Why Investors Care So Much About Who Is On Your Board
“… [E]xecutives who view boards as a nuisance only undermine themselves and the company’s prospects for long-term growth.”
Larry Fink, CEO, BlackRock (January 2018)
“… [T]he long-term prosperity of millions of American workers, retirees and investors depends on the effective governance of our public companies.”
Commonsense Corporate Governance Principles 2.0 (October 2018, with signatories including Warren Buffett, Jamie Dimon, Larry Fink, and Mary Barra)
Attention CEOs of small-cap companies who feel like corporate governance is a form-over-substance waste of time: those who run the largest companies in the world, and those who manage trillions of dollars vehemently disagree with you.
Friends, Activists, and Olive Garden
When you read between the lines of the quotes above, it couldn’t be clearer why investors care as much as they do about who is seated in your boardroom. That is, they know with certainty that better governed companies make more money for everyone. And governance starts with who – and who is not – seated in your company’s boardroom.
Role of the board. Companies have no chance of getting board composition right if they are not clear on the board’s central role. Boards of public companies are in place to oversee management on behalf of all shareholders. In their oversight roles, the core responsibility of the board is to hire and fire the CEO, and secondarily to ensure that the CEO is tactically executing on the key strategic initiatives the officers and directors of the company have agreed to. Unlike in a startup ecosystem, the central role of the board in a public company is not to coach/mentor the CEO or provide business development assistance to the company. If board members are able to perform these tasks in addition to their core oversight responsibilities, that is, of course, fine. Behind many poorly comprised small-cap boards are CEOs who incorrectly believe the primary job of a public company director is to be a trusted advisor and rainmaker.
Objective oversight vs. the CEO’s buddies. Nasdaq and NYSE both require that the majority of listed company board members need to be “independent.” In other words, boards need to be predominantly comprised of non-employees; i.e., professionals from outside your company’s orbit of compensation. But smart investors know that “independence” doesn’t necessarily mean that board members are going to “objectively” oversee the company on behalf of all shareholders. That is, CEOs can satisfy the Nasdaq and NYSE “independence” requirements, but still have a board comprised exclusively of the CEO’s friends. Investors also know that for board members to be a true value-add for investors – in the way Messrs. Buffett and Fink enumerated – they can’t simply act out of deference to their friend. Great board members listen intently to what the CEO says, but they zealously pursue their own conclusions as well. As one well-known, small-cap investor often says: “When CEOs fill up their boards with their buddies, it’s like outfitting an otherwise perfectly constructed submarine… with screen doors.”
Channeling activists. No matter what you may think of “activist investors,” all companies should analyze their board composition through the same lens activists’ deploy. Every company has a handful of strategic imperatives, a handful of key impediments to achieving those objectives, and a handful of key customers or verticals they are focused upon. Activist investors compile these three buckets – goals, risks, and opportunities – vertically on one side of a white board, and then summarize the backgrounds of existing board members vertically down the other side of the white board. What ensues thereafter is like the “matching” tests we all did when we were kids; director skills should map directly to the company’s seminal needs. Where there are gaps – perhaps one of the company’s key risks is accessing the equity capital markets, yet they have no board members with relevant experience – bright, red circles are drawn. Succinctly, boards can’t possibly create value for shareholders if they are asked to oversee strategies, risks, and opportunities they know nothing about.
Darden Restaurants. The NYSE-listed parent of Olive Garden, and other casual fine dining properties, was struggling for years with eroding sales, and a stock price that ably depicted their operating challenges. Subsequent to a tussle with a well-known activist investor, Darden’s entire board – as in, every single director – was replaced on a single day. Interestingly, in the ensuing years, the company’s performance trajectory changed 180 degrees; their stock price has more than doubled, a real estate spin-off is valued at nearly $2 billion, and Darden transformed from industry laggard to leader. Find an investor in Darden, and ask them whether it matters who is seated at the boardroom table.
Theranos. The now infamous microfluidics company had a veritable “who’s who” of famous, erudite board members. Instructively, they would have all failed the board composition test set forth above. None of the board members were experts in the key attributes of Theranos’ business. The moral of the Theranos story for small-cap CEOs and investors is that it doesn’t matter how smart and accomplished your board members are, what matters is whether they are objective experts in the strategies, risks, and opportunities of your business.
There was a time when public companies could put whoever they wanted on corporate boards, and ostensibly tell investors to “mind their own business.” Those days are gone, and the $200+ billion managed by shareholder activists – the majority of which is focused on small-caps – suggests that those days are never coming back again.
The people who manage trillions of dollars know that better governed companies make more money. If you don’t think that axiom applies to your company, you had better have a good answer when the next investor asks: “Why not?”