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Rooting out the usual suspects

By Nick Stride

Friday 2nd May 2003

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Shareholders complain boardrooms are stocked from a self-perpetuating old boys' club. But casting a wider net also has its problems, writes Nick Stride.

Even for the outspoken Simon Botherway, naming names just isn't polite. But a little name-calling is apparently OK.

"Tired old horses," "butt-coverers," and "financial illiterates" are just some of the epithets the straight-talking head of funds manager Brooke Asset Management throws at what he sees as the dead wood in corporate boardrooms.

According to Mr Botherway many of the corporate failures that have destroyed so much shareholder wealth over past decade or two come down to the quality of the directors sitting around companies' boardroom tables.

"There seems to have been little in the way of Darwinian influence in the selection process," he wrote recently in this newspaper. "Shareholders, including many fund managers, have ... re-elected underperforming boards in automaton-like fashion year in, year out."

Mr Botherway reckons the problem is that companies are fishing in too narrow a gene pool for directorial talent. The same names that have presided over disastrous investments and strategies crop up again and again on listed company boards.

His "tired old horses" are those "who are so often referred to as captains of industry but who in fact presided over enormous destruction of shareholder wealth."

Box-tickers and butt-coverers are "people who are strong in their knowledge of compliance but have little in the way of commercial experience."

And then there are the financially illiterate ­ those who don't have a good working knowledge of concepts such as economic value added, return on invested capital and free cashflow generation.

The view that boardrooms are do minated by oldboy networks has currency around the world. For corporate governance reformers the solution is to broaden drastically the gene pool from which directors are drawn.

In the UK the review undertaken by Derek Higgs of the role and effectiveness of independent directors in corporate governance found British boards were altogether too "clubby." Only 6% of directors were women and only 1% were non-white.

Directors argue the gene pool is necessarily narrow because the skills and experience necessary to be an effective director are in short supply.

But Mr Higgs insisted companies weren't making use of the talent available from "non-traditional" sources. They ought, for instance, to be trawling for candidates in the charitable and public sectors.

On the face of it, the urgency to broaden the gene pool here isn't obvious. On the boards of the 33 New Zealand-domiciled NZSE40 companies and seven largest state-owned enterprises, 239 individuals fill 283 seats and no director holds more than three seats.

Economy-wide the problem may be greater. Some of those individuals hold directorships of smaller listed and private companies and subsidiaries of foreign companies, as well as serving on the boards of charities, arts groups, and non-profit organisations.

Mr Botherway's views are regarded sympathetically by directors but some nonetheless feel the issues need careful analysis.

For example, Rob Challinor, a director of The Warehouse and Auckland International Airport and chairman of Mighty River Power, says "tired old horses" often possess skills and experience it would be a tragedy to lose, even if they have made mistakes.

"If you've been a public company director for 10 years and sat on a number of boards the chances of being a director of a company that destroys shareholder value are very high ­ that's the nature of business."

"Look at the Air New Zealand board ­ the company destroyed value but it had top directors. You can't be a good director until you've had a bad situation."

Joan Withers, a fellow director at The Warehouse and Auckland International Airport and a board member of Meridian Energy, agrees.

"It's an interesting phenomenon. Directors who are good in one scenario can be on another board where things turn to custard and huge wealth is destroyed."

Despite caution about watering down the bloodstock, most directors agree an infusion of new blood is needed.

New Zealand boards show the same race and gender imbalances identified in the Higgs report.

The proportion of women holding board seats on our largest companies doesn't appear to have grown much in recent years.

The 17 women who are directors of the New Zealand-domiciled NZSE40 companies make up only 9% of the 196-strong director gene pool.

On the boards of the seven largest SOEs, 15 ­ or 29% ­ of the 52 directors are women. That reflects the government's desire to achieve "balanced" board compositions.

Telecom chairman Roderick Deane says the idea that people ­ in this case, middle-aged white males ­ attract their own kind is not unreasonable. "Directors, however, have to be the people who've had the relevant commercial experience over 20 to 30 years.

"As you get more women who are successful in the commercial world, they'll be drawn onto boards," Dr Deane says.

Some directors feel "affirmative action" policies in favour of women and Maori on state sector boards could gradually open the door to a new range of candidates.

"Appointments to state-owned enterprise boards due to government policy to promote a broad range of directors by occupation and gender has a negative side," Mr Challinor says.

"People have got on state sector boards who'd never have got on public company boards.

"But the process has broadened the pool. Having served an apprenticeship on SOEs, some people will increase the talent available for non-government organisations."

Ms Withers thinks it can be extended quite easily. Chief executives, for instance, should be encouraged to serve on other boards. A former chief executive of The Radio Network, she says she would have been better at the job if she'd had outside directorships.

GDC Communications chairman Stuart Johnstone agrees. "It's important for a managing director to get additional experience in industry. I'd be happy to have my managing directors in non-conflicting outside directorships."

Mr Johnstone also feels directors are being drawn from too narrow a pool. One way to broaden it would be to draw directors from among chief executives and chief financial officers of both public and private companies.

The tricky bit is getting the right mix of people.

Listed company boards, Mr Johnstone says, have relied too much on the professions for new talent.

"If you want legal and accounting input on a board normally it would be better to pay for it as you need it. The bulk [of the board] should be people with financial and operational experience at a very high level."

Kerrin Vautier, an economist and a director of Fletcher Building, says directors should be drawn from all walks but have to be able to assess input from all areas of experience.

"I'm not there to give the company its economic advice. You hire consultants for the expertise those people bring from the richness of their experience," she says.

"Engineers, say, may wax enthusiastic about their lovely machines. A marketing person has to look at the demand side."

Mr Botherway's insistence all directors must be financially literate draws mixed views.

New directors with other worthwhile attributes can do courses to bring themselves up to scratch on the number-crunching, Ms Withers says.

Ms Vautier agrees. "If you had all accountants and chief financial officers it just wouldn't be a balanced board. The judgments you're making aren't day-to-day management, they're strategic issues or investments. The board needs to be multi-faceted."

How many numbers people are enough?

Mr Challinor says it's fine on a seven-seat board to have one director without a strong financial background. Mr Johnstone reckons ideally everyone should be financially literate but not every director needs to understand every aspect of finance.

One Botherway view finds little resistance among directors ­ if companies are to attract highly qualified people not currently serving as directors, remuneration is going to have to rise dramatically.

Ms Withers says for fees to be in line with the time committed, a professional director with a track record of creating value would have to be paid $300,000-350,000 but very few make that much.

"How much would it cost to hire external consultants with the same expertise? We're way out of kilter."

Mr Johnstone says in an ideal world shareholders would be happy to pay seven-figure fees for effective directors.

"But there's so much bad performance around that shareholders rightly object to poor directors paying themselves too much. And that rubs off onto good directors."

If broadening the gene pool involves finding new sources of director candidates with the right knowledge and experience, who you know is always likely to count.

"It's hard for new people to break in," Mr Challinor says.

"Say you go through a selection process for an outside candidate and two names come up and the board debates them.

"If one director says one of them is an independent thinker, can contribute in specialised areas and will get on with the board, then that person is highly likely to be selected over someone not known by the board or the CEO. Maybe that's not the best way but it's the safest and most natural."

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