Tim Geithner, US Treasury secretary, told Congress on June 9 that the boards of banks should shoulder some of the blame for the financial crisis. “I think boards of directors did not do a good job,” he said.
The failure of independent directors to challenge executives and ask probing questions has already resulted in boardroom shake-ups, particularly in the financial sector.
A shake-up of management at General Motors was a central condition demanded by the US government before it would hand over billions of dollar of bail-out funds.
The question now is more broadly: how can directors do a better job? Can they be taught to be better in their role, and potentially put pressure on banks’ and companies’ chief executives to make better decisions and take fewer risks?
Although there is a vast industry developing to help in the selection and education of board directors, there are plenty of observers and analysts who see the actions of boards as a reflection of the way human beings behave in different settings.
“The really essential requirements for a director are common sense and good character, and a willingness to question what’s being presented until he or she and everyone else on the board actually understands it,” says Gary Lutin, who chairs the programmes from the Shareholder Forum.
Indeed – just as economists who study people’s behaviour have established that decisions on anything from choosing purchases to deciding on how much money to save can vary hugely depending on the context in which they are made – boards can also be heavily influenced by recent experiences and herd-like behaviour.
“Their experiences during less severe crises – such as those in 1990, 1997 or 2001 – will lull them into a false sense of complacency; few will adjust their strategies and policies sufficiently,” wrote Andrew Campbell, director of the UK’s Ashridge Strategic Management Centre in a recent McKinsey report. “This behaviour is the result of a clinically observed human trait of being overly influenced by past experiences and judgments.”
This phenomenon is referred to as “anchoring”. Mr Campbell points out that the regular routines and procedures that inform the operations of many boards reinforce anchored thinking. “Chairmen need to play a special role in the coming months by challenging their boards to think things through afresh,” he says.
Changing the way boards interact will be difficult, however.
For example, a 2008 survey by PwC of 10,000 US directors, found that the average director spent 20 hours a month on board matters, including review and preparation time, meetings and travel.
On a practical level, it can be difficult to implement significant changes – or just impossible, given the time constraints and the fact that directors often have other positions too – when relatively little time is spent. This is especially the case when much of that time may be spent trying to understand complex issues.
Numerous specialists in valuing complex securities have found a new source of work in recent months: presenting estimates of the value of complex loans and securities backed by risky loans held by banks to the directors of those banks.
“Non-executives realise they cannot just take executives’ word for it any more,” says one valuation specialist, who has worked with boards recently. “They want a second opinion.”
Getting that additional information is, of course, a sensible step. The idea that investments or strategies that cannot be explained to the board may need to be rethought could already be a useful safeguard.
However, getting such additional information is less a skill that needs to be learnt than an attitude that may include a slightly more questioning stance towards executives.
“The solution is explicitly to change the way the board interacts,” says Mr Campbell. “The chairman should insist that members articulate what they have thought but have not had the confidence to express.”
Mr Lutin says that, even for fairminded and well-motivated directors, it can take enormous courage to raise concerns that are not shared by others.
With more scrutiny of boards likely, one thing directors may need to learn is how to interact with shareholders.
The PwC survey found 63 per cent of directors said shareholders should not have the ability to communicate directly with board members, and nearly half said shareholders should not be allowed to ask directors questions at the annual meeting either.
The days when board directors could operate behind closed doors may be over, and that could be a hard lesson for directors to learn.