For Corporate Boards, Understanding the Business Helps Build on Strengths

Building on strengths, a key theme in my last newsletter (July 2012) and recent blog entries, shows up here in this post as well. Sticking with that theme, I’ll start by re-emphasizing a crucial point: businesses succeed by building on their strengths.

Understanding the business is a strength. And, those who understand the business can better recognize what else might be a strength to build on. Furthermore, understanding the business is of value at many levels within the organization, even as high as the corporate board of directors.

Along these lines, I’ll comment on “You Can’t Know it All: Why Directors Have Such Difficulty Understanding Their Companies,” an article by Jay W. Lorsch, which appeared in the Year in Governance Annual Report special issue of Directors and Boards that came out last week. The article is excerpted from Lorsch’s new book, The Future of Boards, published in July 2012. The book offers a really good discussion of several key issues that affect boards. This blog post touches upon pieces of Lorsch’s book, in addition to commenting on his article.

Lorsch’s article is excellent, particularly in what it imparts about the dark side of director independence. Lorsch points out that independent directors (directors without financial ties, supplier relationships, or other close ties to the company) do not have a deep understanding of their companies’ business. This point by Lorsch is something I have discussed previously (most recently in my May 2012 newsletter and on my June 9, 2012 blog post). It relates to my research, which finds that there is great value in building on strengths and understanding the business. As I have said before, independent directors often do not understand the business, and this can detract from their companies’ success.

That said, despite how I stress the value of understanding the business, I agree with Lorsch that directors cannot possibly know everything about their companies. Since their role is to provide oversight, and they are essentially outsiders devoting a relatively small percentage of their time to their board responsibilities, directors cannot know it all. But, given these realities, it would seem even more beneficial for directors to bring the kind of understanding of the business that might come from ties to the company, though such ties disqualify directors on independence.

Lorsch stated his point about independent directors very well. Here is what he said:

“We believe that a major reason directors find it difficult to understand their companies is that the typical board of a large public U.S. company consists entirely of directors who must meet the test of independence. As a practical matter, it is difficult, if not impossible, to find directors who possess deep knowledge of a company’s process, products, and industries, but who can also be considered independent.”

In his book, Lorsch adds that directors depend heavily upon management for information about the business. He points out that this makes it difficult for directors to assess what management tells them, and it also makes it tough to determine what questions directors should ask.

Lorsch’s book is based upon board member interviews he and several other Harvard experts conducted Each expert contributed to the book, including Lorsch, who is also its editor. The chapter by William George, former Chairman and CEO of Medtronic who has served on ten boards, is especially insightful regarding independent directors’ challenges with keeping informed. I like the term “information asymmetry” George uses to describe the huge disparity between the extensive information CEOs and management have, versus the more limited amount available to independent directors. In light of my research about the importance of building on strengths and how understanding the business is a crucial strength, I find George’s chapter highly relevant. It supports what I have been saying about the dark side of too many independent directors, since directors who lack adequate information may be unable to understand the business.

Lastly, I find it encouraging that prestigious sources, such as Lorsch and his Harvard colleagues, and also recently Baruch Lev, author of the book Winning Investors Over, point out the dark side of director independence. What they say supports and reinforces the views I have previously expressed. As I have said, ties to the business–such as supplier or consulting relationships, for example–enhance directors’ understanding of their companies. Board members with such ties are not the independent directors called for by governance standards. But, those ties often give non-independent directors a far better grasp of the business than their independent counterparts have. And, this added understanding is a strength that can help businesses succeed.

In summary, boards could be more effective if they better understood their companies. But, many directors do not. As I have said before, and as Lorsch’s work reinforces, having too many independent directors on boards contributes to the problem.

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