Category Archives: Boards of Directors

Manage to the rules (only) and you’ll tiptoe right up to the hot red line

The Wall Street Journal recently reported on the splash made by BoE Director of Financial Stability Andrew Haldane at the Federal Reserve’s annual policy conference in Jackson Hole, Wyoming.  Haldane argued that regulations become less effective as they become more complex and likened it to a playing Frisbee with a dog.  Despite the complexity of the physics involved, catching a Frisbee can be mastered by an average dog because he has to keep it simple:

The answer, as in many other areas of complex decision-making, is simple. Or rather, it is to keep it simple. For studies have shown that the Frisbee-catching dog follows the simplest of rules of thumb: run at a speed so that the angle of gaze to the Frisbee remains roughly constant. Humans follow an identical rule of thumb.  Catching a crisis, like catching a Frisbee, is difficult. Doing so requires the regulator to weigh a complex array of financial and psychological factors, among them innovation and risk appetite. Were an economist to write down crisis-catching as an optimal control problem, they would probably have to ask a physicist for help.  Yet despite this complexity, efforts to catch the crisis Frisbee have continued to escalate. Casual empiricism reveals an ever-growing number of regulators, some with a Doctorate in physics. Ever-larger litters have not, however, obviously improved watchdogs’ Frisbee-catching abilities. No regulator had the foresight to predict the financial crisis, although some have since exhibited supernatural powers of hindsight.  So what is the secret of the watchdogs’ failure?  The answer is simple. Or rather, it is complexity. For what this paper explores is why the type of complex regulation developed over recent decades might not just be costly and cumbersome but sub-optimal for crisis control. In financial regulation, less may be more.

Haldane warned that “fundamental limitations of the human mind” thwart increasingly complex (and sometimes frivolous) attempts at regulation.  Most involve the limits of data or modelling or even the nature of knowledge itself:

This belief is new, and not helpful. As the authors note, “Many of the dominant figures in 20th century economics—from Keynes to Hayek, from Simon to Friedman—placed imperfections in information and knowledge centre-stage. Uncertainty was for them the normal state of decision-making affairs.”

A deadly flaw in financial regulation is the assumption that a few years or even a few decades of market data can allow models to accurately predict worst-case scenarios. The authors suggest that hundreds or even a thousand years of data might be needed before we could trust the Basel machinery.

Despite its failures, that machinery becomes larger and larger. As Messrs. Haldane and Madouros note, “Einstein wrote that: ‘The problems that exist in the world today cannot be solved by the level of thinking that created them.’  Yet the regulatory response to the crisis has largely been based on the level of thinking that created it. The Tower of Basel, like its near-namesake the Tower of Babel, continues to rise.”

We once made the same point in the context of what makes great boards great:  boards who over emphasize the process of good governance, including measures implemented in the wake of previous meltdowns, often fail to foresee the next crisis:

Presumably, those companies and regulatory bodies have boards comprised of accomplished and highly intelligent members with personal wealth at stake.  [They were] paying attention and paying consultants; [they had] ethics codes, audit and compensation committees,  Independent Directors, regular meetings, well constructed board packages…  It’s conceivable that a board member here or there could be corrupt or asleep – but entire boards?  Across multiple companies and regulatory agencies?  Unlikely.  It’s more likely that they were following the current and best practices for strong and effective board oversight.  So, if *all* boards have similar formal systems in place, something else must be at work.

A strong board relies on the ‘robust social systems’ among its members – the informal ways in which they trust and challenge each other – to look beyond formal legal and fiduciary responsibilities and proactively assess the shifting regulatory risk environment.

The end of every boom-bust cycle includes a fin de siècle scandal:  insider trading punctuated the ’87 crash, accounting irregularities (Enron, Worldcom) helped pop the tech bubble of the ’90s, and  “rolling the dice” at Fannie & Freddie inflated the housing market with disastrous consequences.  Each scandal led to an avalanche of new regulations atop the snowpack, which never entirely melts away and – more importantly – doesn’t prevent the next crisis.

Haldane summed it up nicely:  “complex and detailed rules lead regulators and financial institutions alike to manage to the rules, tiptoeing right up to the hot red line at which a crisis can be triggered.”

How to recruit a Board of Directors

While the “owners” of public companies often get to pick their board members more in theory than in practice, owners of private companies get to pick both their investors and their board members. Choosing partners who best fit over the long term requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entrepreneurs are almost always surprised how much value a good board can bring to their companies, and the best boards are a function of both the quality of the people involved and, just as importantly, how they operate.

Here we share two recent items on the subject of board recruitment – one that deals with the topic in broad terms and one that looks specifically at recruiting “digital” directors.


In Recruiting the Digital Director, Julie Hembrock Daum, Greg Sedlock and Dana Wade of Spencer Stuart discuss the implications social media’s growth has for the recruiting process.  Demand for digital expertise at the board level is rising faster than the supply of qualified candidates, who can come from nontraditional backgrounds.  Boards may have to recalibrate their perceptions about what an ideal director looks like, define what digital means for the company, and understand the talent trade-offs:

Recruiting board directors from the digital, consumer Internet or technology fields may mean compromising on conventional benchmarks, such as prior board experience or international expertise, in favor of more contemporary skill-sets, for example, experience with social media platforms or digital advertising. Additionally, boards should understand that directors with digital expertise may not have achieved the same stature as candidates from more traditional fields; many of these candidates have not reached the C-level, for example. These young, ambitious and, oftentimes, time-starved executives can be more transient than more established executives, and they may be less familiar with the customs of a corporate boardroom.

Several questions during the recruiting process must be explored.  Is public or private experience critical?  How relevant is governance expertise?  What core competencies does the board require? Are they seeking broad experience or something specific to a hot technology of the day?  And then, once recruited, the new director must be positioned for success:

(C)arefully define the role that the new director is expected to play on the board. Is the new director expected to contribute in the same manner as other directors, or is there a digital-specific function he or she is expected to fill? Is the new director expected to chair a committee? Answering these questions is important when recruiting any new director, but especially [for digital directors].


Firas Raouf of OpenView Partners makes parallel recommendations, with a broader view, in How to Recruit a Board of Directors:

Recruiting a board starts by you realizing that you should recruit a board the way you would recruit employees. Start by defining your needs.  One approach is to examine your skill sets as a founder/CEO… Then think about the skill sets you lack and where a mentor could help in the role of a board member… Then think about your plans for growing the company and the role of a board member in opening strategic partnership doors, whether for funding or business development.

Rauof also describes a few symptoms associated with a bad board:

  • The CEO frequently laments that board meetings take up too much of time for the value added
  • The CEO feels the urge to hide things from them, and/or doesn’t think they’d understand the business
  • Members spend too much time between projects. When you run out of things for them to do, it’s time to recruit their replacements.

Most founders/CEOs think that a board is something that creates a lot of unnecessary work for them, adds little value, and is manned by individuals who will get in the way of running the company.  That can be true if you recruit bad board members. But if you recruit great board members, you will get great value.


Good boards don’t mistake process for purpose

Most research and literature about good governance is developed with public boards in mind, and although the context is a little different than in our business, many of the same lessons do still apply.  Since our long term reward depends heavily on whether or not the value of our portfolio company appreciates, we tend to have a more personal ownership mindset – over and above the legal and fiduciary responsibilities – than public company directors.

Here are two interesting reports on good governance which echo our own thoughts on how to ensure a strong board.  While processes and best practices may be important, great boards rely on ‘robust social systems’ among its members to ensure that they function properly.

First, from Spencer Stuart’s Point of View 2012.  When helping to assemble a board, consider executives who:

…combine integrity with the right mix of knowledge, experience and vision to perform the board’s defined roles with excellence.  Beyond even these considerations, qualities such as judgment, engagement and strong communication skills are critical attributes for every director.  And, just as it is a component in any high-functioning team, interpersonal chemistry also plays a role in every effective board.

And this, from Bridging Board Gaps, by the Study Group on Corporate Boards – a joint effort by Columbia Business School and the John L. Weinberg Center for corporate Governance at the University of Delaware:

Recent institutional failures, surrounded by general economic turmoil, once again sparked the familiar question:  Where were the boards?”  …  But the new rules (e.g. Dodd-Frank) for public company boards are focused on board process.  In addition, boards need a renewed focus on their aspirational purpose and guidance for achieving it… never mistake process for purpose.

That purpose (for public company boards) is stated as “creat(ing) sustainable long-term value for shareholders.”  One Study Group member summed up the report’s conclusions this way:  “Maybe we should rename directors ‘shareholder representatives’ – then they would pull up to the table in the right mindset.”

Naturally this mindset comes a bit more naturally in our field since we are literally a shareholder representative – alongside the entrepreneur and any fellow investors.  (There are also 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.

The Seven Habits of Spectacularly Unsuccessful Executives

We’ve often written on the subjects of failure and success:  while success is better, failure is a part of business and can be a great teacher, and it’s important to fail the right way.  (See here, here, herehere, here, and here for examples of our thinking.)

The current issue of Forbes includes “The Seven Habits of Spectacularly Unsuccessful Executives” – a recap of Why Smart Executives Fail, a book published 8 years ago by Sydney Finkelstein, the Steven Roth Professor of Management at the Tuck School of Business.  Although written with larger firms in mind, the leadership lessons are relevant enough to join our collection here at NVSE.  (Abridged grafs of each Habit reproduced below, please follow the link provided for complete descriptions and warning signs for each.)

Habit # 1:  They see themselves and their companies as dominating their environment 
Shouldn’t a company try to dominate its business environment, shape the future of its markets and set the pace within them?  Yes, but there’s a catch.  Unlike successful leaders, failed leaders who never question their dominance fail to realize they are at the mercy of changing circumstances.  They vastly overestimate the extent to which they actually control events and vastly underestimate the role of chance and circumstance in their success.  CEOs who fall prey to this belief suffer from the illusion of personal pre-eminence: Like certain film directors, they see themselves as the auteurs of their companies.  As far as they’re concerned, everyone else in the company is there to execute their personal vision for the company.

Habit #2:  They identify so completely with the company that there is no clear boundary between their personal interests and their corporation’s interests 
We want business leaders to be completely committed to their companies, with their interests tightly aligned with those of the company.  But digging deeper, you find that failed executives weren’t identifying too little with the company, but rather too much.  Instead of treating companies as enterprises that they needed to nurture, failed leaders treated them as extensions of themselves.  And with that, a “private empire” mentality took hold.  CEOs who possess this outlook often use their companies to carry out personal ambitions.  The most slippery slope of all for these executives is their tendency to use corporate funds for personal reasons…  Being the CEO of a sizable corporation today is probably the closest thing to being king of your own country, and that’s a dangerous title to assume.

Habit #3:  They think they have all the answers 
Here’s the image of executive competence that we’ve been taught to admire for decades: a dynamic leader making a dozen decisions a minute, dealing with many crises simultaneously, and taking only seconds to size up situations that have stumped everyone else for days. The problem with this picture is that it’s a fraud. Leaders who are invariably crisp and decisive tend to settle issues so quickly they have no opportunity to grasp the ramifications.

Habit #4:  They ruthlessly eliminate anyone who isn’t completely behind them
The problem with this approach is that it’s both unnecessary and destructive. CEOs don’t need to have everyone unanimously endorse their vision to have it carried out successfully.  In fact, by eliminating all dissenting and contrasting viewpoints, destructive CEOs cut themselves off from their best chance of seeing and correcting problems as they arise.  Sometimes CEOs who seek to stifle dissent only drive it underground. Once this happens, the entire organization falters…  Eventually, these CEOs had everyone on their staff completely behind them. But where they were headed was toward disaster.  And no one was left to warn them.

Habit #5: They are consummate spokespersons, obsessed with the company image 
CEOs don’t achieve a high level of media attention without devoting themselves assiduously to public relations.  When CEOs are obsessed with their image, they have little time for operational details…  As a final negative twist, when CEOs make the company’s image their top priority, they run the risk of using financial-reporting practices to promote that image.  Instead of treating their financial accounts as a control tool, they treat them as a public-relations tool. The creative accounting that was apparently practiced by such executives as Enron’s Jeffrey Skilling or Tyco’s Kozlowski is as much or more an attempt to promote the company’s image as it is to deceive the public:  In their eyes, everything that the company does is public relations.

Habit #6: They underestimate obstacles 
(W)hen CEOs become so enamored of their vision, they often overlook or underestimate the difficulty of actually getting there.  And when it turns out that the obstacles they casually waved aside are more troublesome than they anticipated, these CEO have a habit of plunging full-steam into the abyss… Once a CEO admits that he or she made the wrong call, there will always be people who say the CEO wasn’t up to the job.  These unrealistic expectations make it exceedingly hard for a CEO to pull back from any chosen course of action, which not surprisingly causes them to push that much harder.

Habit #7: They stubbornly rely on what worked for them in the past 
Frequently, CEOs who fall prey to this habit owe their careers to some “defining moment,” a critical decision or policy choice that resulted in their most notable success.  It’s usually the one thing that they’re most known for and the thing that gets them all of their subsequent jobs.  The problem is that after people have had the experience of that defining moment, if they become the CEO of a large company, they allow their defining moment to define the company as well – no matter how unrealistic it has become.

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.

How does a CEO uncover a board’s doubts?

Writing in The Wall Street Journal, Major General Robert Scales draws a lesson in leadership from Donald Rumsfeld’s recently published memoir, “Known and Unknown.”  Rumsfeld has been (among many other things) a successful Congressman, White House Chief of Staff, Defense Secretary (twice), and Fortune 500 CEO.  Scales wonders how and why an accomplished leader such as this could fail to sense the strategy slipping and doubts growing.

Using an especially apt parallel for today – the sesquicentennial of the first shots fired in our Civil War –  Maj. Gen. Scales sees a historic parallel in Lee’s failure at Gettysburg:

Lee’s generals knew that modern weapons and a determined enemy would turn the charge into a disaster. But who among them would step forward to question the supremely confident general known as the “marble man”? Lee would have been surprised to discover that his generals had doubts, because he considered himself open to their opinions. But his own stature and idea of himself created a barrier that only the trauma of failure could overcome. Thus perhaps in “Known and Unknown” Mr. Rumsfeld inadvertently reveals himself as the 21st century’s first marble man: supremely confident of his ability to manage a war of machines and sadly unapproachable to those below him willing to offer an alterative view of the shifting conflict. In truth his formidable and dominating personality, which had served him so well before, now served to impede those trying to steer a different course—the one that would prove successful in Iraq after Mr. Rumsfeld’s timely and inevitable departure.

It’s easy to imagine either man’s staff struggling to effectively press their contrarian advice.  Any number of factors could cause one not to risk a career “Pickett’s Charge”:  the leader’s force of personality, the high stakes involved, the constrictions of time, the subtle team dynamics of consensus building, or even an over-reliance on formal procedures.  And what’s true for a strong general or cabinet secretary is true elsewhere – including CEOs and their boards of directors.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entrepreneurs are almost always surprised how much value a good board can bring to their companies.  In our experience, boards work best when members’ informal modus operandi animate the formal framework of decision-making.   Are their relationships strong enough to compensate for the all-too-human tendency to learn only after it’s too late?

Strengthen Your Board

What makes a great board great are not so much its formal procedures, but whether or not its members’ informal modus operandi ensure those well-designed procedures function properly.

Robert C. Pozen makes this same point recently in The Wall Street Journal, where he argues that placing too much emphasis on procedure encourages “social loafing” – a situation where individuals don’t take responsibility for the group’s actions and instead assume others will lead.  (Psychologists also believe this phenomenon worsens as group size grows.).  From A New Model for Corporate Boards:

In 2002, Congress passed the Sarbanes-Oxley Act to prevent corporate governance debacles like Enron and WorldCom from happening again. But six years later, many of the largest U.S. institutions had to be rescued by massive federal assistance. All of these institutions were Sarbox-compliant: Most members of their boards were independent, and their auditors’ reports showed no material weaknesses in internal controls. So why were the reforms so ineffective?

I believe that the problem is the current structure of corporate boards. In short, they are too big, members often don’t have enough relevant experience, and they put too much emphasis on procedure.

Regulators, investors and directors should recognize that we do not need more procedures for corporate boards. Instead, we need more expert directors who view their board services as their primary profession—not an avocation.

We agree with Pozen, but wouldn’t call it a *new* model.  As venture capital investors, we typically limit board size at 5 to7 members, include industry experts as outside board members, and spend substantial time communicating with management and working on company issues between board meetings.

Lastly and most critically, our reward depends exclusively on whether or not the value of the company appreciates.   (By way of contrast, Pozen recommends directors receive annual compensation of $400,000 – with only 75% of that in company stock.)

A critical joint task for the venture investor-entrepreneur partnership is to strengthen the composition and performance of the company’s board of directors.  Here is a sampling of our thinking on the subject:

Communicating good news and bad

In this brief MarketWatch interview S.P. Kothari, deputy dean of MIT’s Sloan School of Management, offers advice on how boards can “tease out” better information from their management teams.  Although Mr. Kothari is speaking about publicly traded companies, we do see some similarities that apply to private company boards as well.

Management teams often feel implicit pressure to sugarcoat negative events or downplay bad news.  As a result, Mr. Kothari argues, board members should direct their questioning to areas which management covers more quickly or in a more perfunctory manner.  Look for omissions and do not assume things discussed briefly (or not at all) are fine.

In our experience, the relationship between entrepreneur and venture partner in private companies is more cooperative, longer-term, and (mercifully) not subject to the quarterly reporting pressures of public companies.  Moreover, venture investors have real “skin in the game” and have the same incentive as the entrepreneur to understand the nuances of the business and focus on long term value creation.  As a result, the communication of good news and bad tends to be more forthright and in real-time, enabling partners (assuming they are good partners!) to understand intuitively the right kind of counsel and support to offer during both the good times and during the inevitable challenges of building a business.

Still, even in private companies with strong, motivated board members, there is sometimes a reluctance on the part of entrepreneurs to lay all the cards on the table.  Board members should strive both to do their homework and understand the right questions to ask and make sure they have built the kind of relationship with their entrepreneur partners that will facilitate open and honest communication.

In corporate governance, the right people count more than the right structure

On the one-year anniversary of the GM Bankruptcy an article in the Wall Street Journal draws 3 lessons.  We agree with the author that these “might sound blindingly obvious, but it’s amazing how frequently they’re ignored,” and believe a good venture partner helps address such issues through joint ownership and alignment of interests.

1. Problems denied and solutions delayed will result in a painful and costly day of reckoning.
2. In corporate governance, the right people count more than the right structure.
3. Appearances can be deceiving.

The second lesson – on good governance – is one we’ve made before: systems and best practices are important but members’ informal modi operandi determine whether or not all those well-designed systems function properly.  How this applies to the specific example of GM and Ford:

On paper General Motors was a model of good corporate governance, while Ford was (and is) a disaster. The Ford family’s super-voting Class B shares give it 40% of the votes with less than 4% of the shareholder equity. Class B shares get about 31 votes for every share of the Class A stock that nonfamily members own. And the Ford family gets veto power over any corporate merger or dissolution. This structure seems to fly in the face of what is generally understood to be sound principles of good corporate governance. Such “undemocratic” provisions are sure to be lamented this month at two major corporate-governance conferences: the ODX (Outstanding Directors Exchange) in New York, and the annual confab at the Millstein Center for Corporate Governance at Yale. But the Ford board of directors and family came together in 2006 to seek a new CEO from outside the struggling company, even though that meant family scion Bill Ford Jr. had to relinquish command. He volunteered to do so and remains chairman, but not CEO. Meanwhile, the GM board, consisting of blue-chip outside directors who chose a “lead director” from their ranks, steadfastly backed an ineffective management from one disaster to another and wrung its collective hands while the company ran out of cash. Some GM retirees dubbed the directors the “board of bystanders.”

Ford’s governance may not look good on paper, but at least they found the wherewithal to do what had to be done – this time. The next time – and there is always a next time in the up & down that is the business cycle – they’d be better served by better practices. But that is an easier problem to fix than GM’s, which has more to do with getting the team to deal more frankly and forthrightly with the issues at hand and each other.

Improving Corporate Governance: A Memo to the Board

John J. Brennan, chairman emeritus of Vanguard, writes in the 5/10/10 WSJ on how to improve corporate governance.   Based on a recent speech he delivered at the Drexel University LeBow College of Business Center for Corporate Governance, he offers both conceptual and concrete recommendations:

1. Know that you are the shareholders’ first line of defense
2. Build value through mutual respect
3. Communicate
4. Measure your success
5. Compensate yourselves in equity
6. Share your metrics
7. Hold yourselves accountable
8. Establish an “owners relations committee”

In the venture world, our long term reward is in equity (#5), and there are far fewer investors, so owners are more “meaningfully engaged” (#8) than in a large public company with diffuse ownership.  The balance of Brennan’s recommendations are also sound, but as we’ve written before, good governance hinges on ‘robust social systems’ – i.e., the members’ informal  modus operandi ensure that all those well-designed systems function properly.  While the “owners” of public companies often get to pick their board members more in theory than in practice, 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.

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