Three Dilemmas for Creating a Long-Term Board

Ariel Fromer Babcock is director at FCLTGlobal; Robert G. Eccles is Visiting Professor of Management Practice at the Saïd Business School at the University of Oxford; and Sarah Keohane Williamson is Chief Executive Officer of FCLTGlobal. This post is based on a chapter in the forthcoming The Handbook of Board Governance (2nd Ed.). Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here) and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here).

Research from FCLTGlobal and others confirms that long-term companies outperform on financial metrics, including revenues, profitability, and stock price, as well as non-financial ones like job creation and sustainability. As a recent study of large public companies in the USA found, from 2001-2014 long-term companies cumulatively grew their revenues 47% more on average as compared to their shorter-term peers, and with less volatility. During the same period, these same long-term companies similarly outperformed on measures of economic profit—cumulatively growing by more than 80% on average compared to peers—while also enjoying earnings growth 35% higher than peers.

How do these companies maintain their relentless focus on the long term, investing even in the face of significant upheaval and global market uncertainty? Time and time again, we find that successful companies, in addition to producing compelling financial returns, have long-term oriented cultures and values, underscored by a framework of consistent governance principles, that guide them through tough times. Values and culture are shaped by the tone and actions from the top of an organization—and the board is the ultimate top.

Despite this potential to be a long-term beacon atop their organizations, corporate management teams frequently cite their own board as one of the primary sources of short-term pressure on their companies. Meanwhile, the National Association of Corporate Directors (NACD) found in their 2017-2018 Public Governance Survey that three in four directors  agree that short-term pressure has compromised management’s focus on strategic goals.

But some organizations do ignore the distractions and follow their long-term strategies, even while peers chase short-term performance.

Arguably among a company’s biggest untapped strategic assets, a well-functioning long-term corporate board of directors wields the power to meaningfully influence the purpose, culture, and direction of an organization. Directors, as long-term stewards of their companies with average tenures that typically exceed management, are uniquely positioned to keep a company focused on the distant horizon-setting an appropriate long-term tone for both corporate management and shareholders and ultimately driving long-term value creation. Boards who can get this right offer a significant potential source of value for their companies. But getting it right requires addressing three key dilemmas for boards. These dilemmas are summarized below and set out in our recent contributed chapter for the forthcoming second edition of The Handbook of Board Governance.

First, time spent on strategy. Long-term boards spend almost twice as much time on strategy, business model, risks, and the company’s value creation proposition than short-term boards. But many boards struggle with the question of how to achieve this time allocation.  We found prioritizing strategy for successful long-term boards doesn’t just mean having one strategy meeting a year, but rather addressing progress on strategy in every meeting as well as devoting significant time outside of regular meetings to gathering information relevant to key strategic priorities that can better inform the board’s decision making. This foundational “homework” is a mosaic of conversations with management and other employees, site-visits, competitor product comparisons, discussions with external stakeholders like suppliers or customers, and a continuous review of industry competitive analysis from both internal and external sources—among other things.  That information gathering effort then informs the board’s decision making, sparking more meaningful discussion and debate around key strategic priorities and risks.

Second, directors as owners. Long-term boards build and perpetuate an effective board over time by acting like owners, and they can achieve this by encouraging directors to be owners themselves via direct stock ownership. While there are some concerns about the short-term hazards director stock ownership may create, the preliminary evidence seems to point toward linkage with long-term benefit- but only if the ownership structure is aligned with long-term goals. In our conversations with directors and other board experts, we found consensus around an emerging solution that is relatively straightforward and has just two criteria. First directors could be required, over a period of years determined by the company, to accumulate, in the open market, a proportion or fixed minimum multiple of their cash compensation in stock of the company they serve. Second, directors would be prohibited from selling or hedging all accumulated stock during and for a period of years (again to be determined by the company) through and beyond their term of service. By purchasing stock directly in the open market with their own earned wealth and then locking up that stock through and beyond tenure on the board, directors’ interests and experiences are aligned with those of their long-term shareholders, creating and reinforcing an ownership mindset.

Third, board level direct engagement with shareholders. We find the boards of successful long-term companies are often the most adept at engaging directly with their long-term shareholders. Such direct interactions offer an invaluable source of insight and a means for establishing solid relationships of mutual trust and respect. But many board members worry about how to engage with shareholders without distracting or undermining management, and some question whether it is the board’s role to engage at all. Successful long-term boards find direct engagement with their investors is worth the effort, contributing to a strong understanding of the objectives of long-term shareholders and informing the board’s strategy work.

The boards of public companies today are under significant pressure, often getting distracted by near-term concerns and losing their way in the process—even becoming a source of short-term pressure themselves. However, it’s clear the corporate board of directors wields meaningful influence over a company’s approach to long-term value creation and can provide the steady hand needed to steer a company towards a distant horizon. Setting the right long-term tone at the top is a critical role for the board, helping insulate management and the company as a whole from short-term market pressures.

Boards who follow these prescriptions can set off a virtuous circle. Boards who have devoted significant time to strategy work are well versed in the company’s prospects and can clearly articulate these prospects to shareholders when engaging with them directly. They find shareholder engagement offers new perspectives on their strategy and can use that feedback to inform future board work. And they are often prepared to answer the questions of shareholders because they are indeed shareholders themselves and have thought through the very same questions with an ownership mindset. This positive feedback loop helps boards transform themselves into a valuable long-term strategic asset for their company. By: 1) relentlessly prioritizing and focusing on strategy-related work; 2) becoming long-term owners themselves via director stock purchase and long-term lock-ups; and 3) engaging with long-term shareholders to establish mutual trust and respect while gathering valuable feedback on company performance and direction, long-term boards establish a self-reinforcing cycle of behavior that ultimately leads to a board culture focused on long-term value creation.

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