Dear reader,

Welcome to the April 2016 edition of The Director’s Dilemma.

Our case study this month looks at what happens when decisions are pushed by a powerful lobby within the board. Many boards have one or two highly influential members; managing that power is essential to corporate success.

I hope you will enjoy this dilemma and the three suggested responses.

To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on 'read the latest issue'.

Caleb is a director of a mid-sized listed business that is still led, after seventeen years, by one of the co-founders. More unusual still; the chairman of the board is the founder's uncle; a well-respected businessman in his own right with a portfolio of board seats. The business performs well. The CEO brings flair to his role and has managed the company well; it has a strong balance sheet with robust cash flows and leads its market segment. Governance advisers sometimes mention the family relationships and long tenures of the CEO and Chairman but good corporate performance has muted their criticism.

Now the CEO is proposing to invest in a completely unrelated business. Caleb has examined the business case and it is a compelling proposition. The CEO has been a private investor in similar ventures so he has some exposure to the industry although it is entirely 'hands-off''. The proposal is to take all the equity in a venture which would become a subsidiary of the listed business. The amount of money is not an issue - it would be within the CEO's signing limits if it had been previously planned and budgeted. The problem is that it is a completely unrelated industry and there has been no mention to shareholders of any diversification.

The chairman is supportive and has urged the board to authorise the investment as 'it's small, the CEO has always shown good judgement in the past, and our family founded this firm so we should be able to change the strategy if we want'. The last part of that statement has Caleb very worried. Shareholders will not be expecting this move and could react adversely to a step away from the current successful strategy. The CEO, rightly, doesn't want to announce the deal before it is done as it is a good deal and others could hijack it or drive the price higher if information leaked before the deal was signed.

How should Caleb respond to the chairman's urging?

Eli's Answer

Caleb is absolutely right to be concerned about this proposed acquisition and the manner in which it is advanced.  Knowingly or not, the Chair and the CEO are biasing the process in favour of a fast-tracked and potentially problematic decision.  Even if the transaction is financially sound, it would take the company outside its core business, and such a move requires careful consideration.  The manner in which the founders pursue this acquisition lacks the necessary due diligence and an objective (knowledge-based) decision making process.  Lastly, the Chair's urging indicates the founders' strong sense of entitlement to control the company's future without a due process.

The above flaws can expose the company to risk, and can also inflict damage on the Board's relationship with shareholders, especially when the proposed acquisition would place the company outside its core business without a proper process. They can also diminish shareholders' trust and confidence in the Board's leadership, and can possibly translate into financial and/or legal liabilities.

Caleb should consider it his duty as a director to raise these concerns either privately with the Chair and the CEO or with the entire Board.  His observations would be strengthened if he states them 'through the eyes of a prudent shareholder' who would want thoughtful, informed and judicious Board decisions, made in an objective, transparent and accountable manner.

To make his concerns compelling, Caleb should preface them with an expression of utmost respect to the founders' past efforts in setting up the company and making it as successful as it is.  He should then emphasize that, given that the company is publicly listed, the mindset of 'This is our company' must be replaced by 'We have partners, our shareholders, and we must treat them with respect and engage them in a meaningful dialogue on shaping the future of the company that we all care about.'

Eli Mina, M.Sc., P.R.P. is a Board effectiveness consultant and Registered Parliamentarian. Eli is the author of 101 Boardroom Problems (and how to solve them).  He is based in Vancouver, Canada.

Julie’s Answer

If a shareholder is sufficiently sophisticated to take direct ownership of a share he or she is likely sophisticated enough to balance his or her own portfolio and will not appreciate sudden changes in the activities and risks of his or her investments. Caleb knows this; his problem is getting two very powerful people to appreciate the knowledge.

It is not clear how urgently the vendors are pursuing deal closure. If there is time the board should consider a thorough shareholder communications strategy. This should start with statements about strategic changes and diversification or innovation. It can then lead to a commitment to small, well considered, diversification before culminating in announcing the first 'step out'. Caleb should consider the opportunities for growth in the current and related businesses as well as just the opportunity before him.

Something is very wrong if the CEO has been considering a step out for some time and has not informed the board until the very last moment. If that is the case, time will be too short to enable an orderly process of evaluating the opportunity (and the opportunity cost of other step out ventures that would be foregone if this were to proceed) and engaging with the shareholders to build their support for the strategy. Caleb and the board will have to make a quick decision and either back the CEO in the face of likely shareholder concern or persuade him to abandon a desired course of action.

Caleb also has a tough job of rebuilding proper communication between CEO and board so that the board is never again caught so unprepared by a proposal.

The first step will be to talk quietly with the chairman. Outside of the formal meeting it will be possible to raise concerns about proper communications between the board and CEO. Caleb needs to be honest and accept that the surprise may be partly the fault of an inattentive board or risk averse NEDs.

Better strategic engagement is required in future regardless of the immediate response to this dilemma.

Julie Garland McLellan is a practising non-executive director and board consultant based in Sydney, Australia.

Anna Maria’s Answer

How should Caleb respond to the chairman's urging?

The Board needs to authorise the investment of a subsidiary!

Taking into account the "fiduciary obligation" of the Company Board of Directors, including Caleb one of them, to protect corporate sustainability of the organization, he should ask for a Board meeting followed by an EGM, to discuss and vote the acquisition of an unrelated business, out of current strategy, even if the mother company has a strong balance sheet with robust cash flow and the acquisition is within CEO signing limits if this acquisition was already planned and budgeted!

Caleb should ask for an independent analysis of this Business Case (considering strategy and project finance) to be shared and analysed by him and the Board of Directors as a whole.

So on an ideal basis the "Risk appetite" should be considered and discussed in a Board Meeting and the CEO, following the corporate principle of accountability, should participate in the Board Meeting to explain his motivation by facts and figures, the value add, to perform an acquisition that in the  future it would become a subsidiary of the listed company.

After that, in an exclusive in-camera session of the Board Meeting, proposed by the Chairman, the acquisition should be discussed without the participation of the CEO in order to assure independence to this process.

As a listed company the "Relevant Fact" should be registered in the company website and communicated to the country SEC - Security Exchange Commission. So Caleb's dilemma should be transformed in a decision, sometimes, even taking into account all the  corporate governance instrument to protect the company, an acquisition fails, as part of the business game.

It's important for Caleb and his colleagues to oversee the acquisition process and the results of the new subsidiary on a monthly basis as part of the bonus of the CEO.

Anna Maria Guimaraes is Head, Programas Governan├ža Corporativa at Saint Paul Business School. She is based in Sao Paulo, Brazil.

What's new

Book review - All Above Board; Great Governance for the Government Sector.

Back in print again after selling out - The second edition of Julie Garland McLellan's public sector board handbook, All Above Board: Great governance for the government sector, is now available.

With a new foreword by the Hon Nick Greiner AC FAICD (Life), eight chapters and 46 case studies, All Above Board 2nd Edition is a must-have for emerging and aspiring directors, and a potent refresher for experienced board members.

All Above Board is your guide to public sector governance, including:

  • how governments work with government boards
  • key differences between private and public sector boards
  • ethics and conflicts of interest or duty
  • risk management and strategic planning

Purchase online through the Australian Institute of Company Directors website. Both printed and eBook versions are available.

If you wish to purchase multiple copies please email Julie and she will arrange a bulk discount for you.

Inspirational quote for March - This month my favourite quote is:

"Being powerful is like being a lady. If you have to tell people you are, you aren't"

~ Margaret Thatcher~

Caleb may need to look to his own personal power to solve this month's dilemma. No director is ever powerless unless they are complicit in being so; the ability to act independently cannot be taken from us, we can only give it away. My advice is: Don't.

Where have I been?

March was a whirl that started in Kuala Lumpur (that's me with the Petronas Towers in the background) with a Board Secretariat course and ended with a repeat of the course in Dubai.

In between there was a delightful trip to Tasmania to give a presentation (On Board not Overboard) to the 2016 class of Tasmanian Leaders; several trips to Melbourne for courses on Presenting to Boards, Board Induction, and Board Leadership Masterclasses.

I hope to hear from you should you have a need for board facilitation, performance review, recruitment or education. Or, of course, if you have a dilemma to share!

A note on names - A few readers have asked me where I find the names for the protagonists in each case study. I can only say that I 'steal' them from people I meet or things that I read. Caleb is an old Hebrew name and means 'dog'; it has connotations of bold and faithful. People with this name are expected to perform dangerous and difficult tasks with integrity and reliability. Hopefully the Caleb in our case this month will live up to his name: bold in dealing with the issue and the underlying causes and faithful to the company and all its shareholders.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Be a contributor - if you would like to attempt a response to the dilemmas before publication you are most welcome. I normally post the question in my LinkedIn group 'Company Directors and Governance Professionals' at the start of each month. Your comments and contributions will be most welcome. You may even get selected for publication.

Farewell until the next issue (due 1 May 2016). I look forward to greeting you again then. In the interim I hope you will enjoy health, happiness and hard work.

Enjoy governing your corporations; we are privileged to do what we do!

Best regards,

Julie

 

Disclaimer

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.