As someone who has served on over twenty corporate boards, Warren Buffett (Trades, Portfolio) knows a little bit about what the job of a director should be.
Unfortunately, far too often directors seem to only exist to agree with the management that appointed them. At the 2007 Berkshire Hathaway BRK.ABRK.B, Buffett explained what he believes the three main tasks of a board of directors are.
Buffett says that most CEOs don’t really want the input of their directors. This makes sense; if you are someone who has spent your entire career rising to the level of the executive suite, it is unlikely that you are the kind of person that will embrace the views of people whose opinions are different from yours, perhaps even seeing them as "meddling with your job." For this reason, many directors are what Buffett referred to as "potted plants," or high profile people whose main function is to rubber stamp what management does.
What a board should be doing first of all is picking the correct CEO. Buffett says that “90% of your job as a director is having the right CEO." A director should pick someone who is highly competent and empower them to implement their vision for the company.
With that being said, the second function of a board is to prevent overreach by the CEO, either in cases where management is not acting in the best interest of the company or when a well-meaning executive team is being overzealous and needs to be reined in a little.
The third thing a board should do is bring an independent perspective on acquisitions. As Buffett puts it:
“There is a natural tendency for people with big egos and big motors who get to be CEOs who like to do big things and to become bigger spending other people’s money. Normally, when big deals come along [for approval] management has already made the deal anyway, they have investment bankers there that will go through a little ritual - I’ve never seen one come in and do a presentation which says it’s a dumb idea! They know what the answer is supposed to be, and it becomes a little game.”
In summary, Buffett says that the major functions of the board are to pick a great CEO, not micromanage them and only really exert influence when big deals come up. I think the deal aspect of this quote is most interesting. Generally speaking, proposals only go to board approval if the executive suite wants them to pass. This skewed state of affairs puts additional pressure on the board to approve proposals that are put to them.
I think value investors doing their due diligence on companies should pay close attention to how much boards scrutinise the actions of management, especially if they are considering investing in a business going through a rough patch. If the board is clearly on top of things and is working to improve the company, that is clearly a good sign. If they are sitting back and allowing the CEO to do whatever while the value of the company collapses, then maybe you should look elsewhere.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Chamath Palihapitiya: The Government Should Not Bail Out Mismanaged Companies
- A Brief History of Junk Bonds, Part 2
- Black Monday 1987: Why Investors Should Be Wary of Automated Selling Strategies
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