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Solutions to Cleaning up Corporate Boards 

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The bad decisions made by some of "Wall Street's finest" during the financial crisis are still being felt. Today the Securities and Exchange Commission will be meeting to consider implementing parts of the Dodd-Frank bank-reform law—including the all important shareholder votes on executive compensation.

CEO compensation becomes a hot topic at the end and the beginning of every year. Its especially juicy when a CEO gets a golden parachute that makes you so mad that you, yourself, could fail your way up to a fortune.

But the anger and disgust should not just be directed to the corner office. The boards should also be looked at. We all know boards are not perfect, so what needs to be done to make sure its not a bunch of golf buddies around a table? I decided to speak again with Sydney Finkelstein, Steven Roth Professor of Management at the Tuck School of Business at Dartmouth College.

LL: We have talked before about poor leadership in the C-Suite, let's dig down on the boards. Aren't they ultimately the watch dogs- making sure the CEO is running the business properly?

SF: The problem with boards of directors is not nearly as simple, or complex, as often assumed. Simple solutions that are typically bandied about by corporate governance watchdogs include separating the CEO and Chair positions in a company, instituting term limits for directors, and being hyper-precise in determining whether a director is independent or not.

As it turns out, however, none of these cosmetic changes really makes any difference. After years of academic research into the effects of these “tick-the-box” restrictions, we know that there is no real bottom line impact to any of this! While it might sound comforting to keep CEOs from also sitting in the Chair seat, by itself it won’t help you.

Just think about some of the big flameouts of the Enron era, such as WorldCom, Tyco, Adelphia, and Enron for that matter. In each instance, virtually all of the standard metrics of so-called “good” corporate governance were in place.

LL: What are the strategies boards need to employ then in order to keep on top or anticipate problems?

SF: Things like the quality of debate in board meetings, open-mindedness of the CEO and the directors, whether the board does expansive scenario planning, whether the board is asking the right questions of management, and whether the board engages in “playing devil’s advocate” when discussing various options on the table. None of these qualitative factors are easily measured, which might explain why legislative efforts to regulate the boardroom are doomed to failure.

I also believe that all boards should develop an early-warning system for the types of breakdowns that can threaten the very existence of the company. Remarkably, in my work with boards, I hardly ever see a careful focus on early warning signs. Sure, there’s more and more attention to financial statements, as there should be, but when something goes very wrong it usually takes some time before the impact hits the bottom line.

Further, the enterprise risk management work that most boards engage in, while important, hardly ever gets at the “softer” side of business where the real breakdowns originate. For example, the real risk of a oil spill like that which BP inflicted on the Gulf last summer would hardly be picked up using conventional risk management techniques.

But if the board had carefully considered the potential downside to then CEO Tony Hayward’s fixation on cutting costs, perhaps some attention could have been paid to the inherent tradeoff between cost cutting and safety.

LL: Can you give me another example?

SF: In some ways the recent troubles of J&J have followed the same pattern. Here, it’s not hard to imagine how the J&J board would have been enamored with their long record of exemplary safety, immortalized by the famous Tylenol recall in the early 1980’s.

But 20 years later things are very different, with product recalls in consumer products like Motrin, Benadryl, Rolaids, and, alas, Tylenol, as well hip implants and even contact lenses. This type of breakdown goes way beyond any one business unit, or even division, yet the board has stood by while the once-stellar reputation of the company has taken hit after hit.

LL: It seems more boards are geneticly made up if you will to be reactive instead of proactive. Is there anyway to legislate better practices?

SF: While there’s no guarantee that an early-warning system can identify in advance such fundamental breakdowns like these, it’s hard to imagine a company not being better-off when its board stays tuned in to what really can go wrong, in a big way.

Right now, for example, if a board is not on top of any potential “Wikileak” in their business, they are asleep at the switch. More generally, boards need to take a “diagnostic” approach to their jobs, something that requires time, energy, diligence, and careful attention to all that might go wrong. And there’s no way to legislate that.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."