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Ms. Tartalio is the Co-founder and Research Director for Enlight Research, a board advisory and research company. Prior to her role at Enlight, Ms. Tartalio was a management consultant with Clarkston Consulting, supporting Fortune 500 clients in the Consumer Products and Life Sciences... More
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  • The Dangers Insufficient Information Flow To The Board 0 comments
    Jan 24, 2014 2:52 PM

    An inherent incongruity exists in the interactions between many companies' management and board of directors: many boards are receiving information exclusively from the group that they are supposed to be guiding and overseeing. This incongruity is amplified by legislation in recent years causing a board shift towards regulation and away from strategy setting. This problem is compounded by the growing gap in knowledge between boards and management of the company and the industry. As directors continue to become more independent, the problems associated with asymmetric information are magnified.

    Enlight Research tasked a Management Consulting Field Experience (MCFE) team at Babson College with conducting a study to investigate corporate governance and the role of the board. The study highlighted the realities of a modern board's duties and interactions with management. Through a series of interviews in a variety of different industries, the true role of the board as a regulator and general advisor emerged.

    One director stated that his board "conducted oversight and analysis of day-to-day operations 95% of the time, [and] only spent 5% of their time setting strategy." While other directors that were interviewed acknowledged that some time was spent on strategy, there was a general consensus that it was becoming less of an emphasis. One director in the consumer products industry stated that his board existed in order to watch, recommend, and approve; another referred to management as "the car" and the board as "the guardrails." These sentiments about the evolving purpose of the board of directors seem to parallel the direction of recent legislation. The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 has made boards legally liable for violations in regulation compliance. Thus, out of necessity, boards have been forced into a watchdog role that is focused on guiding rather than leading.

    While this gradual role shift has taken place, boards have steadily become more independent as companies strive for objectivity and a wide variety of expertise. In 2001, 77% of S&P 500 board directors were independent from the company. This figure rose to 84% by 2011. One interviewee in the MCFE conducted study said that "the best boards are independent boards." While this might be true, it does mean that the asymmetry phenomenon has grown as well. More directors than ever before are inexperienced with not only the company they are directing, but possibly also with that company's industry. Nonetheless, firms are clearly striving for independent boards in order to gain a variety of different perspectives. Why, then, do many companies provide their boards with just one internally controlled source of information about the company and industry? To curb the problems caused by asymmetry, this irrational contradiction needs to be fixed.

    It is clear that the nature of the board's relationship with management has changed, and that they are growing more independent. The MCFE study seems to indicate that board members generally trust management. A chairman in the consumer goods industry emphasized that board members trust information provided by management more than outside information. Another interviewee said, "if you cannot trust management, you should not be on the board." While this trust is a sign of a strong relationship, an outside study published in the MIT Sloan Management Review in 2009 reflected skepticism in relying on management alone to provide complete and objective information. [i] Authors Robert J. Thomas, Michael Schrage, Joshua B. Bellin and George Marcotte stated, "if a surprising decline in financial performance is reported… or a potentially material ethical lapse is revealed, directors may not be able to rely solely on information from management." If the Board does not have complete information to work with, then its decision-making ability will obviously be impaired. The timeliness and credibility of information provided to the board is essential to its capacity for advising and oversight, and the authors of the MIT study believe that "most boards have a long way to go in this area."

    Inherently, management is hesitant to give the board access to information that could potentially cause it to make different decisions than those that management has made. Thus, management rarely provides unfiltered (but often publicly available) non-proprietary information to boards. By doing this, asymmetry is worsened and the potential of the board is being restrained. Why limit the education and overall awareness of the board by giving them only part of the available story?

    The problems caused by asymmetry and a lack of information perspectives are certainly fixable. Management must be transparent when providing information to the board, because a well-informed board will make better decisions for the company. Much of the most crucial financial information that a board receives is private, secure, and must be kept internal. Thus, to a large extent, the Board Packs (information packages prepared by management) will always be the primary source of information for directors. The MIT study suggests that one of the best solutions to asymmetry is to provide the board with the same performance measurement metrics that management uses to make its decisions. Additionally, Boards must be diligent in questioning all information that they receive from management (not because of mistrust, but in order to more fully understand and challenge their thinking).

    In addition to working towards management transparency and objectivity, however, third party sources for information need to complement the board materials or board packs. The MCFE study found that directors have no significant source for industry news, and rarely take the time to gather this information on their own. The study found that board members devote an average of 4.3 hours per week to their positions, [ii] so this information must be streamlined in an efficient and convenient manner by a third party. As directors have begun to spend a higher portion of their time focused on oversight and compliance-related issues, it is more important than ever for management and third party sources to convey the right information to boards in an effective and clear manner. Management should consider engaging independent sources to provide unbiased, non-proprietary information that allows the company to take full advantage of the experiences and talent of the board.

    A solution that both studies presented was the continued integration of technology into and out of the boardroom. While some directors inevitably lack full "digital literacy," it seems that boards are becoming increasingly paperless. In August 2011, the consulting firm KPMG found that 90% of nonprofit boards that were surveyed were considering integrating iPads into board operations "in the near future." [iii]

    Portable tablet products do far more than improve efficiency and organization of meetings. They have the potential to revolutionize communication between boards and management. Infrequent meetings exasperate information asymmetry, as directors generally are overloaded with information in the days immediately leading up to meetings. According to the MCFE survey, most directors reported "little in the way of outside preparation between meetings," and generally communicate with one another and management infrequently outside of the days leading up to meetings. iPads can change this reality by providing an efficient platform for easy communication and information exchange.

    Information asymmetry is one of the biggest risks facing boards. As the role of boards shift along with rising independence, asymmetry has greater potential to inhibit effective decision-making than ever before. In order to combat this problem, directors and management both must take active steps. Directors must be diligent in asking questions and communicating with one another to fill in gaps in information, and management must make a concerted effort to provide transparent, concise information while simultaneously granting boards access to unfiltered outside information from other perspectives. Technology like Enlight Research's Board Brief iPad application can help to open lines of communication and provide clear, updated, and unbiased information for directors outside of the boardroom.

    [i] Thomas, Robert J., Michael Schrage, Joshua B. Bellin, and George Marcotte. "How Boards Can Be Better - a Manifesto." MIT Sloan Management Review 50.2 (2009)

    [ii] i Strauss, Gary. "USA TODAY." Company Directors See Pay Skyrocket. USA Today, 26 Oct. 2011. Web. 26 Apr. 2013.

    [iii] Bowman, Steven, and Dottie Schindlinger. "iPad Use on the Rise in Non-Profit Boardrooms." Governance Institute's Governance Notes (April 2012)

    Author: Jack Parker of Enlight Research

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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