Lead Independent Directors are becoming fashionable. They are now an accepted and appreciated element of board work. Boards that appointed them (sometimes on a rotating basis at each meeting to avoid conferring any power on the incumbent) with reluctance are now singing their praises. So what has lead to this Road to Damascus conversion?
Is a combination of roles inappropriate?
The issue is one of fitness for the tasks at hand. If the combined role of chairman and CEO (often called president) is satisfying the needs of the stakeholders (mostly the board and the senior executives but also the shareholders and the regulators) then by all means combine the roles.
In Australia this combination of two roles in one person is more often found in companies that are ‘in transition’; usually recovering from a disaster, newly formed or recently changed, growing very fast, having lost a trusted incumbent of one role unexpectedly and without a clear succession, or heading for disaster and/or unable to find a person to fill one of the roles.
In some companies the concentration of power in one set of hands allows for swift decision-making, clear communications and great performance. In other companies the combination leads to a quashing of diverse views and influences in decision-making which leads to eventually disaster. The difficult issue is to know which sort of company you are in.
What are the roles?
The general convention is that the chairman is ‘the boss of the board’ and the CEO is ‘the boss of the day to day operations of the company’.
There are areas of contention about whether the board (lead by the chairman) or the executive team (lead by the CEO) is responsible for strategy, design of risk management, appointment of internal auditors, etc. To resolve these areas most good boards will decide where to handle each issue based on a rational analysis of the skills available, the time for doing the work, and the level of confidence they have in the management team. If there is any doubt most regulatory regimes stipulate that the board has the power and is in a position to choose what is delegated and to whom. Sometimes a combined board and executive committee will be the best solution, sometimes management propose and boards ‘add value’, sometimes boards suggest and management ‘refine and develop’.
To further cloud the waters, there is a convention that, although we refer to the Chairman as ‘the boss of the board’, the chairman leads the board only with the consent of the other directors. This consent can be withdrawn at any time (unless you are in one of those rare organisations where the board is appointed; usually in the government or quasi-government sector, in which case the shareholder will have to be asked to decide).
When a board is wavering in its support of the chairman there is a power vacuum which will become dangerous if not addressed. At this point another director needs to step up to the task of discussing the issue with the remaining directors and then, when a clear consensus is formed, with the chairman. Ideally this other director would be the person in the role of ‘lead independent director’ or ‘deputy chairman’ as those roles already have some level of conferred trust from the remaining directors.
Agency theory at work
Agency theory has it that management teams, in the absence of firm controls, will naturally tend to reward themselves at the expense of the shareholders. The board is intended to be the principle control and should supervise and direct management so that the needs of shareholders are given priority. In a not-for-profit those needs would include doing more work, at less cost, to further the aims of the organisation. In a for profit enterprise those aims would include optimising current profit and future wealth creation.
When the leader of the board is also the principal manager of the management team agency theory would suggest that the management team will reward themselves excessively at the shareholders’ expense. In that situation an independent leader is required to assist the board to reach a rational and unbiased view of appropriate remuneration and other ‘perks’ such as large offices, executive jets, interest free loans to buy stock, etc. Ideally the lead independent director will perform that role.
Disentangling roles when disaster looms
All companies need to change the incumbents of their most senior roles at some time. Changing the CEO or Chairman is one of those occasions. When the chairman is also the CEO this is a very complex decision to make. Which role is being fulfilled inadequately? Or is it both roles?
When a chairman is also the CEO he or she, as a member of the board, should have a role in firing the CEO, and should have a role, as the chairman, in developing the consensus that firing the CEO is the action that will create the best outcome for the shareholders. This is an impossible conflict of interest and, to resolve it, companies that have decided to combine the roles, have created the role of lead independent director to step in and usurp the role of the chairman in that decision.
Likewise, when it is the chairman role that is being performed inadequately the CEO is usually the first person to reach that opinion and the one with most knowledge of the issues that need to be better handled. When the roles are combined the incumbent is unlikely to recognise that he or she is providing inadequate self leadership. The long suffering lead independent director is expected to recognise these signs and alert the rest of the board to them.
Having established the role of lead independent director to handle these pernicious problems, boards then discovered that this role could offer many additional advantages. Lead executive directors are now often involved in leading the performance assessment of the chairman. This requires a director to have a good knowledge of governance and a high level of interpersonal skill to delve into the information and then convey it to the Chairman.
Another area where Lead Independent Directors add value is in the assessment and appointment of auditors, both statutory and internal, because the Chairman has a conflict of interest in this matter.
When the role was first introduced it was viewed with suspicion. Now, in companies where the incumbent has performed well, it is viewed as an essential component of board success. It is not, and never will be, a role for the faint hearted, inexperienced or Pollyanna-ish. It goes a long way towards resolving the conflicts inherent in combined Chairman and CEO roles. Company where the role has been performed ‘sub-optimally’ are now looking at boards where the role is adding value to governance and upgrading their own performance. There is even evidence that the role (if not yet the title) is spreading to boards where the CEO and Chairman roles are separate.
What do you think?
Julie Garland-McLellan has been internationally acclaimed as a leading expert on board governance. See her website and LinkedIn profiles, and get her books Dilemmas, Dilemmas: Practical Case Studies for Company Directorsand Presenting to Boards.