The Case for the Executive Chair

Sir Adrian Cadbury served as a sounding board for a white paper that guided the board of a Fortune 100 corporation on dividing the roles of chair and CEO. The London Stock Exchange had just published the Cadbury Report on corporate governance reforms.

He posited in a conversation that a chairman should be a “Mr. Outside to the City and Whitehall” with finance reporting to him. The CEO “just needs to get on with things,” he said. He saw a strong chair with executive powers.

Sound wrong-headed? The board thought so. It kept finance reporting to the CEO. But maybe it isn’t so far-fetched. What if Enron had an independent chair with finance reporting to him? What if Boeing created an executive chair and the CEO could focus on fixing its businesses, not on Wall Street, Washington and lawsuits?

Moving finance under an executive chair and focusing the CEO on operations should be considered more often. Actions by the boards of companies that outperform their industry peers show it to be viable.

Boards Understand What Creates Value

Charting the total shareholder return for virtually every industry shows a spike, not a bell-shaped curve. Most corporations cluster within one standard deviation of the industry’s mean. Seventy to eighty percent of valuation is determined by its industry as the chair of every compensation committee knows.

But one or two companies are far off to the right, two standard deviations better than the mean. Cummins, Deere and PACCAR in trucks and heavy equipment, for example. Or Nucor and Friedman in steel. To borrow from consulting speak, they command the profit pool and have for years. Their boards understand what creates value in their industries and have allocated capital to capture that value.

However, since 2008, McKinsey surveys show that only one or two directors on the typical 11-member board say they understand industry economics and how the company makes money. Two or three say they have little or no understanding.

That contrasts with private equity-owned companies, where operating partners know industry metrics and intervene directly. A director of one of these companies says, “Working capital is too high...” and expects corrective action.

L.E.K. Consulting looked at what CEOs did at companies that grew cash by more than 20% annually for five years. It crunched numbers and interviewed a dozen of these CEOs. Three challenged the correctness of focusing on the CEO. They talked about the power a chair has to set the board agenda and translate it into strategic and operational imperatives.

To quote one, “A chair consumed by capital efficiency, or anything he deems important, trumps everyone else.” This turns out to be more than a good quote. Great companies sweat capital. The chair of a leading food company can explain in mind-numbing detail why livestock is off its balance sheet.

The Chair Fosters the Flow of Information to the Board

Not all superb operating executives become effective chairs. At the beginning of a succession project at a major defense contractor, the chairman and CEO said, “I hate this job.” He then lamented the time he “wasted” courting politicians and, more so, working with directors. He hated being chair. He wanted to build things that flew through the air and went boom. And he kept directors at arm’s length.

The best chairs engage the board and foster the flow of information to them. Boards cannot function to their full potential if management decides what’s important for the board to know. Having finance report to the chair assures the symmetrical flow of information among management and the board. This is the argument for why finance should report to the chair.

Perhaps no company in the United States does that today. Chairs and directors describe workarounds like asking extra questions through the audit committee or cozying up to internal and external auditors. But those are workarounds. Nothing offers the efficacy of finance reporting to the chair.

Sometimes the flow of knowledge happens naturally. In industries like semiconductors, directors often live in a shared ecosystem and can be powerful adherents in and for the company. Directors know when “Apple should hear about this.”

Directors Who Can Use the Information

The best companies have continuity on their boards, but with that continuity, they prune underperforming directors. Not all directors engage. Not all can read a balance sheet. The director who busily read background on a bond placement during a succession discussion at a consumer goods company was visibly disengaged and soon gone.

At another company, a new chair sketched out the board by its committees early on. He circled the weak directors. The chair hid his hand, but over the next three years, the board replaced them. The board became more diverse, more international and wiser.

One newly elected director with experience in a related industry walked into his first meeting asking, “What do we do about water?” Another director pointed him to the credenza, and he said, “No, no, I mean rain, drought, floods, water tables, empty reservoirs.”

The company had yet to do anything even as it looked to expand in Africa and Asia. The company scrambled. The question mattered greatly.

Focusing the Board and the Company

The boards of top-performing companies better align capital with how best to create value in their industries. Their returns on capital employed prove that.

Their chairs keep the board and company focused. They assure there’s an open book, and that directors are engaged and knowledgeable. They remove those who aren’t.

Common practice dictates a strong CEO, but a strong executive chair empowers the board. It better focuses the board’s agenda on what matters most to investors and, with that, the CEO on operations. Let them get on with it.

About the Author(s)

Gregory Carrott is chairman of the board of Celectiv.