Good boards need tension and mutual esteem

A frequent theme of our writing here, and our conversations with our entrepreneur partners, is board performance:  there is more to strong board performance than best practices.  The critical factor is a ‘robust social system’ in which members’ informal  modi operandi ensure that all the well-designed board processes function properly.

McKinsey also often writes on the topic of boards, and recently seems to have borrowed a page from our song book.

Just under two years ago we wrote:

The end of every boom-bust cycle during my lifetime has included a fin de siècle scandal:  insider trading punctuated the ’87 crash, accounting irregularities (think Enron and Worldcom) helped pop the tech bubble of the ’90s, and our most recent bust was characterized by lax governance at Fannie & Freddie and more than a few banks.

We all understand the business cycle, and we all understand human nature… but what about all those good governance measures that get implemented in the wake of each meltdown?  Why do they inevitably fail to prevent the *next* crisis?

Presumably, those companies and regulatory bodies have boards comprised of accomplished and highly intelligent members, with personal wealth at stake… (I)t’s likely that they were following the current and best practices for strong and effective board oversight.

Simon C. Y. Wong,  a partner at London-based investment firm Governance for Owners and adjunct professor of law at Northwestern University School of Law, hits many of the same notes in this past June’s McKinsey Quarterly:

Why is it that despite all the corporate-governance reforms undertaken over the past two decades, many boards failed the test of the financial crisis so badly? … (I)t’s a sure bet that most of these boards would argue—and demonstrate—that they had best-practice structures and processes in place.

The answer, I believe, after years of examining and advising scores of boards, is that such best practice isn’t good enough, even if your board is stacked with highly qualified members. Without the right human dynamics—a collaborative CEO and directors who think like owners and guard their authority—there will be little constructive challenge between independent directors and management, no matter how good a board’s processes are.

Here Mr. Wong later uses the formulation that serves as the title of this post:

[B]oards that operate to their potential are characterized by constant tensions, coupled with mutual esteem between management and outside directors. Rather than leading to endless bickering, this virtuous combination helps to facilitate healthy and constructive debate and improves decision making.

And here he makes an excellent point about ownership that is especially true in the venture capital industry:

Directors with an ownership mind-set—whether from the family or outside—have passion for the company, look long term, and take personal (as distinguished from legal) responsibility for the firm. They will spend time to understand things they don’t know and not pass the buck to others. They will stand their ground when it is called for. Ultimately, the success of the company over the long term matters to them at a deep, personal level.

In the venture world our long term reward depends heavily on whether or not the value of our portfolio company appreciates.  Furthermore, there are far fewer investors (than in a publicly traded company) so owners are more “meaningfully engaged.”  Owners of private companies get to pick both their investors and their board members.  If entrepreneurs pick great partners (broadly defined) to fund their business and make sure both financial incentives and long term goals are aligned, they will have achieved “high performance” corporate governance that will contribute substantially to their eventual success.