Dear reader,

Welcome to the June 2013 edition of The Director’s Dilemma. To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on ‘read the current issue’. 

This month our real life case study focuses on the vexed issue of chairman succession and the potentially different role of an executive director when there is a vacuum at the head of the board.

Consider: Which response would you choose and why?

Victor is a director on a medium sized listed company board. The Chairman has been ill for several months and is not going to get better. He has announced that he wishes to retire. The Managing Director is keen that one of the directors, who had a strong track record as an executive within the industry and is very knowledgeable about the operations, be appointed as the successor to the current Chairman.

The board is divided as half the directors support another candidate who chairs the Audit and Risk committee and has a lot of credibility with the two institutional investors. Both candidates have voiced a desire to take the role. The current Chairman feels he is not entitled to vote as he will not be a member of the board under his successor. Neither candidate will vote.

If the MD votes then his preferred candidate will be elected by one vote. If the MD does not vote then the board is split 50:50.

To complicate matters the opposing candidates have begun arguing about whether the MD has a conflict of interest and is entitled to vote. The MD is upset as he feels that he is a director and, under the constitution, entitled to vote. Others disagree as he is a close friend of his preferred candidate.

How can Victor help his colleagues to resolve their current impasse?

The Chairman’s decision to remain silent in candidacy opinion and voting has created a vacuum in authority, direction and leadership of the Board. Whilst the decision to appoint a new Chairman is that of the Board’s, the absence of the Chairman’s opinion has denied the Board of valuable input regarding a successor (not necessarily either of the two candidates).

Secondly, the Chairman has deprived the Board of up to two votes (if the Chairman’s casting vote is required). The Chairman is part of the current Board and must vote for the person who will lead the company in the future. It is not coincidental, given the Chairman’s ill health, that the MD has seized this opportunity to back his candidate and push hard that his/her vote is counted. Essentially the MD’s vote is the casting vote for his/her candidate.

Moreover, the Board is arguing about matters that should be covered by simple Board administrative procedure. It would appear that the posturing about eligibility of candidate and MD voting is more retaliation by other Board members to the MD’s preferred candidate.

The Chairman’s vote is pivotal.

On the issue of the MD voting - some directors argue that the personal friendship causes a conflict of interest for the MD, it also creates a conflict of interest for the candidate. Both the MD and the candidate need to prove to the Board that their personal friendship will not be a factor and how each will ensure that will be the case.

Victor should talk candidly and frankly to the Chairman on these matters, the division that is consuming the Board now and the difficulty either candidate (if elected) will have in securing full Board support in the future. Recommend a set retirement date and remind the him/her that the Chairman better serves the best interests of the company by participating in this process as the first amongst equals.

Simon Pinnock is an independent non-executive director and board consultant. He is based in Melbourne, Australia.

If this issue is not handled sensitively and well it will develop into a costly legal stoush. To avoid exacerbating the risk Victor should check the legal framework by reading the constitution, governance principles or guidelines for the relevant exchange, board charter and/or protocols, etc. These should set out the different rights of the parties involved and also, perhaps, some of the processes to use when resolving the issue.

If the Chairman were to vote there would still be a very narrow majority in whichever direction the Chairman chose. Under this circumstance it is wise for the Board to refrain from voting as they could irrevocably damage the relationships around the boardroom table as well as those between the Board and shareholders. A process to seek and build a consensus, preferably retaining the engaged support of both current candidates, is required.

Under normal circumstances, with an out of action chairman, the Audit Committee chair would be the natural focus for the board (assisted by the company secretary if they have a good one) in developing a governance procedure. In this case there is a conflict of interest to preclude that.

Victor’s first action should be to talk to all his colleagues, first individually, and then in the context of a specially convened Board meeting, not to ascertain their preference for either of the two candidates but to seek approval of a course of action leading to a consensual decision. This may include appointing a professional board recruiter to perform a search; current Board members may not necessarily be what the company needs to deliver its strategy. It may include bringing in the larger shareholders as part of the decision-making process; shareholders, especially in tightly held companies or institutional shareholders where the board is less able to act independent of management, can add value if the process is designed to allow it. It may include appointing another director (if there is scope to do so) to help create a new dynamic in relationships before the Chairman is replaced.

Victor must show leadership and unite this Board behind a strategic course of action. He must also understand that the natural inclination of a CEO is to take charge - of course the MD will attempt to impose order if there is a vacuum at the Board level. Once leadership is flowing from the Board the MD will (hopefully) resume normal good behaviours.

Victor must move quickly as the announced impending resignation of a chairman is price sensitive and the exchange should be informed of the status quo and the way forward.

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

Analysis:

1. While I would like to censure the CEO for pushing his/her preferred candidate, it appears that all directors made their preferences known before a formal vote. So a censure is not appropriate. Maybe advice from Victor to be more discreet is called for. I believe the CEO (as a director) is entitled to vote. It is not a conflict of interest to vote for someone you know well if that person is right for the business.
    
2. The consequences of a deadlock if the CEO and current Chairman do not vote or a single vote majority for one candidate if the CEO does vote, is a recipe for Board unrest and would limit the authority of the Chairman.
    
3. On balance I believe the retiring Chairman must vote, directly or by proxy. It comes down to a matter of numbers. A likely maximum number of Board members in a company this size is eight. If the Chairman, the CEO and the two candidates do not vote, then only half the Board will vote.
    
4. Neither of the current Board candidates should vote.
    
5. The value the ‘industry knowledge’ from one candidate is probably greater than ‘credibility with institutional investors’ from the second candidate.

Solution:

1. Having considered this analysis, Victor should convince Board members to get expert advice. The Board should employ an executive search company with a remit to identify at least one external candidate and interview the two internals. Their report and recommendation should reach the Board (ex candidates) in 4/5 weeks as it would be wise to resolve this matter quickly.
    
2. Six members of the Board (if my estimate of numbers is correct) including the retiring Chairman if able, and the executive search principal, would then review the expert documentation, formally interview the candidates and choose a new Chairman.

Jim Vandore is a practising company director and a principal of Muirton Park. He is based in Sydney, Australia.

This comes down to which stakeholder group should have most influence over the company - shareholders or management?

First and foremost, as long as the directors' role is to steer the company for the benefit of the company, resolving the impasse must take precedence. To this end the MD not only has a right to vote, but also a responsibility. Miring the organisation in indecision and potential conflict could be catastrophic.

Victor's preferred candidate has operational knowledge - an obvious strategic asset. While the chair of the Risk and Audit committee may appeal to institutional investors in the short term, it is up to the Board to signal unity and stability to the market.

Elevation of the head of risk and audit to chair might lead analysts to speculate on the underlying reasons for the appointment and whether these loomed large as major issues for the company.

Appointing a director with specific operational expertise to the chair signals a determination to focus on core competencies.

Unless otherwise specified in the company's constitution, The MD must include himself in the vote. Boards are often divided over matters of succession. However, once the vote is decided, directors should unite in a spirit of cooperation and support the new Chair.

Vivien Gardiner is an executive director of Erase Group in Melbourne, Australia.

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.

Book review - Business Model Generation by Alexander Osterwalder and Yves Pigneur. The job of the board is to develop (or to ensure management has developed) successful business models that meet the needs of shareholders. Many directors struggle to explain how or why our proposed actions will deliver value. This book is simple and practical and will help anyone to present a coherent rationale for their plans. It will also help generate robust plans and/or find and exploit areas to improve in existing business plans. Available on Amazon.com

In the news - Company Director Journal; I was honoured to be asked to present at the Australian Institute of Company Directors Conference in Singapore. Here is a link to the Journal’s coverage of the session. The conference was a great opportunity to learn from world class experts on a range of issues and will refresh the skills of all who attended. Now I am looking forward to the next one which will be in Australia in May 2014.

Inspirational quote – I have subscribed to a service that delivers an inspirational quote every day. It is a good way to get into a positive frame of mind for the work day ahead. I thought I would share my favourite quote each month. This month my favourite quote was:

"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty"
~Winston Churchill

Armed with that insight - how will you challenge your board and company to seek out and exploit opportunities?

If you would like to subscribe the service is run by Darren La Croix at: https://365inspirationalquotes.com/.

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.

Farewell until the next issue (due 1 July 2013). Enjoy governing your corporations; we are privileged to do what we do!

Best regards,
Julie