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CFO Magazine 2004

CFO Magazine is Australia's leading business publication for chief financial officers and other senior executives in finance and related disciplines, including corporate governance. Ann-Maree Moodie is one of CFO's opinion columnists.

Contents

Corporate Governance Opinion Column

It's time to face the music.

Companies in crisis must distinguish between communicating with stakeholders and the general public.

Some seven men form an Association, (If possible, all Peers and Baronets), They start off with a public declaration, To what extent they mean to pay their debts. That's called their Capital; if they are wary, They will not quote it in a sum immense.

When Gilbert and Sullivan wrote this ditty in 1893 for Utopia, Limited, a prescient satire on the limited-liability company, their intent was to emphasise how this legal concept helped protect the interests of shareholders. The sum of the capital to be quoted was "immaterial", as the limited liability construct gave the peers and baronets a Lazarus-like opportunity to start again in the style of Jodee Rich or, for that matter, James Hardie Industries.

As a company if you've come to utter sorrow -
But as the Liquidators say,
"Never mind - you needn't pay",
So you start another company tomorrow.

A musical about a limited-liability company may not be limited in its liability to bore an audience, but by all accounts the work was a success and its themes are relevant more than 100 years later. But if G&S were updating the musical for today's audience, one way to increase the dramatic tension of the libretto might be to broaden the definition of capital, in line with a suggestion made by Catherine Walter last month in a speech to the pre-Congress dinner of the Group of 100 in Sydney.

The former National Australia Bank director made a salient point when she linked the privileges of the limited-liability construct to issues such as corporate social responsibility and the community's expectations of corporations. Numerate types in the audience who might have thought social issues to be "soft", and therefore irrelevant, are likely to have changed their minds when Walter used the example of James Hardie Industries.

The company, under intense community pressure to redress its asbestos liabilities, has sought to "pierce the corporate veil", Walter claimed, by seeking to have shareholders reverse decisions that allowed the company to shirk its responsibilities to victims. "The James Hardie case provides a salutary example where the community, former employees, product users and unions were brought in, with considerable success, to the limited-liability issue," she said. "Companies will learn that they will ignore the social or community licence consequences of limited liability at their peril. And of course, where one company brings limited liability into question, the consequences can be felt by very many companies."

Walter has effectively argued that the fiduciary aspect of a limited-liability company should be widened to attend to any matters that affect a company's reputation, particularly the perception it creates for its care and consideration towards employees, customers and the environment. The characters of Utopia, Limited claim that a limited-liability company can "trade with all who'll trust 'em", but Walter argued that it is the ignorance of corporate responsibilities that are more likely to signal the demise of an organisation.

A business can always seek fresh opportunities to make money, but a cherished reputation, once lost, is difficult to recover.

She said: "We need to constantly remind ourselves that the limited-liability company - however fundamental to an entrepreneurial economy - is not a natural creature," she continued. "It is a legislative construct, which can be legislated away if we are careless of its benefits and responsibilities."

Peter Sandman, an American crisis-management expert, argues that a company's reputation hinges on its ability to communicate effectively, especially in times of risk. Sandman claims that the public relations activities involved in crisis communication should be separated from the interactions between the company and its stakeholders. Stakeholders are typically experts in a company's operations, regularly monitoring media coverage and the company web site, and are not averse to making contact to ask questions, or to vent their concerns. People in this category are the most dangerous threat to a company in times of crisis.

In the case of James Hardie Industries, many hundreds of the cancer victims and their families are yet to be interviewed by the media for the "human interest" aspect of the latest development in the story. The company can do little to contain this coverage and, with each story, its reputation is further damaged. The "outrage" towards the company, to use Sandman's parlance, fuels the passion for retribution.

"Ignore community or social licence at your peril" indeed. This line could well be the beginning to a rewrite by Gilbert, Sullivan & Walter of the libretto to Utopia, Limited, which ironically had the alternative title of The Flowers of Progress:

All hail! Astonishing Fact!
All hail! Invention new -
The Joint Stock Company's Act The Act of 2002!
Tantara, Tantara

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Wanted: Plain speakers.

A Victorian fund manager has provided fresh evidence that ambiguity and jargon pervade corporate life.

The Gardiner Foundation, which manages $60 million of invested funds for the Victorian dairy industry, recently advertised for a chairman and two directors to replace three board members who were due for retirement or re-election.

The advertisement required applicants to demonstrate "the business acumen, tertiary qualifications, skills and knowledge [that would] enable them to complement the existing board structure".

This is a significant signal that Australian boards - including those whose constitutions require advertising for new board members - are nominating applicants more thoughtfully to suit the needs of the organisation rather than the bonhomie of the boardroom.

Restricting the search for new members to the "boys' club" remains the most common method of filling board vacancies.

This advertisement at least indicates a shift towards understanding that board work should be perceived as a job rather than as a reward for good service to business. It also shows that the perpetuation of the tendency to appoint "someone like us" - because it is perceived as less risky and more convenient - is being challenged.

However, the advertisement's wording, which was presumably given the imprimatur of the board, is jargon-ridden, and as such is potentially misleading.

As David Gonski commented in a speech he made last year: "Directors are failing to communicate effectively with stakeholders. Most directors among us are not 'top of the pops' in getting our message across. Quite frankly, we do it badly."

The advertisement therefore provides an interesting starting point for the discussion about the standard of communication skills of board members, especially at a time when clear messages are imperative to renewing public trust in private enterprise.

It is obvious that the board of an organisation charged with investing cash seeks candidates who have finance and investment knowledge, as well as experience in the Victorian dairy farming industry.

But what should be made of the phrase, "who complement the existing board structure"?

Is the board replacing departing skills, or refreshing the board with members of different backgrounds?

Basic due diligence would reveal the formal qualifications and business experience of the other members of the board and, more pertinently, of the three who are due to leave. But this information will not provide applicants with conclusive evidence of the type of person required.

A board member with tertiary qualifications may bring appealing qualities to the role, but it is unclear why this is a prerequisite, or indeed what type of tertiary study is relevant. Is it better that the candidate has a masters degree in international finance, or a PhD investigating the hidden ciphers of Renaissance papal correspondence? Perhaps an undergraduate degree in agronomics is more relevant?

The ambiguity of the specifications indicates that the board cannot demonstrate clearly what is required of candidates, or worse, that it is unable to describe its own role.

In short, how can you hire your replacement if you cannot describe your own job? If a task cannot be described or measured, it cannot be managed. The person in that position will not understand the responsibilities of the job, and it is disputable whether their performance will be assessed objectively and fairly.

This ambiguity is dangerous because it exposes a board to its role being wrongly interpreted. A board member's understanding of their position may be quite different to the expectations of the chairman, of fellow board members and of shareholders.

Exposure to the unlimited interpretations of other people creates the potential for a loss of control, and a shift of power away from the board or a board member. The National Australia Bank (NAB) is once again a pertinent case study. Graham Kraehe and Cathy Walter clashed in part because of a lack of clarity in the expectations of a member of the NAB board.

In making their argument public, Kraehe and Walter fell victim to the interpretations of their situation by fellow board members, NAB executives, staff and shareholders - and ultimately by the media.

The result was the inevitable loss of control that subsequently affected the board, the NAB as a corporate icon and the state of business practice in general.

Ambiguous language, and especially jargon, is rife in corporate life. Jargon has two meanings: the language of the tribe, which makes it legitimate; or gibberish. The public exposure of boardroom dynamics as a result of the cycle of corporate scandals in recent years has caught directors unprepared.

In trying to regain control, board members are resorting to meaningless language, creating a new jargon of corporate governance. The implication is dangerous. If boards cannot plainly communicate the requirements to fill a job vacancy, how sophisticated are the communication skills within the board?

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Easier said than done.

Independence in the boardroom, a difficult notion to define, may ultimately depend on the judgment and integrity of the chairman.

Primarily, two governance structures support the concept of independence in the boardroom: the non-executive chairman and a majority of independent (or "non-executive", "outside" or "lead") directors.

In Australia, company boards generally fulfil these two criteria. Our corporate history attests to a separation of the roles of chairman and chief executive; non-executive directors comprise 70% of directorships of the boards of Top-50 companies.

Independence is now formalised in legislation, regulations or guidelines for corporate governance best practice in Australia, Britain and the United States. It is a term used to describe a concept whereby a board member's web of past and present business relationships do not interfere with his or her work on the board.

The Australian Stock Exchange (ASX) explains that "an independent director is a non-executive director and is independent of management and free of any business or other relationship that could materially interfere with - or could reasonably be perceived to materially interfere with - the exercise of their unfettered and independent judgment".

In its best-practice guidelines, the ASX gives seven ways of "assessing" a board member's independence.

In March, the ASX Corporate Governance Council's Implementation Review Group published its findings.

The group, established in mid-2003 to review the guidelines and the experience of companies that responded before the current reporting period, found that the ASX provided a useful framework for disclosure of a board member's potentially compromising relationships, but that it did not define independence.

"Determining director independence is not an exact science and is open to the subjective interpretation of the board, provided that the board can effectively communicate its reasoning," the group said. "Further guidance [should] be given to the market to clarify the difference between a director's conflict in relation to a specific area of decision-making, and an impediment to their broader ability to exercise unfettered and independent judgment."

But nowhere does the ASX, or the group charged with reviewing the ASX guidelines, suggest a framework for independence of behavior.

The dictionary definition of independence is to be free of subjection, to be free from the influence of others and to be exempt from external control or support. Independence is also defined as a competency.

The closest the ASX gets to this definition is for board members to exhibit "unfettered judgment" in decision-making. But how might a board member behave independently? How can a chairman, a CEO, or other board members judge this person as being independent? And how might individual board members judge themselves to be free from the influence of others?

The more enlightening enquiry, though, is not what independence is or what it means. In order to define the exact nature of the problem, a far more fundamental question must be pondered first: independence from what, and from whom?

Independence in the boardroom needs to be considered within the context of financial performance, executive compensation, executive turnover and the strategic orientation of the company.

The hypothesis that a board member's capacity to act independently will be challenged in financially distressed or bankrupt companies - or in companies subject to a merger, an acquisition or a takeover - should also be tested.

The influence of a range of relationships, and how this may affect independence, offer further inquiry: do board members elected to the board during a chairman or CEO's tenure feel any sense of obligation or loyalty to that person?

Does an interlocking directorship for any one of the members of the board skew that person's ability to form an objective opinion? What is the influence on the board of shareholder activism, particularly if it is highly professional or militant?

The duty of independence involves determining whether board members would have reached the same decision if they were free from influence.

It requires a high degree of self-awareness for a board member to judge his or her ability to behave independently. The arena of influence extends well beyond the boardroom.

The capacity for other board members, especially the chairman, to assess whether a peer is acting without independence is also problematical.

In the elite network upon which our corporate-governance structures exists, calling a fellow board member to account for being subjective of judgment, or for being unduly influenced by a third party, will certainly threaten or damage professional and personal affiliations.

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The ties that bind.

The role of nominee directors has been little researched, but there is evidence to suggest they are potentially compromised and a strain on the organisation.

Since Adolf Berle and Gardiner Means published their classic 1932 study on the separation of ownership from management in public companies, agency theory has led the debate about what constitutes good corporate governance practice.

Agency theory holds that the separation of ownership is an efficient division of labor in large organisations, and is the dominant approach to contemporary corporate governance research. But the agency theory model is limited because it ignores the structural, political, cognitive and cultural contexts in which board members interact as individuals and as members of a group.

Typically, corporate governance research places emphasis on the fiduciary and legal obligations of board members but neglects the study of the work of board members in the context of their relationships to others. An example is the lack of understanding of how board members, particularly nominee directors, ensure that potential conflicts of interest do not compromise their position.

Under a company's constitution, groups of shareholders may have the right to appoint one or more directors. These nominee directors are appointed by various interests to represent them on the board of the company and are most commonly engaged to represent investors of start-up and emerging entities requiring venture capital investment.

The duty of all board members is to the company as a whole. Under the Corporations Act, directors are required to "exercise their power and discharge their duties in good faith in the best interests of the corporation, and for proper purpose". A nominee director is no exception to this rule, even though the very nature of being nominated compromises individual independence.

A nominee director is cognisant of always working within a framework of potential conflicts of interest. However, this is where the law fails most nominated board members, as the Corporations Act does not define conflicts of interest because each breach is circumstantial. (The exception is directors of wholly owned subsidiaries who are offered a lifeline under s187.)

A qualitative research study into this conundrum, conducted by my company, The Boardroom Consulting Group, found that nominee directors such as venture capitalists reveal a somewhat untidy approach to dealing with their dual roles as board members and investor representatives.

In order to separate their duties as directors from any influence or pressure being exerted upon them by investors, they say that they "play a role", "erect Chinese walls", or "put on a different hat". This language is ambiguous because it does not explain how nominee directors behave and how they make decisions in order to separate their duties and deal with potential conflicts.

Academic research indicates that by occupying multiple roles with potentially incompatible expectations to the nominator (be it a supplier, customer or investor), board members experience a type of "inter-role conflict". In one of the rare studies of this under-researched topic, North American academics Karen Golden-Biddle and Hayagreeva Rao studied a non-profit medical research organisation whose directors are elected by members and volunteers. The study concluded that the board members put the governance of the entity under duress because they were unable to separate their duties from the obligations to the interests of the organisation's membership.

The researchers offered an alternative explanation for the problem as being conflicts of commitment, which is also a form of inter-role conflict but one that stems from the incumbent's own commitment to various competing interests. Conflicts of commitment occur when the board member is torn by a choice of behaviors and decisions, which influence the image and reputation of the organisation. In academic parlance, they are in conflict with the organisation's identity.

In the past, the study of organisational identity has been confined to the disciplines of communications and marketing. These days the theory is used by human resource managers, strategic planners and CEOs to analyse the behaviors of employees, customers and suppliers, which affect the organisation's reputation and its brand.

Board members who experience a conflict of commitment are likely to operate on a kind of theatrical sphere of "on stage" and "backstage". They work on stage by acting publicly in a manner appropriate to the social order and to group conformity, while simultaneously working backstage to fix problems or potential threats to their own reputation and to that of the company.

In the current debate about what it means to be an independent board member, nominee directors are well reminded of the adage: ties that bind can also blind.

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Old pals act up.

As boardroom behavior is again called into question, chairmen should consider what is meant by collegiality

The potential conflict of interest on the board of the Reserve Bank of Australia, whose members represent the most influential business elite, demonstrates anew the misguided propensity of board members to align the performance of the board with its ability to be collegial.

A recent article in The Sydney Morning Herald reported that the Reserve Bank governor, Ian Macfarlane, restricted a member of the bank board, Professor Warwick McKibbin, from taking an advisory role with a property investment fund. The article contended that the decision, made because of the potential conflict of interest, throws doubt on the interconnected business relationships between others on the board, who include Frank Lowy and Jillian Broadbent

This news, in the aftermath of the National Australia Bank (NAB) and Telstra boardroom crises, is of concern because it highlights flaws in the methodology used by chairmen to nominate and select new members.

Relying on personal networks of board members and institutional shareholders, chairmen create a self-perpetuating cycle of recruiting individuals who are able to merge seamlessly with the group dynamics of the board.

When I was researching my book The Twenty First Century Board, a chairman told me: "You often hear people talking about boards being a 'club'. But in practice, when you're asked your opinion about filling a vacancy, your answer will be influenced by those directors whom you've seen performing well on other boards. That's why you see the same names appearing on some of the larger boards."

It follows, therefore, that the relationships between board members have a long and varied history. They are likely to have studied, worked and socialised together and continue to be involved in business transactions.

Given the requirement for collective decision-making on boards, it is natural that the members of that board desire a culture of mutual trust and therefore rely on personal networks to appoint new members who will "be a good fit". The boardroom parlance used to describe this type of group dynamics is the word, "collegiality".

Recently, I completed a study of the corporate governance guidelines of the top 50 Australian listed companies - as well as international firms - on the use of the word collegiality. Leading global investment firm Goldman Sachs, for example, states that the criteria against which it selects directors include "the extent to which the interplay of the candidate's expertise, skills, knowledge and experience with that of other board members will build a board that is effective, collegial and responsive to the needs of the company".

The California Public Employees Retirement System corporate governance statement also advocates collegiality: "The board is responsible for creating and maintaining an atmosphere that encourages frank and collegial discussions".

Locally, PricewaterhouseCoopers "emphasises a collegial, team-oriented approach", and Axa states it has a "collegial decision-making body".

The popularity of this term in corporate governance parlance is worrying because it is misused. Collegial comes from the Latin , "of or relating to colleagues", and from the noun , meaning an association. It means authority or responsibility shared equally by a group.

Collegiality is not a synonym for conformity, consensus, like-mindedness or homogeneity. The misinterpretation of the word to denote a desirable atmosphere in the boardroom is insidious, because it is most regularly used as the reason why board members should be sourced from similar backgrounds.

This argument fails when one considers the fact that so-called collegial relationships between board members were central to implosion on the NAB board, and are also the basis of the controversies that continue to surround the Reserve Bank and Telstra boardrooms.

Chairmen are now being called to account for promoting collegiality as a foundation of their methodology for director selection. Macfarlane, for example, is being questioned on the singular structure of the Reserve Bank board, especially the interconnectedness of its members with Westfield companies and the Lowy Institute. Undoubtedly more examples of other boards will be forthcoming.

As I noted in a previous column, collegiality is not a desirable attribute in the boardroom, because it unavoidably obstructs the promptness of decision-making - a view supported by German sociologist Max Weber.

Collegiality limits individual power and gags individual expression, unlikely to be an attribute desired by a chairman who boasts of the "healthy debate" at his board table.

Any chairman who makes such a boast is advised to check the etymology of the word. It means that decision taking and responsibilities are based on the collective rule rather than on the one-man management principle - and no chairman would want the reputation of leading a board of yes-men.

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Corporate Governance - Let the minority speak.

It is January, 1984. The place is No 10. The forum is the British Cabinet's Overseas and Defence Committee. The subject is the possibility of an attempt to normalise relations with Argentina ... Sir Geoffrey Howe is four minutes into the Foreign Office paper on the need to open exploratory talks with the Alfonsin Government. Mrs Thatcher cuts in: "Geoffrey, I know what you're going to recommend. And the answer is 'no'." End of item: nobody argues with the boss. - Peter Hennessy, Cabinet, 1986

A chairman, assuming he is recognised as the leader of the board by both title and influence, plays a crucial role in determining the quality of decisions made by board members.

If the chairman is a person to whom deference is afforded by the group, the decisions made by the board will be influenced by how the board members predict the chair's preference for, and expectations of, the final determination.

A chairman must appreciate that, in order to ensure a high standard of decision-making by the board, he should adopt a neutral position while simultaneously eliciting a range of views, especially perspectives that are the antithesis of the group norm.

Unlike former British Prime Minister Margaret Thatcher, whose domination of her Cabinet is the stuff of legend, a chairman should avoid stating personal preferences too explicitly during the boardroom debate.

In previous columns I have suggested various strategies to avoid the phenomenon of "group think", including appointing independent experts and "devil's advocates" in order to institutionalise dissent and criticism during boardroom debate.

Further distancing can be achieved by the chairman absenting himself from discussions so that board members may not be unduly influenced. This was the position adopted by United States President John F. Kennedy during the 1962 Cuban missile crisis. Kennedy encouraged his Executive Committee to debate policy options freely during the 13-day crisis, deliberately staying away from many of the meetings. He also installed his brother, Robert, then US Attorney-General, as a "devil's advocate" with the authority to criticise ruthlessly every idea offered by the group.

If this approach to facilitating debate is to succeed, it falls upon a chairman to draw upon a range of leadership styles - participative, directive, autocratic and democratic - appropriate for each situation.

It is important that the chairman also appreciates that by allowing a board member to be a dissenting voice - or a "deviate", to use the parlance of group dynamics theory - one of the outcomes may be a polarisation of the group. At worst, it will lead to the scapegoating of the "deviate", which is one interpretation of recent political machinations on the National Australia Bank board.

Group decisions are usually determined by a majority, rather than a minority, rule. The minority rule, however, should not be unappreciated, as it can be exactly the position needed to make a better decision, to reverse a "bad" decision, or to add a new perspective to an outcome that is ultimately determined by the majority rule.

If a chairman encourages the minority rule, it must also be understood this will cause dissent in the group. Board members are predisposed to endorsing the most socially desirable viewpoints of the group, and a "deviate" will upset this balance. The chairman, therefore, must be able to celebrate and support the views of the "devil's advocate" while simultaneously managing the ensuing furore of the group caused by the dissenting voice. The "devil's advocate" must likewise be responsible for the fallout caused by airing a viewpoint counter to the group norm.

The minority rule is most successful if it shows four behavioral styles: consistency, autonomy, flexibility and commitment. According to the French social psychologist Serge Moscovici, the minority rule will be most influential if it shows consistency in its argument and that it is acting out of principle and not from ulterior motives. The minority rule needs to exhibit to the rest of the group that it has a high degree of investment in promulgating its views, especially if they are making personal or material sacrifices for the desired result.

Finally, if the minority rule adopts a flexible, rather than rigid, negotiating style, it is less likely to be extremist in its viewpoint. None the less, a group will quickly eject a member who is seen to be upsetting the balance by not conforming. In the worst cases, that group member will become a scapegoat, especially if their viewpoint is considered a threat to the group's stability.

There are several notable examples of Australian chairmen who are Thatcheresque in the execution of their duties because they believe bullying to be the only way to express authority and power. The more elegant, courageous and influential approach is for a chairman to take a cue from Kennedy and let the minority have a say.

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Legitimise dissent.

"The board is a governance body, not a club. Each of us has duties individually, not to each other, but to the stakeholders."
- Catherine Walter in a letter to Graham Kraehe

The "Three Cs" of what board members say constitute a well-functioning board - "collegiality", "chemistry" and "consensus" - was brought into sharp relief during the crisis besetting the board of National Australia Bank.

These are words commonly used to defend the reasoning behind the closed selection process for directors. They are also liberally applied to describe the protocol by which board members make decisions.

As one board member said in an interview with me for my book, The Twenty First Century Board: "The members of a board must be able to trust one another because they are collectively responsible and liable for anything that goes wrong in the company."

These attributes of solidarity are quickly dismissed at times of self-interest. In a cute sleight of hand, board members also use collegiality as an argument against individual performance appraisals. "The reason why you don't have an assessment of individual directors is because it doesn't work - the board operates as a collegiate (group)", another board member said.

More insidiously, collegiality is used as an argument for ejecting a board member. If a board member is perceived by the board to be no longer a "team player" they are deemed to be a threat. A "maverick" affects the desired "chemistry" of the board and its ability to make decisions by "consensus". Such board members are labelled "recalcitrant", "rebellious" and "dissident". In the case of the NAB's Cathy Walter, she also became a "self-styled justice fighter". The subtext of this argument is obvious: collegiality in the boardroom is desirable until it threatens the reputation, power and position of individual board members. When this happens, it is every man for himself, albeit dressed up by an argument of "what's good for the company and its shareholders".

Given the ongoing crises affecting corporate Australia, I propose it is time to debate whether collegiality is a worthwhile attribute in the boardroom.

The standard against which public, private and non-profit entities are now expected to be judged, the Australian Stock Exchange Principles of Good Corporate Governance, states that "it is important that the board be of a size and composition that is conducive to making decisions expediently". Board members should also "exercise unfettered and independent judgment".

German sociologist Max Weber puts a compelling argument against collegiality when he says it unavoidably obstructs the promptness of decision-making because it gags individual expression. "Collegiality has been primarily intended to promote objectivity and integrity," Weber says, "and to this end it limits the power of individuals." If Weber is right, how then may a board member express unfettered, independent judgment?

In group dynamics theory, independence refers to the degree of freedom with which the individual may function in a group. A group member's independence of action may be influenced not only by the accessibility of information, but also by situational factors, by the actions of other group members, and by the person's own perceptions of the situation.

Ultimately, if expression of individuality is perceived by the group to be an example of non-conformity and is threatening the stability of the group, that group member will be rejected.

What does this mean for a culture of healthy debate in the boardroom?

First of all, it must be acknowledged that there is a marked difference between dissent and disloyalty.

Replacing collegiality with a culture of constructive argument is not as easy as it appears, as any change in the boardroom requires patience and persistence.

In his new book, Back to the drawing board, corporate adviser Colin Carter suggests introducing a culture of "legitimised dissent" by establishing a temporary board committee that would be charged with formulating opposing arguments. Alternatively, a board member is nominated a "designated critic".

With due respect to Carter, one cannot help ponder whether board members are so precious that they will always confuse robust debate with a personal attack and therefore require mechanisms that allow viewpoints to be challenged without causing resentment and conflict.

If the principle of debating - to argue a case for or against - is stifled by boardroom conformity, then there is no doubt that "dissident directors" will continue to be exposed on the front pages of our national newspapers.

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Power - It's all relative.

Kent: "You have that in your countenance which I would fain call master."
Lear: "What's that?"
Kent: "Authority."
- King Lear, Shakespeare

The nexus of power and authority is central to the relationship between the two key members of a board - the chairman and the chief executive.

However, power and authority are not synonymous, and the distinction is crucial to identifying the seat of influence in the boardroom.

Understanding the difference between power and authority is also important in managing a struggle for dominance between the chairman and the chief executive officer, as well as to circumvent any such confrontation which may lead the board to become dysfunctional.

Power is defined as the ability to impose one's will on another, irrespective of the other's wishes, and despite any resistance he may offer, according to the German sociologist Max Weber.

Power is therefore relational; it requires one person to dominate, and the other to submit. This assumes that one person will acquiesce, co-operate with or consent to the domination of the other, and this cannot be true of all relationships. The act of issuing a command does not presuppose obedience. This is especially so in the boardroom, which is traditionally populated by people who are self-determined and confident. Such people are not generally predisposed to subordination.

Weber argues that an individual can exercise power in three ways: through direct physical power, by reward and punishment and by the influence of opinion. It is unlikely that the chairman or the CEO would exhort to physical means to dominate the other. The exercise of power is more likely to be indirect and coercive - a combination of rewarding and punishing through the use of argument, debate and rhetoric.

The question arises: is the power exercised by the chairman and the CEO legitimate? Legitimate power in a social hierarchy, like a board, is manifested in three ways according to Weber: by tradition, by charisma and by legal, or rational, means. By virtue of their roles and the customs and values inherent therein, the chairman and the CEO share only one form of power - legal/rational authority.

The other category, charisma, is determined by personal qualities. The chairman may be permitted legitimate power because his personal conduct is attractive and influential to other members of the board. This may also be the case for the CEO.

But charisma is a religious term meaning "gift of grace". A charismatic induces his followers to suspend critical thinking and invest themselves in the leader wholly and emotionally. The quality is not on the whole characteristic of Australian business leaders.

Authority, by comparison, is a quality that enhances power, rather than being itself a form of power. The word "authority" derives from the verb "to authorise", and so an individual's power must be authorised by the group in order for it to be legitimate.

An individual is considered an authority because of his technical expertise, combined with his ability to communicate effectively with the group.

The individual in authority is the one who is primary in the group, controlling certain aspects of what the other group members do and say, and perhaps even what and how they think.

It's possible, therefore, that the most influential member of a board may not be the chairman or the CEO, but rather a subject-matter expert who can formulate convincing arguments better than the other members of the board.

The well-publicised debate between Telstra CEO, Ziggy Switkowski, and non-executive director, Sam Chisholm, over a proposal to take over John Fairfax Holdings, is a classic example of authority versus power. Telstra chairman, Bob Mansfield, supported the proposal, known as "Project Patrick". But Chisholm - whose argument swayed the board to reject the proposal - was deemed the subject matter expert (rational authority).

It is important to note that the power relationship between the chairman and the CEO is skewed by the fact that the board has the authority to hire and fire the chief executive. The balance of power in the chairman/CEO relationship is technically in favor of the chairman, but Weber would argue that this power is dependent on the chairman's authority being vested in the role, as well as his technical expertise. His ability to influence his fellow board members is also relevant.

The Aristotelian kitbag of rhetoric, argument and debate is therefore the defining characteristic of success in the battle for power and authority in the boardroom.

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We've been here before.

There was unauthorised trading in foreign exchange options. The foreign currency traders exploited weaknesses in our internal procedures. We have identified those weaknesses and closed them. - Frank Cicutto, former CEO, National Australia Bank.

Long before Enron, WorldCom and HIH, and before corporate governance became management buzz, there was a company called AWA. This large, diversified electronics manufacturing and trading company had a problem with a foreign exchange issue. It accused its auditor of negligence for not alerting management to the inadequacy of internal controls that should have detected the problem. The FX deal incurred considerable losses for AWA. In its defence, the auditor accused the AWA board of negligence for not being aware of the problem.

This 1992 case focused attention on the practice of directorship in Australia and highlighted the requirement for risk management to be a prime focus of a director's role. In corporate law circles, this case (including a subsequent appeal) has become a landmark judgment in determining cases concerning directors' duties, and it is the foundation stone for public debate on boardroom behavior.

So well known is the AWA case, it is taught in corporate governance courses as a classic study of why members of a board - in particular non-executive directors - should be regularly monitoring risk management procedures. Risk management is a common subject in a basic course in corporate governance. One role of a board member is to work out the risks likely to be faced by the company and to ensure that there are means to prevent them becoming reality.

The course for company directors offered by the Australian Institute of Company Directors, for example, summarises the key implications of the AWA case and appeal as being the ability of directors to access company documents and to seek independent professional advice. But the key question remains: do directors exercise these rights, and, if they do not, what is preventing them?

Some risks apply to all businesses and some risks are peculiar to a single or a type of company. A bank, for example, will always face risks associated with foreign exchange. It is natural, then, to draw parallels between AWA and the National Australia Bank, and to ask whether lessons have been learnt.

In a keynote address last year, Andrew Rogers, QC, who was the presiding judge in the AWA case, lamented that corporate governance reform in Australia might even have gone backwards. 'The reality is that the monitoring system is only as good as the product it provides. On the surface, the monitoring system may be working satisfactorily. In truth, it may be broken. To my mind, it is a matter of extreme difficulty for non-executive directors to become aware that the monitoring system is not working as it should.'

His comments once again serve to highlight the fact that the role of a board member, and the role of the board as a whole, in its absolute form, is to ask questions, form opinions, debate issues and make decisions.

As Rogers noted, there are now several highly publicised examples of how a board may exhibit the qualities of so-called 'best-practice corporate governance' yet still fail to prevent a corporate collapse. The HIH board had a majority of non-executive directors with broad business experience; an independent chairman; committees for audit, compensation and investment matters; regular monthly board meetings; and a code of conduct for directors. Academic studies of the board of Enron come to similar conclusions.

The defining differences for an effective board must, therefore, be the people at the board table and, more importantly, how they perform as directors. Rogers said: 'The fact that a director may be an engineer, and indeed appointed to the board by reason of the director's particular skills, does not relieve that director from the obligation to know something about balance sheets and financial accounts, and generally to discharge [their] duties. Some despair and say that one cannot legislate for honesty and care and skill. Yet that is what the corporation law does, and imposes sanctions for failure.'

In my 2002 report for KPMG on the training and education of board members, I concluded that company directors, if they are 'experienced', do not see the need to attend courses on corporate governance. The people interviewed for the report considered the content of courses too 'low level' to be of assistance, and that their time would be better spent reading and talking to peers and management rather than attending formal courses.

Even so, it would be wise in today's climate for board members to put the AWA case on their required reading list. The more recent performance of the National Australia Bank board should also be studied.

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Try a little sensitivity.

In a previous column, I looked at the subject of role playing in the boardroom, and at how members of a board play different roles according to the way they perceive themselves and others, and how others perceive them.

This column, ( CFO , October 2003 ), was based on the theories of the American pragmatist George Herbert Mead, who argued that individuals evolve socially, and only by comparing and contrasting themselves with others.

An effective chairman will understand that board members modify their behavior in order to maintain their membership of the group, and will alternate between roles. A self-aware chairman will appreciate that he or she acts in the same way.

The role of a board member can be divided into three categories. First is the administrative category - chairman, deputy chairman, executive director, non-executive director.

The second category is based on the skills and experience of each board member - typically the roles of lawyer, banker and accountant.

The third category concerns individual motives for maintaining membership of the board. The roles might be leader, token woman, name director or maverick.

Following the publication of the October column, a chairman contacted me and said: "I accept your argument that if I understand the behavioral patterns of my board members, I will increase my position of power and authority in the boardroom. I have to put myself in their shoes. But how do I do that?"

It is true that Mead's theory of "adopting the role of the other" fails to specify why individuals choose their roles and how they enact them.

Mead offers a perspective on role-playing, but not a solution to the problem of how a role is interpreted. The answer is to be found partly in the term "social sensitivity", which is common in the study of group dynamics and is more popularly known as empathy or insight.

Social sensitivity refers to the degree to which the individual perceives and responds to the emotions and feelings of others. Social insight and social judgment are, according to academic research, positively correlated with effective group leadership.

These same studies found that independence and resoluteness are essentially the opposite of social sensitivity. These traits correlate negatively with friendliness and social interaction.

Social sensitivity cannot therefore be the missing link to an understanding of the role playing motives of board members.

Independence and resoluteness are essential characteristics of good directorship and are required for effective decision-making, especially when a board member is attempting to control the debate.

Instead, the bridge from Mead sought by my client had already been built by a French philosopher, Henri Bergson, who is known for his system of intuitive introspection.

Bergson argues that an individual "adopts the role of the other", or in his language, "has absolute knowledge" of another through "empathic intuition".

Empathetic intuition is the ability to locate ourselves in the experiential place of another through an understanding of "shared experiences". "Intuition is the sympathy by which one is transported into the interior of [another]", he says.

Knowledge of shared experiences is extremely difficult to achieve as two people will never react to the world identically.

The homogeneity of the Australian boardroom, however, is a perfect environment for testing Bergson's ideas, because board members are generally sourced from the same cultural, work and educational backgrounds.

By combining Mead's theory of role-playing with Bergson's intuition model, a chairman will complement his or her skills as the leader of the boardroom.

The proper execution of the administrative tasks of the role, combined with an intuitive understanding of the individual motives of board members, puts a chairman in an extraordinarily powerful position to persuade the group.

The chairman will recognise, for example, that the non-executive director appointed on the basis of technical skills in accounting is sliding between the role of "subject matter expert" and "leader" in order to influence the other board members to upset the balance of power.

Alternatively, a woman who has been appointed to the board as a "double dipper" - for her investment banking skills as well as her sex - may know that to move from the role of "token woman" to so-called "maverick" would not be wise in the current mood, as Caroline Hewson learnt when she resigned from the AMP board.

Instead, she may choose to become a "name" director, or one who is desired and sought by other boards, thereby distracting attention from her sex, and replacing it with respect for her knowledge and skills.

Chairmen who use intuitive reasoning to unravel the role-playing motives of board members will be the master craftsmen of the boardroom.

As such, they become simultaneously puppet-master, manipulator, rhetorician, mentor, statesman and adjudicator. Mead would be proud of them.

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Take a tip from Einstein.

As an independent observer at a board meeting, I noted board members were attempting to find resolution by examining the facts presented, then listing objectives to respond to issues.

I later suggested the chairman revise his facilitation technique and ask members of the board to offer a range of problems, ideas and theories on the issues presented to the board. At subsequent board meetings the standard of debate and decision-making improved markedly. Why?

Problems are the starting points for learning. One problem stimulates more problems, and by consequence this collection of problems produces a series of theories and hypotheses.

A problem involves the discovery of a mismatch between expectation and experience, actual or anticipated and a desire (or will), to resolve the mismatch in some way. Problems trigger the search for a solution, and the creation of a solution brings with it a new set of expectations, thus deepening the search for answers.

By concentrating on theories, rather than on facts and objectives, the board gained a greater perspective of the key issues facing the strategic direction of the business.

British academic Joanna Swann, who has developed a theory of the logic of learning based on the work of the 20th Century philosopher Karl Popper, argues against objectives-based planning. She says this decision-making generally promotes mediocrity because it provides no mechanism by which bold - and potentially valuable - ideas can be discussed and tested.

Objectives-based problem solving is poor practice in our case, because it encourages concentrating on a solution (and sometimes a quick-fix) as it is easier to avoid problems than confront them. This type of problem solving also discourages contention and conflict, which are both essential to debate.

Theoretical problem solving, conversely, begs for probing inquiry: questions of value, ethics, logic, aesthetics and history. As Popper wrote in his autobiography Unended Quest: "What must be taken seriously are questions of fact and assertions about facts: theories and hypotheses; the problems they solve; the problems they raise."

Take, for example, an issue facing the board to which I have been engaged: should their company remain a single entity or merge with or take over, a similar enterprise. By embracing a theoretical approach to the issue, the board members began by debating the positive aspects of their situation so they didn't lose what was good in the search for something better. In other words, they debated whether the grass really was greener. They asked themselves "what is going well in the present situation?" and "what do we want to defend, maintain and develop?" The board members then discussed the potential negative consequences of merging with or acquiring another business. "What isn't going well in the present situation?" they asked, and "what aspects of the current state of affairs do we want to change?"

The debate then turned to an assessment of the risk of maintaining the status quo. "What is inhibiting these changes from taking place?"

From this starting point, the board members developed theories about how impediments could be removed. Then, after critical discussion, they developed a series of trial solutions from which they could identify positive and negative consequences.

These trial solutions were then tested, and an evaluation was made. The board members asked themselves questions such as "to what extent, if at all, has the initial problem been solved?". They also queried whether any unintended and unexpected consequences (desirable and undesirable), would arise.

The most important question was left to last. "With the benefit of hindsight, what other strategies (theories and trial solutions) would have been preferable?"

Better decision-making was not the only positive outcome of the chairman's revised approach to facilitation, which can be loosely referred to as "structured brainstorming". By employing this process, he also ensured all his board members' conflicting ideas about solutions were addressed and acknowledged. In this way he achieved his goal - to maintain the collegiality of the board, while simultaneously improving its decision-making capacity.

Popper's falsification theory attests that while empirical generalisations may not be verifiable, they are at least falsifiable. He concluded that all we know is a "woven web of guesses". It was by applying this theory that Einstein falsified Newtonian physics.

The chairman in this example now discourages board members from focusing on finding the right answer, instead emphasising the search for the right question.

As US management guru Peter Drucker wrote in his classic The Practice of Management: "The first job in decision-making is to find the real problem and to define it. Too much time cannot be spent in this phase."

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