The Enron and Satyam scandals prove that it isn’t enough to have a star-studded board of directors. In fact, it can be counter-productive
By MAK YUEN TEEN 12 January 2009
Enron had a world-renowned accounting professor who used to be Dean of Stanford Business School chairing its audit committee, when it imploded. Satyam had one of the top business professors in the world specialising in finance, accounting and corporate governance, who is a senior associate dean at Harvard Business School. It also had the dean of the Indian School of Business as a board member, who has since resigned from his position as dean.
After the scandal broke and fingers were pointed at the failure of Enron’s audit committee and board, the colleagues of the Stanford Business School professor were quoted in the New York Times as saying that he was not known to cut corners and that their best guess was that he was just too trusting. My guess is that it is the same with Satyam - that the directors were too trusting. Remember that just prior to the revelation of the fraud at Satyam, the board of directors of Satyam had approved the proposed purchase of two companies owned and run by family members of the chairman. It was the market which disapproved of the purchase which led to the deal being aborted, and it would seem, which ultimately led to the unravelling of the scandal.
The purpose of this article is not to highlight the dangers of having business school professors of Ivy League universities on boards of directors - or at least not completely. These individuals are extremely smart. Many of the other board members in these two companies - and in many other companies which have failed or suffered significant losses, including some of the major financial institutions - had equally star-studded boards, and not all had business school professors. What these cases all indicate is that it is not enough to have a star-studded board. In fact, it can be counter-productive.
Star-studded boards may be useful for signalling the quality of the company to the market. Investors looking at the company may be comforted that the company is in the good hands of smart and well-connected individuals. However, being too smart and too well-connected could also be the downfall of the company. Very smart people may not want to look dumb to others. So, they may be reluctant to ask questions that the other very smart people on the board may think are dumb. I remember reading a business magazine which had a story on how an experienced director was asked what sort of person would make a good director. Her young daughter, she replied, ‘because she is not afraid of asking stupid questions’.
Connections
The ‘connection’ part may also be a real problem. There are often many connections that are not apparent from just reading annual reports or company filings. A few years ago, for an examination in a corporate governance course in the UCLA-NUS executive MBA programme, I gave the students access to the Internet and asked them to uncover all the connections they can find among the board members of one of the major companies in Hong Kong, and to evaluate the corporate governance of the company. Within less than one hour, they found a lot of connections, some from the annual reports and others from the Internet. They found independent directors who served together with other independent directors and the executive directors on other boards and government bodies, and these are often not reported in the annual reports. There was also an Ivy League university connection. The founders had graduated from the university and one of the independent directors was a professor from the same university. Some students dug deeper into when the founders attended the university, and concluded that the founders were probably taught by that professor.
This brings me back to a few years ago when a renowned shareholder activist and experienced board director in the US came to Singapore. We were strolling in the Botanic Gardens on a beautiful Sunday morning when he asked me: ‘Do you serve on any listed boards?’ I said ‘No’ and before I could go on, he said: ‘Good on you. You know what? There are some (Ivy League university) professors who serve on so many boards now that they have stopped being objective when commenting about corporate governance.’
There are other dangers with star-studded boards, with or without famous professors. In addition to great peer pressure ‘to act smart by not asking stupid questions’ and connections affecting substantive independence, they can give a false sense of security to investors or even auditors. It can be awkward when a manager or even a partner of an accounting firm tries to be more probing of management which has a star-studded board behind it - if the board members are known to be very close to and trusting of management. Perhaps the star-studded board was a reason why a UK-based corporate governance body gave a best corporate governance award to Satyam just last September. How else would a UK body be able to judge the corporate governance of an Indian company which is listed in Mumbai and New York?
In fact, it is possible that some poorly governed companies would deliberately put ‘stars’ or at least ‘star dust’ on their boards to try to window-dress their boards. Those with senior government connections and strong business credentials may be good candidates. Foreigners with multinational experience may be good candidates too. I have even been told that some Chinese boards have directors from Western countries and much of the board discussions are in Mandarin! One wonders how the foreign directors can contribute. There is a risk that these foreigners with good intentions to help out local companies will fall prey to companies wanting them purely to window-dress their boards. I know of anecdotal evidence of this happening. It would be interesting to do a fuller study of this issue.
So, if a star-studded board is not necessarily a good board, and could in fact be a bad one, what makes an effective board? Of course, the structure of the board is important. You cannot run like a cheetah if you are built like a koala. However, it is not just a matter of putting big names on the board. It’s no use entering a Rolls Royce in an F1 race.
In addition to effective separation of responsibilities between the chairman and CEO and having sufficient truly independent directors on the board, board size is also important. Citic Pacific had far too large a board with 19 directors when it imploded. The code of corporate governance recommends that boards review their size to ensure that it is appropriate, and I would suggest that a board should seriously ask if it is getting too large when it starts going beyond 10 or 11 directors. Many boards of global companies make do with nine or 10 directors, some complementing their boards with advisory boards or panels which are close to major markets.
However, too small is also a problem. One of the top 100 SGX-listed companies has a board of four directors. While possibly nimble, one could question whether there would be the requisite diversity of backgrounds and viewpoints for more informed board decision-making. One may be able to run fast, but it may still not be fast enough.
In addition to basic ‘structural’ considerations of the separation of the roles of the chairman and CEO, sufficient independent directors and appropriate board size, I would argue that the following are critical attributes of an effective board:
• Strong and diverse competencies
• Professionalism
• Diversity in demographics
Let me explain briefly each of these. An effective board requires independent directors who are good in their areas of expertise, but I should add that they should not just take an interest in matters within their area of expertise. They do not all have to be active or former CEOs. Indeed, too much of anything is a bad thing and I would say that too many active or former CEOs would lead to either too many people thinking they are actually running the company when they are merely overseers, or lead to too much ‘group think’ or mutual admiration.
Good mix
At a recent seminar, one director said that it is incorrect to assume that an experienced senior executive will necessarily make a good director. A good mix of general business background and specialist skills is needed. Knowledge about the industry or closely related industries among the independent directors is also important so that they are not completely dependent on the executive directors for industry knowledge.
There is no need for everyone to have deep knowledge about the industry - that could also be a bad thing just like having too many CEOs. Other directors can acquire the industry knowledge as they serve on the board, but at least one of the independent directors should ideally have deeper industry knowledge. And we must not forget professionalism. By this, I mean people who take whatever they do seriously. Professionalism means making sure that one does not accept a job knowing that one does not have the time or ability to do it well. It means people who know what they do not know and seek to fill those gaps through continuous learning, and people who are able to accept different views and debate robustly without getting personal and scratching other people’s cars.
Diversity in demographics is also important, and that could include people coming from different backgrounds, different gender, different races and nationality, and the like. But it must not be window-dressing. These individuals with diverse demographics must also meet the other two requirements of possessing strong competencies and professionalism.
There is research evidence that women bring different perspectives to issues, consider different factors when making decisions, and of course, they often do not mix in the same circles as men. They may also be more willing to ask questions - even those questions that the men may think are dumb - that will enrich board decisions. The same goes for diversity in other demographics.
Here’s a suggestion for boards. Next time you have a board meeting, go around and ask each director what’s his favourite sport and his favourite type of music. If everyone or most say ‘golf’ and ‘classical’, you have a problem. Bring in someone who likes mahjong and who likes ‘rock’. Actually that’s me, but I’m not available.
The writer is co-director of the Corporate Governance and Financial Reporting Centre at the NUS Business School. The views in this article are his own
1 comment:
Looking Good Versus Doing Well
The Enron and Satyam scandals prove that it isn’t enough to have a star-studded board of directors. In fact, it can be counter-productive
By MAK YUEN TEEN
12 January 2009
Enron had a world-renowned accounting professor who used to be Dean of Stanford Business School chairing its audit committee, when it imploded. Satyam had one of the top business professors in the world specialising in finance, accounting and corporate governance, who is a senior associate dean at Harvard Business School. It also had the dean of the Indian School of Business as a board member, who has since resigned from his position as dean.
After the scandal broke and fingers were pointed at the failure of Enron’s audit committee and board, the colleagues of the Stanford Business School professor were quoted in the New York Times as saying that he was not known to cut corners and that their best guess was that he was just too trusting. My guess is that it is the same with Satyam - that the directors were too trusting. Remember that just prior to the revelation of the fraud at Satyam, the board of directors of Satyam had approved the proposed purchase of two companies owned and run by family members of the chairman. It was the market which disapproved of the purchase which led to the deal being aborted, and it would seem, which ultimately led to the unravelling of the scandal.
The purpose of this article is not to highlight the dangers of having business school professors of Ivy League universities on boards of directors - or at least not completely. These individuals are extremely smart. Many of the other board members in these two companies - and in many other companies which have failed or suffered significant losses, including some of the major financial institutions - had equally star-studded boards, and not all had business school professors. What these cases all indicate is that it is not enough to have a star-studded board. In fact, it can be counter-productive.
Star-studded boards may be useful for signalling the quality of the company to the market. Investors looking at the company may be comforted that the company is in the good hands of smart and well-connected individuals. However, being too smart and too well-connected could also be the downfall of the company. Very smart people may not want to look dumb to others. So, they may be reluctant to ask questions that the other very smart people on the board may think are dumb. I remember reading a business magazine which had a story on how an experienced director was asked what sort of person would make a good director. Her young daughter, she replied, ‘because she is not afraid of asking stupid questions’.
Connections
The ‘connection’ part may also be a real problem. There are often many connections that are not apparent from just reading annual reports or company filings. A few years ago, for an examination in a corporate governance course in the UCLA-NUS executive MBA programme, I gave the students access to the Internet and asked them to uncover all the connections they can find among the board members of one of the major companies in Hong Kong, and to evaluate the corporate governance of the company. Within less than one hour, they found a lot of connections, some from the annual reports and others from the Internet. They found independent directors who served together with other independent directors and the executive directors on other boards and government bodies, and these are often not reported in the annual reports. There was also an Ivy League university connection. The founders had graduated from the university and one of the independent directors was a professor from the same university. Some students dug deeper into when the founders attended the university, and concluded that the founders were probably taught by that professor.
This brings me back to a few years ago when a renowned shareholder activist and experienced board director in the US came to Singapore. We were strolling in the Botanic Gardens on a beautiful Sunday morning when he asked me: ‘Do you serve on any listed boards?’ I said ‘No’ and before I could go on, he said: ‘Good on you. You know what? There are some (Ivy League university) professors who serve on so many boards now that they have stopped being objective when commenting about corporate governance.’
There are other dangers with star-studded boards, with or without famous professors. In addition to great peer pressure ‘to act smart by not asking stupid questions’ and connections affecting substantive independence, they can give a false sense of security to investors or even auditors. It can be awkward when a manager or even a partner of an accounting firm tries to be more probing of management which has a star-studded board behind it - if the board members are known to be very close to and trusting of management. Perhaps the star-studded board was a reason why a UK-based corporate governance body gave a best corporate governance award to Satyam just last September. How else would a UK body be able to judge the corporate governance of an Indian company which is listed in Mumbai and New York?
In fact, it is possible that some poorly governed companies would deliberately put ‘stars’ or at least ‘star dust’ on their boards to try to window-dress their boards. Those with senior government connections and strong business credentials may be good candidates. Foreigners with multinational experience may be good candidates too. I have even been told that some Chinese boards have directors from Western countries and much of the board discussions are in Mandarin! One wonders how the foreign directors can contribute. There is a risk that these foreigners with good intentions to help out local companies will fall prey to companies wanting them purely to window-dress their boards. I know of anecdotal evidence of this happening. It would be interesting to do a fuller study of this issue.
So, if a star-studded board is not necessarily a good board, and could in fact be a bad one, what makes an effective board? Of course, the structure of the board is important. You cannot run like a cheetah if you are built like a koala. However, it is not just a matter of putting big names on the board. It’s no use entering a Rolls Royce in an F1 race.
In addition to effective separation of responsibilities between the chairman and CEO and having sufficient truly independent directors on the board, board size is also important. Citic Pacific had far too large a board with 19 directors when it imploded. The code of corporate governance recommends that boards review their size to ensure that it is appropriate, and I would suggest that a board should seriously ask if it is getting too large when it starts going beyond 10 or 11 directors. Many boards of global companies make do with nine or 10 directors, some complementing their boards with advisory boards or panels which are close to major markets.
However, too small is also a problem. One of the top 100 SGX-listed companies has a board of four directors. While possibly nimble, one could question whether there would be the requisite diversity of backgrounds and viewpoints for more informed board decision-making. One may be able to run fast, but it may still not be fast enough.
In addition to basic ‘structural’ considerations of the separation of the roles of the chairman and CEO, sufficient independent directors and appropriate board size, I would argue that the following are critical attributes of an effective board:
• Strong and diverse competencies
• Professionalism
• Diversity in demographics
Let me explain briefly each of these. An effective board requires independent directors who are good in their areas of expertise, but I should add that they should not just take an interest in matters within their area of expertise. They do not all have to be active or former CEOs. Indeed, too much of anything is a bad thing and I would say that too many active or former CEOs would lead to either too many people thinking they are actually running the company when they are merely overseers, or lead to too much ‘group think’ or mutual admiration.
Good mix
At a recent seminar, one director said that it is incorrect to assume that an experienced senior executive will necessarily make a good director. A good mix of general business background and specialist skills is needed. Knowledge about the industry or closely related industries among the independent directors is also important so that they are not completely dependent on the executive directors for industry knowledge.
There is no need for everyone to have deep knowledge about the industry - that could also be a bad thing just like having too many CEOs. Other directors can acquire the industry knowledge as they serve on the board, but at least one of the independent directors should ideally have deeper industry knowledge. And we must not forget professionalism. By this, I mean people who take whatever they do seriously. Professionalism means making sure that one does not accept a job knowing that one does not have the time or ability to do it well. It means people who know what they do not know and seek to fill those gaps through continuous learning, and people who are able to accept different views and debate robustly without getting personal and scratching other people’s cars.
Diversity in demographics is also important, and that could include people coming from different backgrounds, different gender, different races and nationality, and the like. But it must not be window-dressing. These individuals with diverse demographics must also meet the other two requirements of possessing strong competencies and professionalism.
There is research evidence that women bring different perspectives to issues, consider different factors when making decisions, and of course, they often do not mix in the same circles as men. They may also be more willing to ask questions - even those questions that the men may think are dumb - that will enrich board decisions. The same goes for diversity in other demographics.
Here’s a suggestion for boards. Next time you have a board meeting, go around and ask each director what’s his favourite sport and his favourite type of music. If everyone or most say ‘golf’ and ‘classical’, you have a problem. Bring in someone who likes mahjong and who likes ‘rock’. Actually that’s me, but I’m not available.
The writer is co-director of the Corporate Governance and Financial Reporting Centre at the NUS Business School. The views in this article are his own
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