Holistic Companies

Board of Directors: What does ‘good’ look like?

Effective boards are a foundational necessity for a well-run company. Conversely, a weak board opens a company and its stakeholders to significant risks. An ineffective board leaves a company's prospects to chance due to the group's passive, inexperienced, or biased nature. Board development focuses on convenience rather than effectiveness too often. So, let’s explore how we would build an effective board.

John Oommen

The mousetrap was an intelligent invention for its time. Inventions only move in one direction. Machine-created intelligence has been evolving for a long time and will continue to. I am always more passionate about human behaviors around technology.

So, it's hard to ignore headlines like "Pressure mounts on OpenAI Board to reinstate Altman as chief executive,” and “Staff revolt at OpenAI piles pressure on board over move to oust Altman.” A few dramatic days at OpenAI followed Sam Altman's abrupt firing! Many articles and posts constantly referred to the OpenAI “Board” without more detail.

Consider any company-level drama that leads to losses for investors, employment losses for workers, and value destruction for customers. A weak board is at the core. If we go back to Theranos, Nikola, or Wirecard, the board's ineffectiveness played a massive role in failing to protect the interests of various stakeholders involved in the company.

I work with executive teams to improve the inner workings of companies and get to be part of board-level conversations due to the topics I help solve. Sadly, the literature out there supports my observations that the vast majority of boards are not effective. In a PWC survey, only 29% of executives described the board's overall performance as excellent or good. 89% of executives agreed to the statement, "One or more directors on their board should be replaced."

Returning to the drama at OpenAI, the “Board” came up a lot. I always find it more insightful to look at reality underneath than to let vague words like "board" get in my way of understanding what's happening.

During the OpenAI episode, all the articles and posts repeatedly referenced the OpenAI Board of Directors. Using this term frequently gives it a sense of formality, like saying the US Congress, which has 535 seats, or the College of Cardinals, which has over 200 cardinals from all over the world, that choose the Pope.

So, what did the OpenAI Board look like during the incident? I casually shared the following statistics with a few people during that week, and they all looked bewildered.

  • OpenAI Board only had 5 directors.
  • Their average age was 37 years, with a standard deviation of 2 years, which means they were all between 34 and 39.
  • The first interim CEO's age was 34.
  • The second interim CEO's age was 40.

Given this basic information, do we feel more or less impressed by the word “board”? Is it ineffective for such a board to govern a company that may change people's lives everywhere in the world?

I won't make any categorical judgments about this board. Going by the PWC survey and my observations, it's better to have a broader conversation about board development. We should be happy that the OpenAI Board showed its hand with the Altman incident so that we can use this as a learning opportunity.

Acumes - Board Development - What does a good Board look like - John Oommen

Why does a board exist?

Regardless of size, every region mandates that we register specific members or directors when registering a company. 60% of US corporations are registered in the small state of Delaware. The Delaware State guidance for corporations starts with, "the board of directors of a corporation shall consist of one or more members..." Wait! One or more members?

A company can only have one director on the board if the company is owned entirely by one individual. Once we go past a small mom-and-pop business that does not have any loans, companies become a complex web of interdependencies. Unfortunately, almost all board regulatory guidance is written with the most straightforward situations in mind.

Board of directors are in the role of risk managers to ensure the company is "good." Good companies, which I call Holistic Companies, have a purpose that balances the incentives of all stakeholders. The board is accountable for articulating this purpose and aligning all company activities with this balanced purpose.

A board's mandate is also to be the de facto decision-maker on all aspects of the company. So, the board is responsible and accountable for ensuring that the interests of investors, customers, employees, partners, and society are considered and satisfied.

Suppose a company's operations spread harmful chemicals into rivers or the air, the company's products hurt customers, or the management mistreats employees or dupes investors. In any of these cases, it's the board's fault.

Isn't it the CEO's job? No! The CEO is an employee of a company and is appointed by the board. The confusion around the CEO's accountability comes from the standard practice where the CEO is on the board and is often also the head of the board.

As outside-in observers, we often see the CEOs face the brunt of significant issues associated with the company. Sacrificing the CEO, who is also one of the directors, is simply the most convenient answer that allows a group of individuals - the board - to avoid culpability. It is a much easier story to blame one person than accept the ineffectiveness of a group of individuals.

Boards are expected to represent the interests of all company stakeholders - investors, employees, customers, partners, and even society at large.

Given this all-important purpose...

What is a good “board”?

Each state or region where companies register provides some generic guidance. Stock exchanges offer similarly non-actionable suggestions for the relatively few publicly traded companies. Turns out, there are no globally or regionally accepted laws or practically enforceable guidance on what a good board looks like. Almost all the guidance for a board comes from each company's by-laws. In other words, guidance for creating a board and staffing board directors is largely handed down wisdom and the convenient choices of the owners. Outside of picking people we know or choosing folks who own shares in the company, what is the optimal composition of a board?

At the risk of sounding too obvious, a good board is stuffed with individuals who understand and act in the best interest of all company stakeholders – customers, investors, employees, partners, and society. The converse is that a board is stacked with individuals not representing the interests of one or more of these stakeholder groups or are primarily self-serving.

Let's use Section 141 for Delaware corporations as a proxy for available board guidance. My first observation is that the guidance includes a lot of sentences with "may" and none with the framing "may not."

Browsing the board development literature available gives us three commonly accepted guiding themes that are considered the responsibility and duty of a board of directors. Most business school programs touch on these. But they primarily serve as a floor to protect each director from being personally answerable for company-level problems. These don't specify what constitutes a good director or what they must do. Let's make them more tangible.

1: Duty of Business Judgement

The first responsibility is the Duty of Business Judgment. The Delaware corporation section 141 states the following. "The board generally has the power and duty to make business decisions... including establishing and overseeing... long-term business plans and strategies, and the hiring and firing of executive officers."

I interpret this first theme as a call for skills and experience. Each director must bring deep skills in relevant business functions and have an aptitude for business strategy and operations. These aren't skills that can be read or gained through osmosis. It takes years of practice. Directors must also be able to look at every aspect of the company's strategy and operations while considering the incentives of all stakeholders, including customers across its market and even innocent bystanders who might face second-hand impacts.

Collectively, the board must light up all the relevant checkboxes around running the entire business across all functions and from top-of-the-house thinking through day-to-day operations. The board must have tangible experience with and empathy for the company's customers, partners the company works with, all the investors putting money into the company, all the employees toiling away every day to make the business function, and have the vision to consider the long-term impact and side effects of the company's operations.

Here are some questions we can ask ourselves when assessing a director’s or the board’s collective effectiveness:

  1. If we eliminate a specific director from the board, will the company miss out on their depth and breadth of experience? The more "no" answers imply more profound skill gaps on the board.
  2. Was the board selected based on a competitive search, or is the selection based primarily on relationships and loose associations that do not connect to skill? The ideal answer is the former.
  3. Is the board's composition broad enough from an experience, industry, business function, and stakeholder representation perspective? Diversity on one- or two-dimensions will not suffice. A "no" answer implies a biased or narrow-minded board.
  4. Is one or more directors’ primary qualification to join the board limited to prior roles as a board observer or investment experience? Board observer roles or “investor” tags have become shortcuts for inexperienced individuals to gain credence to find board of director roles.

Unfavorable answers imply a board that lacks the experience to meet the Duty of Business Judgment.

Using these questions, let us ask ourselves whether the OpenAI Board during the Altman incident or the board of a company we care about has the necessary size, depth, and breadth of experience.

2: Duty of Loyalty

The second theme is the Duty of Loyalty. This duty “requires directors to act in good faith to advance the best interests of the corporation... And refrain from conduct that injures the corporation. Directors must exercise good faith efforts to ensure that the corporation has policies to ensure compliance with the regulatory laws applicable to its operations and to monitor senior management's adherence to those policies." The meaning of this first part of the Delaware state guidance is evident. But it also states, "Duty of Loyalty also prohibits directors from using their positions to advance their own personal interests.”

These two parts are equally important because, collectively, these statements articulate the importance of avoiding a conflict of interest for each director. Ignoring the second portion of this guidance about self-interest can go wrong in a few different ways.

Imagine a director who has invested money in the company hoping to make a relatively quick return on their investment regardless of what happens to anyone else. Would this director be motivated by the Duty of Loyalty to the whole enterprise or their ability to get their short-term return on investment? Obviously, the latter.

The reality is that it's prevalent to have directors on the board solely to represent the money they have invested in the company. In fact, it is the most common path to a board role. Even non-profit boards often set sizable minimum annual donations, pushing affordability as the top criteria for director selection.

I am often philosophically aligned with the themes preached by activist investors who take board seats and demand significant strategic changes with immediate effect. However, activist investors are only chasing short-term share price boosts and are not considering customer value, impact on partner value chain, employee interests, or societal impact.

Another version of conflict of interest focuses on self-branding and career propagation. A director could lack objective focus on value creation for customers, investor interests, employee needs, external partner incentives, or risk management for the rest of society because the individual lacks life perspective or career experience to serve all these stakeholders. In such a situation, the only reason to hold a director role is career propogation or social standing.

Board roles have increasingly become a resume builder where individuals seek board roles to boost their profiles. There are many recruiting-type businesses whose business model encourages inexperienced individuals to embellish their limited experience and seek board roles. The problem in this scenario is that valuable board seats are taken away from experienced individuals who could create far more value for all company stakeholders. It also risks an inexperienced director providing biased and poor analysis and recommending subjective decisions or voting with the majority, risking harm to stakeholders.

We can ask ourselves some questions to assess a director's or the collective board's Duty of Loyalty.

  1. Does the collective board primarily represent a single stakeholder group’s interest and have limited interest in other company stakeholders or the company's long-term trajectory? A "yes" answer implies that the company will likely operate on a short-term strategy that aligns with only one or two stakeholders' incentives.
  2. Is it evident that one or more directors have far more to gain – investment return or career propulsion – from being on the board compared to what the board gains from the director's presence on the board? More "yes" answers imply a self-serving board that is not focused on its intended mandate.

Based on these questions, was the OpenAI Board focused on the Duty of Loyalty to all its stakeholders during the Altman incident? How does a board you care about rate on these questions?

3: Duty of Care

The final criterion is the Duty of Care. It “requires directors to make informed business decisions… in evaluating information provided to them by management, directors are expected to review the information critically and not accept it blindly...”

I interpret this framing from Section 141 of Delaware state to mean that every director must apply time, mindshare, and analytical muscles to seek and review objective data and explore business realities beyond depending on obvious or carefully curated information. Or worse, be unprepared even with the information provided to them. Additionally, the guidance to use objective information implies that each director avoids subjective personality politics.

This aspect primarily goes wrong when a director doesn't have time and mindshare to perform their duties. What if a director has a hectic day job? How about a busy day job and multiple other board of director roles? What if a director simultaneously held several board seats? Humans can't effectively juggle so many concurrent roles regardless of their perception of their skills.

Unfortunately, I have heard the line, "The board doesn't have time or interest in details," too many times. Board meeting content is often like a Michael Bay movie trailer packed with action scenes and cameos from beautiful people, masking underlying gaps in the script and actor skills. Imagine writing movie reviews solely based on movie trailers!

Attending quarterly meetings to watch a picture-heavy PowerPoint presentation with scant details and voting "yay" or "nay" with the majority is not the call to action intended via the Duty of Care. As silly as this sounds, this is how most boards operate.

We can ask a few questions during board selection or board effectiveness assessment around Duty of Care:

  1. Are one or more directors on more than two boards? More "yes" answers imply that the board is likely passive and does not engage beyond acquiescent board Meeting attendance.]Does every board director have the time, interest, and mind share to work on one or two topic-specific committees to create hands-on value and solve problems for the company? The correct answer is obviously "yes."
  2. Does every board director have the time, interest, and mind share to work on one or two topic-specific committees to create hands-on value and solve problems for the company? The correct answer is obviously "yes."

In addition to these self-assessment questions, what are the specific recommendations I'd implement when developing a board or assessing the effectiveness of one? Below are my top five suggestions.

Board Development Recommendations

1: Find an experienced board - A young board does not imply ingenuity. On paper, diversity statistics don't lead to effectiveness.

Historically, retired executives primarily occupied board director roles if we exclude owners or large investors, which is highly logical for several reasons. Retired or near-retirement folks have decades of experience with the highs and lows of business operations at their companies and macroeconomic waves. Late-career individuals often have the breadth and depth of experience with many business functions and seniority levels and have a mature view of all stakeholders. Lastly, conflicting incentives like personal financial gain and career advancement are likely less muted, reducing conflict of interest.

When OpenAI replaced four of its 30-somethings directors and added Larry Summers and Bret Taylor, this was precisely the change made – a significant increase in average years of relevant experience. The headcount of three directors is still baffling!

2: Formalize board selection process - A board director seat has far more accountability than a senior executive role. So, use an executive hiring process.

Stacking the board with investors who put money into the company or relying on personal references to source candidates results in heavy groupthink and a board that exists to serve a subset of stakeholders. Choosing personal connections or references implies more loyalty to other directors than all the company stakeholders.

Duty of Business Judgement, Duty of Loyalty, and Duty of Care focus on what each director brings to the company, not what the company brings to one or more directors. So, it is critical to rely on a formal selection process to source a broad range of candidates to create a funnel of objective candidates who have the maturity to put the company's stakeholders above personal motives.

3: Conduct a skill assessment - Staff board of directors with hands-on business strategy and operations expertise.

Board roles are paid positions, and each director has a job to do on the board. It’s not a volunteer position. All of us get paid to bring a specific value. So, we must staff a board as we'd staff any other role – based on the depth of topical expertise and experience. The assessments will ideally focus on candidates' business strategy and operations wherewithal and breadth of knowledge. If all board development concentrates on skills and experience, many scandals we read about wouldn't happen.

An expert investor would let folks with deep experience running businesses take board seats. It is counterintuitive for a specialist money manager to think they are also the best person to decide how companies can create value. An investor should put money into vehicles due to the intrinsic properties of that venture, not because it gets them a board seat.

4: Demand commitment - Board directors must hold at most two or three board seats.

Some folks list several board associations simultaneously on LinkedIn. If we take these at face value, we must wonder whether they have time to create value for any of these companies. Many boards operate as a check-the-box operation with several passive directors. In these situations, one or two strong-willed individuals swing all the decisions and actions in a manner that suits their incentives. For a board to be effective, all directors must bring their A-game and commit time and mindshare to think critically about the organization's trajectory, strategy, and operations without being swayed by interpersonal overtures or carefully packaged biased information.

5: Use board observer seats effectively - Board observer seats are not a training ground. Use the seats as working director seats.

Board observer roles can't vote like board of director roles. But they can create strategic and operational value for the company. So, use the seat to create value. Unfortunately, we increasingly water down board observer roles to seat inexperienced individuals without the necessary breadth and depth of tangible work experience. Each poorly allocated board observer seat eliminates an objective and critical thinker who can provide valuable feedback and insights to a board and executives, regardless of voting rights.

Additionally, skills that enable the Duty of Business Judgement require deep critical thinking and decision-making skills that can't be gained by watching others during quarterly meetings. Rejecting inexperienced individuals from occupying board observer roles protects another company in the future from suffering the consequences of staffing a director based on the qualification of previously holding board observer roles.

If we could poll all employees at all companies, well over 90% of employees wouldn't know the names and backgrounds of their company's board of directors. That's unfortunate. Choices made by a small group of individuals on each company's board affect all customers, investors, employees, partners, and society. The board of directors must pass an effectiveness assessment that minimally includes the questions we framed and the five recommendations for effective board development.