A company's revenue may rise or fall in the near-term. Market share may go up or down in the mid-cycle. Nevertheless, it is the board of directors that creates or destroys a company over the long run — a vital reason for a company to evaluate directors' performance constantly.
It is the board's responsibility to lead the company through the vagaries of the business environment. While the global market has created new ways of realising shareholder value, the responsibilities of the board, necessary to evaluate company's performance, are still behind the curve.
The challenge for the board is to strike a balance between strategic activities and achieving a meaningful economic outcome.
Tsunami Hits Sourcing
Though the tsunami did not cause damage to the company's production plant situated in Cuddalore, Tamil Nadu, little did the management of this Chennai-based pharmaceutical company know they would still be facing the biggest challenge in the company's long history. For the next six months, the CEO made several trips abroad to face a barrage of client questions, many doubting the company's capability to stock up raw materials from Far East Asia. During this time, apart from casual conversation, the board members did little to address future measures and safeguards needed to ensure that economic risks are addressed — a primary obligation of the board.
“We simply did not evaluate sourcing disruption and the supply bottlenecks that caused production to stop for over four months,” says Prasad Rao, Managing Director of the company, over the phone. The company lost their main client who was giving them over 40 per cent of their revenue.
It was definitely within the board's range of responsibilities to evaluate outside risks — changes in the client industry, international regulations and supply-side issues.
“In 2008, as a service provider to the US financial services industry, the possibility of a mortgage sector collapse was staring us in the face. Client account teams periodically raised their concerns on the increasing risks. We hedged on our low-cost competitive advantage and did little to evaluate systemic risks. Two of the primary clients collapsed, several projects were cancelled, and we let go of over 450 people in the subsequent days,” recounts Bipin Doshi, board member of a large IT company.
Responsibility for shareholder risk
Normal demand and supply shifts simply pose operational challenges for line managers. Whereas, addressing inherent uncertainties requires an outside-in approach. The ability to identify critical risks is central to every board member's role.
There is always some level of business-economic improvement the board evaluates. With the wealth of expertise around, different perspectives lead to different conclusions in assessing uncertainty. Doshi states, “It is often the disagreement in uncertainty or the value of the outcome that stops the board from driving critical decisions.”
Stipulations of corporate law, external borrowing requirements and as a demonstration of market maturity, promoters are required to form a board. Promoters on their part look to handpick directors who would favour biased outcomes.
For promoters, the struggle to accept honest, objective and occasionally hurtful feedback holds them from forming a board that best reflects the potential. “Promoters don't have the time or patience to deal with a board of directors, so they put off the process for as long as possible. That was my external excuse, when internally I did not want someone saying I was wrong,” says Rao. “Putting a board together means easing the grip the CEO once had.” That's a position all too familiar for Rao and the readers alike.
The current management team, family members, customers, celebrities or other individuals taken on board for cosmetic benefit, should not dominate the board count. A diverse team of knowledgeable individuals, with a desire to work towards shaping the next three to five years of growth is a key measure for the promoter's success.
Proponents argue that selecting family members to the board would maintain the focus on protecting the company's distinctive principles, customs and culture — an obligation to current employees in a fast-changing business environment.
“We brought in a relative living in the UK as a director right after the company won export orders to Europe,” Rakesh Bothra says. “We also wanted him to help with succession planning and an exit strategy.”
Rakesh is the elder partner in a Kolkata-based large industrial production company. He acknowledges the desire to take on board someone who is sensitive to the promoters' wishes and respects the organisational culture; this often overshadows the director's overall objectivity towards increasing business-economic value at the time of exit.
From a commercial perspective, the board is the promoter's supervisor and a coach to help achieve economic results. Good directors are knowledgeable, maintain objectivity, and advise diligently. Whereas friends and family members often bring emotion into the relationship, failing to focus on shareholder value — with the result objectivity is often lost.
“When we started facing strategic issues, this director's voice was ignored on the pretext of his younger age and lack of experience compared to the rest of the board, that was filled with people in their late fifties,” Rakesh explains, looking back at the difficult days of transition.
Doshi says board personalities can make or break a company from top-down.
“Hire board members to offer advice and engage in open conversation where ideas and opinions are fair game. It is detrimental to one's growth when the board is filled with a group of ‘yes men'.”
“After the UK customers started raising serious quality concerns that affected future orders, we were forced to replace the director who had oversight for that region. We interviewed 17 really good ex-CEOs, board members and executives before finding the current one,” explains Rakesh, about the investment involved in identifying a good-fit board person.
Reverse stress test
One of the author's clients rolled out a “reverse stress test” to evaluate areas of shareholder value weakness.
“The process of simulating business performance is a complete eye opener for the entire board. Taking out the bias provided us with insights that we would never have determined ourselves. This in spite of having a professional board that clearly understood the market,” says Doshi on coming out of the one-day session.
With a provision for subjective judgments, stress tests invariably lead to optimal action for the rest of the company to address uncertainty.
Anthony Kurien, a leading industrialist in Mumbai says, “Directors must periodically perform a reverse stress test. For most part, directors traditionally focus on earnings and balance sheet issues. Introducing the board to new ways of evaluating risk will nourish a company's longer term growth.”
Though some opponents criticise the exercise as a tertiary overhead, advocates of long-term growth emphasise the need for shareholder-focussed thinking and sensible planning — pointing to how ill-prepared textile manufacturers were for the recent crisis during the short-lived export ban.
Outside assessment of shareholder value is an imperative for the board to consider. It will become clear through ‘stress tests' that thinking counter-intuitively about customers and suppliers can significantly drive high value both in the short and medium run.
What are the chances that the next business ‘tsunami' will affect your company? In a global economy, where the health of bees in Brazil impacts stock prices on the New York Stock Exchange, and the use of Facebook can bring a country down to its knees, economic catastrophe is just a step away.
(The author is a management consultant focused on business performance. You can reach him at www.cor-growthadvisors.com or e-mail him at >email@example.com )