Why do good boards make bad decisions?

Good boards often make bad decisions. They make bad decisions about management and governance. They make bad decisions about people and process. They make bad decisions about strategy that have long-term consequences.

Why does this happen?

People serve on corporate boards for excellent reasons, including networking, enhancing their credentials and using their business knowledge in new ways. There is often compensation, averaging about $74,000 per year.

The core of the problem is the nonmonetary reward system. We reward taking risks that pay off (good decisions) with benefits that include continued board service. But there’s no accountability for bad decisions. When boards make bad decisions, directors don’t get fired. Shareholders are the ones who suffer.

Faced with tough choices, boards may play it safe, sticking with the status quo. Members may not put enough thought into decisions, because they won’t get fired even when bad choices are made. They participate in meetings, but they don’t work in between the meetings to address issues where the CEO needs guidance.

Shareholder activism is on the rise, and directors need to step up their game. A recent example highlights the problem. According to Bloomberg opinion writer Timothy L. O’Brien, “George Shultz was one of several marquee names on the Theranos board. And with [founder Elizabeth] Holmes now facing … years behind bars, it’s worth remembering that feckless directors failed to rein her in. It’s also a reminder of how weak corporate governance — and overly compliant but handsomely compensated directors — have regularly plagued Silicon Valley startups and larger companies across the business landscape.” (Timothy L. O’Brien, “Theranos Directors Pay No Price for Holmes’s Fraud,” Bloomberg, Jan. 4, 2022.)

Boards of all types can improve their own policies and practices

Board mistakes don’t just happen in the largest global organizations. It’s not just a problem for infamous companies like Theranos or Enron. Public and private businesses of all sizes are governed by boards, and quite often those boards make bad decisions. There are many contributors to the problem, including the lack of mandatory board education.

What makes a good board?

According to FINRA, “the primary job of a public company’s board of directors is to look out for the shareholders’ interests …The board plays a supervisory role, overseeing corporate activities and assessing performance.” (“Get on Board: Understanding the Role of Corporate Directors,” FINRA) Here are some ways good boards provide that oversight.

• A good board looks at stakeholders, not just shareholders. Stakeholders — including employees, suppliers, community members and more — can be deeply impacted by the guidance boards provide.
•  A good board takes ESG seriously. Environmental, social and governance criteria are integral to the decisions a good board makes. They are not just lip service.
• A good board looks at compensation at every level and asks questions. They align executive compensation with the performance of the company — and not just the short-term performance.
• A good board welcomes healthy friction with management. If directors become a rubber stamp for the CEO, they’re not doing their job.

Three common mistakes

Below are three common mistakes we often see with boards, whether public or private.

1. Boards don’t provide effective oversight. Many directors lack conflict management skills, so they avoid asking tough questions. They don’t want to embarrass management. These directors are failing to provide effective oversight, and they’re not safeguarding the interests of shareholders or stakeholders. In some cases, this may be to protect their board positions. Even if that’s not the motive, it can appear to be. On the opposite side of the spectrum, some directors micromanage the CEO. Oversight does not include making operational decisions.
2. Directors aren’t truly independent. Current or retired operating executives often serve on a company’s board, which isn’t conducive to maintaining the oversight role. In some cases, the CEO proposes the candidates to the nomination committee, which vets them and recommends them to the shareholders. Independence is eroded on boards without term limits or effective governance policies. In these cases, board members stay on too long and independence suffers.
3. Boards fail to measure and improve their effectiveness. Effectiveness is assumed, but typically it’s not measured. Clear expectations and metrics should be established for individual and group performance. Directors should be up to date, engaged and competent. They should be knowledgeable about the organization’s activities, shareholder expectations or activism and current trends in governance, like ESG and board diversity. The board should engage professionals for objective assessment and should mandate 40 hours of board education annually.

First steps to take

Good board practice requires well-defined roles and processes. Even if you’re confident that your board is performing well, check yourself in these key areas.

• Does the board truly reflect a diversity of people and skills?
• Does every director do their homework and, if they don’t, do you hold them accountable?
• Do directors stay in their lane, providing sufficient guidance and asking tough questions, but not overstepping into the CEO’s territory?

Trip Tripathy and Glenn Davis are advisory principals with Kaufman Rossin, a top 100 CPA and advisory firm. They help boards and directors minimize risk and maximize performance. Learn more at kaufmanrossin.com.

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