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Other Books by Ram CharanProfitable Growth Is Everyone’s Business: 10 Tools You Can Use Monday Morning What the CEO Wants You to Know Boards at Work Books coauthored by Ram Charan: Confr

TLFeBOOK

Other Books by Ram Charan

Profitable Growth Is Everyone’s Business: 10 Tools You Can Use Monday Morning

What the CEO Wants You to Know

Boards at Work

Books coauthored by Ram Charan:

Confronting Reality: Doing What Matters to Get Things Right

(a best-seller with Larry Bossidy)

Execution: The Discipline of Getting Things Done

(a best-seller with Larry Bossidy)

The Leadership Pipeline: How to Build the Leadership-Powered Company

(with James L Noel and Steve Drotter)

Every Business Is a Growth Business: How Your Company Can Prosper Year after Year (with Noel Tichy)

E-Board Strategies (with Roger Kenny)

Strategic Management: A Casebook in Policy and Planning

(with Charles W Hofer, Edwin A Murray Jr., and Robert A Pitts)

Custom books for in-house use:

Business Acumen

Making Matrix Organizations a Competitive Advantage

Action, Urgency, Excellence

Boards That Deliver

Boards That Deliver

Advancing Corporate Governance from Compliance

to Competitive Advantage

Ram Charan

Copyright © 2005 by John Wiley & Sons, Inc All rights reserved.

Published by Jossey-Bass

A Wiley Imprint

989 Market Street, San Francisco, CA 94103-1741 www.josseybass.com

No part of this publication may be reproduced, stored in a retrieval system, or mitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400,

trans-fax 978-750-4470, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: permcoordinator@wiley.com.

Bass books and products are available through most bookstores To contact Bass directly call our Customer Care Department within the U.S at 800-956-7739, outside the U.S at 317-572-3986 or fax 317-572-4002.

Jossey-Jossey-Bass also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books.

Library of Congress Cataloging-in-Publication Data

Charan, Ram.

Boards that deliver : advancing corporate governance from compliance to competitive advantage / by Ram Charan.—1st ed.

p cm.

Includes bibliographical references and index.

ISBN 0-7879-7139-1 (alk paper)

1 Boards of directors 2 Corporate governance I Title.

HD2745.C44 2005

658.4’22—dc22

2004025829 Printed in the United States of America

FIRST EDITION

HB Printing 10 9 8 7 6 5 4 3 2 1

Introduction: Advancing the Practice of

1 The Three Phases of a Board’s Evolution 3

2 What Makes a Board Progressive 14

Part Two: The Three Building Blocks of

4 Information Architecture 47

5 Focus on Substantive Issues 61

6 The Right CEO and Succession 75

9 The Leadership Gene Pool 129

10 Monitoring Health, Performance, and Risk 139

Conclusion: Leveraging the Board for

Appendix A: Sample Strategy Blueprint 177Appendix B: The Research Agenda 183

vii

Acknowledgments 187About the Author 189

viii CONTENTS

This is a book for directors, CEOs, and other business leaderswho want corporate governance to be the best it can be Yes, boardshave changed in recent years for the better But they are not yetfully evolved Most boards are in flux and still not living up to theirpotential of providing truly good governance—that is, governancethat doesn’t just prevent misdeeds but actually improves the cor-poration They haven’t figured out the “how” of adding value.That’s where this book comes in It provides the guidanceboards need to go from being merely active and in full compliance

to making an important contribution to the business It is a roadmap for how boards can make the transition to the next step intheir evolution, becoming a competitive advantage for their com-panies And it is a guidebook for CEOs to see how they can get themost out of their boards

Beginning with my doctoral work on governance at the HarvardBusiness School more than thirty years ago, I have closely studiedthe inner workings of boards I haven’t performed quantitative orstatistical correlations between corporate performance and vari-ables of corporate governance Frankly, such research doesn’t get

to the causality of what leads to good governance Rather, I have

ix

focused on what happens behind the curtain, so to speak, inside the

boardroom My first book on this subject, Boards at Work (published

in 1998), described what the best boards were doing at that time.Since then, through continued research and analysis, I havecome to identify three factors that create the foundation for goodgovernance I have also identified the essential practices and col-lective behaviors needed to build that foundation—and to build

on it These are practices and behaviors I have observed to have apositive impact on governance for the companies that used them.That is, they seem to be causal factors They can be adopted by anyboard to make good governance a reality

My view of what makes governance good differs from that ofso-called board watchers To them, governance is measured byinputs—the processes and structures used by the board To thecontrary, I believe governance is measured by outputs—the valuethat a board adds to a corporation A board’s practices are a means

by which it can perform good governance, not ends in and ofthemselves

Though this book mostly describes practices in the UnitedStates, the principles of a board’s work hold true around the world.Virtually all nations’ corporate codes charge some form of boardwith the task of ensuring the successful perpetuation of the firm overthe long term The influence of shareholders may be stronger in na-tions such as the United Kingdom or weaker in nations such asKorea The composition of boards may emphasize employees in na-tions like Germany or emphasize independent directors in nationslike the United States Regardless of the differences in mechanicsand rules, the board’s fundamental mandate is the same—and thecharacteristics necessary for it to function well are universal.This book does not describe the myriad requirements for com-pliance It doesn’t list the rules prescribed by Sarbanes-Oxley, forexample, and by the stock market exchanges CEOs, directors, andgeneral counsels know these rules intimately by now, or have ac-cess to comprehensive sources of advice on compliance The aimhere is to prompt boards to continue their momentum, to build

on their accomplishments to date, and to put in place the tive behaviors and practices that will allow them to deliver on thepromise of good governance once and for all

collec-x INTRODUCTION

The Road Map

Part One of this book identifies the current state of transitionmany boards find themselves in Chapter One defines the threeevolutionary stages of corporate boards: Ceremonial, Liberated,and Progressive It ends with a self-test for boards to evaluatethemselves—“Where Does Your Board Stand?”

Chapter Two describes the three building blocks that are sential to move from Liberated, where most boards are today, toProgressive These building blocks are not what external observersare focusing on Board watchers have become preoccupied withthe size of a board, the degree of independence, the number ofcommittees and meetings, the separation of the CEO and Chairpositions, and other such variables, none of which gets at the heart

es-of Progressive governance The true causal factors that lead to ter governance are group dynamics, information architecture, andfocus on substantive issues, which I outline

bet-Part Two of the book includes a chapter on each of the threebuilding blocks, to present an in-depth look at the practices andcollective behaviors that boards can use to transform themselvesinto Progressive boards Chapter Three describes the practices thatare essential to the board’s group dynamics, the first building block

of Progressive boards Readers will quickly understand how simpletechniques can transform the manner in which directors interactwith each other, and with management, and become a productiveforce for governance

Chapter Four describes the best practices that Progressiveboards use to ensure an efficient and productive exchange of in-formation between management and the board Getting the in-formation architecture right has profound effects on the quality ofdialogue in the boardroom

Chapter 5 describes the best practices that Progressive boardsuse to focus on substantive issues Boards’ time and attention arevery precious The trap some boards fall into is to allow theirtime to be dominated by routine financial monitoring and com-pliance activities Progressive boards use simple tools to remindthemselves of the most critical areas and improve the return ontheir time

INTRODUCTION xi

Part Three of the book includes a chapter on each of fivesubstantive areas where boards can make their most importantcontributions: the right CEO and succession, CEO compensation,the right strategy, the leadership gene pool, and monitoringhealth, performance, and risk In practice, boards tend to givethese areas relatively little of their time and attention, yet these arethe real opportunities for a board to become a true competitiveadvantage.

Chapter Six describes tools boards use to ensure they have theleadership they need today and in the future The right CEO andsuccession remains job number one for all boards Every boardneeds a succession process that draws on the judgments of all di-rectors and leads to high-quality decisions

Chapter Seven captures an emerging approach to definingCEO compensation, one that provides true alignment between CEOpay and performance This is an area of critical importance andintense public scrutiny; it behooves all boards to pay close atten-tion to the philosophy behind CEO compensation, as well as to theprocess of defining the package and the framework that links paywith performance

Chapter Eight describes how boards can ensure they stand hind the right strategy There are very specific practices that Pro-gressive boards use with great effectiveness to get a full and sharedunderstanding of strategy—a source of misunderstanding on Lib-erated boards—as well as to help shape the strategy Appendix Abuilds on this chapter to present a sample of a strategy blueprintthat can jump-start discussion

be-Chapter Nine lays out the approach that Progressive boards use

to make sure the company is developing its leaders at all levels Theleadership gene pool is an essential component of the company’sability to create value and sustain a competitive advantage over thelong term And a strong leadership gene pool will make the CEOsuccession process more robust in the future

Chapter Ten helps boards go beyond the usual in monitoringhealth, performance, and risk Progressive boards dwell relativelylittle on routine financial figures that describe yesterday’s perfor-mance; they cut to the core issues of financial health, the factorsthat drive tomorrow’s performance, and the dangerous interac-tions of risk

xii INTRODUCTION

Finally, Part Four provides a pragmatic approach to ing momentum Chapter Eleven contains advice on a range of lessimportant factors under the rubric of board operations, includingthe logistics of board meetings Chapter Twelve deals with in-vestors, who are increasingly vocal constituencies But not all inves-tors are alike Boards should know how to filter the legitimateconcerns from the self-serving voices.

maintain-Appendix B is addressed to readers interested in pursuing search in this area I propose an approach that will generate bet-ter insights into corporate governance and uncover the real factorsthat underlie effective governance Resulting research will provideboards with better guidance on how to improve

re-Looking Ahead

The opportunity for boards to add value is very real What’s more,the desire and motivation of directors to realize the opportunity isevident With the right set of practices, any group of directors canbecome a board that delivers value to management and to investors.The board sits in a critical position in the modern free enter-prise system It has the responsibility, as well as the opportunity, tomake a significant difference The chapters that follow are sug-gestions to all directors so they can fulfill their responsibility andachieve their opportunity

INTRODUCTION xiii

Boards That Deliver

Part One

Boards in Transition

Around the world, boards have accepted a new mandate and areadopting a new mindset toward their work But living up to newexpectations is posing a challenge for many boards Understand-ing the true nature of the transformation corporate governance isundergoing can help directors recognize where they are gettingstuck, why, and how to move forward

Chapter One describes three phases boards go through—fromCeremonial to Liberated to Progressive—as they try to increasetheir contribution to the corporation Many boards today are stuck

in the middle phase and therefore do not add as much value asthey could

Chapter Two explains what makes a board Progressive, the thirdphase of board evolution Three building blocks must be in placefor boards to make a substantive contribution to the business

But the evolving relationship between the CEO and the boardhas yet to find the right equilibrium in most cases It’s importantthat boards become active, but there is danger in letting the pen-dulum swing too far Astute directors and CEOs sense the tension.They recognize that just as past practices have failed them, recentattempts to make the board a true competitive advantage are notalways hitting the mark.

Here’s one example In the spring of 2003, a CEO approached

me at a conference “Something’s gnawing at me,” he said

“What do you mean?” I asked, with some surprise “I saw yourlatest earnings report and it looks like you’re really delivering.”This was true I knew the company went through a period of ad-justment following the recession, but business had rebounded andthe company was turning niche products into real growth oppor-tunities both domestically and abroad “Is there some bad newsthat you’re not making public?”

“No, no It’s not that, Ram,” said the CEO, whom I’ll call JimDoyle (He, like some of the other executives I spoke with in re-searching this book, would prefer to remain anonymous.) “Thebusiness is rock solid We’re executing well.”

“Well, it sounds like you’ve got it all together,” I said

3

Then came the punchline: “It’s the board.”

I let Jim continue “I took over from Alan three years ago fore that, I was president and I remember how Alan ran boardmeetings There was essentially no dialogue; communication was

Be-a one-wBe-ay street When I becBe-ame CEO, I wBe-anted the boBe-ard to help

me I wanted to make it a modern board So we made all the tural changes that have been asked of us, like changing the com-position of the Audit Committee We now have eleven directors;eight of whom are independent by any definition Only two direc-tors are holdovers from the old board We have eight full-day meet-ings per year, and everyone participates The boardroom is verylively,” Jim explained

struc-“Sounds like you’re doing all the right things,” I said

“I thought so But lately, I’ve heard more and more questions

in our meetings Now I don’t mind fielding questions from tors In fact, I consider it their job to ask questions and my job toaddress those questions But some of the questions and the analy-ses directors ask for are off the wall I’m getting sidetracked cov-ering all of them And the same questions keep coming up It’sfrustrating and I know some directors are frustrated, too.”

direc-“Give me an example, Jim?”

“Sure I presented our new strategy to the board several timesand they tell me in the boardroom that they support it But aftersome one-on-one chats, I began to realize that not everyone gets

it So we held a retreat last weekend, and I brought in the name strategy firm that helped design the strategy to present it,”Jim said

brand-“Let me guess, they flipped through a deck of a hundred Point slides,” I conjectured

Power-“I admit that I probably let the consultants show a few toomany slides,” Jim said “But within thirty minutes, two directorsbegan to go off on minutiae Charlie told us he didn’t believe themedia strategy was appropriate Then he said he didn’t like the na-tional TV ads he saw last week He thought regional advertisingwould be more effective than national TV ads This was during adiscussion that was supposed to be dedicated to strategy The otherdirectors bit their tongues Later on, Jeff started in on how hethought discounts were too high for large customers He wouldn’tlet it go, even though he knew we depend on our ten biggest cus-

4 BOARDS THAT DELIVER