3.5.3 Active role of independent directors in challenging and debating strategy

Since the Enron, Tyco and WorldCom scandals much emphasis has been laid on monitoring. However, the main item on the agenda of the board of a US company is still discussing company strategy.1

As the board has the power to initiate and adopt corporate plans and actions,2 its members clearly have an active strategic role. In the US 's view risk management should be an enterprise-wide, top-down strategic effort of the board rather than merely a compliance practice.3

The board and hence the independent directors should be involved in the active challenging of the strategy proposed by the officers. It therefore goes without saying that not only the CEO and his fellow officers, but the independent directors too should be involved in determining strategy. The full board acts and decides together.4 In every opinion of the Delaware courts about board decisions, the names of all board members are mentioned. In the Disney case it was regarded as an important factor that all directors had been involved in the decision making process. The following quote shows that the strategy role is the starting point: "An increasing number of directors acknowledge they must oversee business risk as part of their strategy-setting role."5

The role of NEDs in strategy development in the UK was described in 2.5.5 above. A description of the role of US independent directors in strategy follows below and the differences between the UK and the US will be discussed:

The answer to this question is the same in the US as in the UK (for the UK see sub-section 2.5.5(i) above). In the US too strategy also exists in the wider sense, which includes purpose, vision, philosophy (this can include questions such as what role or added value does the company wish to provide to society), succession, enterprise risk management, financial objectives and material transactions. Strategy in the narrower sense is making business plans, defining core businesses, what to divest or buy and how to allocate resources.

It is clear that in the US all directors, including the independent directors, have a leading and active role in strategy debate and can add value. In practice, the whole board has an annual strategic meeting (called "away days") in a resort for two or three days. A strategic element is also discussed at each board meeting or at least every third board meeting. In the US the emphasis is on flexibility. Corporate law allows directors great latitude in how they divide their activities in relation to corporate strategy — without undue interference from shareholders or the courts.6 There is not a "one size fits all" division of roles or procedures. The board itself decides on the procedure for discussions.

In most companies officers design a strategic plan (and changes to existing plans), whereas the board regularly reviews and endorses such plans and changes. To fulfil their responsibilities in strategy development, directors should understand the company's business, the factors driving its growth and the major risks and vulnerability to which it is exposed.7 This requirement of in-depth knowledge is very important and is an integral part of being a decision-maker, even as an outside director. Directors stimulate, broaden and criticise the quality of the officers' strategic thinking.8 Boards should rarely have to take the initiative to draft a company's strategy or create its vision, mission statement or detailed plan. The officers do that. The board's role should be to provide strategic thinking, to oversee and to encourage, rather than to suggest specific strategic tactics. Its members must understand the assumptions and analysis of the officers. To obtain this understanding often requires that directors become engaged in the formulation of the strategy at an early stage. If directors have approved the management's proposal for a strategy, based on a thorough understanding, they will be better able to monitor its execution.9

In the process there should be step-by-step cooperation between the board and the officers. Below is a diagram showing an example of such cooperation.10 It illustrates the methodical, almost scientific, approach to management and business in the US. Although this approach is followed more and more in other countries where American style business schools have opened, it still differs — this is, of course, a generalization — from the style in the UK and the Netherlands where business organization is less a matter of academies and more of tradition and gut-feeling.

Below is a famous example of cooperation between the board and the officers in the "bet-the-company decision" on the design of the Boeing 787.

The board's first two decisions were a necessary precursor to the third, and all three were required for the full go-ahead. On each occasion the directors had sought tangible evidence to support management's major assumptions. Two principles emerge: strategic decisions should be divided into smaller steps and directors should remain vigilant and keep on requiring evidence.

This example shows that the decision on disposals can be split into steps: first, a decision on the criteria in general and, second, a decision on each individual disposal. The same applies to the criteria for acquisitions and the decisions on each acquisition.12

These examples can teach us that strategic thinking evolves over time and in a series of many consecutive meetings and that US boards can serve best by providing strategic thinking, oversight and enhancement rather than suggesting specific strategic tactics. Progress on initiatives is not linear and management and directors continually reinvent initiatives. Finally, an interactive, participative process nourishes open and full communication between management and board.13

Directors should work with management to get a better grasp of the current strategic position. In tum, management should draw up and propose a number of different long-term strategies. Boards should test and challenge them before deciding, with management, on the most appropriate strategy.14

Strategy development nearly always involves the following steps:

To summarize, US independent directors do not develop strategy themselves. However, they are actively involved in all the steps of the development of strategy. They sometimes require management to build up a process of a step-by-step development plan and they challenge management and require further evidence of assumptions. Boards also ask management to present alternatives.

The board of directors, while deciding on a long-term strategic plan, should be mindful that shareholder value depends on a nexus of relations with other business stakeholders, including employees, suppliers and customers, as well as the local communities where the company operates.16

The examples onder (ii) above, especially the step-by-step procedures, show that in the US the board generally gets involved well in advance of taking a decision.

Again, it is seen in practice that the manner of communication varies. In many corporations the board takes ample time for each board meeting. The Disney case17 is an example of one extreme sparse communication, where board members did a lot by phone, particularly after the chairrnan/ CEO, Eisner, had issued a press release about Ovitz's appointment.

In the Lyondell case18 the question was whether the board had taken sufficient time to consider the options. The Delaware Chancellor found that the board had not taken sufficient time for discussion. Although the Supreme Court reversed this decision, this case serves once again as a warring for many boards to take their time for strategy discussions.

The Time (Warner), Dollar Thrifty and Air Products v. Airgas19 cases were examples where the court considered the time taken and the seriousness of the discussions on strategy and the fact that there was a long-term strategy. In both cases the board prevailed. The cases are described below in the list of takeover cases in 3.7.3.2.

Bainbridge describes US research showing that groups of 5 to 8 come up with better ideas than individuals alone because they contemplate more alternatives. This debating of alternatives is the US style of discussion.20 Some boards have open discussions. There are even cases where an outside facilitator leads a group discussion to stimulate creativity.21 In other boards, the discussion is much less open and more an exercise in brisk formal decision making based on detailed preparatory work by committees.

Creativity is seriously jeopardised if too many outside lawyers are in the room. I have seen a power point slide of Cravath, Swaine & Moore (a highly ranked New York law firm), saying: "stay out of the boardroom", by which they mean22 outside lawyers should steer clear of boardrooms if at all possible. Clearly, the problem is recognized.

Open dialogue also requires the right people to participate, by invitation, in boardroom discussions on strategy and risk, including all officers, general counsel, controllers and business unit leaders.23

A 2004 survey by Chris Bart entitled "The governance role of the board in corporate strategy" and a 2008 survey conducted by the McKinsey Quarterly both revealed that:

The US concept of board activity is that directors should have their own specialism and they should know the business well or at least get to know the business quickly. They should quickly become well educated about the business so they can contribute added value. It is essential that they have received full information.25 In the US knowledge of the business is highly cherished.

The US view on corporate governance is that a director can be a better critical monitor of the execution of strategy if he has been involved in its development.26 Because he has been involved in the decision making, he has more understanding of the issues and can add value in being a critical monitor.