In the ideal situation, board directors and chief executive officers should consider themselves as members of one team, working in a win-win relationship rather than constantly battling for power. The most important issue for all to agree upon is: “What is the role of the CEO in relation to the board?” I would encourage boards and CEOs to make this question explicit and to find an answer that suits their specific company situation.
The balance between CEOnand board depends on a company’s key issues
In the past few years, we have witnessed the demise of formerly successful US companies such as Enron, with CEO Kenneth Lay; WorldCom, with Bernie Ebbers; Tyco, with Dennis Kozlowski; Conseco, with Stephen Hilbert and Adelphia, with John Rigas. European corporate collapses include Skandia, with Lars-Eric Petersson, Parmalat with Calisto Tanzi and Swissair with Philippe Bruggisser. Japan has also had its share of corporate scandals with Mitsubishi Motors under CEO Katsuhiko Kawasoe and, more recently, the controversy at Seibu Railway under Yoshiaki Tsutsumi, one of corporate Japan’s most influential figures.
The role of the CEOs in these corporate collapses does not follow one specific pattern, except that all have shown, at the very least, poor corporate governance judgment and, in the worst cases, blatant greed. Taking away CEO authority and shifting the balance of power towards the board may seem the right response to scandals such as the above. Reality, however, requires a more sophisticated solution. A workable balance between board and CEO will be different for every company and mostly depends on its competitive context.
For example, let us compare a shipping company with a bank. In a major shipping company, the board can only lay out the general premises behind its strategy, such as general attitude towards risk-taking, overall diversity of the company and so on. It must, to a large extent, delegate the actual decision-making to the CEO, because speedy execution is required to take advantage of opportunities in shipping markets. Since speed is so critical, relevant initiatives regarding key decisions must largely come from the CEO. The board can only ask to be kept informed within the overall general parameters and limitations that have been set for the CEO.
At the other extreme, it is a legal requirement for the board of a bank to play an active role in each major credit commitment decision. When the Basel II Accord comes into force, which is currently scheduled for 2008, the board may have to become even more involved! I agree with Jaime Caruana, chairman of the Basel Committee on Banking Supervision, that implementing the Basel II rules will be “as difficult and as important as drawing up the accord, which took five years”. One reason why it will be so difficult is that these legal requirements risk ruining a well-balanced relationship between board and CEO.
Defining the board’s roles and responsibilities by following a standard set of prescriptions - such as those contained in reports like the Cadbury Report (UK), the Smith Report (UK) or the N¿rby Report (Denmark), or prescribed in legislation, such as the Sarbanes-Oxley Act (US) - does not always make sense. Instead, the CEO and board should consider the specific circumstances of their company and identify which types of decisions are vital - these are the ones that the board needs to address.
Some commentators portray the discussion about who decides what, single-handed or together, as a trade-off between the CEO’s power and the board’s power. I claim the contrary. The board and the CEO need to implement decisions on key success factors for the company together. This includes agreeing upon the types of decisions and issues about which the board expects to be kept informed, so that its members always have up-to-date - and what they see as relevant - background information to deal with issues as they arise.
Much of the legal drive towards dealing with compliance issues has come from the US. So far, Europe takes a more judgmental approach, although pressures towards more formal compliance criteria are also growing there. With the two-tier board system found in certain continental European countries - notably Germany - there is, however, a strong checks-and-bounds balance already built in, making the quest for further compliance regulations less pressing. In Japan, which is characterised by very large boards driven by ceremony, one can expect increased pressure towards more legislation and compliance.
How the CEO and board should build a strategic plan
The first thing a board can expect from a CEO is a sound strategic plan. The plan should emphasise both longer-term, “top-line” performance and shorter-term “bottom line”. This is a balancing act - not a trade-off - and the CEO must discuss the right balance with the board. The CEO can facilitate the strategy discussion among the board by mapping the various activities for each business area.
Some of the activities in a particular business area will consist of focusing on the existing business, in terms of both established markets and proven competences. This “protect and extend” strategic activity will typically lead to steady bottom-line results. If the company tries to develop new markets by building on its strengths in this specific business area, it may then be able to leverage these competences relatively easily. For instance, it can take its successes into new markets, say new countries, thereby creating longer-term growth, but without necessarily causing too much of a drain on the bottom line.
It can also build related competences, adding them to the present strengths. Building related competences can involve resources and typically requires a longer-term focus, but the idea again would be to make sure that the build activities are realistic when it comes to adhering to the long-term/short-term balance for the company. Finally, we have the transform activities, which are clearly long term. These must not be allowed to absorb resources to the extent that they become a threat to the short-term, bottom-line results.
Taken together, these activities can form a framework around which the CEO can build a strategic plan in order to secure both growth and profits, and gain the board’s full support.
A second strategy issue for the CEO to define, together with the board, is the best number of business platforms in the company’s overall portfolio strategy. How widely should a company spread itself and what should the relationship between these business areas be? For instance, the board and CEO of Norsk Hydro, the Norwegian industrial group, debated for years whether it should maintain the company’s three unrelated business platforms: oil and gas, light metals and agricultural products. It was widely felt that the market was heavily discounting the Norsk Hydro stock because shareholders perceived the company as a conglomerate of unrelated activities. It was also felt by both the CEO and board that too much complexity made strategy execution difficult. Inside analyses - supported by the findings of consultants - pointed towards splitting up the company. Although this meant saying goodbye to a business platform that had been there since the company’s origins 100 years ago, the CEO and board in the end decided unanimously to spin off the agricultural business. This focused the company on two unrelated business platforms, rather than three.
In all strategic decisions, the CEO and board must discuss and agree on potential risks. Let us look at Kvaerner ASA, another Norwegian industrial conglomerate, which in 1996 acquired Trafalgar House, the UK shipbuilding and construction group.
At the time, Kvaerner operated in rather mature markets. It could potentially gain a lot from acquiring a more growth-oriented business like Trafalgar House. The acquisition did, however, involve taking on a lot of debt and the new company - now with a much higher breakeven point - became too vulnerable to downturns in revenues. In retrospect, the CEO and the board may have taken on too much risk, and both were forced to leave. They should perhaps have resisted the temptation of accelerated growth via the much-larger Trafalgar House.
When it comes to mergers and acquisitions, sentiments of the stakeholders have to be taken into account. The board must make sure that the CEO and the management will be able to master chemistry issues between the parties. For example in 1997, Royal Caribbean Cruise Lines, which is based in the US, acquired Celebrity Cruises, which is based in Greece and the UK. The stakeholder issues were well understood. The majority owner of Celebrity became a member of the Royal Caribbean board. Two essentially independent divisions - retaining their original commercial brand names - were set up representing separate growth platforms within the cruise industry. Where synergies could be achieved, the management consolidated some parts of the operations area. All stakeholders in the two organisations - owners, investors, boards and employees - seemed to work well together in supporting the CEO of Royal Caribbean to create a leaner and stronger company.
However, when Royal Caribbean attempted to acquire Princess Cruises from P&O, it ran into problems. Royal Caribbean’s top management was eager to acquire Princess for the growth and market leadership potential it provided. Royal Caribbean’s board, however, was not prepared to win this deal at all costs. When Royal Caribbean made an offer, P&O conditionally accepted. But in the end, Royal Caribbean’s arch-competitor Carnival Cruises managed to close the deal, in what was seen as a major blow to Royal Caribbean.
Carnival Cruises had offered a higher price and guaranteed to leave Princess Cruises’ organisation relatively intact. Had Royal Caribbean’s CEO and board perhaps failed to understand fully the sentiments and conditions of P&O’s stakeholders? At a crucial moment in time, did Royal Caribbean’s board perhaps focus too much on discussions with its own upper management on price? Even if Royal Caribbean’s top management seems to have done a great job with the acquisition of Celebrity, we can question how well the team was able to orchestrate the key stakeholder issues among the boards on both sides for the Princess acquisition.
Royal Caribbean’s CEO faced particular criticism for the failed takeover attempt, but the board members should also have obtained greater clarity about the stakeholders’ positions, perhaps by becoming more involved in these discussions and at an earlier stage.
Legal, organisational and ethical issues
The law in many countries is becoming increasingly specific about what constitutes critical governance issues, and is requiring that such issues be handled by both the board and CEO. This requirement is an attempt to ensure governance that protects the interests of investors as well as society at large. In many instances, there is a compliance protocol for the board regarding the various issues that affect the company, such as pollution control, safety and so on. The CEO must fully support the board in this regard and may be expected to initiate a review of these issues in the non-executive board meeting at least once a year.
Updates and exchanges on the latest legislation are, however, only one aspect of learning at the top. Learning, for the board and employees, should be a standard part of the board’s agenda, so that the company can continuously improve its understanding of the critical issues it faces. Research has shown that, when the board actively stimulates a culture of organisational learning, the company tends to be more successful.
The CEO and board must also ensure that they have a workable succession plan in place. Even if the board expects the CEO to make the contingency-based succession plan for the senior management team, the CEO does not appoint his or her successor - this is the responsibility of the board.
In turn, the CEO should expect the members of the board to be independent and to refrain from cronyism. To prevent the formation of sub-units within the board, the board should be one team of independent members, and sub-committees should probably be avoided. Even the formation of the common nomination, compensation and audit committees might be questioned. Although they may represent efficiency gains, they can also fragment the board’s responsibilities. The danger is that special interest groups could dominate the board and potentially create an environment in which politicking thrives.
Board members should be expected to speak up, and not be held hostage by the company due to economic or other dependencies. If the compensation received by board members becomes too significant, there is a danger that their desire to keep their seat on the board will outweigh the duty to speak out and rock the boat. The same goes for the CEO. Too many CEOs become major stockholders. Some borrow extensively to purchase company stocks or exercise options and may thus become dependent on the company. This may inspire them to take actions that are not necessarily for the good of the company, but rather in their own interest only.
Traditionally, careers have been managed from an organisational-need perspective but, in today’s brain-driven organisations, we are starting to see this inverted: individual careers may increasingly be driving the organisation. Talented executives decide for themselves what types of job assignments they are prepared to hold; most likely, only those that will enhance their personal and professional development.
The board and shareholders no longer hold ultimate power, nor does the CEO. More and more frequently, it is the company’s key knowledge or talent holders who do. With the increasing importance of this group of employees, the governance equation may evolve to become even more complicated than just balancing the roles of the CEO and board. To ensure ongoing commitment from a wider set of stakeholders, a broader balancing act may be needed.
Parts of this article are based on material from the book Mastering Global Corporate Governance, edited by Ulrich Steger, and published by John Wiley Sons, Ltd, London 2004.
Peter Lorange is president and NestlŽ professor at IMD (The International Institute for Management Development) in Lausanne, Switzerland. He serves on the boards of several international corporations.
