict of interest which, being unknown, could not thus be managed.
• The CEO of a major listed retail company fired (with termination benefits but without performance bonuses) after admitting harassment of a female employee.
• A CEO fired for having a consensual, although extramarital, affair with a subordinate.
• A director of a major investment bank revealed in the international press and in a ‘true story’ book as not knowing the difference between equity and revenue (no wonder it failed).
• Directors and senior executives caught using derivative instruments to protect their shares and options from losses when investors had been lead to believe that these equity holdings were created to align interests.

But how can a board specify an appropriate ethical standard without venturing into the realm of people’s private lives?

Historical performances, personal wealth, having achieved a position of eminence in society, and many other indicators that we use have all been proven to fail.

We need something that, without enforcing any single religious or philosophical code upon all directors, will allow shareholders to understand the settings and sensitivity of a proposed director’s moral compass so they can make an informed vote when asked to elect that individual to their boards. It should encompass the ideals of ‘innocent until proven guilty’ and of ‘wiping the slate clean’ after repentance and rehabilitation.

Until we find such an indicator we are destined to continue to suffer improper behaviour from our board members. These are the people responsible for setting the tone at the top and developing the culture of the enterprise. Shouldn’t we have some measure of their values before we appoint them to our boards?

What do you think?

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Julie Garland-McLellan has been internationally acclaimed as a leading expert on board governance. See her website and LinkedIn profiles, and get her book Dilemmas, Dilemmas: Practical Case Studies for Company Directors.

As BP continues to be in the spotlight, with every business practice being scrutinized, we can learn some lessons on how ethical companies balance safety and costs.

Ethical Culture

There is nothing inherently “ethical” about balancing safety and costs. Few programs, even government projects, can reduce safety risks down to zero. The key factor is how does the company balance the risks and how are those decisions made known to key stakeholders, both inside and outside the company.

As reported in today’s Wall Street Journal:

Until the April 20 explosion of the Deepwater Horizon oil rig in the Gulf, Mr. Hayward (BP’s CEO) repeatedly said he was slaying two dragons at once: safety lapses that led to major accidents, including a deadly 2005 Texas refinery explosion; and bloated costs that left BP lagging rivals Royal Dutch Shell PLC and Exxon Mobil Corp.

In a review of internal documents, BP seems to have taken a reactive approach to managing safety issues. Only when confronted by government agencies did BP make commitments to take action:

The agency had inspected a refinery in Toledo, Ohio, which BP now jointly owns with Husky Energy, in 2006, uncovering problems with pressure-relief valves. It ordered BP to fix the valves. Two years later, inspectors found BP had carried out requested repairs, but only on the specific valves OSHA had cited. The agency found exactly the same deficiency elsewhere in the refinery. OSHA ordered more fixes and imposed a $3 million fine.

However, as we have seen from the fallout from the Gulf Oil Spill, the recent mine accidents in West Virginia, as well as FAA intervention on airline safety issues, relying on government identification of safety issues may no longer be a viable fall back position for companies that have greater knowledge of the issue than the government.

In February 2009, Allison Iversen, a coordinator at Alaska’s Petroleum Systems Integrity Office, sent BP a letter saying it had failed to inspect the stretch of pipeline for more than a decade before it broke. A scheduled 2003 inspection was never performed because the pipe was covered in snow and the company never returned to do it. The state also said it was “deeply concerned with the timeliness and depth of the incident investigation” conducted by BP. It took four months to provide a report that other oil companies typically submit in two weeks.

The result has been a spotty record of being proactive on safety issues:

“They claim to be very much focused on safety, I think sincerely,” says Jordan Barab, deputy assistant secretary at the Occupational Safety and Health Administration. “But somehow their sincerity and their programs don’t always get translated well into the refinery floor.”

At the same time, BP has been focused on cost reductions:

Meanwhile, company officials continued hammering home the message on costs. Mr. Shaw, the Gulf of Mexico head, made the point at a meeting for top managers in Phoenix in April 2008. His aim, according to an internal BP communication, was to instill a “much stronger performance culture” in the organization, based on strictly managing costs and “this notion that every dollar does matter.” BP declined to make Mr. Shaw available for comment.

But there have been challenges in balancing a “performance culture” with maintaining adequate safety standards:

Obstacles soon emerged. A 2007 internal document setting out the safety policy spoke of an industry shortage of engineers and inspectors that could endanger plans to implement new standards for inspecting and maintaining critical equipment. An internal presentation in May 2009 cited a shortage of experienced offshore workers and said more training was required to “maintain safe, reliable and efficient operations.”

Some think the cost drive affected safety. Workers had “high incentive to find shortcuts and take risks,” says Ross Macfarlane, a former BP health and safety manager on rigs in Australia who was laid off in 2008. “You only ever got questioned about why you couldn’t spend less—never more.” BP vigorously denies putting savings ahead of safety.

Ethics and Safety

So how do companies effectively balance safety and costs?

The first step is to differentiate two critical types of safety expenses: the cost of identifying safety risks and the cost of mitigating them. Organizations cannot make an intelligent decision to bear the risk of a particular action if they are not getting adequate data on which to make such a decision.

In today’s world, with a global corporation’s daily actions affecting so many external stakeholders (e.g. the public), it is ethically unacceptable for a company to not have full knowledge of the risks it generates. Cutbacks in safety personnel, as well as creation of performance incentives that quash disclosure of safety issues, is questionable at best.

It is a separate matter to act on mitigation once a safety issues is fully acknowledged, even just internally within the company’s decision-making hierarchy.

From BP to Toyota, companies have to make decisions daily as to what level of safety they can economically bear. If a decision to take a certain level of risk is legal, within industry guidelines and best practices, and fully vetted internally among subject-matter experts, such a conclusion, even if it leads to a problem, will result in far less damage than if the company either never evaluates the risk, or intentionally quashes discussion on how to manage that risk.

The public accepts the inherent risk in deep water drilling as well as manufacturing safe automobiles. What is not acceptable is an organization that abrogates its responsibility to fully weigh those risks by short-cutting the internal intelligence gathering mechanisms that keep critical data from being openly discussed.

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David Gebler is the President of Skout Group, an advisory firm helping global companies manage ethics risks. Send your thoughts and feedback to dgebler@skoutgroup.com.

The British Financial Reporting Council has just released an updated version of the corporate governance code. The new Code recommends “in the interests of greater accountability”, that all directors of FTSE 350 companies shoulder-elected by the shareholders each year at the AGM.

As with all other provisions of the Code, companies are free to explain rather than comply if they believe that their existing arrangements ensure board effectiveness, or that they need a transitional period before they introduce annual re-election.

This provision sits uneasily alongside the provision that requires directors to be appointed for a specified term and for there to be an especially rigorous explanation of any term beyond six years. It is obviously not intended that, as in some not-for-profit boards, the board is to be substantially changed each year. It is also at odds with the provision that states (and we should all agree) that the nomination committee nomination committee should evaluate the balance of skills, experience, independence and knowledge on the board and, in the light of this evaluation, prepare a description of the role and capabilities required for a particular appointment.

It is very difficult in a fast moving commercial environment to find people with the specified skills and experience that also have a vacant slot in their portfolio of board seats at the time when you need to fill your board vacancy. Having found such a person it is a relief when the shareholders ratify the appointment at the next AGM. Although it is rare for shareholders to overturn the recommendation of the board there is always the chance that this may be one of those rare occasions. Boards work (or should work) at the strategic level and they need time to impact the company culture and implement strategic changes. To attempt to provide this high level input in a short time-frame (and one year is perilously short) and have noticeable results to ensure being voted in again at the next AGM is an impossible task. At worst it will lead to a rash of short term initiatives that could weaken the company in the long term (such as cutting back on training and R&D) and at best it will lead to more time at AGMs being wasted with matters of form rather than issues of substance.

The boards of smaller companies are also encouraged to consider their policy on director re-election. Presumably with the idea that they too might benefit from a complete loss of corporate knowledge or an unbalancing of the carefully built skills set available on their boards.

This recommendation is a disaster. It shows that the code-writers have no respect for the value of a skilled board team that acts on strategic long-term issues. Let’s all hope that the FTSE 350 companies opt to explain rather than comply.

What do you think?

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Julie Garland-McLellan has been internationally acclaimed as a leading expert on board governance. See her website and LinkedIn profiles, and get her book Dilemmas, Dilemmas: Practical Case Studies for Company Directors.