Could our boards have helped prevent the economic crisis?
Without a doubt and with perfect hindsight, some boards could have acted more boldly in their attempts to avert the current meltdown. But the real fallacy about corporate governance in this crisis does not involve what boards did and didn't do. It involves what was expected of them.
Not that I'm a board apologist. Over the past three years, my columns have taken boards to task several times. But in this case I think boards have a right to defend themselves against the scolding cries of "where were they?" The answer in most cases is that they were where they were supposed to be, doing their jobs—within the limitations of reality.
Shareholder activists may want board members to act like the superheroes of detailed company operations, like some combined forensic accountants and cops. But let's get real. Most boards meet one or two days per month and are comprised of individuals who hold demanding full-time jobs elsewhere.
Given those circumstances, it's absurd to believe that board members—even the most experienced and best-intentioned among them—can uncover systemic flaws or acts of malfeasance, particularly at complex financial institutions. That's what regulators, outside accounting firms and internal control systems are for, to help boards ferret out excessive risk and wrongdoing.
Boards serve another purpose. Their job is to hire and fire the CEO based on his performance and values, the quality of his team, and the coherence of his business model. When boards are operating as they should, their members are engaged in a vigorous, candid dialogue with the CEO and his top lieutenants about strategic direction and whether the company has the right talent to implement its key initiatives at the right speed. And they're spending time in the guts of the organisation talking to "regular" employees, looking for signs that the CEO's vision is understood and shared, and that company values mean more to the organisation than just lip service proffered for the board's entertainment. They're protecting shareholders not by wielding their calculators, but by deploying their good judgment.
Unfortunately, even good boards using good judgment didn't stand much of a chance against the newfangled financial instruments that sparked the current crisis. You can just imagine how the meetings went. Financial wizards showed up with gee-whiz presentations that demonstrated how they could capitalize on the "home ownership society" by packaging mortgages in a way that passed risk to others. They told their boards that consumer credit was rapidly increasing but the models were predicting only modest losses, and assured them that, with low interest rates, huge private equity loans were somehow different in this cycle than in the past.
"Don't worry," they surely told their boards, "we have the downside covered." Obviously they didn't. Should the board have known that? No, but the CEO and his direct reports ought to have. And if they didn't, the board should have at least sensed that knowledge gap in their bones. And that is where boards merit some flak for the current situation.
Surely some financial institutions' board members should have pressed their CEOs and executive teams harder about their risk assessment systems and demanded to know how risk managers were being rewarded. Instead, too many boards waited until the media started asking questions before they forced their CEOs out the door. In the future, perhaps boards won't wait for the "ratification" of negative publicity before they act.
But that can only happen when boards have the right kind of people serving on them. They need board members who, in only a very limited time, can exercise good judgement and act with courage. Members who have a special ear: who can hear a presentation from an executive and, with probing, differentiate between an executive who over-promises and one who under-delivers, between an executive who is a glib salesman and one they would bet their own money on.
If there are to be governance lessons from this crisis—aside from the need for realistic expectations—let that be among them. The list of guilty parties involved in bringing about the current economic situation is long indeed, and boards belong on it. Just don't put them near the top. It's giving them too much credit for a job they couldn't do.
Jack Welch was chairman and CEO of GE for 21 years, during which time he acquired a legendary reputation for tough decision-making. With his wife Suzy he has written the international bestseller Winning. Their latest book, Winning: The Answers: Confronting 74 of the Toughest Questions in Business Today, is out now.
Posted 26 January 2009 : Director.co.uk
