Welcome to the October 2010 edition of The Director's Dilemma newsletter. I hope you find it interesting, informative and inspiring.

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers several responses to a real issue. Which response would you choose?

"Tina chairs the audit committee of a large not-for-profit organisation. The Chairman of the Board is a passionate advocate for the cause and a major donor but doesn't know much about governance. Tina is a professional accountant and company secretary and they complement each other well.

The CEO has just announced that she would like to resign soon; this is sad but not unexpected as she has been with the organisation for many years and is approaching retirement. One of the board members has applied for the CEO role (before it has been advertised) and the Chairman as assured him it will be his. Tina is concerned that he is not the best possible replacement, may not get the support of the staff (some of whom are better qualified for the role), and sees no problem in remaining on the Board whilst the recruitment process proceeds and after appointment as CEO (which he now assumes is guaranteed).

The Chairman doesn't see a problem and is reluctant to back down after making a commitment to a friend but some of the other board members are muttering about conflict of interest and may leave the Board if this appointment goes ahead.

What should Tina do?"

Ed's Answer

In addition to a possible "conflict of interest" in an ethical context, this situation presents a conflict of opinions and personal ambitions of those involved. Each must be considered by the Board of Directors.

Aside from competency concerns, there is a breach of basic governance principles and probably the bylaws of the organization if the Chairman's promised appointment was "assured" without following the organisation's duly adopted nomination and election procedures. An honourable donor would understand the need to follow due process and his or her pride would give way to the rules, with appropriate apologies to the disappointed appointee. But here, the Chairman has let pride colour his actions because he is now reluctant to "back down." His refusal to follow the rules is a form of belligerence and insubordination to the role and will of the Board.

If board members feel strongly against the proposed CEO's election on competency, ethical or other objective grounds, they should vote against the nominee and elect another candidate. But the Board can also waive a procedural step if it chooses, especially if doing so is deemed insignificant and a greater advantage for the organization is thereby achieved. They can ratify the nominee and make him their own.

Most board members will fear losing the Chairman's financial support. If the Chairman's nominee can reasonably handle the role, albeit imperfectly, then compromising the nomination process in favour of the overall funding and mission of the organization may be the right and prudent course. If so, then let those who don't like it find work elsewhere. Board members who cannot ratify the choice can resign.

This issue of due process and consequences should be the focus of Tina's conversation with the Chairman. Does it matter that some staff or board members may resign? Does he understand what is at stake? If so, has he usurped the role and power of the Board, or will he subject himself to the rules and the Board's electoral will?

In the absence of corruption, deceit, true incompetence (not just differences of opinion) etc., there is no "conflict of interest" in making this nomination. But the Board will be required to either ratify or reject the CEO's election under the organisation's bylaws. Once the Board approves, the new CEO is no longer just the Chairman's favourite, he is the CEO and nobody else has standing to complain on ethical grounds.

Edward O. Hunter is an Attorney and Corporate Governance Specialist based in Irvine, California, USA.

Julie's Answer

A quick resignation looks tempting but if Tina aspires to a board career she needs a track record of resolving problems not a history of avoiding them.

She could privately advise the Chairman of the risks of failing to properly manage this conflict of interest (loss of donor and staff support, reputation damage, harm to the intended beneficiaries of the organisation, etc). Tina could propose a compromise whereby skills criteria are designed for screening applicants and the role is advertised. The fellow board member will be assured a place on the final shortlist of candidates reviewed by the nominations and remuneration committee.

Tina should mention the mutterings of her board colleagues and the danger of losing good board members and staff. The Chairman is a major donor but, as a passionate advocate of the cause, will possibly not wish to see the organisation restricted to operating only with his financial support. Other donors may withdraw support if there are concerns about governance.

The Chairman may find it easier to maintain a position where he can assure the board member that his candidacy will be treated preferentially and his short-listing is guaranteed.

It is imperative to manage conflicts of interest well. The Chairman must agree to exclude the applicant from all discussions on the appointment of a replacement CEO. He could ask the applicant to resign from the Board during the recruitment or ask the Board to delegate the process to a committee on which the applicant does not sit.

This is a sensitive issue as ego and salary are now at stake for her colleague. If Tina stands firm and talks only from the viewpoint of what is best for the organisation she will gain her Chairman's support. This will require some difficult conversations.

In the longer term Tina should implement a program of board training so that basic governance principles are understood by all directors and these issues don't reoccur.

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

Sandy's Answer

It may help to think about this in terms of governance principles. The key one here is board holism, the Board acting as one entity. The Chairman might have an opinion (and even voice that) but it does not bind the Board, until its collective view is established. The Chairman is NOT the Board and has no individual authority. Therefore Tina needs to quickly garner the support of other board members to reconfirm the Board's collective authority.

Given the Chairman's breach of such a significant matter it is important that Tina and the other directors insist on a job description for the role of Chairman. This should limit the Chair's authority to those matters that the whole board has delegated to the Chair, eg, meeting discipline, media engagement, etc.

Tina needs to quickly encourage the Board to deal with the important task of appointing a new CEO. This will include the process the Board wishes to follow, the use of a subcommittee, the key requirements of a CEO, and how any selection and appointment decisions will be reached.

With regards to the other issues of conflict of interest and the CEO being part of the Board, ideally the constitution or governance policies address this. Tina needs to refer to these and remind the Board of them. If not covered in these documents then guides and wording on these and many other issues are readily available for discussion and then adoption by the Board. Some of these conversations are quite philosophically based and the directors will be strengthened by debating them.

Such situations when they arise, while difficult, create opportunities for board members to strengthen their collective understanding of governance.

Sandy Brinsdon is an independent Director and owner of Talent Finders Ltd based in Christchurch, New Zealand.

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 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.

What's new

Book reviews – Directors need to read. It is a great way to learn from other people's experience. This month I have reviewed Selling to the C Suite by Nicholas Read and Stephen Bistritz.

Where's Julie? – A few readers manage to catch up with me on my travels and it is such a pleasure to meet them that I now share my travel plans each month.

Please call or email me if you would like to schedule a meeting or find out more about attending one of these events.

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. It is (still) free. As an existing subscriber you will continue to receive a free subscription when a charge is introduced this year.

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

Farewell until next issue (due 1 October 2010). Enjoy governing your corporations; we are privileged to do what we do!

Best wishes
Julie

www.mclellan.com.au | PO Box 97 Killara NSW 2071
email julie@mclellan.com.au | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711