Corporate Governance Thin On Top – The bald truth of director incompetence

Bespectacled and ebullient Bob Garratt, the chairman of the board of the London-based international consulting firm Board Performance, bounded through New Zealand recently delivering variety of messages and warning to anyone willing to listen. Unless directors do better job, they will do what communism failed to achieve and, perhaps, destroy capitalism.
Those are my words, not his. But at the heart of his current teachings and writing, that is undeniably what he is suggesting. Boards around the world are in state of crisis, he says, as companies and organisations lose their way without competent leadership.
And why don’t directors deliver. Greed and personal ambition play part, but mainly it is because directors are not up to the job. “Most directors do not have day’s training” to equip them for what they must do. And what they must do is becoming both more important and more demanding by the day.
How to deliver directors’ fiduciary duties is at the core of his book Thin on Top: why corporate governance matters and how to measure and improve board performance and, frankly, Garratt makes an extraordinarily good fist of explaining it.
He begins by suggesting that to make progress on raising the standards of corporate governance in the boardrooms of the world, we should first look back – about 250 years. He is, he writes, “attempting to rebalance the corporate seesaw so that Adam Smith’s notion of capitalism developing naturally, with strong ‘moral sentiment’ as its counterpoint, comes back into play”. The foundation of his “business renaissance” is an internationally accepted system of corporate governance that is built on the three values of “accountability, probity and transparency”.
Garratt has, over the past 25 years, become increasingly “angry” about what he calls “the lack of quality in corporate governance”. For long time he felt he was lone voice on the issue but now “investors, politicians, and the general public alike have shown themselves to be unhappy with the lack of quality, integrity and basic competence in boards of directors and with their messy and unprofessional relationships with shareholders, executives and the wider social community of stakeholders”.
He points out the obvious that the vast majority of directors are not “fully competent”. He then adds; “This is not to say that they are all therefore incompetent, but rather that most have not been able to distinguish between managing business and directing one.” They are, in other words, “over-trained as executives and under-trained as direction-givers”. Their rewards, therefore, have come from being effective professionals or managers, not from giving strategic direction. Because board directorships come late in most individuals’ careers, it doesn’t occur to many of them that they must retrain to become competent director.
“This mixture of ignorance and arrogance is both dangerous and paradoxical,” he writes. “It separates directors and top executives from their shareholders” at time when “the investor base is widening dramatically to take in the much larger capital funds flowing from” pension funds, privatisation shares and life policies.
“With the current woeful under-performance of stock and other markets, compared with the rise and rise of executives’ pay, these ordinary investors want to ask many more questions about the competence of directors and their very well-paid advisers.”
There are, according to Garratt, three organisational myths that get in the way of improving corporate governance. They are the myth of the all-powerful chief executive; the myth that director’s primary duty is to the shareholders and the myth of executive and non-executive/independent directors.
Managing directors and chief executives are not free agents and for some reason many directors lose sight of the fact that they are directly accountable to the board and through it, to the shareholders. “They have an absolute duty to exercise care in their proposals and actions and to hold the company ‘in trust’ for future generations,” writes Garratt. Boards “blunder through their corporate life not appreciating these duties, having no systems for monitoring conformance with them, and giving all their trust to the chief executive in the naive hope that he or she at least understands what is required”.
Under our law, as in the UK, US and most other western jurisdictions, the moment director is appointed his or her primary loyalty switches from those who appointed them to the company itself, as separate legal entity. director’s primary duty is not to the shareholders. As Garratt points out; “… most directors, private or public, are appointed quite incorrectly as ‘representatives’ of the owners, lenders, staff, trade unions, or pressure groups. This often puts them in direct, if unwitting, conflict with their corporate and personal legal liabilities”. If, of course, director protects the interests and safety of the enterprise then by definition the interests of the shareholders are assured.
And finally, there is only one class of director, not two as the terms executive director and non-executive or independent director, imply. “In case-law countries the only term used is director.” There is no differentiation in class and much of the description of the director’s role is found in Insolvency Acts rather than company law. “The key assumption is that of directors acting together as group of equals around the boardroom table charged with driving the enterprise forward while keeping it under prudent control.”
Garratt’s book deals with the “big issues” of ownership, power, control and corruption in corporations “about which pro- and anti-capitalists are in heated debate”. But rather than take right-wing, left-wing or nihilist stance, he takes “pragmatic, libertarian view” derived from 30 years of working with boards in five of the six continents – “South America still eludes me”.
Thin on Top is book of two halves. The first half is about the human aspects of governance because “… effective direction-giving is ultimately matter of judgement”. Garratt is interested in what happens “behind the boardroom door”, through the interacting dynamics of “those powerful egos who are charged with the fundamental dilemma of directing – how to drive their enterprise forward while keeping it under prudent control”.
In the second half he draws out “best practices for effective corporate governance” while addressing the fundamental directorial dilemma of dynamically balancing board performance with board conformance. “Good corporate governance is not just complying with the rules in formulaic way, but is about the board’s performance contributing to the direction, health, and wealth of the organisation.”
Garratt thinks most of the current international debate on corporate governance is not about improving board performance and shareholder value, but on such “relatively arcane issues as agency theory, voting rights, and the drafting of more regulatory legislation”. All of this, he says, is aimed at improving the “hard” (and easily debated) issues of board conformance and compliance, rather than the “soft” (and difficult to debate generically) aspects of the specific mix of human vision, values and behaviour that leads to better board performance.
To make any progress directors must be better groomed and educated for the job. “The need to train and develop both boards and directors is now so acute that the question is no longer whether? Or when? But how?” he says. good place to start the learning process is with this book.

Thin on Top is published by Nicholas Brealey. Price: $75.

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