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Trust in Boards: A Leading Indicator of Performance

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Corporate boards today confront one blockbuster challenge after another, from corruption to product defect to employee mistrust to cybercrime. As a result, they and their turbulent performance stand at center stage - this new reality check calls for a disruptive governance blueprint that generates measureable trust and independence.

Institutional investors, consumers, NGOs, and other influential constituencies increasingly are holding boards accountable for company performance. They're demanding high-performing boards with genuinely independent boards. And a scorecard exists both to help directors achieve that expected level of leadership execution and measure their performance.

If you doubt this thesis, just peruse the new 2016 Edelman Global Trust Barometer, which for the past 15 years has measured people's levels of trust in key institutions, including business. Those trust levels have declined over the years to the point where about half of those surveyed annually generally distrust business. As for boards of directors, the level of trust in them both in 2015 and 2016 is below that of CEOs. Only 44 percent of respondents voiced trust in boards in the latest survey, while the trust in CEOs was 49 percent.

For the most part, blame it on the spate of reputational crises (up 500 percent since 2011) for this drop in board confidence. Consequently, large institutional investors are pushing hard worldwide for reforms that will help them elect independent, non-executive directors who can hold senior leadership accountable and challenge management constructively. So the United Kingdom has adopted an investor stewardship code and other countries, notably Japan and Malaysia, are following suit.

True Independence is Vital

Today's directors must navigate uncertainty (including geopolitical turmoil and climate risk); guard against the forces that let an unchecked market of collateralized debt that nearly drowned the world with new threats emerging; keep their pulse on company leadership and other talent and morale; monitor and analyze risk on numerous fronts; and be transparent in the process.

Board independence has always been a troublesome and ticklish issue. While boards have become optically more independent, it doesn't mean that most have ties to one another and the company. The Securities & Exchange Commission defines independence as having no material ties to a company and it bars former employees gone less than three years, close relatives of senior executives and those with "significant" financial arrangements with the company.

There are other ways to improve board independence - and it provides a prototype for a truly independent board. We have worked with companies to help develop and employ such a plan that, in effect, seeks greater transparency from a board. Sometimes, it consists of scorecards that evaluate various elements of a company and its leadership.

Here are few recommendations to bridge the performance-expectation gap:

• Establishing a quarterly scorecard of key corporate indicators to maximize corporate performance. These scorecards should comprise at least four operational centers: HR (for employee engagement, morale and talent issues); Operations (for manufacturing, service and customer performance); Risk (for enterprise, IT security/breach preparedness, and reputational matters); and Communications (for external reputational purposes to gauge online and social/traditional media factors).

• Conducting stress-test simulations for directors on crisis management and other material events: Such training, comprising situations and value conflicts that boards could confront including CEO incapacitation and/or immediate succession, are becoming commonplace at financial institutions since the financial crisis. But nonbanking boards also should consider such training to force directors to challenge corporate and leadership values in times of crisis when information will always be grossly insufficient but, at the same time, decision making must be prompt and consider competing interests.

• Adopting internal and/or external assessments of boards including measuring trust at least annually to gauge how effectively directors are performing their roles against the objectives and goals they've set for themselves and the company. Accounting firm Deloitte Touche Tohmatsu Ltd. Notes that in large international corporations, such board evaluations are conducted by the Governance and Nomination Committees, with help from outside experts. But, increasingly in Europe, companies are using only an independent external expert considered to be in a better position to make an independent assessment.

• Ensuring that boards have independent access to key senior management other than the CEO, chief operating officer and general counsel - say, the head of human resources, the chief risk officer, the chief information officer, and chief communications and marketing officers - through specific board committees or to the board as a whole. This arrangement helps guarantee that directors can get these executives' views without fear of repercussions from the CEO or others.

• Setting term limits, say eight years, for independent directors so they don't become too chummy with management over time. And limiting the number of boards on which a director can sit at the same time will add considerably to optimizing time, focus, and fulfilling the needs of interest holders. Many companies set a maximum age for a director - often 72 to 75 - but a board can make waive that age restriction. Only 12 percent of boards have term limits for directors, reports a 2015 PricewaterhouseCoopers survey. (The average term for a director has been 8.6 years, according to the executive recruiting firm Spencer Stuart). France doesn't consider directors to be independent if they've served over 12 years.

Boards Face a World of Divided Trust

This true board independence is critical more than ever. A key reason is emphasized in the latest Edelman Global Trust Barometer, which reveals a world of divided trust between the general public and the "informed public" - those with at least a college education, who are very engaged in media and have an income in the top 25 percent. Trust has risen among those elite respondents but, among, the other 85 percent of the survey respondents, trust levels have barely budgeted since the Great Recession.

So this chasm sparked by income disparity generates a fragile trust between corporations and their boards and the general public. By becoming truly independent, boards will be able to navigate today's corporate operating realities more appropriately.

Boards must remember: Shareholder value is a dependent variable. It hinges on all those elements that comprise how well a company performs today - from employee morale and operating results to societal expectations and all things reputational. A truly independent board simply stands a better chance of protecting all those interests while maintaining stakeholder trust. It's a board's performance blueprint for enduring corporate health.

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