This may the last installment for my review of The Handbook of Board Governance: A Comprehensive Guide for Public, Private, and Not-for-Profit Board Members. With the current post, I provide comments on Part 8 of the book, Governance of Different Forms… a kind of catch-all for nonprofits, non-North American firms, startups, small-caps, and family firms… whatever didn’t easily fit in prior parts.
See prior posts on introductory comments and those on Part 1, Part 2, Part 3, Part 4, Part 5, Part 6 and Part 7. As I have indicated before, The Handbook of Board Governance is one of the most popular collections of articles of interest in the field of corporate governance. Look at where it ranks at Amazon today within the entire field (fluctuates daily) and you will note that its scope is arguable much broader than all those ranking above it. At more than 850 pages with 50 authors for less than $50, it has to be a best buy for those looking for practical information and theory in corporate governance today, and for several years going forward.
If I have one criticism of the Handbook, it is that it seems to be addressed not just to directors but also to everyone with an interest in corporate governance… even if they are unfamiliar with that term. Yes, the core of the book deals with the board’s responsibilities but also covered are the rise of shareholder activism, issues surrounding the social framework and the corporation’s accountability to the larger society. This final part of the book delves into an even broader range of topics, including variants of the corporate form as well as the distinctly international example of corporate governance in Middle East and North Africa (MENA) countries. Why not Europe or Asian countries? Probably because most readers will already have at least some familiarity with those regions.
Of course, my criticism also points to a major source of strength in this rather large volume. Where but in a director’s handbook edited by Richard Leblanc would readers be exposed to my thoughts on the individual shareholder’s role in corporate governance or Alissa Amico’s study of corporate governance practices in the Arab world? These are widely divergent topics.
Diversity in skills, demographics and in thought will help today’s boards address tomorrow’s concerns. The Handbook of Board Governance does an excellent job of exposing readers to the topics every director must address. While it plumbs the depths of value creation and measurement, corporate incentives, CEO succession planning, risk management and best board practices, it also introduces future directors and their advisors to m0re recently emerging concerns in information technology, start-ups, small company governance, social and environmental issues.
As TK Kerstetter writes in the book’s Forward:
[T]he mind-set of the book’s authors is not only the status quo, but, more importantly, what could, or in their minds, should change in the governance field, and what these changes are, over the next three, five, and ten years.
The Handbook of Board Governance: Transforming Nonprofit Boards to Function in the Twenty-First Century
We start out the last part of the book with a chapter from Eugene H. Fram on adapting nonprofit boards to fit the current century. No, this is not a discussion of social media or the impact of 3D printing or driverless vehicles on board practices.
Instead, it is a rather prescriptive piece on the problems Fram has encountered while counseling nonprofit boards or advising other advisors. For him, the challenges facing twenty-first century nonprofit boards are primarily “too many meaningless standing board committees, meeting agendas filled with operational details, and board micromanagement of operations.”
Having served on several nonprofit boards, I have no doubt he is correct. However, I am less sure that “only three standing board committees should be utilized:”
- Assessment – focusing on measuring organizational and ECO impacts
- Planning and Resource – conserving resources and developing policies and strategies
- Executive Committee – coordinating group for the other two and acting for the board between meetings
I would take the whole chapter as one person’s excellent reminders on a number of topics. Here are a few I highlighted for importance or insight, as I read the chapter:
- Do not expect real director independence if the nomination committee considers only candidates based on social, business or family connections. Add qualitative abilities such as critical thinking, interpersonal skill, teamwork, and strategic outlook to your desired skills matrix.
- Succession planning is critical. Involve the outgoing CEO in the evaluation of successor candidates.
- Fundraising is the primary function of many nonprofit boards. Although all directors may be expected to make an annual contribution, fundraising may be the major strength of only a few.
- Make use of termed-out board members though advisory boards, alumni groups, short conferences and/or continued direct contact. (Great advice; I have seen too many castaways that still have much to offer.)
- Annual reviews are important to insure viable governance structure, assessment of CEO, board and organizational performance, as well as strategic planning and organizational integrity.
- Pay special attention to the IRS Form 990 submission. It contains 38 questions related to governance that can affect your organization’s tax status. “The Intermediate Sanctions Act needs special consideration; it has the greatest personal liabilities perils for directors, managers, volunteers, and even vendors.”
The Handbook of Board Governance: Startup Boards – All In for the Company
Like many others in the Handbook, I have been following the author of this chapter, Adam Quinton, for years on Twitter as @. I have been involved in only one startup, so I am inexperienced in Quinton’s topic. I will hit a few of my takeaways, although there are many more.
In established companies, boards focus on downside protection but in startups the focus is on growth… although cash management is also critical. One reason startup boards are highly engaged is that they generally have skin in the game. Board representation is usually a key condition of investment by venture capitalists. Boards add value through human capital (networks) and business development acumen (introductions).
Among high-tech startups, the objective is generally to be “first to scale.” Since the median time between financing rounds is just over a year, tracking cash flow burn rates is critical and CEOs need to balance the demands of constant fundraising with running the business. Limited partnerships generally have limited life, about 10 years, so they are looking to cash out through one of three routes:
- Sale to a corporation
- Sale to private equity
IPOs get most of the press but out of 3,900 companies receiving venture funding recently, only 50 were IPOed. Quinton points out a real risk in that 94% of VC partners are currently men and only 3% of venture-backed CEOs were women. This is clearly an area of opportunity or in need improvement, depending on your perspective.
The Handbook of Board Governance: Systemically Overlooked Anomalies of Governing Small-Cap Companies
I have met Adam Epstein, the author of this chapter, several times at various conferences and he has contributed to my blog through guest posts. I was really looking forward to his chapter because Epstein’s insights might be of immediate practical value to me in a current challenge to the board and CEO/founder at Reeds, Inc, a micro-cap.
Epstein notes that 7 out of 10 exchange-listed companies in the US have market capitalizations of less than $1 billion. Reeds, Inc has a market cap of less than $50 million, so you can bet I am looking for advice from the small-cap advisor. He lists out 15 challenges faced by many small-cap companies. Several seem especially significant to me, as I examine Reeds, Inc.:
Company is run by a first-time CEO
- Has no board members with experience operating or governing a public company
- Each independent director sits on every committee
- Doesn’t have an in-house counsel
- Does not have a CIO
- Does not use a Big Four audit firm
- Institutional investors cannot own because of illiquidity (a few are invested in Reeds but such investments make of up less than 1/100 of a percent of fund portfolios. In other words, it probably is not worth their time of day to monitor.
- Offers their directors less than $50,000 in total annual compensation. Reeds pays one director $750/year.
Epstein points out that since raising external capital is such a recurring need for small-cap companies, one would think their boards would often include experts in finance. Yet, they typically do not because small-caps lack the resources to attract such experts and because most do not see it as must have experience, like knowing how to get through clinical trials. Epstein views this as a big mistake.
[S]erial capital raising, small-cap companies are undertaking needlessly dilutive financings that, at best, hurt existing shareholders, and, as worst, might make future financings untenable due to onerous covenants and encumbrances.
Investment bank loans in the small-cap ecosystem are packaged by those earning a commission on acceptance. There is a basic conflict of interest at play. Additionally, since small-cap boards often negotiate from weakness, it is hard to tell if the real clients are the boards or the banks and the financiers.
When the responsibility for managing poorly understood risks is then passed along to conflicted third parties, the results are predictably even worse.
Epstein offers several bits of advice. I will cite just two here. One is to search for a new board member with recent, relevant capital markets experience. A second is to become familiar with recent financings at peer companies through online tools such as Placementtracker.com, Dealogic, Capital IQ, and Privateraise.com. These are all new to me.
Asymmetric Information Flow
The CEO handpicks the board members at most small-cap companies. Information provided by institutional investors proxy advisors and others is nonexistent or minimal. Epstein lays out a scenario at hypothetical software company ABC. I got nervous just reading the situation because it became obvious, the board did not have the requisite experience to make a good decision and they are too small to be hiring top-notch outside consultants.
Additionally, CEO-controlled nominating practices usually end up with board members quite similar to their CEO/Founders. They not only think alike, they are likely to be differential to the person who selected them – the CEO. “[D]irectors handpicked by the CEO are simply less likely to oversee than they are likely to acquiesce.”
Epstein offers a list of questions perspective nominees should ask of directors and the CEO. That is all very helpful for them. For investors, he holds out hope that proxy statements will include a line or two of information disclosing prior ties to the CEO and other directors. That might help us assess if nominees are really qualified or just friends of the CEO and/or other directors. Almost all of us recognize more diversity could help solve many of these problems; we just need to know when it is real and when it is fake.
Corporate Service Providers
The smaller the company, the shorter the list of willing, affordable service providers… and the less predictable is the quality of their service. Epstein provides examples of law firms and audit firms bungling their work with small-caps due to inexperience. He gives plenty of good advice on how to choose a service provider. One bit he does not include is a bit of self-promotion, so I do it for him. Hire Epstein’s Third Creek Advisors; then he can help you find the right auditor, legal counsel, etc.
The Handbook of Board Governance: Boards and Value Creation in Family Firms
This chapter by Jonas Gabrielsson, Andrea Calabrò, and Morten Huse is one of the more theoretical chapters in the book… and that is a good thing to ensure balance. I have read about the team production approach, mostly as espoused by Blair and Stout. It is good to read how corporate boards can that that approach. Although the emphasis here is on family firms, do not be tempted to skip over this chapter if you will never be involved with a family firm. The concept has widespread applicability.
The team production approach sees the board as a mediating hierarchy. Decisions should be made to benefit all stakeholders that assume risk, enhance firm value and possess strategic information. Their firm-specific investments are essential for competitive advantage. Of course, “it is not enough that resources and core-competencies exist, but they must also be used and integrated with the chain of value-adding activities that make up the firm.”
Although family firms may have special needs with regard to the value chain and preserving socio-emotional wealth while perpetuating the family dynasty, I believe the framework can be useful to most directors. All boards should be building and balancing commitment, openness, creativity, cognitive conflicts, cohesiveness, criticality and independence.
The Handbook of Board Governance: Succession in Family Businesses
Ronald I. Zall provides a horror story of a succession plan supposedly written but not disclosed. The founder died unexpectedly, war broke out among his sons. With all the turmoil, the wife/mother then died unexpectedly (heartbreak?) and the company faltered and failed. Is your family firm motivated yet? I am sure the downward spiral did not just affect two generations.
Whether your family has a board of directors, family committee, council or forum, this chapter is for you.
The Handbook of Board Governance: From Regulation to Enforcement of Corporate Governance in the Middle East and North Africa
Just as I began reading this chapter by Alissa Amico, I received the first edition of Proxy Watch Arabia, a joint publication of Govern, the Economic and Corporate Governance center, and Global Proxy Watch, the leading global corporate governance news provider. That weekly publication, largely by Alissa Amico, is the only independent source of governance and shareholder news in the Middle East and North Africa (MENA), covering global developments as well.
In this chapter, Alissa Amico provides an overview of the corporate governance infrastructure in the MENA region, including a discussion of the regulatory framework and capacity limitations. For example, the Saudi securities regulator is known as the most vigorous in the area. In March 2014 they announced penalties levied on 26 listed companies “for breach of certain board-related provisions, each company being fined $2,600.” Not all fines are that small. The Dubai Financial Services Authority (DFSA) apparently fined a subsidiary of Shuaa Capital $850,000 for manipulation of shares.
Public enforcement has focused on graft, corruption and market integrity. Unfortunately, there is little evidence of investors being able to pressure management by divesting or through proxy fights. Amico calls for bilateral and regional training programs, with increased capacity to adjudicate specialized lawsuits. Currently, it takes an average of 651 days to resolve commercial disputes through the courts in Arab economies. The establishment of specialized economic courts is a priority for many in the region, as is publicizing enforcement decisions on the Internet to increase the deterrence effect. Amico also highlights that comply-or-explain codes favored in Europe may be insufficient, since the European Commission found only 39% of explanations were sufficiently informative. She hypothesizes that regulators may want to require audits of disclosures by external auditors or more mandatory provisions.
Amico goes on to discuss MENA area efforts to address related-party transactions, insider trading, director duties and shareholder activism, dispensing substantive advice in each area. Her concluding remarks are most instructive:
Although the rise of capital markets and the banking sector has been under a consistent spotlight in the public debate in Western markets, the focus in the MENA region has been on the role of the state not as a regulator but more as an actor of wealth redistribution through subsidies, services provided by state-owned enterprises, and public sector employment.
This discourse does not take into account recent economic trends, notably the fact that the motor of the economic growth in the region is the private sector, including publicly listed companies.
Amico’s chapter certainly contains lots of advice that could be helpful to those who seek to recognize the increasing role of the private sector and corporate governance.