Building a Better Board Book

We recently published a paper on SSRN, Building a Better Board Book, that evaluates the quality of information presented by management to directors in advance of board meetings.

Board members rely on information provided by management to inform their decisions on strategy, capital allocation, performance measurement, and risk management. These materials suffer from three overarching problems. First, they prioritize the director’s duty to oversee financial reporting above the need to truly understand the economic drivers of business performance. Second, board books tend to have an abundance of information but a dearth of metrics that lead to true insight. Third, the structure of board presentations becomes formulaic over time. As a result, board books do not change with the marketplace, preventing directors from understanding how the industry—and therefore their corporation’s strategy and investments—needs to evolve.

Based on its collective experience serving on boards since 2000, ValueAct Capital has identified six common and serious pitfalls that plague corporate board books and provides recommendations for remedying them. These pitfalls include the following:

1. Data lacks important context. Board books spend an inordinate amount of time bridging performance to plan. However, in doing so they leave out important contextual information, such as absolute performance, historical trends, and performance relative to market. A company’s reported results should be reviewed alongside relevant financial metrics from competitors or customers to facilitate discussion and decision making.
2. Data focuses on results (outputs) rather than drivers (inputs). For example, a company might report historical and projected trends for customer subscription counts without providing a breakdown of how the product mix has changed across its customer base over time. Breaking down the installed base to show how many customers are subscribed to older versus newer products helps directors understand the size of the company’s future opportunity. Board books should regularly include metrics that have a clearly related impact to the long-term performance of the company, and the linkages to performance should be well understood and reviewed often.
3. Data does not inform organic (P&L) investment decisions. Boards review an exhaustive amount of information before making an external acquisition, but spend significantly less attention reviewing large ongoing expenditures that drive organic growth. The same discipline should apply to all expenditures that drive profitability, such as research and development, advertising budgets, and salesforce headcount. These expenditures should be explicitly tied to future changes in revenue and profit so that the board understands what level of organic investment is required to achieve long-term goals.
4. Accounting allocations obscure true economics. When analyzing the profitability of various product lines, management must make judgments, such as the allocation of shared overhead. In many cases, these allocations are driven by external reporting requirements which may or may not reflect the true economics of the business. “True” (or more appropriate) allocation of expenses often reveals that a business is significantly more or less profitable than perceived based on GAAP allocations. The establishment and tracking of accurate profit and loss statements at product, business, or geographic level can help boards understand how their companies derive cash and improve strategic decision making.
5. Data does not match a manager’s sphere of responsibility. For example, a company might report sales figures by product line when accountability for that product line is shared among multiple managers across geographies. To improve accountability, results should be presented to coincide with the sphere of responsibility of individual managers. Supplementing revenue information with cost data (cost of goods sold; sales, general, and administrative; and other relevant costs), further increases accountability by providing a profit and loss statement associated with each manager and allows for better performance measurement in computing managerial bonuses.
6. Unexplained outperformance is insufficiently investigated. Boards spend insufficient time exploring the factors that led to significant outperformance in a given period—in particular, questioning whether those factors are sustainable or will instead create a headwind in future years. Revenue or volume outperformance driven by one-time price promotions, product end-of-life, or competitor disruptions are not sustainable forms of growth and, if not acknowledged and understood, will lead to future disappointment and loss of credibility with external investors. A driver-based view of performance will expose the true causes of outperformance, either positive or negative.

As a first step in thinking about board books, it is important to ensure that:

• Analyses reflect true economic realities and are not unduly constrained by accounting conventions.
• Metrics presented to the board match the way management actually runs the business.
• Performance measures are distilled to drivers rather than just results or outcomes.
• Data are presented with appropriate context, such as historical trends, customer behavior, and external benchmarking.
• Analyses focus on emphasizing long-term plans rather than annual budget allocations.
• Performance statements align with spheres of responsibility so that individual managers can be held accountable for results.

Finally, it is also important to recognize that improvements made to board books should be an ongoing process, and not done periodically every five to ten years.

The complete paper is available here.