Creating and Sustaining the Strong Director

Director education is a vital but underestimated contributor to a culture of board independence, and is worthy of systematic attention by those who care about the governance of corporations.

Constance Horner is a guest scholar in governmental studies at the Brookings Institution, where her field of expertise is public management reform. She joined Brookings in 1993 after serving in the White House as Assistant to the President and Director of Presidential Personnel. Her corporate directorships include Pfizer Inc., Prudential Financial, Ingersoll-Rand Co., and Foster-Wheeler Corp. She chairs the Pfizer board’s corporate governance committee and is a member of Prudential’s corporate governance committee. This article is an adaptation of a talk she gave at the Directors’ School put on by the State of Wisconsin Investment Board and the University of Wisconsin Executive Education Center in September 2001.

Creating and sustaining the strong, independent corporate director is a relatively new imperative for companies and their boards. Gradually and in an ad hoc manner, the structures and practices which support independence have been arriving in the boardroom. Arguably, the time has come for directors, not just students of corporate governance, to think seriously and systematically about the elements which can enhance independence.

To understand the need for thoughtfulness on this subject, we need only recognize that, although the basic function of the board—overseeing the company and mediating between investors and management—remains unchanged over recent decades, there have been substantial changes in the makeup, structure, and culture of corporate boards. Many of these changes reflect a heightened value placed on director independence. Independence, although variably defined, has become a core value.

My own experience, which includes a dozen years in government service,
foundation and academic boardwork, and several corporate directorships, has led me to the unremarkable conclusion that a successful organization thrives on independence of thought and expression within its ultimate governing body—whether that be a White House council, a foundation board, or a corporate board. That conclusion is pretty obvious to most serious observers.

The less obvious question is, how do we create a climate for such independence of thought and expression? We do it through board structure, of course. We also do it through a number of other tangible factors: the codes for director selection, the size of the board, the operations of committees, and the like. All these tangibles are transparent—part of the public record.

However, beyond these tangible factors, there are important intangible factors that help ensure independent thinking and action. These include the intangible aspects of individual performance and character, and the intangible dimensions of team success.

The critical commitment

I believe that one of the most critical “intangibles” is a commitment to director education—a commitment made by both director and company. Director education, both formal and informal, is in my experience a vital but underestimated contributor to a culture of board independence.

Independent directors committed to defending shareholder interests must take seriously the common wisdom that education is a lifelong process. At the same time, companies truly committed to building a culture of board independence must provide opportunities for director education, particularly at the start of a directorship.

This is not a one-way street. Strong independent directors cherish their chances to learn more about the company and its operating environment, all the while understanding that they are overseers, not managers. Self-assured management takes on the challenge of director education, understanding that it may lead to more assertive, less docile directors. By virtue of this fact, both board members and management recognize that director education is a strong contributor to developing the board’s capacity to serve shareholder interests.

Director education is also the pathway by which directors and managers build other “intangibles,” those hard-to-express team dynamics that mark the workings of an effective board. A company whose board and management do the work of director education well is Pfizer Inc., on whose board I serve. It is one of the world’s most valuable companies and one of the most widely held stocks in America. It has a highly visible board, whose job has been complicated over the past two years by the acquisition of Warner-Lambert Co. Although this acquisition started out as an unsolicited bid, it eventually turned friendly. The integration took place in record time. However, through it all, there’s been enormous pressure for top performance on management and the board.

A climate for independence

Pfizer is regarded as a best-practice company in creating a climate for independent thinking by board members. This independence begins with strength in numbers. Pfizer has just two of its 18 board positions held by current management, and one other held by its former CEO. Independent directors hold well more than the balance of power. Board independence is further strengthened by a set of board-selection guidelines that prevent obvious “conflict of interest” entanglements.

Pfizer is certainly not unique in this board structure, or in its board selection guidelines. Standards for board independence have been codified by many organizations, and much of this codification is common sense. But little of it addresses what may be the most difficult and insidious conflict of all. That is the recognition that board members often owe their board positions to personal recruitment and endorsement by the company’s chief executive.

Therefore, best-practice companies such as Pfizer take structure and board service guidelines several steps further to ensure that independent directors are independent in both theory and practice. These steps include independent committees to oversee critical functions such as audit, and periodic, scheduled meetings of nonmanagement directors on significant issues.

For example, Pfizer’s corporate governance committee, composed of nonmanagement directors, devotes substantial time each year to executive succession. This committee is able to ask tough questions of Pfizer’s chief executive and ensure that the next generation of leadership is being prepared. This process is part of a culture of independence which has made Pfizer a hallmark of smooth executive transitions, including one from Bill Steere to Hank McKinnell in 2000. New CEOs at Pfizer come in with the unqualified endorsement of the board. In 150-plus years of operations, Pfizer has had only 12 chief executives. There may be changes in leadership styles, but there are no surprises, and that is reassuring to investors in a quarter-trillion-dollar company.

Now, while board structure and guidelines are important for director
independence, they do not guarantee it. Empirical studies of hundreds of public companies find it difficult to distinguish the performance of boards based solely on their structure. The conventional wisdom says that independent boards should do better at corporate governance than insider boards. Yet this is not proven.

Two experts in corporate governance, Sanjai Bhagat and Bernard Black, provide a thesis as to why this is so. They say, “Insider directors are highly knowledgeable about the company’s operations, but often conflicted. Independent directors are independent, but often ignorant about what is happening inside the company. The independent directors may be quicker to act in a crisis because they are independent, but more likely to do the wrong thing because they are ignorant.”

Sources of learning

If we accept this thesis, we have two choices. First, return to the norm of insider-dominated boards—intimately knowledgeable but almost surely conflicted. The most retrograde director is unlikely to suggest this course of action. Or second, remedy the ignorance and do so by better educating directors. Keep them independent, but make them more knowledgeable.

Unfortunately, many companies, especially smaller ones, provide better orientation for employees in the mailroom than they do for directors in the boardroom. Many organizations send the message that directors should “learn on the job.” This results in an unnecessarily steep learning curve for new outside directors, impeding board performance. Perhaps more corrosive, though, is that the message “learn on the job” is one that signals board work as more casual than serious.

Directors learn through three sources: through the management of the company they oversee, through third-party sources of information, and, of course, through other directors.

If we look at director education through the lens of these information sources, clearly the most important channel of information is the company’s management. Once in the mainstream of board life, directors are likely to find themselves inundated with reports. Making sense of all this information starts with a thorough orientation to the company and its working environment.

A tailored tutorial

If you are a new director, what should you expect to receive from management? You should expect a tailored tutorial to ground you in the following:

• the drivers of the business;
• major strengths, weaknesses, opportunities and threats;
• the company’s financial management and reporting;
• the regulatory and legal environments;
• the investment environment;
• and last but not least, the company’s people and talent issues.

In gaining this information, you should meet and talk with the executives who typically make presentations to the board. Pfizer engages new directors in an extensive orientation. It includes numerous face-to-face meetings, travel to company facilities, and well-prepared briefs on issues. This process extends not only to new directors, but also to current directors assuming new board committee chairs.

Successful orientation may require new directors to be assertive about learning from management. Conversely, management must make it clear that new board members must take time from clearly busy schedules to gain the thorough grounding they need.

Of course, directors need to learn not only from information developed by management, but also from independently acquired information about their companies and competitive environments. Again, as a best practice model, Pfizer has a sophisticated group that creates and makes available relevant information from third-party sources. This is likely beyond the capability of smaller organizations. Still, directors everywhere should insist on regular distribution of analyst reports, newsclips, and other readily obtainable sources.

There may also be opportunities to review information that, while collected and audited from independent sources, may reside only inside the company. These include market share data and employee surveys. While this information should not be used for micromanaging, it may be useful in the board’s oversight role. Employee attitude information, for example, may be valuable should turnover threaten shareholder interests.

The investor perspective

What about information from investors? Directors have the responsibility to oversee management’s actions, but management has the responsibility to run the company and plan for its future. Hence, the task of dealing with investors is best left to management in all but the most unusual of circumstances. Responsible investors know that their first port of call is senior management, and responsible senior management ensures that investors, big and small, are dealt with fairly.

However, if you are a director, it is important that you make yourself familiar with the general perspectives of activist investors, through their publications and, where possible, conferences and directors’ schools like that conducted by the State of Wisconsin Investment Board or by business and law schools.

Besides learning from management and from independent sources of information, directors of course learn from one another. Each of us on Pfizer’s board brings an array of skills, knowledge and experiences, made all the more robust by the company’s insistence on diversity. We have high-profile executives, educators, and leaders of prominent nonprofit institutions. Our backgrounds range from a former member of Congress to a new-economy business leader. We leverage our collective stock of experiences and our shared knowledge.

Value of shared learning

I’d like to make two points about “directors learning from directors.” The first concerns joint trips by the board and management. These are often criticized by outsiders. My view is that, properly organized, these trips provide a tremendous opportunity for shared learning. The Pfizer board makes periodic road trips, typically every other year, for briefings by country managers and frontline employees. These trips expose us to people and operations we would not otherwise see and show us new dimensions of the company together, so that we can share and learn from each other’s observations.

My second point on “director to director learning” concerns evaluating our performance. At Pfizer we do this primarily through our corporate governance committee. Honest self-evaluation, conducted appropriately along the spectrum from informal to formal, is a mark of an effective board. Other marks of effectiveness include the ability to express heartfelt opinions without rancor, to ask questions assertively without hesitation, and to hold people, even people you consider as mentors and friends, accountable for actions.

Ultimately, this effectiveness is rooted not in the board structure or by-laws, but in the “intangibles”—the links between one’s talent, experience, character, and store of knowledge.

These kinds of linkages are not at all unique. Indeed, they are not only useful but routine. Biomedical scientists on our board give reasoned views of new products. Executives provide keen insight into marketing and branding. Educators understand how to reach diverse audiences. Pfizer’s board has the “intangibles,” including the willingness to learn from each other as part of our director education.

Instilling confidence

This commitment to director education is costly in time. It takes many hours on the part of everyone involved. I respect Pfizer management’s commitment to director education. Educated boards ask assertive questions—and sometimes make themselves difficult. However, educated boards also have the confidence to know when to stand firmly with management, even when that management comes to the board and says, “We have an unexpected opportunity to acquire Warner-Lambert, to put together the two fastest growing companies in the business, to add great value now and in the future. It may be rough for a while. And it will take about $100 billion to do it.”

The payoff of such a successful decision for millions of investors and, in this case, hundreds of millions of patients, cannot be overstated. In contributing to successful, independent board decisionmaking, director education has important consequences. It is worthy of systematic and serious attention by those who care about the governance of corporations.