Director Dilemma

Color Commentary

1. Probably a Waste of Time

I’ve been working on understanding how boards of directors help or hurt their company. My goal is to be able to understand, from the outside, whether a board of directors is doing well for a company by representing the long-term interests of the shareholders and all stakeholders, or whether they’re ineffective representatives who do nothing but show up and cast the votes the executive team expects from them.

In a well-managed company, those two goals will be the same – the votes the executive expects from the directors will be meant to further the long-term interests of the shareholders and all stakeholders. A great CEO would welcome dissenting opinions from the group of (presumably) smart people who are there specifically to help the company out. Real life, however, tends to deviate from that ideal.

Furthermore, as outside investors, is it even possible for us to find out enough about the inner workings and relationships of a board of directors to effectively evaluate them? Or is this a fool’s errand and a waste of my time? I have to prioritize how I spend my research time, and perhaps looking at a board via the sources I can find online is not actually very illuminating.

I was willing to potentially waste some of my time to try to find out.

2. What a Board Does

I like to look at the people running a company because I need to trust them with my money before I hand it over to them. The financials give an excellent view into what they’ve already done. It gives an indication of what they may accomplish in the future. If I can understand what kind of people are running the company and actually making the decisions about where and how to allocate the capital, then I have a more complete picture, overlaid on top of the financials, of how I bet this company will do in the future.

If you’ve been reading my work for a while, this isn’t news to you. Until now, though, I’ve really only been focused on CEOs. Occasionally I’ve looked at the other executive officers (CFO, CIO) but really I’ve researched the CEOs. And then I started thinking a little more deeply about how companies are run, and who represents the shareholders. Who represents ME?

It’s the Board of Directors that represents me, the shareholder. The shareholders own the company, but because the shareholders are often numerous and involved in other things, they elect representatives to perform overall governance of the company. These representatives are the directors. The directors, in turn, hire professional business people to do the day-to-day operations of the company. These professional business people are the officers (also called executives, also called managers). The person who holds the office of Chief Executive Officer has been appointed to that position by the directors, who represent the shareholders. So really, a CEO is employed by the shareholders.

Often, those various positions are held by the same people, which can make the separation of powers, so to speak, rather murky. For example, it’s very common to see the founder of a company hold a seat on the Board of Directors and also be employed by the company as the CEO, as well as owning a big chunk of shares. That founder is a shareholder, director, and officer.

Furthermore, the officers – especially the CEO – tend to represent the company publicly and get a lot of the attention from the outside. This is often done for the very good reason of having one message and one voice out there, but it serves to make the CEO seem all-powerful, when in fact, they are not.

One of the most famous examples of a Board of Directors wielding its power over its employee was when Steve Jobs, founder of Apple, was essentially pushed out of his job in 1985. Jobs was a director – actually, he was even the Chair of the Board of Directors – as well as holding a job in Apple entitled “chief visionary”. Another person, John Sculley, was the CEO, and the two had differences of opinion about where and how to lead the company. The Board sided with Sculley. To protect Sculley’s power, they voted to remove most of the responsibilities of the role of “chief visionary” and, by giving Jobs nothing to do, essentially fired Jobs (though technically he still had his job, just nothing to do in that job). He himself characterized that time as “[getting] fired” when he described it in a commencement speech at Stanford in 2005. Note that he was still the Chair of the Board of Directors! Totally separate roles. (Two good sources about that story here and here.)

OK. So there I was, focusing on trying to understand the person employed by the Board to run the company, and I started to wonder if it wouldn’t be worth some time to understand the people on the Board who choose that person. After all, as the Steve Jobs tale illustrates, if the CEO and Board clash, the Board is going to win. Who are these people on the Board? Maybe they were even more important to understand than the CEO.

I started researching the board members of companies I was interested in, and quickly realized there wasn’t really that much information about most of the directors. Some, yes – the ones like Apple’s director Al Gore, former Vice President of the USA under Clinton. We’re not lacking in information about him. But Apple doesn’t even give us a bio of the Chair of Apple’s Board, Arthur D. Levinson, and there isn’t much information about him online.

Check out the varying way these boards of directors of consumer-facing giant public companies are presented to potential investors. I chose the following companies totally off the top of my head, and really enjoyed looking at all the different ways these companies put out director information.

Some have photos (Merck), some don’t (Lowe’s). Some have longer bios (Shake Shack), some have only the original press release (Apple). Some make you click on each person (Tesla), some make it easy to read about them on one page (Adobe). Some share the names of the other boards on which each person sits (ExxonMobil), some don’t share that information (Square).

I can’t link to the Board of Berkshire Hathaway because they don’t even provide a webpage about their directors.

It’s interesting to see the differences, and you know I always am interested to see how a company chooses to present itself to me. But those are just websites. They’re just PR. What’s going on underneath, in real life, with these groups of people?

3. Adobe Case Study

I’m fortunate to have a friend who coaches and evaluates boards, as well as to know other investors who think the people running a company are worth understanding, and together we developed a framework, which I’m partially sharing here.

I ran through an exercise recently with some fellow investors to see what we could learn about one particular Board of Directors. We focused on Adobe, a digital media company (you know, that one that makes Acrobat for reading PDFs and a bunch of other software we all use). There’s no great story on why we chose Adobe instead of any other company. It’s a company one of the other investors was interested in, and that’s all. None of us had any special knowledge about its board, and so we figured it would be as good a case study as any.

I found this Harvard Business Review article to be very helpful in framing my ideas, though it’s almost 20 years old.

  • What level of diversity of background, age, education, expertise is there?
  • Does that diversity match the strategic goals of the company going forward?
  • How did each director meet the company and get nominated to the Board?
  • What is the turnover on the Board?
  • How is each director compensated, and how much?
  • How many board meetings are actually held per year, and how many are required?
  • How many board members attend the annual shareholder meeting?
  • Are candor and dissent encouraged?
  • How often do board members meet with management away from the boardroom?
  • How is company information disseminated to board members?
  • Do the votes of directors match the values put out publicly by the company?
  • Do the directors know each other outside of the boardroom, such as going on a board retreat together?
  • How are the directors reviewed and evaluated, and how often?
  • Do they hold any open board meetings with employees?

Now. Can we know the answers to most of these questions?

Nope.

There’s no way. I will probably never know how a Board of Directors discussed a contentious issue, or if they even have contentious issues in the boardroom at all. Most outsiders will never know because they usually keep that information confidential to protect the company’s internal processes. Still, I gave it a shot with Adobe.

Adobe’s board actually turned out to be a pleasure to research, because they release a decent amount of information about them. I’d classify the bios of the directors as a medium amount of information, with some even stating what expertise that person brings to the board (but not all).

Adobe releases its board governance policy and its lead director policy, as well as its compensation policy. It’s usually kind of hard to find this information, so I give Adobe high marks for making it easy to get and putting it right on their governance page of their website (where you can find other documents as well, like their bylaws and charter). It’s the company’s annual proxy statement where you find the real information, and I really appreciate that Adobe formatted theirs well, and they’re clearly making an effort here because if you go back a few years, the old ones don’t read quite as easily. So, let’s get to answering the questions I posed.

  • What level of diversity of background, age, education, expertise is there?
    • The directors are classified as all being independent except one, the CEO, but that’s misleading because two of them are actually the founders of the company from all the way back in the early 1980s! Love that they’re still there, don’t like that the company classifies them as independent when they’re as inside as you get. So really the ratio is 3 internal members, 8 independent members. All of them are American except two, who are both Indian and now live in America, so it’s a very US-centric group. 3 women out of 11, which isn’t a great ratio but frankly, compared to many boards, it’s not horrible. Their educations are not all from top schools and that indicates having to work their way up – a gross generalization, but I’m ok with it. Their expertise seems like a decent mix for a tech/media company and while I do wish they had some younger people – the youngest is 44 and he just joined last year – I like that they’ve kept the institutional memory and experience around as this company has done incredibly well for the last ten years. If it ain’t broke, don’t fix it. Overall, I’m good with this mix, and I hope they add one or two younger thinkers in the next few years.
  • Does that diversity match the strategic goals of the company going forward?
    • I’m not sure if it does. I think it has matched the strategic goals of the past, but going forward as a huge company that has to find ways to grow, they may need some new ideas. One interesting fact, which I’m not entirely sure how to characterize, is that they have two board members from very different industries: one from Marriott (hotels) and one from Eli Lilly (pharma). Furthermore, the CEO is on only one other board, and that is Pfizer (pharma). In fact, he’s not only a member of Pfizer’s board, he’s the lead director. What Adobe’s connection with pharmaceutical companies, and is this just a coincidence or is that how they’re looking to expand to support other industries with specific products? I don’t know what it means, but I do think info like this is worth noting.
  • How did each director meet the company and get nominated to the Board?
    • Don’t know.
  • What is the turnover on the Board?
    • They hold one-year terms, with no limits. The governance policy supports keeping directors for a long time. Might this lack of term limits encourage complacency? Yes. The company has been doing amazingly well, though, so it’s worked for them so far, though.
  • How is each director compensated, and how much?
    • This is actually one of the most interesting non-normal factoids about Adobe’s board. They are required to hold stock in the company, and to that end, they are paid only $50-60 thousand in salary and the rest of their roughly $350-400 thousand compensation is paid in stock awards. This is super interesting because that’s a pretty normal amount of total compensation for a board member of one of the top public companies in the US, but it’s usually paid entirely in cash. Sometimes stock is awarded on top. What the company is trying to do here is align the directors’ incentives with the shareholders. I like it. There is an argument that owning stock means no director is truly independent and therefore won’t raise controversial issues. The first part I agree with – they not truly independent – but I don’t see how that would keep from raising controversial issues. To the contrary, they’re literally invested in this company’s future. I’m not sure I see how that’s a bad thing. I’d rather have directors who are invested along with me than those who take a paycheck and walk away.
  • How many board meetings are actually held per year, and how many are required?
    • Last year they held 7 board meetings (2020 Proxy Statement p.15), and were only required to hold 4 (Governance Guidelines #18). I like that they spent more time than strictly required, and 7 meetings in one year is actually pretty often, like every 6 weeks or so if you take out time for the holidays.
  • How many board members attend the annual shareholder meeting?
  • Are candor and dissent encouraged?
    • Don’t know.
  • How often do board members meet with management away from the boardroom?
    • Don’t know. The Proxy Statement says something about them meeting with management, but no real details.
  • How is company information disseminated to board members?
    • Don’t know.
  • Do the votes of directors match the values put out publicly by the company?
    • Don’t know their votes. However, considering how long most of these directors have been with Adobe, and how strongly Adobe supports stakeholders and having strong values, I’m comfortable guessing that the board is at least supportive, if not encouraging, of such corporate actions.
  • Do the directors know each other outside of the boardroom, such as going on a board retreat together?
    • Don’t know.
  • How are the directors reviewed and evaluated, and how often?
    • There is a regular board evaluation, but we don’t know more than that. I would like to see an annual review, and regular probably means annual, but we just don’t know.
  • Do they hold any open board meetings with employees?
    • Not that they’ve told us about.

4. Probably Not a Waste of Time

Adobe seems to have an effective, somewhat diverse, Board of Directors. I’d like it to be a little more diverse in its expertise, and I wish I could know how much of what the company has done is due to the CEO and how much is due to the Board, but otherwise I see this Board as having checked the box of a decent group of people with good governance principles, who probably aren’t going to get in the way.

This case study taught me that I was sort of halfway right about studying boards being a waste of time. A really in-depth study is probably not necessary for me to come to a useful conclusion about that Board being, at least, non-terrible.

I do want to know the basics for any company I research seriously:

  • how many people are on the Board
  • diversity of background/education/work
  • independent/internal
  • what their terms of office are
  • how they get paid and how much
  • whether they represent the company publicly or not

That review shouldn’t take long, especially with a clear template for a framework to fill in the blanks. That part is not a waste of time. Completing it should get me to a basic level of knowledge that will send me one of two ways.

Either, it’s a boring Board that probably doesn’t have much more that I can learn about it (my estimate is about 90% of Boards will be like this), OR it’s a group of people who are fascinating and add a tremendous amount to the company or are awful and could completely tank the company (probably the other 10%). In the latter case, that’s a Board I’ll spend more time trying to understand and it may lead my conclusion about that company in one clear direction or the other.

I’m really happy I spent time on this board review, so that I won’t spend quite so much time next time and can start to really get a quick sense of what’s normal, and what isn’t – and go from there.

LET’S GET PRACTICAL

If you haven’t read it lately, Steve Jobs’ commencement speech at Stanford is one of the great modern speeches about how to make decisions in life, handle failure, and move forward with “the lightness of being a beginner again.” I read it every few years and take away something new every single time. This reading, again, it brought tears to my eyes. Stay Hungry. Stay Foolish.

Try out a board review case study on one of your companies. You might find exactly what you expect – not much – or you might be surprised. Either way, see if you think it’s worth your time.

Ownership Disclosure: Danielle Town owns shares in Berkshire Hathaway (BRK) and Square (SQ).

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