The Fading Bright Line

Directors - both new and experienced – often struggle with differentiating their role from that of management. As a board member – whatever the nature of the organization you serve – you want to get a handle on your governance role.

“I would like to find out more about / receive a refresher on the division of governance and operations – what falls under governance, operations, or possibly joint responsibility.”?– A Savvy Director reader

?“I found it hard not to dabble in operations - I know I tended to ‘takeover.’ That's a skill challenge worthy of sharpening up on, in my humble opinion.”?– A Savvy Director reader

The traditional advice is that there’s a?bright line?between the role of the board and that of management. It’s an attractive idea, but the reality is not that simple.

What Bright Line?

There’s always a line down the center of the road, marking distinct lanes that keep traffic orderly.

Or is there?

In my part of the world, we’re used to dramatic weather extremes – sweltering summers and brutally cold winters. Along with frigid winter temperatures comes snow, and along with the snow comes road clearing.

The annual damage inflicted on our roads by the combination of snow, salt, sand, and heavy equipment is significant. For one thing, the painted lines fade away. By the time spring comes, they’re almost invisible. When the crews get around to repainting the lines, the clarity is a welcome relief. There are no more excuses for vehicles to straddle two lanes or randomly switch from one to another.

When it comes to governance vs. management, we may long for the same lack of ambiguity – a freshly painted line that delineates the two lanes. Unfortunately, at times it seems like the repainting trucks have lost their way. For some organizations, the bright line is as faded and blurred as the lines on a Winnipeg street in April.

“… the Board is becoming more and more involved in the business and the boundary of what the Board should direct and what is management’s responsibility is blurring.”?– A Savvy Director reader

Noses In. Fingers Out.

In simple terms, boards are responsible for oversight and planning and management takes care of the daily operations, as described by the colorful phrase “noses in, fingers out.” It’s meant to convey that the board should challenge management but refrain from meddling. The article ‘The Difference Between Governance and Management’ provides a clear explanation.

The board’s oversight involves duties such as selecting and evaluating the CEO; establishing the tone at the top; ensuring effective compliance and risk management; approving and monitoring the strategic plan; ensuring the integrity of financial reporting; allocating capital allocation; and directing crisis management.

The CEO is expected to manage the affairs of the business, develop and implement the strategic plan; recommend capital allocation; respond to enterprise risks; prepare budgets and financial statements; select the management team and work with the board on succession; and develop crisis management procedures.

But one size doesn’t fit all.

Every organization has to find its own division of responsibilities – one that works for its size, maturity, and the sector where it operates.

The law doesn’t preclude boards from managing the companies they serve. There’s enough flexibility for a board to fully delegate management responsibilities or to actually run the day-to-day affairs of the business. Usually, the board finds a middle ground where some responsibilities are delegated to management and others retained by the board.

There’s a variety of scenarios where board members might need to get their fingers in. Sometimes board directors are required to participate in a variety of roles to help the organization be successful. This type of scenario is particularly common in the non-profit sector, or with start ups and smaller companies. That’s completely fine.

“In the NFP sector, balancing governance with the need to be more hands on.”?– A Savvy Director reader

“Boards of smaller companies may need to roll up their sleeves and be more involved in the company’s day-to-day activities. … Directors … may need to be accessible to investors, lenders, and other stakeholders, as well as to auditors and other external advisers, and may need to take a more active role in seeking capital and other activities.”?– An alternate universe: The small, young company board. Deloitte Center for Board Effectiveness

But when fulfilling their governance responsibilities, the directors’ role needs to be clear. Everyone needs to be on the same page. Getting consensus when times are good helps avoid problems down the road. This could be a written board mandate or terms of reference, or board-approved policies that specify the limitations on the CEO’s authority.

Even within one organization, the role of the board shifts depending on the area being considered and the situation it’s faced with. The book 'Boards That Lead' by Ram Charan, Dennis Carey and Michael Useem (? Harvard Business Review 2014) describes a model where boards consciously choose to take charge, partner with management, monitor, or stay out of the way, (as illustrated in the graphic below, adapted from the book.)

A crisis may require a board to adapt its approach – for instance, shifting from staying?Out of the Way?to?Partnering?or even?Taking Charge. Directors need to know when and how to make that shift – and then shift back when the time is right.

When Everything Changes

When the external environment changes dramatically, or a black swan event occurs, or an unforeseen crisis develops, even the most carefully worded board mandate will probably not be up to the task. Think of the crisis as a blizzard. Even the brightest lines are completely obscured by the falling, blowing, swirling snow. If things get bad enough, traffic is restricted to one lane - there’s no separation at all.

When the blizzard ends, driving in the newly fallen snow creates ruts – and when the ruts get deep enough, it can be all but impossible to escape from them without extra traction, a good hard push, or maybe even a tow.

That may be what happened to board governance during the COVID-19 pandemic. Boards were required to?lean in. They got involved, received more frequent updates, had more meetings, and generally drifted into what had been management’s lane.

The COVID blizzard may be ending (let’s hope so!), but I’m pretty sure it’s going to take some work to get out of the governance rut we find ourselves in and catch sight of that bright line again!

Because it’s not just about COVID. During the same period, governance expectations have increased exponentially in so many other areas as well – DEI (Diversity, Equity and Inclusion), ESG (Environment, Social and Governance), VUCA (Volatility, Uncertainty, Complexity and Ambiguity), Stakeholder Capitalism, and so on.

According to the HBR article ‘Covid-19 Is Rewriting the Rules of Corporate Governance,’ the new expectations of boards will require directors to devote more time working closely with management on strategy, tracking a richer set of performance measures, overseeing an expanded menu of risks, rethinking compensation policies, engaging in more thoughtful deliberation, and reviewing board composition.

Navigating the New Reality

“At this moment, when old assumptions are being questioned, [boards will want] to ensure that their members have a shared understanding of the board’s role and responsibilities, and of their individual role and responsibilities as directors. In the flurry of Covid-inspired activity, it is important that boards not lose sight of their central functions as governing bodies of the companies they serve."?– Covid-19 Is Rewriting the Rules of Corporate Governance. Lynn S. Paine. Harvard Business Review.

If you need a push getting out of the post-COVID governance rut to re-discover the faded bright line, I recommend the article 'Distinguishing Governance from Management' by Barry S. Bader. It was written for a hospital administration audience and dates back to 2008, but it’s still tremendously useful today regardless of your industry sector or the size of your organization.

The author explains that different situations affect the appropriate level of governance involvement. Adverse financial results, allegations of impropriety, or consideration of a major transaction would all call for more board engagement and closer oversight. The article provides seven questions – summarized below - to help a board and management agree on their appropriate roles for any situation.

If you’re concerned that the board is straying into management’s lane, ask yourself whether the answer to one or more of these questions is?yes?or?no.

Question One. Is it big??The bigger the impact, the more the board ought to play a role in shaping the action and its consequences. One rule of thumb is that organizational decisions impacting roughly ten percent or more of revenues are strategic decisions.

Question Two. Is it about the future??Boards make their impact on what the organization will be down the road – their fingerprints should be on the long-term vision and the strategic plan.

Question Three. Is it core to the mission or purpose??The board is the guardian of the mission. The board has to examine strategic and financial decisions in that context.?

Question Four. Is a high-level policy decision needed??Board policies set forth principles or guidelines for situations that have a major impact, require compliance, or affect the conduct of the board and management. Examples are conflict of interest, executive compensation, CEO evaluation, and public transparency.?

Question Five. Is there a red flag??The board should recognize red flags and troublesome trends. Even one-time events such as unethical activity or dramatic underperformance – or a pandemic! - require the board to ensure that management recognizes the problem, has the capability, tools and resources to address it, and has plans in place.

Question Six. Is your watchdog paying attention??Who’s your watchdog? That depends entirely on your organization and the sector it operates in. It might be a regulator, activist investors, government, stakeholders, or news media. If the watchdogs care about something, the board should care too.?

Question Seven. Does the CEO need the board’s support??Sometimes the management team needs to know that the board has their back. Or the CEO may want help from directors with connections to important stakeholders. When the CEO calls for support, the board should respond with one voice.

Your takeaways:

• Don’t expect the line between governance and management to always be bright. It’s not that simple.
• The pandemic, along with a host of additional external factors, have blurred the fading line even more.
• It’s useful to clarify and document the specific roles of the board and management, even though it’s impossible to address every situation that will arise.
• When in doubt, encourage your board to examine the issue through the lens of the?Seven Questions?to help clarify roles.

Resources:

• The Difference Between Governance and Management. Michael W. Peregrine. Governance Institute. July 2017.
• Boards That Lead. Ram, Charan, Dennis Carey and Michael Useem. Harvard Business Review. ? 2014.
• Covid-19 Is Rewriting the Rules of Corporate Governance. Lynn S. Paine. Harvard Business Review. October 2020.
• The effects of Covid-19 on boards and governance. Bertrand Richard. Spencer Stuart. October 2020.
• An alternate universe: The small, young company board. Adam J. Epstein, Debbie McCormack, Jim Parkin and Bob Lamm. Deloitte Center for Board Effectiveness. July 2021.
• Distinguishing Governance from Management. Barry S. Bader. Great Boards. 2008.

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Thank you.

Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of?DirectorPrep.com?– an online hub with hundreds of guideline questions and resources to help prepare for your next board meeting.