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Column

Hoffer Kaback
President
Gloucester Capital Corp.

From the Outside Looking In
Checklist-ism won’t tell you what you might really need to know about a board.

By Hoffer Kaback

At a February 8 New York Society of Security Analysts corporate governance conference, Holly Gregory of law firm Weil, Gotshal & Manges voiced the important question, “How do we judge a board’s effectiveness?”

Let us first of all recognize numerous sub-questions inherently involved:

— What does “effectiveness” mean?
— Over what time frame is it to be measured and evaluated?
— What criteria should be used?
— Who sets them?
— Who does the evaluating and judging?
— Is that judging to be wholly internal, wholly external, or something else? That is, should evaluation be made by 1) directors of their colleagues, 2) ratings services types, 3) the editor of Business Week, 4) the editor of Directors & Boards, 5) majority vote of hedge fund managers (like the popular vote of baseball fans in past All-Star selections), or 6) others?

Consider just a small portion of the difficulties: Can “effectiveness” be equated, more or less, to a board’s thoughtfully and carefully hiring the right CEO for the job? (Many do believe that selecting an appropriate CEO is the board’s most important responsibility.) But, because experience shows that CEOs who appear “right” on paper often fail, how do we know until after the fact whether the board’s decision was correct? Should we perhaps say that an effective board is one that timely fires the wrong CEO?

Or, is an effective board one that gets the stock price up, and an ineffective board one where the stock price languishes? After all, isn’t the lodestar for good governance supposed to be “value creation for shareholders,” and what is a high stock price but value creation?

Always the same?
Those inclined to think so should ponder examples like Sunbeam, Enron, and WorldCom. Was the Sunbeam board “effective” when it hired Chainsaw Al Dunlap (stock at roughly $12)? Was it effective as the stock zoomed to $50? Did somehow the identical directors, possessing the identical capabilities and responsibilities for overseeing the identical business, become ineffective when the stock started to tumble (toward, literally, zero)? Or was this the same board, qualitatively, throughout, irrespective of stock price movement (dramatically up followed by dramatically down)? Was the Enron board good (“effective”) at one point and bad (“ineffective”) at another, or was it always the same quality?

Does it really make sense to look to stock price movement as a key indicator of board quality or effectiveness?

Numerous firms “rate” the quality of governance, using their own metrics and point scales revolving around checklist items. Raters generally admit that, without an actual presence in the boardroom, it is difficult to determine whether a board is performing well or not. But the argument is that half a loaf is better than none, and therefore that their ratings are a reasonable approximation.

False Positives and False Negatives
Are they, though? Do such ratings really distinguish quality boards from shoddy ones, effective boards from ineffective ones? Do they measure the right parameters? (For more on these critical points, see my “Two Modest Proposals,” Winter 1998.)

Are ratings valid and reliable tests, or, on the contrary, do they produce so many false positives and false negatives that using them is counterproductive?

Experienced directors would, I think, overwhelmingly agree that, from the outside, it is almost impossible to obtain an accurate sense of how individual directors conduct themselves and how the board as a whole functions. Proxy statement biographical sketches, press clippings, checklist items, and the like don’t provide a clear window into actual boardroom behavior.

Governance ratings reflect numbers and static facts (how many other boards is the director on? how many shares does he own? what percentage of meetings has he attended?). They do not describe, or relate to, character or behavior. Behavior is dynamic. Ratings are lifeless.

‘Inside’ Information
Would you want to know the following kind of information about your board and your CEO?:

• The CEO never gets through a board meeting without drinking 10 large mugs of black coffee.

• The CEO consumes too much booze at board social events.

• The comp committee chairman — 100 percent “independent” per every ratings criterion — is, in fact, a longtime buddy of the CEO’s.

• A director with outstanding paper credentials plans, with the CEO, the points the director will raise at meetings — recommendations the director describes as being “spontaneously” made by him.

• Which directors say nothing (yes, literally nothing) at meetings for years.

• Which directors stand up in the boardroom for what is right while others “go along” (where proxy statement bio notes would not aid you in distinguishing them).

Without being inside the boardroom, how could you possibly know this sort of information? You couldn’t.

How Scoresheets Might Differ Wildly
Moreover, even if, magically, evaluators were enabled to be physically present at board gatherings (formal meetings, social events, everything), their respective judgments of the effectiveness of the board, and of individual directors, would vary widely. Would Bob Monks and Marty Lipton submit identical scoresheets? Carl Icahn and Richard Parsons? A governance metrics rater and a highly experienced director?

Checklist-ism goes to appearances and outward show. Consider Act III, Scene 4, of Richard III. The Bishop of Ely comments to the Duke of Buckingham that he believes that Buckingham knows better than others how Richard thinks. Buckingham replies:

   We know each other’s faces; for our hearts,
   He knows no more of mine than I of yours;
   Nor I of his, my lord, than you of mine.

Hoffer Kaback is President of Gloucester Capital Corp., New York, and has served on several corporate boards. He has been the lead columnist for Directors & Boards for 10 years, authoring the “Quiddities” column in each edition. He can be contacted at hkaback@directorsandboards.com.