The Privileges of Board Work

By any measure, being a director is a privilege. It's true that some people have abundant board opportunities from which to choose. But in my experience, most people are pleased and even thrilled to be invited to serve. If a primal human need is confirmation that "I'm here and I matter," an invitation to serve on the board of a good organization, for-profit or nonprofit, is one of life's confirming experiences.

Being a director includes the privileges of service, membership, protection, pay, and respect.

The Privilege of Service

We talk about "serving" on a board. Service is the mindset that directors and trustees should bring to their work. It is best described in the work of Robert Greenleaf on Servant Leadership.

Greenleaf's view was that the best leadership begins with a desire to serve, not ambition for power, position, privilege, or prestige. Servant leadership is marked by humility, dedication, and deep recognition that what matters most is the organization and its people. Privileged positions are seductive. An attitude of servant leadership helps directors maintain proper focus in what can be a heady environment.

Servant leadership, like stewardship, reminds directors that they are not at the pinnacle of the organization; they are part of a strong base. The people of the organization do not serve the board; the board serves them. The future of the company or nonprofit is not assured with directors simply along for a prosperous ride; rather, every entity is at risk in a dynamic, competitive environment. In evaluating their own performance, directors must ask, "Has the company or organization entrusted to us thrived on our watch? Do we continue to control its destiny?"

The general concept of servant leadership is ancient. But it is associated in many people's minds with Christian beliefs, even though the New Testament and life of Christ do not appear to have been the conscious inspiration of Robert Greenleaf's work. I suspect the association is due to the revolutionary leadership example Jesus set by associating with the poor and ministering to those in need, regardless of status: "For even the Son of Man did not come to be served, but to serve, and give his life as a ransom for many." Christian business leaders like the Gordons and Max DePree of Herman Miller embrace servant leadership and strive to make it a bridge between their work lives and their Christian beliefs.

The Privilege of Membership

Board service is not just a group activity. It's a team sport. Membership on a board is satisfying because companies and organizations compete, and it's really fun to win.

The board is just the beginning of belonging for a director. She becomes associated with the organization and industry of which it is part. She develops networks of relationships that last for years with fellow directors and people who work with the board, including members of senior management and outside experts.

A good board bonds. Experiences over time create shared history and a collective memory of crises handled, obstacles overcome, problems solved, and goals achieved.

Does this focus on belonging imply that boards are, as some charge, clubby and incestuous, insulated and self-perpetuating? They can be. But one of the most impressive things about an effective board is its ability to manage competing values, like being simultaneously independent and collegial, critical and constructive.

Directors need both unity and occasional dissent. Too little unity and the board can't come to decisions and give clear direction to management. Too little dissent and groupthink sets in with all its perils. Too much unity and the multiple views and different takes of individual directors are lost. Too much dissent and the board dissolves into a destructive conflict.

It is important for directors and management to remember that while they all belong to the organization's leadership, their roles are distinct and different. The board governs. Management manages. The board's job in a company is primarily to represent owners. In a nonprofit, it is to represent stakeholders. Directors are obliged to monitor management with vigilance, ensuring integrity and high performance. Directors must emphatically not manage. One good description of the board's proper role is nose in, fingers out.

The Privilege of Protection

Directors make decisions that sometimes don't work out, such as appointing a CEO who turns out to be a dud or overpaying for an acquisition only to write down its value later. Companies can go bankrupt on a board's watch. We live in a litigious society. When things go wrong, people are encouraged to sue, and they do.

So a natural question is "At how much risk are directors?" The answer is not much, if risk means directors having to pay money out of their own pockets.

There are two reasons. One is the business judgment rule. The other is that company assets and directors and officers insurance provide resources to help satisfy successful claims against the board.

 

The Business Judgment Rule. A director or trustee is a fiduciary. A fiduciary is a person to whom property or power is entrusted for the benefit of another. As such, the director has certain duties. He or she also has protections under the law. Arguably the most important for directors is the business judgment rule.

The rule specifies that courts will not review the business decisions of directors who performed their duties

1. in good faith;

2. with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and

3. in a manner directors reasonably believe to be in the best interests of the corporation.

 

The business judgment rule does not necessarily protect directors from charges that they wasted corporate assets or committed fraud, misappropriation of funds, or others. Nonetheless, the rule creates a strong presumption in favor of boards, freeing members from possible liability for most decisions that result in harm to the corporation.

The business judgment rule, along with limited liability for investors and the rule of law, are key underpinnings of modern, developed economies. They facilitate pooling capital and taking risks required to develop products and services and produce and distribute them on a large scale. They allow individuals, including directors, to act in ways essential for economic development while keeping personal liability at an acceptable level.

 

Company Assets and Directors and Officers Insurance. Companies can indemnify their directors through provisions in their bylaws or certificates of incorporation. This means that company assets are available to defend directors in legal actions and to settle claims. In companies rich in marketable assets with conservative balance sheets, this provides a lot of protection. In companies with few tangible assets, it provides little protection. In the case of bankruptcy, it may provide no protection at all.

Directors and officers policies, commonly called D&O insurance, provide cash to cover most or all settlements or judgments in cases against directors. In large companies, such policies may be written to provide $50 to $100 million or more of coverage.

Do directors ever pay settlements out of their own pockets? Rarely but occasionally. For example, it was reported in 2005 that directors of WorldCom and Enron agreed to settlements that included personal payments. Ten former outside directors of WorldCom agreed to a $54 million settlement for their roles in the company's $11 billion accounting fraud. A third, or $18 million, was paid by the directors personally with the balance paid by D&O insurance. The $18 million reportedly represented 29 percent of the directors' cumulative net worth excluding primary residences, retirement accounts, and judgment-proof joint assets. Ten former directors of Enron agreed to personally pay $13 million of a $168 million settlement for their alleged role in Enron's fraudulent accounting practices. This was 10 percent of their personal pretax profit from Enron stock sales.

These were rare exceptions to the norm of directors seldom paying settlements personally. Nonetheless, there are certain risks from which no one can indemnify a director. One is being vastly underpaid when the work of a board is most difficult, like in a crisis. Another is being sued and spending hours producing documents for plaintiffs' attorneys and testifying in depositions. And directors' reputations can suffer when things go wrong.

The Privilege of Pay (for-profit boards)

Let's be honest. A part-time job with interesting work, good colleagues, and only occasional heavy lifting that pays (in the case of corporate boards) five or six figures is an attractive proposition.

There are exceptions. For directors who are CEOs or independently wealthy, board compensation is chicken feed. When serious trouble strikes, directors would gladly return all they've earned just to make it go away.

Still, for most directors, board compensation is meaningful money, and because of the way the pay is structured, it can be a path not only to current income but also to long-term wealth building.

What do directors earn? We know with certainty what public company directors are paid because companies are required to disclose it, in detail, in their annual proxy statements. (Comprehensive data on private company board pay is not available. My impression is that it varies greatly from company to company, as do the duties of directors.) Not surprisingly, boards of the largest public companies earn much more than those of smaller companies.

These days, the value of what directors are paid depends a lot on how company stock performs. This is because most directors are paid, in part, in stock or stock options. The purpose is to focus directors, as well as management, on growing the company's earnings and enterprise value.

Surveys of public company director compensation suggest that directors are paid, on average, between $100,000 for smaller companies (those with revenues up to $500 million) and $250,000 for the largest companies. There is, however, substantial variation around mean compensation levels.

There are variations in how directors are paid. A normal arrangement is a two-part pay package. First is a base retainer plus committee fees, which can be taken in cash or deferred until retirement from the board and, until then, invested in the company's stock or, sometimes, other stock and bond funds. Second is equity-based pay, that is, restricted shares of the company's stock (restricted because shares are granted then vest over a period of time) or stock options (the right to buy company shares in the future at the price on the day of the grant).

Paying directors in stock and options is a development of the last twenty years. A fellow director, older than I, once told me that in the 1960s and '70s, directors were paid relatively nominal amounts and only in cash. In fact, he said, independent directors were forbidden or discouraged from owning stock in the companies on whose boards they served because it was considered a conflict of interest! The shareholder value revolution twenty years later changed all that. Directors owning company shares became de rigueur on the theory that the practice would align the board's interests with shareholders who elect them. Today the smallest public companies pay about half of director compensation in equity, and large companies pay nearly 80 percent in equity.

Another change in practice over the last twenty years is the elimination of most forms of compensation for directors beyond cash and stock. Large companies used to provide directors with pension plans and perquisites, such as the right to direct a corporate contribution to nonprofit organizations of their choice. The shareholder value movement argued, correctly in my view, that directors should not be incented to remain on the board for the purpose of accruing service that would increase their pension benefit. This could reduce director independence and impair healthy board turnover. Director-designated corporate contributions were deemed a misuse of shareholder resources because they would likely benefit the director more than the company.

The Privilege of Respect

Being respected by others is a basic human need. Respect is a central theme in film and drama.

In the great film On the Waterfront, Marlon Brando as Terry, laments his lost boxing career to his brother, Charley: "You don't understand. I coulda' had class. I coulda' been a contender. I coulda' been somebody!"

In the central line of Arthur Miller's great drama Death of a Salesman, Willie Loman's wife, Linda, cries out plaintively about her struggling husband: "Attention, attention must finally be paid to such a person!"

Being a director is being somebody. Attention is paid to directors.