Academic journal article The McKinsey Quarterly

Change across the Board: Investors Are Angry. Directors Can Run but They Can't Hide

Academic journal article The McKinsey Quarterly

Change across the Board: Investors Are Angry. Directors Can Run but They Can't Hide

Article excerpt

How long must corporate boards look bad? A swath of scandals has eroded trust in US corporate conduct to levels last seen a century ago, when the abuses of monopolies ushered in an era of trust-busting. Having watched tumbling share prices batter capital markets and retirement plans, investors are now demanding that the government's promises of reform be turned into action. A handful of the highest-profile scandals have called into question the integrity of US capitalism, and the longer uncertainty lingers over that question, the greater the risk that critical issues of corporate governance will be reduced to the currency of narrow political posturing.

The good news is that directors want to promote change: our survey of nearly 200 US corporate directors sitting on some 500 boards highlights a clear desire for substantial reform. These findings, bolstered by more than 50 interviews with directors, corporate-governance experts, and investors, show a growing concern among members of boards about whether those bodies truly understand the problems--including the risk of increased liability--that now confront business.

Our research and experience point to a clear path forward for directors who would usher in a new era of corporate governance. The essential objective must be to reestablish the balance between management and the board so that the former runs the company while the latter contributes to its strategic and operational development and provides the oversight needed to satisfy shareholders. Although a minority of boards--in the United States and beyond--have struck the right balance, this delicate equilibrium has tipped too far in favor of management. The way to restore the balance is to strengthen the independence of the board and to give it clear leadership separate from management.

At many companies, achieving these goals may require the appointment of a nonexecutive chairman or of a strong lead director. It will also be necessary to revise management-compensation plans substantially and to raise performance criteria for CEOs and board members alike so that only active, engaged directors remain. In addition, there is a need for a new understanding of the risks companies run and for the transparent and effective communication of the principles of corporate ethics.

Although these elements are essential to any agenda for boardroom reform, they are just a few of the improvements that must take place within a broader corporate-governance context. Accurate and timely financial disclosure, stronger audits, and strengthened shareholder rights are necessary as well, since such steps all influence the behavior of boards and make them responsive to the interests of the shareholders.

Business has little time to waste. As part of a larger agenda for institutional change, the reform of boards must be pursued urgently to preempt even more regulatory activity and to send investors the correct message. The people problems and power dynamics that invariably lie at the heart of such reforms create tensions that also take time to overcome.

Our seven-step framework for tackling the problems builds on our experience developing core board-governance processes, including new approaches to meet the evolving needs of business and investors. (1) These suggestions are not startlingly new, but adhering to them would be. Keep in mind that we are not proposing an "a la carte" approach to board reform: while each step involves its own challenges, only the comprehensive and simultaneous pursuit of all seven core processes is likely to succeed in rebuilding trust at every level--not least the trust of investors.

1. Managing the board effectively

One of the central building blocks of board-governance reform is to ensure that boards can perform their roles. Almost without exception, our interviews showed that restructuring and new processes can't make up for a lack of independent, qualified, motivated, and honest directors who represent shareholder interests. …

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