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Heidrick & Struggles on Boards our thoughts on the perennial and pressing challenges facing boards today
IntroductionEach year sees more demands and higher expectations placed on
boards of directors. The issues they face are more numerous – and
nuanced – than ever. To explore those issues, Heidrick & Struggles
publishes its ‘Governance Letter’ in Directors & Boards magazine,
treating perennial as well as pressing challenges with the depth they
deserve. In the pages that follow, you will find all of the letters for 2014.
To each of these discussions, the Heidrick & Struggles authors bring
their long experience in helping boards become more effective,
achieving the right mix of competencies and expertise, and leading
the way in good corporate governance. That experience, combined
with the wisdom of the many directors and other corporate leaders
they spoke with in the course of writing, have generated a wealth of
insights we think readers can readily put to work.
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
2 Heidrick & Struggles on boards
How board governance and company culture intersectBecause culture can directly affect performance and business results,
understanding how the organization manages and measures culture should
be a part of the board’s mandate.
Assembling a venture-backed company boardRead what some leading venture capitalists had to tell us about the unique
challenges of assembling boards for portfolio companies.
Time’s up: Director tenure moves to the front burnerInsistent questions about length of director service have been pushed to the
fore by four trends are converging to give the issue new momentum.
How directors can mentor potential CEOsTo strengthen the leadership pipeline and minimize CEO succession risk, smart
organizations facilitate relationships between high-potential executives and
corporate directors.
Assessing the merits of an activist investor’s point of viewFew companies are immune to the attentions of today’s new breed of activists,
and directors find themselves squarely in the middle, compelled by their
responsibility to the stockholders to carefully weigh the soundness of activists’
proposals and respond appropriately.
These articles were previously published in
Directors & Boards magazine throughout 2014
www.directorsandboards.com
47
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Heidrick & Struggles’ Governance Letters 2014
Heidrick & Struggles 3
Most directors today are accustomed to
thinking about culture and its profound
effect on business performance in the
organizations they lead or have led.
As sitting or former CEOs, divisional
presidents, or functional heads, they
have likely led culture change. But
as independent directors of other
companies, they may devote little, if
any, time to understanding the cultures
of the organizations they oversee and
the impact – positive or negative – that
culture has on company performance.
When urged to do so, they typically raise any of several
objections, beginning with the fact that the day-to-
day functioning of the culture is largely inaccessible
to directors. Culture does not show up in the financial
documents or other materials they review, and directors
have only limited contact with the organization and its
leaders. “How can you address what you cannot see?”
they ask.
On the other hand, despite limited contact, some directors
say that they have an instinctive grasp of the company’s
culture and silently factor it into their thinking already. Still
other directors believe that wading into culture, regardless
of how accessible it is, might be seen as meddling,
crossing the line between overseeing the enterprise and
managing it.
Culture is as culture doesIn answer to the first objection, culture does not have to,
and should not, remain invisible to the board. Directors
oversee strategy and are held accountable for shareholder
value – and they must address impediments to
achieving those goals. Because culture can directly affect
performance and business results, understanding how the
organization manages and measures culture should be a
part of the board’s mandate.
Numerous straightforward methods exist for taking
the cultural temperature of a company. The board
can begin with the company’s existing set of values.
These will, of course, differ from company to company.
However, the ultimate goal of any culture remains the
same: high performance against the measures the board
and the executive leadership team have established to
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
How board governance and company culture intersectFew issues of organizational effectiveness and performance
have moved so decisively to the front burner in recent years as culture.
by David Boehmer and Mike Marino
4 Heidrick & Struggles on boards
enable and gauge long-term success. In our experience,
cultures that generate high performance do share many
essential values. In the top quintile of such organizations,
boards and leaders typically emphasize and hone these
characteristics:
• Strategic thinking
• Integrity
• Results
• Collaboration
• Customer focus
• Innovation
• Optimism and confidence
Based on the company’s values, a cultural diagnostic can
be conducted with senior leaders. The diagnostic would
ask those leaders the extent to which they encounter
specific, relevant behaviors that align with those values, as
well as troubling behaviors that may need to change. With
innovation, for example, leaders can be asked to what
extent they agree with a series of descriptive statements:
The organization is open to change. Creativity is
welcomed. People are agile and flexible. These statements,
and others like them, would together cover the many
behaviors that innovation encompasses. Other values to
be assessed would receive similar treatment.
In responding to the diagnostic, leaders need not act as
anthropologists and analyze the rituals, unspoken norms,
folkways, beliefs, assumptions, attitudes, and myriad other
factors that figure in culture. They need only judge the
extent to which people in the organization exhibit the
behaviors that characterize each of the values and the
desired culture those values frame. And it is behavior –
what people actually do – that determines the extent to
which the desired culture is a reality.
The eye of the beholder At the opposite end of the spectrum stand those board
members who believe that the culture of the company is
readily visible, at least to them. They reach this conclusion
any number of ways: interactions with management,
comparisons with other companies they’ve known,
assumptions about the typical culture of the industry,
and ‘gut feel.’ In any case, the characterization of the
culture remains largely anecdotal and personal. Further,
assessing culture through intuition and instinct can
produce perceptions and misperceptions that vary widely,
depending on the beholder.
Even when the individual members of the board agree
about the nature of the company’s culture, they can
quite simply be mistaken. For example, the board of
a leading health services organization believed that
the organization’s culture was, among other things,
highly collaborative. In a field where lives are at stake
and optimal outcomes depend on input from multiple
sources, the board understandably placed a high value on
collaboration. But when senior leadership was surveyed
about relevant behaviors, the board was surprised to
learn that leaders encountered less mutual support,
cooperation, and teamwork than the board had assumed
was the case.
In both cases – widely varying perceptions and mistaken
consensus – the absence of objective, empirical
evidence leaves the board with little basis for discussion
other than opinions and conjecture. As a result, it will
be unable to achieve what should be the ultimate
objective in addressing company culture: making better
governance decisions.
“Even when the individual members of the board agree about the nature of the company’s culture, they can quite simply be mistaken.”
Heidrick & Struggles 5
Gaining an edge in governanceAs the third of the three objections mentioned previously
asserts, the board certainly should not address culture
with the aim of micromanaging it. However, a judicious
use of real knowledge about the culture can give a
thoughtful board an extra edge in addressing some of
its chief governance responsibilities: CEO succession,
compliance, and risk management. A number of highly
progressive boards are already addressing culture, not
with the aim of micromanaging it, but to take culture
appropriately into account within the bounds of the
board’s oversight role. In fact, the board of the health
services organization cited earlier undertook its look at
culture in order to fine-tune its search for a new CEO.
Board members believed that an objective view of the
senior leadership team’s operating culture – its attitudes,
beliefs, and behaviors – could enhance the overall
selection process and decision.
The board’s behavioral survey of leadership had turned
up not only less than desirable alignment with the ideal
of collaboration but also with another of the board’s
essential values – innovation – which the board believed
was becoming increasingly critical for the organization’s
continued success. With these findings in hand, the
nominating committee made it a point to explore the
historical ability of the CEO candidate finalists to promote
collaboration and innovation, giving more weight to both
attributes in the hiring decision.
The cultural exercise was not a substitute for the job
profile and search criteria that the board had been using
in the succession process, but served as an additional
helpful tool. The profile and the search criteria already
included collaboration and innovation as key aspects of
the role, and all of the finalists possessed competency
in both, as well as in the other values that constituted
the board’s desired culture. Otherwise, those candidates
would not have advanced so far in the winnowing
process. However, not all of the finalists possessed
those cultural competencies to the same degree. By
revising the weighting of qualifications in light of the
behavioral survey, the board was able to make a more
finely calibrated decision. They chose not just an excellent
candidate but an excellent candidate who was also likely
to make a real difference to the culture.
A similar dynamic holds for compliance and risk
management. Cultural assessment can reassure the
directors that they are unlikely to face surprises in
compliance, or it can raise red flags that put the issue near
the top of the board’s agenda. Similarly, assessment can
help determine whether the degree of risk taking that
leaders perceive in the culture is in line with the board’s
tolerance for risk. But it is no substitute for policies,
processes, and controls designed to assure compliance
or manage risk. Nevertheless, by uncovering the extent
to which behavior reflects such overarching values as
accountability, integrity, and results, the board does not
have to wait until a failure of compliance or a setback due
to carelessness – or recklessness – signals that something
is awry in the culture. In fact, it may be too little, too
late, when a real crisis surfaces that could cause serious
reputational and financial damage.
The next frontierFew issues of organizational effectiveness and
performance have moved so decisively to the front
burner in recent years as culture. Only two decades
ago, insistence on the importance of culture often drew
blank stares and, occasionally, amused contempt. Few
leaders now doubt the relevance of culture to company
performance, employee retention, corporate reputation,
customer loyalty, and a host of other areas that contribute
to competitive success. Board governance is now shaping
up as the next frontier in this extraordinary progress as
boards increasingly recognize that accurate knowledge
of company culture can enhance governance decisions
– putting values in the service of the value directors are
obligated to protect and enhance.
6 Heidrick & Struggles on boards
Establishing and maintaining an effective
board requires skill and tact under even
the most favorable circumstances. From
exercising oversight, to balancing the
competing interests of stakeholders, to
addressing the many other issues that,
broadly speaking, fall under governance,
the challenges can be daunting. In the
fast-forward world of venture capital,
those familiar issues are greatly magnified
by rapidly changing competitive markets
for portfolio companies, explosive growth
rates, succeeding rounds of investment,
and potentially conflicting exit timing and
strategy among the investor base.
Based on our experience helping VC firms build and
maintain boards for their portfolio companies – and on
a series of conversations we recently conducted with
leading venture capitalists – the most intimidating of
those challenges not only differ in degree from those
faced by public companies, and even other private
companies, but often differ in kind. While no perfect
responses to these issues exists, understanding their
dynamics and addressing them can help ensure that the
board of a Venture Capital-Backed Company (VCBC) does
what any effective board should: advance the interests of
the enterprise with appropriate corporate governance,
which, in the long run, advances the interests of the
VC firm.
Board compositionThe venture capitalists we spoke with agree that board
composition bears careful thought at every stage of
funding. At the Series A level, the VC firm will potentially
find in place a very small board that might include
a founder, CEO, an angel investor, and perhaps an
independent director, all of whom could possibly be first-
time directors. Filling out the board, ideally to a maximum
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
Assembling a venture-backed company boardVC-backed companies need a board optimally composed, structured,
and incented for each stage of a fast-moving development cycle.
There are unique challenges that have to be met.
by Mark H. Livingston and Rebecca Foreman Janjic
Heidrick & Struggles 7
of five members at this stage and no more than seven over
all the rounds of financing, calls for a balance of expertise
among members: operational, strategic, financial, and
industry-specific.
However, Series A investors and later investors that come
in on subsequent rounds want to have their interests
vigorously represented, which could possibly conflict with
the aim of having the right mix of expertise on the board
and a board that is aligned strategically. That basic tension
– between the ability to raise capital and the desirability
of having a fully functional board with the right mix of
skills, which actively supports the successful development
of the company – can be especially strong during the
early stages of funding and the company’s development.
Further, there can be difficult sensitivities to manage with
a founder who has chosen unqualified yet personally
close directors to serve on the start-up board. The venture
capitalist must balance the desire to upgrade the board
with the potential for conflict in forcing the issue prior to
or just after investing.
At every stage of development, there remains the allure
of filling a board seat with a ‘door opener’ – someone
presumed to have connections at companies with which
the VCBC would like to do business. However, because
executives who hold current operating positions are
unlikely to be able to take on the intensive demands of
VCBC board service, the ‘door opener’ is likely to be a
retired executive. Unfortunately, the useful life of those
connections diminishes far more rapidly than is presumed,
as retired executives networks begin to stale within their
first year of retirement (with the exception, perhaps, of
those executives still active through industry associations
and related boards). Since quickly removing the director
is extremely difficult, the VCBC board must live for far too
long a time with someone whose value rapidly wanes and
who may lack relevant competencies. As one prominent
venture capitalist advises, the wiser course is to put
presumed ‘door openers’ on an advisory board or sign
them to consulting contracts.
Rapid board evolutionAs the VCBC evolves through the four typical stages of
its life cycle – seed funding, early commercialization, late
stage expansion, and liquidity – the board must evolve
with it, maintaining the right mix of expertise for each
stage and being prepared to change directors when
circumstances warrant. Maintaining and refining that
mix of directors is even more difficult with VCBC boards
because of the rapid pace at which VCBCs develop and
change. They may double in size yearly and suddenly find
themselves in unfamiliar territory when, for example, rapid
expansion thrusts them into challenging supply chain
issues or other strategic manufacturing decisions.
Not only do VCBCs scale rapidly, but they often pivot
strategically in the course of their development.
Their technology may take off in a new, unforeseen
direction. They may find different markets that are more
accessible and accepting than the markets they had
initially addressed. Or the business model could change
dramatically, from, for example, an asset-intensive strategy
to a licensing model. Such changes can render the skills
of current board members obsolete almost overnight,
requiring the difficult and delicate task of easing them
off the board in favour of people with more relevant skills
and experience.
Board members must not only apply differing business,
strategic, and operational knowledge at each stage of
the VCBC’s development, but they must also be able to
apply different governance skills as the company grows
and changes. In the early stage, the entire board usually
implements and oversees governance duties as a body.
During early commercialization, the board may designate
a lead audit member or form an audit committee to
review critical financial information and assess the finance
team. In late-stage expansion, the board should create
compensation and nominating/governance committees.
The role of chairman also varies over time, and the
delicate question of who should fulfill those duties (the
CEO, an independent director, or a venture capitalist)
is a particularly challenging decision. In many cases,
VCBC boards have to discharge a critical governance
8 Heidrick & Struggles on boards
responsibility that every board faces eventually: choosing
a new CEO. Although notable exceptions occur, few Series
A CEOs have the skills required to lead a company through
late-stage development and rapid scale-up.
When choosing a new CEO or new directors, VC firms
and VCBC boards may feel impelled by the accelerated
development cycle to take a shortcut: appoint people who
don’t need to be assessed for the job.
Simply recruit people who have an impeccable resume
or bear a well-known name that is likely to excite
stakeholders or potential investors. Such compromising
on the assessment of candidates is risky. No matter how
good candidates look on paper or in the press, they
should be thoroughly vetted through referencing, proven
assessment tools, and structured interviews – tools that
can enable decision makers to measure candidates against
required skill sets, create the right mix of skills for the
board overall, compare candidates, and ensure the right
dynamics for the board.
Board recruitmentBoard service makes great demands on any director’s
time, in public or private companies. The demands on
VCBC directors can be greater. Compare the intensity and
velocity of overseeing an established company, growing
at a rate of 10 percent annually and facing no crises, with
that of a company growing at 10 times that rate. “Directors
of VC-backed companies find themselves faced with a lot
more 10 p.m. phone calls than other directors do,” says
a veteran venture capitalist. Further, while the boards
of public companies typically meet four to six times a
year, which is certainly demanding enough in terms of
preparation, travel, and participation, a board of a fast-
growing VCBC may meet as often as monthly. Finding a
board candidate with the right qualifications who is willing
to make that kind of time commitment can be difficult.
The willingness of well-qualified candidates to serve
will also be affected by the unique circumstances of a
particular board. For example, some experienced public
company directors, accustomed to having enforceable
oversight power, might decline to serve on a VCBC board
that is advisory only versus those VCBC boards where
all directors – independent or a VC – have equal voting
rights. Other experienced public company directors might
welcome an opportunity to experience the VC world and
be part of industry-changing technologies away from the
scrutiny of proxy advisory firms or activist funds, as well
as avoid the frustrations of the heavy compliance load for
today’s public company directors.
Similarly, a first-time director might prefer the decreased
liability and lower pressure of a purely advisory board or
a governing board where the decisions being made are
far more focused on company strategy and overall growth
than on high-profile compliance or compensation issues
subject to public filings. Many candidates, regardless
of the board’s status, will be attracted by the chance to
interact with today’s generation of entrepreneurs, taking
equity in these exciting enterprises and perhaps directly
investing their own money to boot.
In recruiting directors for VCBC boards, we take care to
convey to potential candidates the unique circumstances
of the company and its board. As one senior venture
capitalist says, “Each director slot we seek to fill is a
bespoke description of role, contribution potential,
and desired characteristics driven by the nature of
the company.” Whereas in large public companies
the processes, committee structure, and governance
“At every stage of development, there remains the allure of filling a board seat with a ‘door opener.”
Heidrick & Struggles 9
regulations would be instantly recognizable to an
experienced director, VCBC boards run the gamut from
boards that resemble public company boards to small
boards dominated by a single investor or a powerful
personality. Securing a candidate who is the right fit for
any board, public or private, involves a careful, deliberative
process, but as with so many aspects of high-velocity
VCBCs, the process must often be tightly compressed, with
no sacrifice of candidate quality, integrity, and culture fit.
Board compensationPerhaps few things have changed as dramatically with
VCBC boards in the past decade as the issue of director
compensation. Though the bulk of director compensation
still comes in the form of equity, candidates now expect
at least some modest cash compensation for their service
– and they are increasingly willing to request it. Says a
leading venture capitalist, “Twenty years ago, in the then
unlikely event that a board candidate asked for cash, I
think most VC people would have found it offensive.” No
more. VCBCs increasingly offer some cash compensation,
and, say a number of venture capitalists, the VC firms that
resist the practice are swimming upstream.
Board diversityBoard diversity may be seen not merely as an issue of
board composition but as an issue of board competencies.
Today, many of the world’s leading global companies
define diversity not in terms of race and gender only but
also as differences in nationality, cultural experience,
career experience, and skill sets such as operating,
marketing, technology, and product development.
Although not subject to the same scrutiny around
diversity as a public company, VCBCs are serving end
markets, which may place significant value on how a
company’s board reflects the world around them and
their own customer base. Health care appears to be an
industry vertical with less of a challenge in delivering
gender diversity than the technology or industrial sectors.
A key consideration may also be the future desirability
of a European listing of shares, taking into account the
increasingly tight regulatory frameworks around board
diversity in the European Union.
Venture capitalists expend an enormous amount of time,
energy, and intellectual firepower finding entrepreneurs
and businesses that offer an extremely rare combination
of innovation, a compelling business model, an impressive
management team, and great potential for rapid growth.
To this winning formula the VC firm brings needed capital
and often expertise in its chosen technological field. But
to ensure that the formula produces maximum yield,
the best venture capitalists add one further ingredient:
a board optimally composed, structured, and incented
for each stage of a fast-moving development cycle to
ensure ongoing, meaningful, and desired support for their
portfolio companies.
“Strategic pivots can render the skills of current board members obsolete almost overnight.”
10 Heidrick & Struggles on boards
Over the past 10 years directors have
devoted an enormous amount of time
and attention to a long list of pressing
concerns, from compliance to risk
oversight, succession planning, and more.
Now, another long-simmering issue has
become one of the latest flash points
in board governance: director tenure.
Insistent questions about length of
director service have been pushed to the
front by four trends that have converged
to give the issue new momentum.
First, the bar for independence on the part of directors
has been raised considerably. Formerly, an independent
director was simply a board member from outside the
company. Subsequently, independence also meant that
the external director had been appointed by the board,
not the CEO. Today, the argument goes, someone who
has been on the board for 15 years, working with the
same CEO, can become too cozy with management
and, for all intents and purposes, can cease to be
genuinely independent.
Second, boards, institutional investors, and advocates for
good governance increasingly frame director tenure as a
question of board “refreshment.” They recognize that as
a company and its strategy change over time, a reliable
mechanism must be found for bringing new ideas and
fresh perspectives to the board – an understanding of
markets, geographies, business models, or functions that
have become newly critical for success.
Third, facing the dizzying emergence of new technologies,
many boards want and need to tap into the pool
of candidates who are on the cutting edge of these
revolutions – many of whom are relatively younger than
the average director. Just a few years ago, for example,
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
Time’s up: Director tenure moves to the front burnerTerm limits and age limits are blunt instruments for addressing the real
issue: creating and maintaining a high-performance board with the right
mix of competencies.
by Matt Aiello and Lee Hanson
Heidrick & Struggles 11
cyber security, digital marketing, and big data hardly
registered on board radar screens. The convergence of
social, mobile, cloud, and information technologies now
offers additional complexities. Older board members,
especially those who are no longer active executives, may
have less feel for these transformational and potentially
perilous waves now washing over every industry. Tenure-
limiting mechanisms are seen as a means to make way for
candidates who are completely at home in this new world.
Fourth, limiting tenure, either by age or term, has also
been strongly advocated as a way to make room on
boards for traditionally underrepresented pools of
talent, such as women and people of color. By increasing
board turnover, tenure-limiting mechanisms increase
the opportunities to create more diverse boards. On the
evidence of the Heidrick & Struggles Board Monitor,
established in 2009 to capture key characteristics of newly
elected independent directors of Fortune 500 companies,
turnover among board members has remained stable
– and low – throughout the past five years. From 2009
through 2013, the number of newly appointed directors
of Fortune 500 companies averaged 326 per year, with a
turnover rate that ranged from 5.4% to 6.8%. With SEC
regulations now calling for more transparency about
diversity and the selection of directors, and with quotas
gaining ground in the European Union, the push for
mechanisms that enable more diverse boards continues to
drive much of the conversation around tenure.
Longer tenure and response of the investor communityThe evidence does suggest that tenure has grown longer.
Public company researcher GMI Ratings, commissioned by
the Wall Street Journal, found last year that among Russell
3000 companies, 6,457 independent directors – nearly 34%
of the total – have served a decade or longer. That’s up
from 3,216, or about 18%, in 2008.
The investor community and their advisors increasingly
see such long tenure as problematic. In ISS’s 2013–2014
Policy Survey, 63% of investor respondents specifically
cited the worry that long tenure diminishes independence.
For its part, ISS is considering whether director tenure
should be taken into account when classifying directors as
independent or in making recommendations on director
elections. And in its ISS Governance QuickScore 2.0, a
corporate governance risk scoring tool for institutional
investors, director tenure of longer than nine years is
included as a weighted factor. Similarly, the Council of
Institutional Investors, representing institutional investors
whose combined assets total US$3tr, now includes
tenure as a factor in determining director independence.
Meanwhile, regulatory bodies in a number of countries
around the world have set an upper limit on tenure –
typically nine to twelve years – after which a director’s
independence is regarded as problematic.
Age limits versus term limitsIn our conversations with directors and other corporate
governance experts on the topic of age versus term limits,
we have often encountered a paradox. The use of age
limits far outstrips the imposition of term limits, yet few
observers think that age limits are as effective as term
limits for refreshing a board. Many, though far from all,
seasoned board members share this view. Nevertheless,
in our experience, about three-fourths of major public
company boards have a mandatory retirement policy for
independent directors, while only a small percentage of
boards employ term limits.
Critics of age limits point to the tendency of boards in
recent years to continually push the age limit up – as high
as 75 in some instances, and now typically 72. Further,
boards often waive the limit for particular directors when
it appears desirable to do so. A director approaching
retirement age might be in the midst of leading a CEO
succession or providing invaluable oversight during
a major acquisition, or the director might simply be
seen as irreplaceable – a bearer of institutional memory
who understands the full context of the company.
Nevertheless, critics counter, an easily waived age limit is,
in effect, no limit at all. “Age limits is a corporate construct,
not an investor-led construct,” says one of the leading
voices on governance in the investor community.
“It hasn’t worked.”
12 Heidrick & Struggles on boards
Advocates for term limits believe that set terms can
avoid the potential problems that come with age limits
or no limits: erosion of genuine independence over time,
inability of the board to refresh itself in a timely manner,
and loss of touch as the company’s business environment
changes dramatically. Further, such limits increase board
turnover, offering more opportunities to diversify, in every
sense of the word, including securing the competencies
that the board needs as the company evolves. Term limits
can also address the longstanding reluctance of many
boards to appoint young directors. On a board lacking
term limits, the appointment of a 40-year-old who could
turn out to be an underperformer and remain a director
for 30 years might be seen as an unacceptable risk. Term
limits could mitigate at least some of that risk.
Blunt instrumentsThough term limits provide greater flexibility in board
composition and may inspire more confidence in
investors than age limits, many of the interested parties
agree that both mechanisms are blunt instruments for
addressing the real issue: creating and maintaining a high-
performance board with the right mix of competencies.
For example, when applied consistently, both approaches
indiscriminately eliminate outstanding performers
and underperformers alike. Further, both mechanisms,
especially age limits, can allow manifestly poor performers
to linger for years. And neither adequately addresses the
issue of timeliness in bringing new competencies onto
the board.
An alternative to both age and term limits is sometimes
seen to lie in using board evaluation, as a means not only
of improving performance but also of enabling board
refreshment. Through rigorous self-evaluation, perhaps
supplemented by a third-party facilitator, boards can
identify and replace underperformers, insufficiently
independent members, or those with competencies that
are dispensable in a changing business environment. We
have worked with a number of directors in leadership
roles who have taken the evaluation process very seriously
and at its conclusion diplomatically and humanely
eased members off of the board for the greater good of
the company.
In an ideal world, such rigorous director evaluation or
some similar process would regularly and reliably enable
board refreshment – and with more surgical precision than
the blunt instruments of age and term limits. However,
putting evaluations to work in that way can be extremely
difficult for many boards, especially where members have
been pulled from the same network or have established
strong personal relationships among themselves over
many years of service.
Until that ideal world arrives, term limits appear to be a
potentially effective means of satisfying the need for board
refreshment, director independence, technology-savvy
younger directors, and diversity of all kind. They also give
directors sufficient time to render real service. And the
length of term need be neither arbitrary nor universal. It
is possible that the optimal term may vary by industry, by
company, or by some other variable, such as the director’s
length of service in relation to the CEO’s tenure.
There is no perfect solution when it comes to refreshing
boards, but terms limits will likely continue to gain traction
as an effective approach.
“Term limits can also address the long-standing reluctance of many boards to appoint young directors.”
Heidrick & Struggles 13
Virtually every director we speak to
strongly affirms that CEO succession
planning is their board’s number one
priority. And most subscribe to the
view that under ordinary circumstances
promoting from within is preferable to
bringing in an outsider – too much is at
stake to risk a cultural mismatch.
Beyond risk reduction, internal promotions reveal much
about the company’s health and sustainability. According
to Glenn Hutchins, co-founder of Silver Lake Partners and
director at Nasdaq OMX, “The best organizations are those
that promote CEOs from within. It shows that you are a
company that attracts and develops its own talent. This
is motivating because your best people see that they can
aspire to the top levels of the organization.”
Less appreciated in boardrooms, however, is the notion
that promoting an internal superstar can be risky when
board members lack a deep understanding of their
executives’ leadership potential. When an internally
promoted CEO doesn’t work out, the reasons can seem
mysterious. But most of the time it happens because
boards do not fully understand their internal candidates’
character nuances and leadership potential and, as a
result, cannot predict how they will actually perform when
in-role.
Truly understanding an executive’s leadership potential
to serve in the CEO role can be challenging. How
does one distinguish between equally qualified high
performers? How does one compare the stellar CFO to
the top-performing executive vice president of sales?
As former Agilent Technologies CEO and current eBay
director Ned Barnholt observes, “When you get to the
point of interviewing candidates for the CEO role, they
all have a pretty high baseline of technical and strategic
competence. At that point, the key differentiators are the
soft skills.” But properly assessing an executive’s soft skills
and potential is an almost impossible task when directors
have exposure to internal candidates that is limited to the
cursory once-a-year dinner or golf outing. And even more
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
How directors can mentor potential CEOsPutting substantive mentoring into practice is not easy, nor is it a short-
term ad hoc solution. It requires commitment from the board, buy-in
and support from the CEO, and careful pairing of board members with
rising stars.
by John T. Thompson and Karen R. West
14 Heidrick & Struggles on boards
importantly, executives that could be great never get the
proper development opportunities if the skill gap was
never identified in the first place.
This tough issue can be solved by breaking down the
traditional barriers between directors and high potentials.
To strengthen the leadership pipeline and minimize CEO
succession risk, smart organizations facilitate relationships
between high-potential executives and corporate
directors. Well before an actual succession event,
corporate directors are paired with rising stars in formal
mentoring relationships. The pairing results in a mutually
advantageous relationship that leads to better corporate
performance. The directors better equip themselves
for their CEO succession duties by gaining an intimate
knowledge of internal high-potential talent, and the high
potentials receive invaluable mentoring from seasoned
corporate leaders.
A framework for conversationMany boards do use occasions such as dinners or golf
outings to get directors together with rising stars,
and such socializing and informal contact is certainly
worthwhile. But to contribute most fully to CEO
succession planning discussions, directors need to have
ongoing, substantive, one-on-one conversations with
internal leaders. In this highly interactive process, board
members and high-potential candidates develop formal
relationships that last a year or more.
To ensure that these discussions are in fact substantive,
we have found that three critical dimensions of potential,
which we apply in our leadership consulting work, can
provide directors with a frame of reference over the course
of the mentoring relationship. In ongoing discussions
with the mentee, the director simultaneously addresses all
three of these dimensions, not as a checklist but as strands
of the conversation to be woven in as appropriate, with
the aim of helping the mentee expand the soft skills of
leadership critical for success in the top job. These three
dimensions of potential include the following.
Self-awarenessSelf-awareness is the ability to understand oneself in terms
of strengths, weaknesses, and motives, as well as an ability
to regulate emotions and to understand the ways other
people affect your behavior. A mentee will likely have
some idea of his or her motives before the relationship
commences. Beneath instrumental motives such as desire
for advancement or financial reward are many possible
deeper motives: desire for achievement, intrinsic love
of the work, desire to make a meaningful contribution
to a greater good, and countless others. The mentor’s
goal in this strand of the conversation is not to tell the
mentee what motives he or she should have, but to help
the mentee draw on the energy supplied by the deepest
motives he or she does have.
In the course of the company’s development program,
mentees should have gained some prior awareness of
their strengths and weaknesses. The mentor can help
the mentee explore those strengths and weaknesses in
the context of the mentee’s current role and how those
traits are likely to play out in different roles and different
business situations. As this suggests, self-awareness
and the behaviors it results in do not take place in a
vacuum – they are intertwined with situational and social
awareness, the other two dimensions of potential, which
is precisely why the conversation proceeds on all three
levels simultaneously.
“Most directors have gotten where they are through finely honed leadership ability, and few people are better placed to explore the nuances of leadership with rising stars.”
Heidrick & Struggles 15
Situational awarenessWe define situational awareness as the ability to read and
understand contextual clues about the dynamics in a
situation and the ability to react accordingly. Executives
with a high degree of situational awareness are able
to discern issues that others miss. They can also frame
problems so that others can understand the situation and
help develop actionable solutions.
Achieving situational awareness often requires diagnostics
that are appropriate to the state of affairs. In business
there are innumerable diagnostics: quantitative and
qualitative analytical techniques, business frameworks,
third-party assessments, ‘gut-feel’, experience, and many
more. Mentors can encourage mentees to expand their
repertoire, to consider many possible angles of approach;
and, as they seek contextual clues to the real situation, to
be wary of falling into the scores of cognitive biases that
researchers like Nobel prizewinner Daniel Kahneman have
so vividly warned against. Confirmation bias, for example,
is the tendency to overvalue evidence that confirms a
favored belief or the failure to impartially seek evidence.
Champion bias is the tendency to evaluate a proposal on
the basis of the track record of the person proposing it,
rather than on the facts. Loss aversion is the tendency to
feel losses more acutely than gains of the same amount,
leading to unnecessary risk aversion. In addition, the
mentor should stress the necessity of clear framing of a
situation in a way that others can understand, even if it is
highly nuanced and multidimensional.
Social awarenessThe third dimension, social awareness, is the ability to
understand one’s impact on others, to manage one’s
reputation, and to strategically flex one’s leadership style
to best suit the needs of various audiences. The mentor
should explore the mentee’s understanding of which
people, audiences, and stakeholders in the organization
are critical for success and how best to influence them.
They should also explore the different leadership styles
likely to be most effective with different audiences, as
well as how to develop leadership styles that may not
come naturally. Most directors have gotten where they are
through finely honed leadership ability, and few people
are better placed to explore the nuances of leadership
with rising stars.
The real goalThroughout these intertwined conversations, the objective
is to expand the executive’s awareness along all three
dimensions. The goal is not to solve a particular business
problem, though these conversations might greatly help
the executive in such endeavors. If the goal were to solve
a business problem, then the director would be acting
less as a mentor and more as a superior, devising metrics
for the candidate’s progress and setting performance
targets. Further, some high potentials, thrust into a stretch
assignment, may in some sense fail or otherwise fall short.
Even so, the mentoring should have laid the groundwork
for success in future roles.
If solving a business problem is not the goal, how then do
you gauge whether the mentorship is proceeding well?
There are three telltale signs: First, the mentee begins
interacting with you more like a peer than like someone
involved in an extended job interview. Second, you
begin to realize that the mentee is expanding your own
awareness in unforeseen ways. Third, the mentee begins
to cascade mentorship downward in the organization,
multiplying the benefits of your effort.
A case in pointPutting substantive and systematic mentoring into
practice is not easy, nor is it a short-term ad hoc solution. It
requires commitment from the board, buy-in and support
from the CEO, and careful pairing of board members with
rising stars. It requires time, patience, and honesty from
both directors and executives.
A pioneer in this approach is Frontier Communications,
an 87-year-old communications firm based in Stamford,
16 Heidrick & Struggles on boards
Connecticut Frontier’s chair and CEO, Maggie Wilderotter,
is the longest-tenured female CEO of any Fortune 500
company. She also sits on the boards of Procter & Gamble
and Xerox Corporation. A big believer in having her
company’s board members mentor its rising stars, she
established what she calls a “buddy system” to enhance
the company’s succession planning process. Ten to fifteen
high-potential executives are paired with board members
over a two-year period. The pairs are expected to meet
at least three times a year outside of the boardroom. The
pairings focus on creating a practical plan that helps fine-
tune the executive’s soft leadership skills. After two years,
the pairings rotate.
“The buddy system gives board members more
accountability and knowledge about the company and
its talent,” Wilderotter says. “It takes risk off the table
because everyone is involved in the succession planning
process, not just a small group of people on a nominating
committee.”
A win all aroundTogether, both parties in a mentoring relationship
produce results neither could achieve on their own.
In fact, it’s a win-win-win: for the organization, the
mentee, and the mentor. With all directors having a
more robust understanding of internal talent and the
company’s strategic challenges, the board can have rich
succession planning discussions that strengthen the
entire organization, create a more robust leadership
pipeline, and reduce risk. High-potential mentees get the
opportunity to further develop the soft skills they will
need to be considered a serious CEO candidate.
And, as we have found, delighted directors often get to
say, “I got as much out of it as my mentee did!”
“Together, both parties in a mentoring relationship produce results neither could achieve on their own. It’s a win-win-win: for the organization, the mentee, and the mentor.”
Heidrick & Struggles 17
Comb through any major business
publication or website over the past
two years and you were likely to see a
story about “the golden age of investor
activism.” And no wonder. According to
the firm Hedge Fund Research, activist
investing was the top-performing strategy
among hedge funds in 2013, with such
firms returning, on average, 16.6% while
other hedge funds returned 9.5%. Activist
funds continued that dominance in 2014,
earning through the first half of the year
almost double the returns for the average
hedge fund.
Not only have the returns grown, but so have the targets.
According to the financial information firm Activist Insight,
which tracks trends in shareholder activism, the number of
companies worth more than US$10bn that were targeted
by activist investors was almost twice as high in 2013 as it
was in 2012, rising to 42 large-cap companies, from 23 the
previous year.
The activists’ campaigns are also enjoying more success.
Institutional Shareholder Services (ISS) estimates that
activists secured board seats in 68% of proxy fights in 2013
(not including cases in which board seats were gained in
a settlement without a fight), versus 43% in 2012. In the
context of M&A deals, says the Harvard Law School Forum
on Corporate Governance and Financial Regulation, it has
been estimated that the percentage of activist attacks that
were successful in either raising deal price or terminating
a deal was 71% through November of 2013, an enormous
increase from 25% in 2012.
What this suggests is that few companies are immune
to the attentions of activists either now or at some point
in the future, especially if the stock slips significantly
or the company performs poorly. Inevitably, directors
H E I D R I C K & S T R U G G L E S ’ G O V E R N A N C E L E T T E R S 2 0 1 4
Assessing the merits of an activist investor’s point of viewBy adhering to these recommended principles and practices – objectivity,
dialogue, appropriate involvement of management, attention to major
investors, and prudent use of outsiders – boards can more adequately and
accurately respond to an activist’s approach.
by Theodore L. Dysart and John S. Wood
18 Heidrick & Struggles on boards
will find themselves squarely in the middle, compelled
by their fiduciary responsibility to the stockholders to
carefully weigh the wisdom, value, and soundness of the
activist’s proposals and respond appropriately. Assessing
those proposals begins with an assessment of the
activists themselves.
Assessing the activistAs John Cahill, chairman of Kraft Foods Group and
a former partner at private equity firm Ripplewood
Holdings, observes, activists run the gamut from those
who want to cooperate with the board and management
of target companies to “headline hunters” who do not
genuinely have the best interests of all shareholders at
heart. Many activists, he says, are reasonably easy to work
with, and most want to be extended the respect of a
conversation about the issues. When confronted with an
activist, the first task then for the board is to determine
where that activist falls on the spectrum.
Many activists we talk to agree. A founder of one of today’s
most successful activist firms says that boards should look
at the activists’ track records. Determine whether they
have a fixed “duration of capital” for their investments
that would allow little flexibility in their demands. Review
the kind of strategic, operational, and financial changes
they have urged on other companies in which they have
invested. And, he says, boards should seek references.
Bankers, he says, are a particularly good source of
information on an activist’s past behavior and reputation.
Fred Reynolds, former CFO of CBS Corporation and a
director for, among others, AOL, Mondelēz International,
and the Hess Corporation, takes a similarly nuanced view.
Not all activists are alike, and not all encounters follow
the same script. Even with activists whom you respect,
as he does Starboard Value, which publicly announced
its designs on AOL in late 2011, there may be legitimate
disagreements that cannot be resolved. When the AOL
board and Starboard were unable to resolve their strong
disagreement about the company’s strategy, the parties
engaged in a proxy fight, resulting in the re-election of all
eight of the existing board members and the rejection of
the candidates proposed by Starboard.
Assessing the argumentsAs the AOL case suggests and as activists and directors
alike say, the real challenge for board members, after
assessing the activist, is to adequately assess the
activist’s arguments. Says one director with meaningful
experience dealing with activists, “If, as a board member
in this situation, you are relying solely on the information
provided by management, then you are probably the
least informed person in the room.” A director who has
been on both sides of the situation points out that there
is an “asymmetry” of information: Activists usually have
considerable resources, including teams of analysts, to
delve into the details of the companies on which they
focus – resources that boards lack.
Nevertheless, the board is best positioned, as John Cahill
says, to play the role of Solomon. Our conversations with
board members and activists indicate that directors can
best fulfill that role by adhering to the following basic
principles and practices.
Don’t make it personalOften, activists first declare their intention in highly critical
open letters published in the Wall Street Journal or the
like. Those letters can sting. But, says one director who
has twice been on the receiving end, you cannot take
“Don’t take an activist’s criticism personally and let it cloud your judgment.”
Heidrick & Struggles 19
the criticism personally and let it cloud your judgment.
Refusing to take it personally can be particularly difficult
for directors who have been explicitly targeted by the
activists for removal from the board; nevertheless,
objectivity on the part of all directors is essential for
reaching the optimal resolution.
Consider talking with the activistsEven if initial research about the activist is unfavorable,
independent directors could benefit from hearing
firsthand the investor’s alternative strategies. Given
activists’ considerable resources, they may have
perspectives to offer that management may not have
been able to provide or may not have considered.
Don’t exclude the CEOInitially, at least, the CEO should be included in those
discussions. Including the CEO gives directors the
opportunity to hear management respond to criticism
and make the case for the current strategy in the face
of the activist’s analysis and evidence. “Unless the board
is completely at odds with the CEO,” says a longtime
director who currently sits on the boards of several leading
companies, “directors should take care not to undermine
him.” Roles and responsibilities in dealing with the activist
should be made clear, he says, along with consistent
lines of communication so that the company speaks with
one voice.
Nevertheless, says the longtime director, it is only human
nature for activists to temper their argument when
confronting a distinguished CEO. The independent
directors should therefore also meet with the activist in
private, he says, where they may hear a less inhibited
version of the argument. That doesn’t mean going
around the CEO – management should be apprised of the
meeting as a normal part of the process of dealing with
the activist, much as executive sessions are a normal part
of other board deliberations.
Listen to other investorsBefore tipping their hand, activists have also likely
marshaled support for their position among at least a few
other major investors. While boards should always listen
to their major shareholders during the normal course
of investor relations, they may want to listen even more
attentively now. Though the logistics on both sides can be
difficult and SEC regulations governing company contact
with selected shareholders must be strictly observed,
these conversations can provide additional perspective on
the activist’s proposals.
Use outside resources prudentlyOften, the first reaction of the board is to call in outside
counsel, investment bankers, and strategy firms for the
express purpose of mounting a vigorous defense against
the activist. These resources can be invaluable, especially
if no accommodation can be reached and the situation
escalates to a full-scale proxy fight. But they can also
unnecessarily inflame the situation in the early stages of
the board’s consideration, or the outside resource may
apply a standard template to the situation, resulting in a
foregone conclusion.
By adhering to these principles and practices – objectivity,
dialogue, appropriate involvement of management,
attention to major investors, and prudent use of outsiders
– boards can greatly increase their chances of adequately
and accurately assessing the merits of the activist’s case.
Whether the activist is proposing to return excess cash
“Not all activists are alike, and not all encounters follow the same script.”
20 Heidrick & Struggles on boards
to shareholders, sell off a poorly performing business,
reallocate capital, or take some other bold action, the
board can only benefit by seeking the broadest range of
reasonable perspectives. Further, the board may find that
it has a wider range of satisfactory options for resolving
differences. For example, board members may adopt
recommendations that have real merit, while resisting
those they see as destructive; or they may compromise
with the activist on issues of board composition. On the
other hand, they may conclude that the activist’s case is
without merit and that the best course of action is to fight
wholeheartedly. But whatever decision they reach will at
least have been given the full consideration it deserves.
The best defenseVirtually all of the directors we have talked with agree
that the best defense against activists is to be sure that
the company isn’t vulnerable in the first place. To guard
against that possibility, directors should ask the tough
questions before the activists do, stress-testing the
current strategy against alternatives and diplomatically
and tactfully taking on the role of devil’s advocate. Is
there a potential for a spin-off or sale of an asset? Is the
company perceived as having management problems?
Are there major opportunities for cutting costs that would
tempt an activist? What are the fixable problems that are
constraining company performance? Says John Cahill,
even a director who is not an industry expert can push
those directors who are experts to ask probing strategic
questions and keep pushing until all directors fully
understand the questions and the answers.
Above all, say directors, the board and management
should continually communicate with major, long-term
investors, not just when activists appear. “Those long-
term investors want to understand your strategy and its
risks,” says one veteran director. “They want to know what
Plan B is in case Plan A doesn’t work. They want to know
how you’re allocating capital and what your priorities
are for allocating excess cash flow. And if you have an
advantageous risk-adjusted internal investment you want
to make or a promising acquisition, then they will often
encourage you to go ahead because they want growth.”
Of course, despite all of the board’s best efforts at ensuring
strong company performance, understanding alternative
strategies, and communicating with investors, an activist
may appear anyway. For example, the stock can suffer
large declines for reasons beyond the company’s control.
Large cash reserves, accumulated precisely because the
company is performing well, can make a tempting target.
And the sheer amount of hedge fund money available for
investment can increase the likelihood of an activist play
for any company. In the event, the well-prepared board
will not only squarely address the only question that
ultimately matters – what is the best way to create the
most value – but also know how to arrive at the
best answer.
CEO & Board Practice The Heidrick & Struggles’ brand and our Chief Executive Officer and Board
Practice have been built on our ability to execute on top-level assignments and
counsel CEOs and board members on the complex issues directly impacting
their businesses.
We pride ourselves on being our clients’ most trusted advisor, and offer an integrated suite of services to
help manage these challenges and their leadership assets. This ranges from the acquisition of talent through
executive search to providing counsel in areas that include succession planning, executive and board
assessment, and board effectiveness reviews.
Our Chief Executive Officer and Board Practice leverages our most accomplished search and leadership
consulting professionals globally who understand the ever-transforming nature of leadership. This expertise,
combined with in depth industry, sector and regional knowledge, differentiated research capabilities and
intellectual capital, enables us to provide sound global coverage for our clients.
Leaders in Heidrick & Struggles’ CEO & Board Practice
Americas
Bonnie Gwin New York [email protected]
Jeff Sanders New York [email protected]
EMEA
Will Moynahan London [email protected]
Asia Pacific
Karen Choy Singapore [email protected]
George Huang Beijing [email protected]
Fergus Kiel Sydney [email protected]
Harry O’Neill Hong Kong [email protected]
Graham Poston Singapore
22 Heidrick & Struggles on boards
Contributing authorsMatt Aiello Partner Washington, DC [email protected]
David Boehmer Regional Practice Managing Partner London [email protected]
Theodore L. Dysart Vice Chairman Chicago [email protected]
Rebecca Foreman Janjic Partner San Francisco [email protected]
Lee Hanson Vice Chairman New York / San Francisco [email protected]
Mark H. Livingston Partner Houston [email protected]
Mike Marino Partner and Executive Vice President Senn Delaney a Heidrick & Struggles company [email protected]
John T. Thompson Vice Chairman Menlo Park [email protected]
Karen R. West Partner Chicago [email protected]
John S. Wood Vice Chairman New York [email protected]
Heidrick & Struggles 23
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