Boards Revisited: Michael Useem on the New Corporate Governance

Lenovo has just announced plans to acquire IBM and Motorola businesses for a total of more than $5 billion. Of the IBM deal, Wharton management professor Michael Useem, co-author of Boards That Lead: When to Take Charge, When to Partner, and When to Stay Out of the Way, says Lenovo’s board of directors “has helped that company go from a company we have never heard of 15 years ago to the number one personal computer maker in the world.” Useem, who is also director of Wharton’s Center for Leadership and Change Management, recently sat down with Wharton lecturer Robert Borghese, a corporate attorney in private practice in Philadelphia, to discuss his new book, co-authored by Ram Charan and Dennis C. Carey. In this interview, Useem explains why monitoring is no longer the only responsibility of the board, where board directors should draw the line in their leadership of organizations and where some companies and boards are getting it right, including Lenovo.

An edited transcript of the conversation follows.

Robert Borghese: Mike, thanks for being with us today. What led you to write a book on board leadership?

Michael Useem: Corporate governance has been a topic of great interest for many people, including myself, for a number of years. My colleagues Ram Charan, who is a very high-end consultant, and Dennis Carey, who is the vice-chair of Korn/Ferry, which is a very large executive search firm, and I got into a dialogue on what exactly is happening in boardrooms these days….

Boards have to monitor, and they do that much better after Sarbanes-Oxley and Dodd-Frank, these two legislative acts that strengthen the hands of boards of directors. But increasingly, directors are also exercising a leadership function in the boardroom and with top management.

As we drew upon our experience – and all three of us have been in boardrooms – we did inductively conclude that it is good for all of us to rethink what boards do [beyond] just monitoring, which is what they are required to do, but to also see boards as helping the company to be going where it has to go, [which we will] call leadership.

Borghese: Mike, give us a little historical perspective on the role that boards have played over time and how that role has evolved beyond the monitoring function to more of a leadership function.

Useem: If we go way back, boards were aptly described by the title of a very well known book, which was Pawns or Potentates, by a professional colleague, Jay Lorsch, who is on the faculty of the HarvardBusinessSchool. He had a bit of a question mark there, but his conclusion was that historically – 30, 40 years ago – boards tended to be pawns. They had become passive. They were really under the thumb of the chief executive. They met, had a great lunch together and all went home.

“If you are a director, it is good to think of what you are doing both as a defender of shareholder value and as a leader of the company.”

With the rise of big institutional investors – the California pension fund, Fidelity, BlackRock, hedge funds – the pressure came from investors for directors to not be pawns, but to get in there and to keep management’s feet to the fire to avoid malfeasance. Think Enron. On the affirmative side, [in order] to get great growth at a reasonable degree of risk, boards [needed to] move from that pawn role to a much more active monitoring role. We can see that [in the research] on the background of directors and how boards are organized. Virtually all the major Standard & Poor’s 500 boards, for example, now have an independent audit committee, an independent governance committee and an independent compensation committee. “Independent” meaning that they are not under the thumb of the chief executive. They actually have that relationship turned around.

With a more vigilant monitoring function pushed by the big stockholders out there and reinforced by legislation coming out of the early part of the last decade after the Enron failure, boards began to exercise more leadership – in an unanticipated way and in an almost unplanned way. What we mean by that is that directors now often come from top management positions themselves. Many former CEOs, for example, occupy board rooms now. When they come into a board meeting, they are helping the top executive think through a spin-off, an acquisition. They are helping top executives think about how they develop top talent here so they have a great replacement once their day is up.

We ended up titling this book,Boards That Lead. Implicit in that is that boards also monitor on behalf of stockholders. That is the deal set forward by the SEC and the New York Stock Exchange. We all want that to happen, but in addition, because of this historical and quite profound transformation, boards now increasingly are at the plate, helping the company to go where it ought to get to, substantively.

Borghese: Mike, one of the issues that you identify in the book is the tension between exercising leadership and crossing the line into executive prerogative. What advice would you give board members to make sure that they strike the right balance?

Useem: A good way to keep this point in mind is that, on key issues, the directors have to be at the table. They have to be driving the issues, the commitment to ethics and integrity, the central idea that drives the firm and compensation for the top people. In all these areas, directors are number one. That is their job. That is their calling.

Having said that, what is not their calling – in fact, not their place to go to at all – are the operations that a top executive team is concerned with every day: getting products into the store, running a supply chain, research and development. These are really the prerogatives of top management and not for the board to be concerned with.

A good way to keep that point in mind is to remember the challenge of spelling the word “banana.” You have got to know when to stop when you start spelling that word. In a boardroom, you have to be very self-conscious about knowing where to stop.

Many companies that we described and observed for this book have developed devices, sometimes written documents: Here are the issues that have to go to the board, and here are the issues that have to stay out of the boardroom. Typically, it is more informal than that, but there are a number of governance, management and leadership devices that help boards get their leadership function done without micromanaging the firm.

Borghese: If what we are looking for are boards that lead, how can shareholders do a better job of identifying the right type of board leaders, motivating them and compensating them?

Useem: Bob, it is a really timely question because we are going into proxy season, as it is sometimes called. Most companies have their annual meeting over the next four or five months. This is when investors and stockholders elect their board of directors. If you are an investor, as you are looking at the slate put forward to, let’s say, serve as directors of American Airlines or Citibank or Procter & Gamble, you do want directors who are terrific at appreciating what it takes to deliver total shareholder return, stock appreciation and dividends. Now there are a hundred issues within that that you have to be very mindful of to ensure that top management delivers value to the stockholders. That is job number one as a director.

“If you are an investor, it is good to look at directors: Do they bring a lot to the table both to monitor for shareholder value and to lead strategically?”

But job number two is to fulfill this leadership obligation. For that, we recommend in the book, for example, that investors and investment managers, those who are most responsible for placing money in big companies whether at a college endowment or a big money management firm like Vanguard or Fidelity, take a close look at the directors. Are these people good at leading enterprise? Do they have a background in top management of another large enterprise? Do they have a record of being able to work with others? After all, a board really is a team of ten to twelve people….It is really good to take a hard look at who is on that slate. Can they monitor? Can they lead?

The flip side of that, in our view, is the great obligation of what is usually called the nominations and governance committee within the boardroom – to pick people who keep the feet to the fire of top management and know how to do that, but also bring content to the table to help top management get its job done.

Borghese: If the board is leading, who is monitoring the board?

Useem: We all have a boss. So, top management is monitored by the board. The board – and we need to strengthen this – is ultimately monitored by shareholders. After all, the board is elected by stockholders. That is the arrangement. It is a fairly weak electoral system in that, as we know, most slates — with some rare exceptions — typically have 12 people up for re-election for 12 seats. If you are nominated, you are almost always going to be elected by the stockholders. There are exceptions to that.

Having said that, big investors that do get more of a voice when they approach a company – they do get their phone calls answered – have an obligation to communicate directly with directors to ask those two tough questions. Are you monitoring, and are you leading? In that sense, directors ultimately are responsible to the stockholders and should be. That is our free enterprise arrangement.

Borghese: Mike, Warren Buffett often points out that in a tight community of corporate directors, comity toward other directors and toward the executives – the notion that there should be courtesy in the boardroom – often prevails. It is the notion that you do not want to rock the boat. That is a powerful force in a boardroom. Sometimes it is one that has to be resisted. What advice would you give board members?

Useem: Bob, we want both. We want civil behavior in the boardroom, of course. Typically, if you look at the 10, 11 or 12 directors in the boardroom, they have had 20, 30 years of experience in working with many people. They are very effective in working directly and collaboratively.

Having said that, if the people in the room already agree – let’s say with the chief executive or are cowed into agreeing with the CEO or with other directors – they might as well not be in the room. They are there to bring their own judgment and their own experience. Even though there can be a pressure to comity, to not say what you really think, in our observations of how boards increasingly have operated over the last 10 or 15 years, a new norm has developed.

Comity prevailed many years ago back in those pawn days. Today, directors look askance on other directors who do not say much, who do not bring a weighty point of view into the room. We want the 10 to 12 people who are in that board room to … bring their best judgment as a leader of enterprise as to what should be done, even if others do not agree with that.

“Today, directors look askance on other directors who do not say much, who do not bring a weighty point of view into the room.”

Borghese: Mike, can you give us some examples of boards that have done a good job of executing on their leadership role?

Useem: If we go back to 1996 and 1997, Apple was on its last legs. Steve Jobs had been kicked out quite a few years earlier. A former chief executive of DuPont now serving on the Apple board began to ask very tough questions of the chief executive.

Think about that: a non-executive director asking very tough questions of the chief executive. The chief executive then was – I guess I will put this in a charitable way – sanguine about the future of Apple. He thought it was doing well. But when the non-executive director asked the CFO privately, “What do you really think,” the CFO said we are heading off a cliff. They got into the numbers, and it was true.

The non-executive director on the board – the former CEO of DuPont – said, we have got a problem. He began to ask around if anybody might want to purchase Apple. They approached Dell computer. Michael Dell famously said, “Forget it. Why don’t you just close shop and return the money to your stockholders?” So the non-executive director, modestly paid at that time, called up Steve Jobs and said, “Steve, why don’t you come back and help us out?” Steve said, no way.

But this non-executive director persisted looking for leadership and was ready to help a new leader come in to turn this company from where it was careening off a cliff to a different direction, and he finally persuaded Steve to rejoin the firm. When Steve Jobs came back fully into the company in 1997, it had a market value of about $2 billion. When Steve passed away not so long ago – because of the intervention of the board to pick a great leader and then to work with that leader over some years – that firm went from a $2 billion market value to, at one point, more than $700 billion.

Here is an example from quite some time ago of a board that was not just there to keep an eye on management to tell them to deliver shareholder value, but here was a board – and a particular member – who took on a very active leadership role to bring that firm back to health.

To pick another firm, it was just announced that Lenovo, the great Chinese PC maker, is acquiring a major division of IBM for over $2 billion. This, in a sense, is the second such purchase. Back in 2005, Lenovo also bought a division of IBM – the personal computer division – for a little less than $2 billion. We know that company well. I have talked to some of the directors. I have spent time with the chief executive.

Unequivocally, the board of Lenovo – not just top management – has helped that company go from a company we have never heard of 15 years ago to the number one personal computer maker in the world. It has topped Hewlett-Packard. It has topped Dell. It is by far number one in China, and now it is number one in the world — partly because of the great strategic insights of the people who built the company as executives, but also very importantly because of the leadership that the directors brought in to the company.

Borghese:  Mike, in the last minute or so, please share one or two points that you would like to leave us with.

Useem:  If you are a director, it is good to think of what you are doing both as a defender of shareholder value and as a leader of the company. If you are an investor, it is good to look at directors: Do they bring a lot to the table both to monitor for shareholder value and to lead strategically? If you are a top executive, who do you want on your board? You want people who can do both. As executives move into the top ranks coming up through their own ranks, increasingly I believe, a quality of their own leadership will be to work extremely well with their board to draw the best from the board in their own leadership.