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Director, Heal Thyself

Corporate boards are in the hot seat because too many of them have failed to spot and stop the accounting irregularities, compensation excesses, and sometimes fraud that have rocked American business. The Sarbanes-Oxley Act and the new listing requirements of the stock exchanges are aimed at strengthening boards and making them more accountable.

By COLIN B. CARTER and JAY W. LORSCH

http://www.wsj.com

But there are ironies in focusing on boards as a major cause of corporate malfeasance. While some did fail in spectacular fashion, many have raised their game over the past decade. Also, focusing on high-profile scandals sidetracks meaningful attention to a larger problem: Even honest and diligent boards are struggling to do their job.

The problem at the heart of improving boards is how independent directors with limited knowledge and time (the average independent director spends around 120 hours per year on each board) can carry out the job expected of them. Since society isn’t able to reduce its expectations of the men and women in these important roles, boards must redesign their practices to resolve this problem. What might boards do to improve their performance? Here are some suggestions that will take many boards into new territory.

• Boards must explicitly define the role they intend to undertake. To what extent and around what issues do they want to monitor management and company performance? Which decisions are in the board’s domain, and should be raised for the board and which belong to management? In essence, does the board intend to be a watchdog over management, or does it want to be a more active participant in decisions? Until each board answers such questions, they cannot define the time they will need or the knowledge they must develop.

• In a world of diverse and revolving shareholders, boards also need to be more explicit about the financial goals they and their management are pursuing. Boards, along with management, must deal with unrealistic market expectations and must also focus on the underlying drivers of shareholder value within the company. Without this clarity they will find themselves reacting to what analysts and money managers want, often to the detriment of their company and long-term shareholders.

• Boards must widen the talent pool of director candidates and seek the skills and experience that the future needs of each company requires. Instead of just looking for directors who are CEOs, boards need to find members with the requisite ability and from diverse backgrounds. And although the legal need for independent directors is obvious, this doesn’t mean that every director must be independent. It may even be beneficial to have one or two nonexecutive directors whose knowledge of the company and its industry is extensive, who know a lot about the company even if in some respects they are conflicted. What is critical though, is that the board, as a whole, has the capacity to act independently.

• Boards must also encourage constructive dissent. Without dissent directors will be reluctant to keep probing and the wrong decisions will be made. Such dissent can be designed into the board process by assigning a director to be a "designated critic" with license to keep probing on a very important issue. An alternative is to set up a due-diligence committee to play the same role.

• Other than the work of the various committees, directors don’t like to divide up their work. Yet when time is limited and the job is huge and complex, such delegation may be the best way for directors to grapple with the issues. Some directors can be encouraged to choose a topic to build deeper knowledge. Or a temporary committee can be established to explore important issues in depth. For example, if investment in Asia is a key issue, ask one or two directors to learn about the experiences of other companies investing there. Directors will learn more about the business at large while exploring a narrow slice of it.

These are just a few examples of how attention to board design can improve corporate governance. It would be unrealistic to expect that such changes will prevent all misdeeds. But they will make boards better at monitoring compliance and company performance as well as making the major decisions their role requires.

If boards do not act to improve their capacity to meet the rising expectations of investors and the public, we could see more and more regulation out of Washington. This would likely further complicate the task of providing effective governance of American public companies — an outcome that is not desirable for boards, investors, or the American economy.

Mr. Carter, a senior adviser at the Boston Consulting Group, and Mr. Lorsch, a professor at Harvard Business School, are co-authors of "Back to the Drawing Board: Designing Corporate Boards for a Complex World," just out from the Harvard Business School Press.

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