Charles Darwin and the Insurance Company Board

As a New Zealand taxpayer – and therefore collectively on the hook for a possible $0.5 – $1.0 billion support package (read ‘bailout’) – I was delighted to see that the Government has appointed an experienced insurance professional, John Pritchard, to the board of AMI Insurance.

It may come as a surprise – as it did to me when I read AMI’s latest annual report – to find that not one of the existing board members appears to have a background in either insurance or risk … unless you count the ownership of racehorses in the latter category. I know, and have considerable respect for, some of the directors: an outstanding retired banker, a leading former retailer, a successful market gardener, and so on. But nobody about whom I could find any experience in the industry in which AMI operates.

Going one step deeper, the Chief Executive’s own earlier career was mainly in banking, not insurance. When you look at the executive management team, you see Heads of Customer Division, Customer Experience, Marketing and Products, all of which helps us to understand how the company has been so successful in growing market share over the last decade, from a relatively small Christchurch-based insurer to one of the leaders nationwide.

However, nobody in the top team has a title that suggests deep involvement in risk management. You have to delve to what appears to be at least third tier to find someone described as Actuarial Team Leader.

I doubt whether anybody could have foreseen the destruction caused by the seismic bombs that hit Christchurch last September and more tragically on 22 February. But a part of risk management is about assessing events of low probability but high impact.

Much of AMI’s business was, not surprisingly, centred on Christchurch, where it had acquired a large share of the House and Contents insurance market, and a disproportionate concentration of its portfolio. And I have read that its reinsurance rates were among the industry’s lowest. Not being from the industry, I wouldn’t have a clue about appropriate reinsurance levels, but I do understand a little about concentration of risk.

What bothers me is that I’m not convinced that anybody else on the board would have had much more knowledge, so would not have been in a strong position to ask whether the reinsurance rates were too low for the high concentration of the company’s exposure.

My daytime business is ‘Building boards into leading teams’, and I’m the last person to suggest that everyone at the board table should come from the same industry background. To the contrary, I believe that having a range of backgrounds and perspectives is vital in achieving effective board oversight. However, having nobody at the board table with a background in the industry seems to defy common sense – because directors must be sure they are receiving the information they need in order to make good decisions. If you don’t have somebody with experience, you won’t know what you don’t know.

Without knowing the background, I can only make some assumptions about AMI’s board practices and (lack of) evolution. The Chairman has been on the board for about twenty years and several of the other directors have been there for a long time, while the CEO was appointed more than 15 years ago.

I’d imagine that some of those relationships had grown quite comfortable during the good times of rapid growth. One of the dangers when this happens is that a director who wants to ask hard questions, challenging the strategy and management’s assumptions, can feel increasingly uncomfortable and isolated if he (at AMI they’re all ‘he’) starts to ‘rock the boat.’ This is why it’s so important that a healthy board culture doesn’t just accept, but insists on dissenting views being aired.

I’d also guess that, as the business grew rapidly, the board’s priorities reflected its experience in growing businesses and satisfying customers, and didn’t focus adequately on changes to its risk exposures or concentration of its portfolio.

The lack of board turnover, combined with the directors' industry backgrounds, seems to have resulted in a failure to grasp the increasing significance of such agenda items, in line with AMI's changing position in a rapidly changing world. As Charles Darwin observed (see my earlier post on his anniversary a couple of years ago):

• It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.

A failure to recognize this at AMI’s board table over many years may well cost you and me up to a billion dollars. Let’s hope Mr Pritchard can make enough of a difference to prevent this from happening.

I'm only a director... Yeah, right.

Auckland mayor John Banks was quoted recently as dismissing his involvement in one company’s troubles with the explanation, “I’m only a director.”

How much should a director know? How responsible should he or she be for what goes on in the company?

It's quite reasonable that non-executive directors (who by definition don’t work in the company day-to-day) don’t have the detailed operational knowledge that we would expect of the chief executive and senior management.

I’m no lawyer, but the Companies Act seems quite clear: the board is responsible for management of the company. Even when the board delegates management to the chief executive, as normally happens in larger companies, the board remains responsible. So it’s understandable that, when a company runs into difficulties, all directors - including the non-executives - come under the microscope.

It may come as a surprise, but the courts won’t normally try to second-guess the commercial decisions a board makes: it’s not a crime to make poor decisions - we’ve all done that - or sometimes even to go broke. However, what the judges will consider is whether, in making those decisions - good or bad - the directors complied with their legal obligations.

In most cases, the main test for directors (section 137) is whether they have acted with “the care, diligence and skill that a reasonable director would exercise in the same circumstances.” Where I think that bar has been lifted a little in recent years is in what we expect a reasonable director to do. At the very least, the days of what we used to refer to as a “sleeping director” (the one who lends his or her respected name to the company’s letterhead and shows up for the annual general meeting, but makes little further contribution) are - or should be - past.

More positively, thanks to some recent cases, we have a few pointers about how the courts define a “reasonable director.” Among these,

• A “reasonable director” is one who turns up at board meetings - anyone who’s been around for a while will know that this is not a universal attribute of all directors. It’s no defence that you missed the meeting where the board took a bad decision. The logic here seems to be that the company has a right to the wisdom of its directors, so they in turn have a responsibility to show up. We can all applaud that one.

• A “reasonable director” is one who takes an active interest in the affairs of the company, and asks for the information he or she needs, to understand the company’s business and financial position. They have a duty of diligence and care to make sure - within reason - that the information they receive is complete and accurate. The longer I sit at board tables, the more I realise that one of the most important skills of a good director is the ability to ask good, thoughtful, questions, and to understand the issues well enough to ask the follow-up, “So, if that’s the case...”

From what I understand of directors’ duties, and of the courts’ attitude, I don’t think Mr Banks’ alleged comments would provide him much legal defence... Or even whether they’d sway that other jury, public opinion.

Biting back? When, and how?

In the last few weeks I’ve seen two sad episodes of former employees taking shots at their former boss or their successor. When do you “kick and tell”?

If you want people to know they can trust you, and perhaps to consider offering you a senior role in the future, the simple answer is, “Never”.

The first case that caught my eye was an ex-employee of a multi-national organization, who, in my view, took advantage of his high-profile communications background to celebrate, via his blog, the transfer of a former work colleague out of a very visible management position, into a more internally focused role. His colourful language included references to “this person’s malicious self-service” and “hundreds of venomous emails...” I expect you can fill-in the rest.

I have met the blogger and his target and I understand that they might not get on, professionally or otherwise. But this public e-flogging seems likely to ricochet, as well as damage its target:

• The target (the bloggee?) is tarred by one person’s allegations, which are now stored on hundreds of servers, and there’s no realistic right of reply (call me outdated, but has the idea of “natural justice” totally disappeared?). As a result of this blog, is there any realistic hope that this accusation can ever really be buried? Surely the better approach - if the writer had been genuinely well-intentioned - would have been to raise it with the individual in person, or if that didn’t work, confidentially with the person’s boss, the CEO?

• For the blogger, on the other hand, I’d recommend that any potential employer or client should read his blog post and think carefully of what might happen if they too were to fall out later. As a result, the new employer or client might well ask themselves, “Why take the risk?”

So, no winners from this.

Then, a couple of weeks ago, at the height of Telecom’s troubles with its new mobile network, the company’s former CEO, Theresa Gattung, indulged in the print version of kicking her successor with heavy boots while he was bruised and flat on the canvas.

Of course she will have insights that most of us don’t and probably there will be some truth in her analysis of the issues. But one thing she should have learned in her time as CEO is that it’s easy to offer gratuitous solutions from the touchline; it’s much harder to apply them when you’re on the field (what the Americans call a “Monday-morning quarterback”).

Among her more headline-grabbing comments was rather disingenuous criticism of her successor’s salary, which you could read as either sour grapes or simple envy - neither of which fits well with a former chief of the country’s largest listed company.

I don’t expect Ms Gattung needs to look for another job, since she was well remunerated in New Zealand terms - even if the amount was, as she noted, far less than that of her successor. So perhaps the fallout for her won’t amount to much. Her comments may even help to sell a few more copies of her memoirs. But a Board looking for a chief executive, or for another Board member, would hope that confidentiality and loyalty will endure beyond the term in office.

From a practical governance perspective, what goes on in the Boardroom isn’t usually that sensitive - you could publish much of it without a second thought. However, if you’re concerned that you might be misquoted or taken out of context later, you will inevitably lose the spontaneity and full, open discussion that are so valuable in getting to good decisions.

So, again, if someone shows a tendency to “reveal all”, a Board might be inclined to ask, “Why take the risk?”

Many years ago, an executive headhunter had a sketch on his wall: an outline of the lower half of a wading bird. The caption read, “Remember that the toes you tread on today are attached to the feet, that are joined to the legs, that support the backside you may have to kiss tomorrow.”

Tread softly.

The little things

I was unavoidably overseas this week, so I was away for an important Board meeting, where we were due to make a big decision that we’ve been building up to for over a year. I was keen to take part, so I had arranged for the Board secretary to call me from the boardroom conference phone so that I could join in. He had my mobile phone number and email address as well, in case of problems.

At the time the Board meeting was due to begin - an anti-social hour of the morning for me - I was ready, board papers open, questions prepared, waiting for the call. Nothing.

After 15 minutes, I texted the Board secretary. Nothing.

20 minutes later, I had a text saying they’d rung twice, but the hotel hadn’t picked up the phone, and the Chairman had (understandably) decided to get on with the meeting... and he doesn’t then like to be disturbed. A little later, when the Board adjourned for a cup of tea, I finally received a call from the Board secretary, who had got through this time, to give me a run-down on the discussion, and I was able to ask a few further questions.

We probably didn’t lose much in practice, other than about three hours’ sleep for me. But as I headed to breakfast a couple of hours later I saw the irony in my role as chair of the Board’s Audit & Risk Committee: one risk I hadn’t factored on Thursday morning was that a five-star international hotel wouldn’t answer its phone at 4.30am.

So often, in the end, it’s the little things that get you.

Where did that come from? How well do we understand our risks?

I expect we’ve all heard enough of the corporate horror stories. One big failure has barely dropped off the front page when another hits. Some, like General Motors and Chrysler, resembled train wrecks in slow motion that we couldn’t stop watching, over months or years, even though we sensed how they were going to end. Others, like Bernie Madoff’s vanished billions and Bank of America’s boss Ken Lewis after the Merrill Lynch acquisition (hero to zero in six months), seem to have hit from nowhere.

So what have all these cases in common? One question being asked with increasing frequency is ‘Where was the Board of Directors?’ This leads to another thought, which is that in each of these cases the Board, generally a group of very smart and experienced individuals, must have made some (conscious or subconscious) assumptions that turned out to be flawed.

At GM maybe the underlying assumption was ‘we’ve been in this situation before and the great American public will see us right,’ or perhaps ‘we’re a national icon and a huge employer... we’re too big to fail’ (and how often have we heard that epithet in the last 12 months?). Around Bernie’s Board table, perhaps the mistake was something more fundamental, maybe ‘what a great investor he is’ - overlooking the now-obvious question of where (and whether indeed) he was investing, or just moving the money around.

In today’s climate especially, one of the biggest challenges for a Board of Directors is identifying the real risks that can derail the company. But how many Boards ask the simple question, ‘what are the things that could put us out of business... however unlikely they may seem today?’ And why don't they ask? Because the CEO might be offended?

I’m not talking about Boards becoming entirely risk averse: that’s not how you make your shareholders rich. However, I am talking about a Board’s real understanding of the risk profile, and making some conscious decisions about the corporate appetite for various risks. I’d expect that in at least the majority of these cases the camel's-back-breaking-straw risk that finally brought the company down was one that the Board hadn’t fully seen coming. I’d also guess, without knowing the answer, that most if not all these companies had formal committees set up to identify and monitor risk.

Knowing that the quality of your Board’s decisions depends on understanding your opportunities and your risks, how do you know that the risks you’re hearing about are those that require the greatest focus? How do you ensure that the decisions you’re making will address these risks? How can your Board ensure that they have asked the right questions of the management team?

Well (for once here’s a direct pitch), we’ve brought to New Zealand what is possibly the first - and almost certainly the most thorough - method for assessing the effectiveness of your risk committee(s). We look at ten different aspects, from your risk culture to your management processes, and we ask you to assess two factors: how important each is to you, and how well you think you deal with it.

Sounds simple, even simplistic? Well, one large international client, which has put all its risk committees through this (board, management, operating units, subsidiary companies), and then saw the 'gap analysis' that emerged, has told us that if they’d done it four years ago they would have identified holes in their systems and culture, which would almost certainly have prevented some huge, very public, problems they faced.

If you’d like to know more, please contact me. Meantime, if you’d like me to send you a copy of some analysis we’ve done (as part of a larger survey among over a hundred Boards), on how effectively Boards generally oversee their risk, let me know and I’ll forward that to you too.

No obligation, no pressure, but can you afford not to be interested?

Wisdom to know the difference

Most of us know the ‘Serenity Prayer,’ which asks for

• “Serenity to accept the things I cannot change; courage to change the things I can; and wisdom to know the difference.”

Sometime we find a limit to what we can achieve as an independent director.

A few years ago, I joined the Board of a company in which the Chairman and the Chief Executive had worked together since the company’s establishment. By the time I joined, they were the only two at the Board table who had been with the company from the start.

To some of us, the CEO appeared to have lost the energy for taking the business forward, despite having had some significant successes until then. The Board’s meeting agenda was usually composed mainly of rearward-looking or operational detail and we didn’t see much creative or strategic thinking - at a time when our industry was going through big changes and some of us could see exciting opportunities for the company to take a leadership position.

On the surface all our boardroom discussions were very polite and we seemed to reach a consensus on most matters - including an agreement to take a new look at the company’s direction. However, although we had some useful strategic planning discussions and regularly discussed future options, nothing seemed to change in practice.

Perhaps most telling was that any strategic ideas that came up at Board meetings were generally repeated back to us by the CEO, with no further thought or analysis - or even pushback; but month by month, nothing actually happened.

“Courage to change the things I can...” As most of us would, I suspect, we - two of us especially - kept trying to make progress. We had regular Board-alone sessions, where we discussed our concerns with the Chairman, who usually agreed with our analysis. But, when the CEO joined the meeting, the Chairman would negate any of our questions or comments, with a remark such as, “Now this isn’t meant in any way as a criticism of management.” This became so frustrating that we came to see the Chairman as ‘Counsel for the Defence’ for the CEO. Putting myself into the CEO’s position, I’m not surprised that he saw the Chairman’s comments as endoresement for taking no further action on our concerns.

“Serenity to accept the things I cannot change...” By now you’re probably asking why we didn’t raise this directly with the Chairman. We did - several times. What we gathered was that he had invested so heavily in bringing the CEO up to speed in the early days that he now didn’t have the energy - or the heart - to act. Also, in case you’re wondering about another option, there were good reasons why he was the right person to lead the Board, and changing this was not a practicable option.

“And the wisdom to know the difference...” I worked out that I had three options: to keep banging my head against the frustratingly hard wall; secondly, to wait until the Chairman retired and hope we could do something then; or to spend more of my time in places where I might be able to make a difference.

I don’t know what you’d have done in this situation. I was fortunate enough to have been offered another Board position, working with a group of people where doing nothing was never going to be an option.

I still have a sense of missed opportunity and unfinished business, and I’m not sure that I showed much ‘serenity’ in my frustration. But at least I feel I was given ‘the wisdom to know the difference’. In my new role, I know I won’t die wondering what we might have done.

"Failing our Students" - what the business schools haven't been teaching

“By failing to teach the principles of corporate governance, our business schools have failed our students... By not internalizing sound principles of governance and accountability, graduates have matured into executives and investment bankers who have failed workers and retirees, who have witnessed their jobs and savings vanish.”

Not my words, but an extract from an article in the Wall Street Journal on 24th April (that a friend sent to me), by a business school professor from North Carolina, Michael Jacobs, who was previously director of corporate finance at the US Treasury.

Besides agreeing strongly with Professor Jacobs, what else should we learn from this? First, that we’ve sometimes been talking to the wrong people; and second that we’ve usually left it too late.

I spend quite a lot of my time presenting at directors’ workshops and courses. The typical participant has already built a successful career - chief executive, second-tier management, new director, or sometimes quite experienced as a director but with no formal training in the role. To reach this current stage, such people have learned what works for them and have usually developed some well-entrenched approaches to doing things.

If they haven't previously factored-in good governance practices, it’s unlikely that a few days on even one of my programmes will change the habits of a lifetime!

All our experience teaches us that habits learned early are habits learned well. So what if we listened to Professor Jacobs’ advice and started teaching principles of good governance at a much earlier stage in these leaders’ careers? What if we included corporate governance as a core element of MBAs - and not just in the sense of the controls, checks and balances, but showing examples of the real value that a dynamic and engaged Board can add to an organization, and its chief executive?

The lesson I’ve taken from Professor Jacobs is that we should be exposing people to the principles of good corporate governance while they are still putting together the building blocks for a career in leadership. By the time they get there, it may be too late to change.

I hope we’ll see many more younger participants on our director-training programmes, and that I (and others) can spend more time in front of MBA classes, where tomorrow’s leaders often build the framework for their high-flying careers. If they come, and if Professor Jacobs is right, then maybe we won’t see a repeat of the excesses and behaviours that have so dented credibility and faith in the free enterprise system in the last 18 months.

And that would have to be good for everyone, not least those who choose to learn what good governance is, far earlier in their careers.

Running the company or asleep at the wheel? The director's duty of care

A couple of weeks ago, I discussed whether it was possible to run a company by consensus. The emphasis was on ‘consensus’. In the last few months, however, we’ve seen more people asking the question we’d like to be able to take as read: whether the directors were actually running the company at all.

The last six months have seen more spectacular company failures than most of us have ever seen before. And let’s be honest: a government bailout is actually a failure - just ask the traditional shareholders in British or American financial institutions or US car makers. Closer to home, we’ve seen a string of failures in New Zealand finance companies. Now the shareholders and investors with some of these companies are looking for their day in court, and perhaps for some vindication, even if they may not get their money back.

First, though, another moment of honesty: it’s not a crime for a company to go broke. It’s just a part of the free enterprise system that companies come and go. Sometimes a company fails because a major supplier or customer goes out of business; sometimes the bad news just becomes overwhelming. The law acknowledges this and directors won’t be legally on the hook.

But where the law does become interested is usually in one of two areas: were the directors asleep at the wheel, or did they continue trading when they should have known the cause was hopeless?

I’d like to think about the former, what we call the director’s ‘duty of care’ (the general legal requirement is to act ‘in good faith’ and ‘with reasonable care, diligence and skill’ in what the director believes to be the best interests of the company). Most directors I work with are very aware of this duty and I suspect that the general level has increased recently.

But there’s still the notable exception - for example most of us can name at least one director who regularly fails to read their board papers before arriving at the meeting (although it’s a while since I’ve seen a director blatantly rip open their courier pack as they sat down). In this case, how can they possibly understand the issues or know what’s going on?

Worse still, and one that gets my blood boiling, is the director who consistently fails to turn up for board meetings: I’m not talking about a director who misses one or two meetings a year - we can all get sick or have to travel overseas - and I’m happy to say that I’ve seen less of it in recent years.

But one notable exception jumps to mind. The pattern is familiar - a last minute phone call just before the meeting starts, to tell us about an unexpected visitor he has to see; or a family member who urgently needs to be taken to hospital. Given the pattern of the last few years, he must have a huge family, or they all have a genetic predisposition to sudden serious illnesses - and, thinking about it, he must be the only family member who can drive too. In a case like his, I’d describe it not so much as reasonable care that's lacking, but a total abrogation of his duty as a director.

While a company is doing well, the absent or ill-prepared director may not seem too much of a problem. But a company is entitled to the benefit of its directors’ collective wisdom. My guess is that, if it goes to court (which will occur only if things have gone horribly sour), the judge is likely to decide that that entitlement was retrospective: in other words the board meetings a director failed to attend in earlier years will count against him or her.

And I haven’t even discussed those directors who turn up for the board meeting, enjoy lunch (in fact are often good company), nod sagely at everything that’s said and never contribute an original thought or worthwhile question of their own...

Ah well, back to that latest courier pack for another evening’s reading. Did I hear someone say, ‘Get a life, Richard’?

A propitious number? How big shouldn't your Board be?

"Kong Hee Fat Choy" and welcome to the Year of the Ox! As you will have known, last week marked the Lunar New Year, and I expect that the virtues we associate with the ox - such as strength, persistence and determination - will be very apt for the year ahead.

Among other cultural preferences that westerners have become familiar with in the last few years, we all know the value that the Chinese place on the number eight (how many millions of dollars changed hands for that single-digit number plate in Hong Kong?).

Well, sorry to rain on that parade, but last year some interesting research, entitled 'Parkinson's Law Quantified', established that eight is the worst possible number of members for an effective decision-making governance body: most of the research centred on the number of cabinet members in nearly 200 governments, but the researchers apply the findings equally to Boards of directors.

The first finding, which will surprise nobody, is that "cabinets or Boards become highly inefficient once

their size exceeds a critical 'Coefficient of Inefficiency', typically around 20." (Do you realise they actually fund people to research the blindingly obvious??)

The second observation is a re-statement of the widely-acknowledged 'Parkinson's Law', namely that "the growth of a bureaucratic or administrative body usually goes hand in hand with a drastic decrease of its overall efficiency." Well, yes, I do live in Wellington so this isn't actually news either.

As one outcome of their research, though, they found that a Board (or cabinet) of eight members was the most likely to lead to deadlock and internal conflict.  I'll let you work your own way through the complex maths that the authors use to explain their findings, but I think that here they may have missed one crucial point - particularly as it relates to an effective Board of directors. This is that an effective Board will operate largely by consensus decison-making, rather than on a simple majority. In other words, most effective Boards will be unanimous in most of their decisions. I don't see any loss of effectiveness in having one or two dissenters, as long as it's not the same one or two people with every decision; but if you get to the point where a Board is split down the middle, then usually some more fundamental questions - like agreement on direction and strategy - need to be sorted out first.  

It's for this reason that I have never been concerned about a Board having an odd or even number of members. In fact, in over 16 years and a large number of Boards, I can't think of one decision where having an even number of Board members became an issue for us. An effective Chair will usually pre-empt any difficulties, understanding in advance what most people's views are likely to be (without pre-judging the outcome), and will generally not allow an issue to go to a vote if it is likely to become divisive.

On balance, despite the mathematical 'proof', I have been happy serving on Boards of eight members. My preference usually is for fewer rather than more (I like Boards of 5-7). However, sometimes you need a reasonable size - very seldom more than 10-12 - to cover the full range of perspectives, experience and competencies that a Board might need.

As a footnote to the paper, the researchers uncovered only one cabinet of eight members, King Charles I's "Committee of State". And, as they note, "Look what happened to him!" Based on that sample size of one, therefore, who are we to argue?

Not another Economic Forecast

As we begin another year, you might like to throw yourself back twelve months and think about what we were expecting for 2008.  

With oil in January 2008 selling at about $US 85 per barrel, you might have been very smart and predicted that it would go to a record high of $US 140 or more - as it did in June. I remember some people telling us then to prepare for life at $US 200 (was that really only seven months ago?). But how many people told you last January that the price would drop below $US 50 again before the end of the year? Well, we know what has happened since: as I write, the price is almost exactly $US 100 below its peak - here's a chart showing the average monthly oil price since 1946, both nominal and in 2008 dollars.

In the last four months, we've also seen one of the largest financial markets meltdowns in history - certainly the most traumatic since 1931-32 - and the largest ever co-ordinated loosening of monetary policy.  This chart on Wikipedia shows movements in the US Federal Funds Rate over the last half century, which reveals an uncanny symmetry between 1954 and today with a 'pivot' in about 1982. But, what hit me the hardest and highlighted the significance of what has happened is this table from the Bank of England, which records the Bank Rate from October 1694 (sic, I have not transposed the digits), when the Rate was set at 6.00%.  It reached its historical low of 2.00% in April 1852, and on a few subsequent occasions, including 1932, 1939 and December 2008.  But, unless I have missed something, the Rate has never been lower than that... until last week, 8 January 2009, when it dropped to 1.50% - for the first time in more than three hundred years.

I'm no Economic Historian nor an expert in Central Banking. But I am old enough to know that central banks have spent most of the last thirty years using the few tools they have - mainly the setting of interest rates - to keep inflation low but positive, in order to provide a sound platform for the sustained economic growth that the planet has experienced over the last twenty years.

Who knows where this dramatically-loosened monetary policy will take us? Will we see a resurgence in global inflation in the next twelve months, leading to a fresh cycle of unprecedented tightening in order to stop prices running out of control; or will even these drastic cuts in interest rates (effectively to zero) fail to prevent a spiral into deflation, which none of us has experienced before? Or neither of these extremes?

I have no idea where this recession will lead, or how bad or long it will be.  I'm certainly not going to try to forecast.  

As a board member, my big lesson from the last twelve months is that we need to prepare ourselves NOT for a $US 200 oil price, nor a New Zealand dollar exchange rate of $US 0.40, nor for a specific price for any commodity (money, gold, milk powder...).  No, what I think we need to be ready for is continued volatility, where we learn to live with - and take advantage of - the unpredictability and lack of clear price trends. This calls for greater risk awareness from all board members - not necessarily risk aversion - and a real understanding of our strategic risks and opportunities. (When did your board last ask - and try to answer - questions like 'What could actually put us out of business?' and 'Where does our money really come from?')  

We all need to think carefully about what our real business is, and our own unique value proposition, since we can no longer lean on sustained economic growth or continued price inflation to cushion our poor strategic decisions.

So there we are - back on deck for another year of challenge and excitement... as the late Sir Peter Blake used to ask, 'If it was easy, why would you bother doing it?'

And, if I'm completely wrong and 2009 is a year of unprecedented calm and stability in prices, then this time next year I'll probably write about the volatility of everything, including volatility. 

Evolution - the survival of those most responsive to change

As you will of course have remembered, it was 'Evolution Week' recently, the anniversary of the launch of Charles Darwin's 'The Origin of Species' (24 November 1859).  So often we misquote him by referring broadly to 'the survival of the fittest', but Darwin's thesis is far more encouraging than that cliche indicates:

• 'It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.'
  

Any of us can take heart from that: how strong we are and how intelligent were both decided to a large degree very early in our development as a human being (personal trainers and pop psychologists notwithstanding). But how responsive we are to change is a conscious decision, which we can take at any time.

If you want a dramatic example, finish reading here, then watch this short video on Youtube. I honestly don't know whether it's genuine - there seems to be some debate - but I've looked at it several times and it still looks good to me. Regardless, take it at face value and think about the instant decisions this pilot had to take when faced with a catastrophic change that, according to all precedents and accepted wisdom, would have given him about five seconds to live... and how responsive he was to this change.  

Now think about the changes you (and your business) face in this global downturn. And whether you'd prefer his challenges or yours.  

Have a good, adaptable, week.

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What? Were they thinking?

You've probably read about this summer's tour to New Zealand by the West Indian cricketers. If so, I wonder whether you've also shaken your head in disbelief at Dunedin's planned welcoming call: "It's all white here." Let's leave aside for a moment the rush of blood that generated such a catch-cry, with excuses that it's a contrast to Dunedin's traditional "Black-out" campaign for the All Blacks (the West Indians can be expected to be up with the play on local rugby traditions - yeah, right)... or that it refers to the players' test match uniforms - yeah, right again.

This little example seems to confirm the view that common sense really is an oxymoron (a bit like fun run or civil war). Where was the plain good sense when the City Council was discussing it? Did nobody stop to consider how it could - almost certainly would - be interpreted? Would they have used the slogan if, say, it had been the English cricket team instead of the Windies?

What were they thinking? Or, rather - What? Were they thinking?

Why I mention this today is that it reminded me of a question someone on a directors' course asked a few weeks ago: What is the most important skill for a director to learn? I don't claim to have a simple answer for this, but I thought of a couple of possibilities that I've gleaned from other, more experienced directors, including "To object without being objectionable," or that "Dissent is not disloyalty."

What I replied was, "To ask the second question". The reason I think this is such a valuable skill is that it's easy to ask the first question about something, for example "Have we chosen a slogan for welcoming the West Indian cricket tourists?" More likely, in the boardroom, it'll be a question of clarification on a topic the Board is dealing with, or a challenge to a proposal from the Chief Executive. In the latter case, especially, it is quite common for the CEO to push back quite hard: he or she has probably thought through their case in some detail, and has anticipated the first round of questions. I've seen instances where the CEO's immediate response was sharp enough to deter further questions from any but the bravest Board member. This is when it helps to have thought through the issue before you ask the question: if I get this response, that will prompt a further question, and so on...

I don't have a transcript of the Dunedin City Council's meeting, but I can imagine the discussion may have gone something like this, after the "All white here" slogan had been announced:

1st question: "Don't you think that might be a little inappropriate?"

Pushback response: "Don't be so sensitive and b..... PC [politically correct]!"

... Silence, end of discussion.

On the other hand, what if somebody had had the common sense, wisdom, or guts to ask:

2nd question: "Never mind what we think of it, how are we and Dunedin going to look when this is spread across the front page of the world's newspapers?" (in case you can't guess, read the answer here).

Then again, this seems so numbingly obvious that perhaps there was a bigger, more devious game being played, in line with the old cliche that any publicity is good publicity. Was it all just a set-up to gain attention? If so, they should all stand in the corner for twenty minutes, just like any other four year old trying the same trick.

"It's a no-brainer"... but when should the Board get involved?

I'd like to share a small quandary with you. The last month has involved a lot of activity around some of my Boards - the main reason for the relative silence on this page.

A couple of weeks ago, on a Saturday morning, our company's legal adviser rang to ask if I would sign an urgent document that needed the signature of two directors. I don't need to go into the details, but it related to a fairly large transaction, which I knew was coming up. But it had emerged since our previous Board meeting and we'd never discussed it together as a Board.  

I talked it over with our lawyer and asked whether he thought this was a matter that ought to go to the Board first. 'Well, it's really a no-brainer, isn't it?' was his reply. I agreed, and signed. I did ask him to confirm that in his opinion it was in the best interests of the company for us to sign this document, which he did. 

Looking back though, should I have pushed back a little harder? Certainly, there was some urgency about the transaction. And yes, I did (and still do) believe that going ahead was in the company's best interest (one of the legal tests for a director's actions). But I have this feeling that we might have been a little lax in our process. All Board members had seen the emails on the subject, so I suppose they could have raised any concerns. But my main question is where the boundary is: when does a 'no-brainer' become a 'half-brainer', or a matter that might actually benefit from some considered Board discussion, or finally a decision that really needed some thorough testing? And who decides where these borders are? After all, part of our reason for being there is to test and challenge management thinking.  

As directors, we don't usually do much in our individual capacity, and the whole Board is likely to be responsible for the actions of any of us. So the other directors were - possibly without knowing it - putting their faith in the two of us who agreed to sign.

I think I have learned from the experience. If I'm in the same position again - whatever the need for haste - I think I'll at least ask for a Board conference call to discuss it first - as much for the benefit of the other directors as for my own peace of mind. 

We've just had another Board meeting, at which the Board ratified our actions. What if they hadn't? I'd be interested in any similar experiences you may have had - and what you did.

Never a good time - increasing directors' fees

There are some things for which it's never the right time: closing a major highway intersection for repairs, refurbishing the company's head office, and testing the office fire evacuation procedures, for example. And raising directors' fees.

Last week we saw another classic case of an unpopular motion to raise directors' fees in a large public company, Contact Energy Limited. I'm the first to argue that directors need to be adequately rewarded: Contact is one of the two largest listed companies in New Zealand and its independent directors currently receive about $100,000 per annum in fees (read details in the annual report). While this may sound a lot, I believe it's actually quite reasonable, even modest, given the calibre of people Contact would hope to attract, and the demands and responsibilities placed on directors in large public companies. For the record, I have great respect for the technical abilities and professional achievements of Contact's Board members, which is not to say that some of them haven't made some big mistakes in the past.

Besides this, the fees have not been adjusted since 2004 - and I don't know many senior executives who would have accepted zero adjustment to their salaries for the last four years.

And that's where it seems to have gone all wrong. The rational case for an increase seems strong. But I believe the way the Board has gone about seeking this increase has smacked of either insensitivity to the company's small shareholders and customers (many of whom, including your blogger, are both), or an arrogance that tends not to go down well in this country.

As I say, it's never a good time to raise directors' fees - someone will always get upset, if only through pure envy. Now put yourself into the Board's shoes and consider the following - none of which is a secret:

• The world's economy seems in danger of stalling, if not of going into a flat spin;
• We're two weeks away from a general election, so everything is political fair game; and
• On the actual day of the Annual General Meeting, many of Contact's customers (yes, me too) received a letter from the company telling us that our power bills were going up by about ten percent.

When I was learning to fly, many years ago, my instructor gave me his definition of a superior pilot - "a pilot who uses their superior judgment to avoid situations that would require their superior skill." If the directors of Contact had applied superior judgment, I suspect they could have seen the fight they were buying for themselves. Instead of ignominiously retreating at the AGM, and handing a moral victory to a shareholders' representative in a Viking helmet, the directors might have modified their proposal: rather than asking for a doubling of the approved fees (which they hadn't intended to use in full), perhaps they could have argued and gained greater support for a smaller increase, based on the long period since the last pay rise.

It's not the increase itself which is so significant, but broader questions that this issue (not the first) raises about the Company's attitude to its large base of small (and definitely minority) shareholders - and whether the Board is too far removed from the real world to appreciate that the Company doesn't operate in a vacuum. Telecom has paid the price for such arrogance (or corporate myopia); it would be pity if our next largest listed company also fell victim to its own hubris.

Social responsibility, however you define it, is not an optional add-on to a director's role. It is an integral part of governing a company that operates in a real world of people who pay their power bills, read the papers, vote at elections and try to make the best living they can. No company can afford to ignore this for long.

Springboard or Tramlines? How do you manage the Meeting Agenda?

I suppose we're all creatures of habit - even those of us who talk about and sometimes initiate change. But I've had a good experience recently that has made me really think about the order in which we deal with things at our Board meetings.

I've always advocated getting to the key decision items and strategic issues as early in the meeting as we can, so we can spend as much time as we need on these. (These big items are what we sometimes refer to as the 'gorillas in the room': however docile they may seem, you can't ignore them.)

But until now I've been a fan of working through the CEO's report ahead of these items. I've felt that the Board needs to be updated on what has happened since the report was written - probably up to a fortnight before the meeting, if the papers are well planned and reach the Board members a week or so before the meeting.

Well, I've changed my mind. I've chaired three Board meetings in the last couple of months (in two separate organisations), where for various reasons we hit the strategic items almost immediately - right after the formalities and action points from last time. What a difference it made to the meeting: the whole Board was engaged and involved in the discussion from the start. We enjoyed some great thinking, including some big ideas from 'outside the square'. This week we even generated a spontaneous whiteboard session for half an hour, to capture some ideas that we haven't adequately explored before. Not quite the typical image of a traditional board discussion - I'm pleased to admit!

I've thought about why these meetings went so much better. It wasn't just that we gave ourselves enough time for the big items - we usually do that reasonably well - but I think the real difference is that we hadn't been drawn down into the operational issues, which is what probably happens once you get into the CEO's report. The Board members had arrived - well charged with caffeine in most cases (this may also be relevant) - to talk about big issues, and nothing got in their way before we did just that.

And what did we lose by this? Well, if anything, we became even more efficient in our use of time. By the time we got to the CEO's report, we'd discussed most of the main items she'd written, so we spent only about ten minutes on some of the smaller, but important, matters in the report.

There is one assumption in all this: our Board members have to read their papers, and think about the issues, before our meeting. I'm lucky with the Boards I chair, but I know this failure to prepare is a 'sea anchor' that holds some boards back. We take our papers as read (... and understood and thought about) - we couldn't have an effective meeting otherwise: then we use the information from them as background - a springboard - for the type of discussion that effective Boards need to have around the table.

The alternative - sadly quite common - type of meeting is where the Board works its way from page 1 to the end of the papers, without deviating, looking up or adding a creative (or strategic?) thought for the full three or four hours that they're together. Just like a tram-driver really, with the difference that the latter doesn't need to worry about steering the vehicle.

Next, I'm thinking of keeping the minutes from the last meeting until near the end of the agenda too. Why not?

A recipe for New Zealand

Last year, John Williams, one of New Zealand's relatively unsung entrepreneurial heroes wrote a piece for the website nzedge.com setting out ten strategies that would restore New Zealand to the league of wealthy nations, where most of us - I suspect - believe we should be. John used to own Marton-based company PEC (New Zealand) Limited, which developed some revolutionary petrol-pump technology that is now in common use around the world.

From this smart, technology-based platform, which has successfully been taken to global markets, John has produced a list of his 'must-dos' that would see New Zealand transform itself into a genuine knowledge-based, smart economy that we need to become if we are to remain globally competitive.

The list begins, not surprisingly, with a suggestion that New Zealand industry should emulate his success, by 'maximising growth in the sectors where we currently produce world-class products and/or services.'

He includes several strategies for business and commerce, but he also recognises the need for a sound basis in a strong and fair society, recommending (No.4) that the values-based "Kiwi-Can" programme should be extended to all primary and secondary schools.

Whether you agree with the details of this 10-step recipe is, I think, less important than that here at last is someone taking a long-term, strategic look at what New Zealand needs to do. One of the features that I feel has been sadly absent from our national debates over the last decade has been that we have not really talked about what sort of a country we want New Zealand to be. We have argued at length about policies, fairness and tactics; and we've even talked loftily about 'knowledge economies', 'growth waves', 'innovation frameworks' and so on; but without some hard decisions about what we're actually going to do, these will remain simply as cliches.

This debate isn't optional: if we don't at least have the discussion, we'll continue on the current path, where, while enjoying its best trading conditions for decades, New Zealand has barely held its place in the OECD's income rankings. If we have the debate, it's quite valid that we might reach a consensus that we don't want to get back among the rich nations. But I doubt that will be the answer.

What I think we might discover is that dragging ourselves back up the growth curve is in reality the best path to those global standards of health, education and social outcomes that most New Zealanders instinctively want. Unless we're generating the wealth, we can't spread it around. New Zealand's general election is only seven weeks away. Let's challenge ourselves, and the people who aspire to represent us, to take this national debate seriously... to show us their strategies for growing the pie, rather than changing the way we divide the existing one... and to make sure that all sectors of society take part and help to develop a sense of vision and purpose for the next decade.

And, while we're at it, let's not leave it just to the politicians. As leaders in our own sectors, we need to have these discussions around our board tables: how do we build our company to take advantage of the global opportunities (and counter the threats) of the increasingly complex global environment we're in? If we all address these questions, the sum of our answers will go a long way towards providing the answer for New Zealand.

Measuring real success

I realised I'd had enough of the Olympics for another four years when I found myself staring at a semi-final of the women's Handball tournament between, I think, Norway and Georgia. Now come the analysis and post mortems, including the recent discovery that Bronze medallists ('Wow, I got an Olympic medal') are generally happier than those who win Silver ('If only I'd gone just a little harder ...').

New Zealand has had a successful fortnight, with a haul of three Gold, one Silver and five Bronze (that's why we needed that earlier analysis), placing it twenty-fifth in the overall Medal rankings.

We're sure to see commentary around New Zealand's traditional area of strength - medals per head of population. Here we are near the top again this year, with just over 2 medals per million of population, pretty much in line with Australia. On this measure, we're six times as successful as the USA (three million people per medal) or Britain (1.2 million per medal), but we all trail Jamaica, who dazzled on the track with eleven medals in total (six of them Gold), from a population of fewer than three million (remember 'Cool Runnings' - the movie about the Jamaican bob-sleigh team?). If you want more, see this forecasting model produced by Professor Andrew Bernard in the United States and this clever graphical analysis by the New York Times, showing relative performance at each Olympic Games since 1896.

Enough jingoism for one blog post! What I really want to write about is a more meaningful, and sobering, measure of a country's success - New Zealand's ranking in GDP per head of population. Here we have little to be proud of over the last forty years. From being one of the wealthiest countries in the 1960s, we slipped to 22nd out of 30 OECD countries by 2005, sitting between South Korea and Spain, with about 85% of the OECD average Real GDP per head. In 1970, we were up at about 115% of the OECD average.

The good news is that we stopped sliding in the early 1990s. The bad news is that, despite stated political ambitions to return to the top half of the OECD ladder, and enjoying New Zealand's best terms of trade for some decades, we've made no real progress in the last few years.

Looking ahead, I think we face two dark clouds, both related to our remoteness: the growing issue of 'food miles' presents yet another non-tariff barrier to our food exports. Regardless of the science, and the proven fact that total carbon emitted in sending our produce to Europe is less than that of European produce (where stock are generally housed under cover during winter), what really matters is what the supermarket shopper believes. We need to get our message across.

The second point is similar: whether we can remain a destination of choice for the world's tourists, if they get more concerned about the carbon footprint of long distance travel.

As a resource-rich country, we're blessed with some of the world's best conditions for producing protein, we have plenty of fresh water (usually) and a broad range of options for our energy needs. Until recently, we've been sheltered from the adverse trends by high prices for our commodities and a strong and growing global economy. The latter is fading fast, while the former may continue for a few years. But we need to face the reality that one day we won't be the world's cheapest food producer: South America and Eastern Europe are not standing still.

This is a challenge for governance at all levels: for Boards, it's important that we all play our part in thinking how we can genuinely transform our businesses, to get ouselves back onto a faster-growth path. We have the raw materials, we have the brains and the education; we need to commit to investing in a country that wants to grow the pie faster, rather than simply distributing what we have differently.

Next time, I'll look at one person's recipe (non-party political) for restoring New Zealand to the levels of wealth we could enjoy - with all the other benefits that flow in health, welfare and life expectancy.

Welcome a-board - more news on better balanced boards

If you read The Economist, you'll know that it never lacks confidence in its own rightness.

It promotes a liberal, free-market view of the world and, healthily, has little time for the fuzziness of much modern economic policy making. So I think that an article this week, Getting more women on board, is quite significant. As you'd expect, this article is about the improving gender balance on Boards and in top-level management (known these days as 'The C-Suite' - as in 'C' for 'Chief [insert function - Financial, Information, Executive ...] Officer').

The article discusses the slightly disappointing findings of a survey by Catalyst, an NGO that promotes equal opportunity in workplaces, indicating that the rate at which women have reached the top floor offices has 'stalled' in the last few years. Even now, Catalyst estimates that women occupy only one in seven board positions in Fortune 500 companies.

One interesting, and not surprising, finding is that the strongest predictor of how women will progress into the top executive positions in the future is the current proportion of women on their board:

• 'Companies with 30 percent women board directors in 2001 had, on average, 45 percent more women corporate officers by 2006.'

You'd expect this if a company has a culture that creates a work environment providing opportunity for all its people - as seems probable if there is real diversity around its Board table. There is also some evidence that female directors are seen as role models who both inspire and support aspiring female executives.

The Economist takes this a step further, getting close to what I see as the real point - the incentive for shareholders to select leaders from the broadest possible pool of talent, regardless of gender or other demographics (apart, one would hope, from ability).

Several years ago, I was a member of a Board of five directors. Normal succession processes had resulted in my being the only male on the Board. The best part of that experience was that it was three or four months before anybody even noticed this rather unusual circumstance. And that, surely, is the end-game - when surveys such as Catalyst's, and blog posts like this, are redundant, because all of us around the table are seen simply as directors, each appointed because the shareholders considered us to be the best person for the role.

Realistically, I think it'll be a while yet.

Paying dividends - a director's duties

If you've taken any interest in financial markets over the last year (and if you either borrow money or have some to invest, it would be a good idea - especially now - to take an interest), you'll know that a number of finance companies in New Zealand have found themselves in difficulties.

You're also likely to have heard various commentators allocating blame. Some commentators have known what they're talking about, but others we might describe, charitably, as having less than a full understanding.

I thought it might help to explain some of the basic duties of directors in these situations (remembering that I'm a company director, not a lawyer, so I'm drawing any inference as an informed layman, rather than a legal expert), so you'll be in a better position to judge the facts:

1. Dividends

In general terms, dividends are income that shareholders receive as a return on their investment, usually paid from the company's tax-paid profit. Section 52 of the Companies Act says that the Board of directors may authorise the payment of a dividend if it is 'satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test' - together with a few other conditions.

So what's the 'solvency test'? For this we look at Section 6: '... A company satisfies the solvency test if -
(a) The company is able to pay its debts as they become due in the normal course of business [my italics]; and
(b) The value of the company's assets is greater than the value of its liabilities.'

My guess would be that finance company deposits which fall due on a particular date would be classed as 'in the normal course of business'. In determining the value of the company's assets, 'the directors must have regard to the most recent financial statements of the company ... and all other circumstances that the directors know or ought to know ...' [again, my italics].

Even allowing for the tidal wave of changes in financial market conditions, and the precipitous decline in reinvestment rates (the amount of deposits that are renewed when they fall due, rather than being repaid to the investor), which has led to the liquidity difficulties of some finance companies, these provisions in the Act should prompt some searching questions of a few people who are known to have been paid large dividends in the not too distant past.

2. Reckless trading

There's another Section (135) in the Act, entitled 'Reckless trading' which may also turn out to be relevant. Under this, a director 'must not agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss ...' to the people the company owes money to.

The Act provides various defences for people charged under these Sections, so you can expect any legal actions to be lengthy, strongly contested, affairs and, naturally, to be far more complicated than this simple explanation.

But I hope that, after reading this, you will be better able to form your own view of the actions and responsibilities of various parties likely to feature in the news in coming months.

Does absolute power corrupt absolutely?

Last week British retailer Marks & Spencer faced attacks from shareholders and members of the financial press, when Chief Executive Sir Stuart Rose was promoted to Executive Chairman.

23% of shareholders abstained or voted against Sir Stuart's re-appointment to the Board because they considered it went against good governance principles to have one person holding both positions, Chief Executive and Chairman.

This is an old debate and I think it's very easy to over-simplify it - right or wrong. The real answer, as always, is much more complex and depends on the substance rather than the form of the appointment.

If we start with what we're trying to achieve - a successful company - we can find case studies that both support and oppose the appointment.

In many large American companies (which Marks & Spencer is not, of course), the roles are combined. This has often been quoted as one of the weaknesses that led to the fall of companies like Enron and Worldcom. I think it's always a risk if one person holds too much power in an organisation, but the American system provides balance by having, usually, one or two other positions in addition to the Chairman and CEO: we usually find a President and Chief Operating Officer and, since Sarbanes-Oxley, the position of Lead Independent Director. So, in practice, this 'standard' American model builds in some real checks and balances on each individual.

What really matters is not so much the Board's structure, but how (and if) Board members fulfil their roles adequately. There's plenty of evidence to show that the difference between effective and ineffective Boards comes down to how Board members act, whether they deal with the tough issues and have the necessary debates, and that this matters far more than details about the Board's structure. If you've got the right behaviours in the boardroom, you can deal with deficiencies in the Board's structure or composition. But not vice versa.

As has been in the case in several of my previous 'posts', it comes down to the substance of the matter, not just the form.

Marks & Spencer will be an interesting case to watch. As an English company, it would not be typical to have the President/COO and the Lead Independent providing balance. However, my guess is that the Deputy Chairman and other Board members will be very conscious of their obligations to perform: perhaps we'll have material for another comment in a couple of years.