The True Purpose of a Board

By Nikos | June 19, 2008

Corporate Governance

Henry Ford is the textbook example of a successful businessman finding himself in conflict with shareholders who failed to see the value of his purpose. He lost a couple of times and then went on to win. His first venture was not, as it happened, the Ford Motor Co. but the Detroit Automobile Co., founded in 1899. It lasted a year. The other shareholders, according to Ford, saw the company as a mere “moneymaking concern” rat her than as “a vehicle for realizing my ideas.” His second venture, the Henry Ford Co., was more successful, but he left after eighteen months (it later changed its name to Cadillac), commenting that “thinking first of the money instead of the work brings on fear of failure and this fear blocks every avenue of business.” 

     

By the time he set up venture number three, the Ford Motor Co., he had learned his lesson. In 1906, three years after the company was founded, he threw his original backer, Alexander Malcomson, off the board because Malcomson wanted to develop an expensive car, responding to current market demand. This was out of line with Ford’s purpose, which was to “democratize the auto mobile”; as he put it to one of his mechanics, “the proper system, as I have it in mind, is to get the car to the people.” 

     

This, of course, is what he did. From 1908 to 1917, Ford steadily cut the cost of the Mo del T from almost $950 to just $345. By then he was selling 730,000 cars a year. These price cuts were not needed to match the competition or ensure that demand was maintained, nor did Ford watch the company’s cash very closely. He was happy to throw away comparatively new machinery in order to improve the production process, and he never assessed the return on his investment.  He was striving to democratize the automobile—and, in the process, making a fortune for himself and his shareholders. 

     

Strangely enough, his shareholders were not especially grateful. In 1917, they launched a lawsuit, trying to force him to distribute dividends rat her than invest mo re and more cash in lower prices and expansion. They could not have been more wrong—the profits of the company continued to soar as production expanded — but it didn’t seem like that at the time.

 

The Well-Balanced Board

 

Does the Ford story show that shareholders and boards should just shut up and let the CEO get on with it? The history of Ford after 1923, when it steadily lost share to General Motors, shows how badly wrong things can go when there are no checks and balances on a leader. Equally, recent corporate scandals have made the country-club style of corporate governance simply unacceptable. Partly for this reason, shareholder activism is on the increase: Funds with large stakes are increasingly finding it worth their while to intervene, threatening to remove and sometimes actually moving against management.

 

One school of thought, often adopted by those with a private equity background, is that the answer to the problem is for board members themselves to be substantial shareholders, to more directly re present shareholders. Were this to be the case, they would have strong incentives to keep a close eye on potentially way ward executives and to exert themselves when monitoring strategy, succession plans, acquisitions, and the like.  In the jargon, directors and shareholders’ incentives would become perfectly aligned, and there would be no agency problems. 

     

Such a system indeed works well in private equity, where lack of liquidity forces shareholders to take at least a medium-term view of their stakes and where everything is geared to the eventual sale of those stakes. The danger with extending the formula to public companies is that boards, under pressure from market- watching shareholders, become excessively interested in short – term share – price movements. Few observers, and fewer CEOs, feel that the market needs more influence in the boardroom. On the contrary, as Warren Buffett has pointed out, part of the value he adds at Berkshire Hathaway is acting as a buffer between the CEOs of operating companies and the pressures of the equity market.  Boards generally can also perform this role, but if they are to do so, then, like any mediator, they need a degree of independence.

     

How Boards Support Purpose

 

If companies driven by a strong shared purpose are more successful, then part of the board’s mediating role must be defending such a purpose—and if there is none, fostering one. It must be satisfied that the purpose is consistent with advancing shareholders’ interests, of course. But it must also support the company’s leadership and protect it from short-term market pressures. 

     

This does not mean the board should itself discover or create a purpose for the company, but if there is no purpose, it can encourage the top team to discover one, just as it would encourage the team to develop a strategy were it not to have one. In other words, it is the top team’s job to discover a purpose and strategy that the board can back while being true to its fiduciary responsibilities (which may, depending on the jurisdiction, be to the company, the shareholders, or in some cases to other stakeholders).

 

Once such a potential purpose has been identified, board members can test management’s commitment to it and test whether it is compatible with a strategy to deliver shareholder value. If all is well, they can agree on it and act as its guardian.

 

This they do by gently reminding management about the purpose when necessary, asking the occasional question about its implications for strategy, and assessing whether it is taking hold among those employees whose support is important.  (Of course, the board is entitled to reject a purpose presented by management if it regards it as inconsistent with shareholders’ interests—and this might be a resignation issue for the CEO.) The board must then adopt the purpose as its own and defend it vigorously in public.

 

The chairman has a particular role to play. He can act as a kind of father-confessor and help team members focus on the long-term tasks of developing and applying the purpose and building advantage. He can reassure them that it is OK not to respond constantly to short-term pressures imposed by analysts, governments, unions, and nongovernmental organizations.

     

In my experience, within the framework I have just described there are two patterns of useful board intervention.  The first pattern is more common in companies with a strong, united, and often quite small leadership group. Such businesses may, for example, have expanded by rolling out a standard business model globally. Companies such as Microsoft, Coca-Cola, and McDonald’s are known precisely for using efficiencies of scale to roll out similar operations and marketing all over the world without much adaptation. They are the icons of American business, in which managers, no matter where they live, are expected to de mo n s t rate not just ability but fealty to the core. This type of organization benefits from its strong sense of collective purpose. The danger is that the purpose can deg e n e rate into narcissism and isolation.

 

In such companies, the board’s most important role is not usually to foster the purpose or even to promote it to shareholders (although, as always, the father-confessor chairman can encourage and support the CEO in this area). More important is ensuring that it is the purpose — rather than the leadership itself or the institutions of the company— that attracts loyalty. Boards may have to take a strong stand on behalf of the company’s purpose and make it clear to everyone, including the CEO, why the company’s stake in that purpose is so important.

 

The second pattern is mo re common in the many businesses that do not display this kind of single-mindedness. This might be because they have been assembled by acquisition, or because different divisions are relatively autonomous, or because the leaders deliberately seek to cultivate diversity of style.  The leaders of such businesses will often need more active help from the board in reaching a purpose that can be shared across the company, and then promoting it to different stakeholder groups. The board may need to challenge the team to say what unites the company and its leadership: Is it a lowest common-denominator consensus, or are they working to establish a real, positive shared purpose? The board may also help to mediate not just between the leadership and stakeholder groups but between parts of the company. A single purpose does not imply a single style, but the attempt to establish a single purpose may cause concern about cultural imperialism.  In such cases, the board has an important role to play as a kind of final court of appeal: Being somewhat above the fray, it can help provide unity.

 

Few corporate boards currently live up to this ideal. While many have recently advanced from passive governance to active monitoring of executive management and careful probing of company strategy, few take notice of a company’s purpose. For boards to fully live up to their responsibility in our new era of board engagement, a company’s purpose must be at the top of directors’ agenda. The board that can help the top team define the company’s purpose—and direct it there again and again—is a board able to guide any company to excellence.

 

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Originally published in The Conference Board, March/April 2007