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How much industry knowledge does a board member need?

Management consultants, McKinsey,  published a paper this week titled, 'Corporate boards need a facelift'. It includes:

"Knowledge gap: Our 2013 survey of 772 directors revealed a shocking lack of comprehension of their companies. Only 16% said directors strongly understood the dynamics of their industries, just 22% said directors were aware of how their firms created value, and a mere 34% said directors fully comprehended their companies’ strategies. Our latest survey indicates these findings haven’t changed much since 2013. Frankly, these flaws limit the effectiveness in the board and often lead management to limit interactions with their board by trying to manage through meetings, rather than viewing the board as a helpful source of new ideas and expertise and a sanity check on strategy."

Here is an exchange with a Cuffelinks reader on the subject of board expertise. In response to revelations at the Royal Commission and the subsequent resignation of four directors from the AMP Board, I wrote this editorial comment last week:

"The structure of wealth management is a complex and intriguing web. There are so many gatekeepers, with dealer groups, asset consultants, rating agencies, fund managers, regulators, industry associations, media groups, platforms and financial advisers, each with a power base and clients. The Royal Commission is only unraveling parts of it.

Which is why the calls for 'clean brooms' from outside wealth management to sweep through the industry are misplaced. Every time I see a person from another industry appointed to a board position in wealth management, I wonder what they know about the value chain and who pays the piper. The AMP head of advice told the Royal Commission he had not "turned his mind" to commission structures. How could the former Chair of AMP, previously a middle-level executive at investment bank ABN Amro, have understood thoroughly what was happening in the advice payment structure?"

Response from a reader

A reader who is not known to me personally, Carlo Bongarzoni, sent this email with another perspective:

"As a relative newcomer to Cuffelinks Newsletter I count myself lucky to receive such a wide and penetrating set of thought and opinion frameworks so regularly. However in this issue 253 I would like to take issue with the negative views expressed about “non financial industry” people being appointed to positions aimed at cleaning up various facets of the industry.

Firstly many non-financially qualified people have proven ability in the investment side and other avenues within the FS industry. Secondly in my own experience within a broadish industry career range I think I can modestly claim that entering an executive role with no previous experience in that industry has in fact been an advantage to changing the culture and the results. Thirdly I would advance that ASIC’s failure to be a pre-emptive and prosecuting “supervisor” has seriously something to do with its staff mostly being drawn from industry insiders.

Becoming knowledgeable about a product or an industry or for that matter any subject does not necessarily require prior ancillary or mainstream background – only the keen desire or need to do so. It’s the qualities/abilities of the candidate that are paramount. As well – I found that listening first to those who could warts and all explain processes, history and the fundamentals prepared an initial framework of understanding. From then on it became first a process of thorough exploration within the ‘entity” asking dumb questions where necessary but always aiming for complete comprehension of the organisation, its business, its culture and its directions. Second – engaging with customers and suppliers sufficiently to learn the strengths/must dos/improvement areas and explore opportunities. Thirdly – as far as possible engaging with competitors and relevant community groups. Diving down through the organisation to the “shop floor” also vital. On this last – usually it’s the people within an organisation who can tell you what needs doing! Something that outside consultants milk and then claim it as their own insight.

That above process equips one with the ability to fulfil the CEO/Chair role or lesser executive function. I have managed that in a leading financial service organisation; the superannuation industry; the logistics industry of port management; the chemical industry and in general consulting. I raise all of this not as a boast but as a relatively striving rather than intellectual person who successfully showed that one can lead achievement in an industry without previous background.

ASIC needs a head from outside the industry who is zealous about changing the Corporation with will and the unfettered energy to prosecute its duties and clean up the industry. The banks have long portrayed little desire to fulfil their obligations under their charter – having consulted within and engaged as a B2B customer. My contact with advisor groups and investment managers indicates likewise. There are exceptions but few to the maxim that "experience within an industry" is often the best way to achieve needed change, recant the operation to fulfil its socially as well as business obligations and forecasts.

Sorry about the length but I get so frustrated with the expectancy that inside knowledge/experience is the vital pre-requisite in such matters. That’s why using past politicians to head up enquiries or to change situations invariably fail too. The head of the Royal Commission has little financial industry experience I would guess? Regards Carlo"

Then I wrote back

"Hi Carlo

Thanks for your extensive comments. We would like to post them to our website if that is ok.

I accept the need for a diversity of backgrounds on a board, as skills from other industries can be shared. However, it is also important for many on the Board, I think a majority including the Chair, to have deep experience in the company's industry, so they can provide the appropriate due diligence and governance. In any large company, the Chair needs to guide and advise the CEO, and we saw the consequences at CBA of the former Chair being too distant from the business.

It was especially important in AMP's case to have industry knowledge because it seemed the Head of Advice was 'hands off' himself. If he wasn't watching the business closely enough, did the board know what was happening? The fact that 70% of AMP's advice commission was subject to grandfathering which now may be overturned is a massive issue the company should have discussed at board level. How much did the board know about the value chain in the advice business?

So this is what I meant when I wrote:

"Every time I see a person from another industry appointed to a board position in wealth management, I wonder what they know about the value chain and who pays the piper. The AMP head of advice told the Royal Commission he had not "turned his mind" to commission structures. How could the former Chair of AMP, previously a middle-level executive at investment bank ABN Amro, have understood thoroughly what was happening in the advice payment structure?" 

I was not saying boards should not have people from other industries."

And then he responded:

"I do agree that some if not most Board members should have industry experience but that’s only as good as it should be if they’re prepared to question wisely and penetratingly. I’m not sure that the Chair needs industry experience though – just broad scope of background and a persona that isn’t easily side-tracked. One of the problems with having industry knowledge sometimes is that it offers a tendency to sometimes make assumptions about a matter that more properly should be questioned more deeply. But thank you for your response. Regards Carlo"

Your comments are welcome.

 

Graham Hand is Managing Editor of Cuffelinks

7 Comments
Fundie
May 19, 2018

From the AFR today: "Veteran experts like UNSW professor Peter Swan say that independent directors with no skin in the game or understanding of their company are the real culprit."

Leigh
May 18, 2018

The current Royal Commission has seen a number of "witnesses" produced by financial institutions who have followed the "management" route to senior levels.

They simply do not have the knowledge of grass roots operations and this is evident by the flaws that have been allowed to develop over a number of years.

Having worked in the financial services industry for many years i am not surprised by what has been made public via the Royal Commission.

The introduction of people of certain personalities and values, without knowledge and experience, with minimal training, and who are driven by bonuses has contributed to the situation.

This practice was introduced by senior management and endorsed by boards - especially if it produced the results that resulted in additional payments for board members.

Once, a long, long time ago, I may have thought certain attributes may have been adequate training for board members - that was with the belief senior management had the abilities and values to keep shareholders safe. I no longer feel that way.

In our current environment, I feel it imperative very good knowledge of the industry is required for board members in the Financial Services Sector. Certainly, in the future I may relax that view, however at the moment the cultures of these organisations needs to be changed and that means looking through the various layers of senior management to eliminate the culture that contributed to our current situation.

It has taken years for the current situation to develop.... it could take that long for a new paradigm to take its place.

Phil
May 17, 2018

My direct experience with Boards is limited (zero, actually). But I remember a head of the wealth management division of a bank once telling me about his recent strategy presentation to the Board. Based on the questions and comments received, he was convinced they had no idea about how the industry worked. I have also been involved (at the bottom of the chain) in answering "questions from the Board", many of which confirmed that sentiment.

My view is that lack of specific business knowledge need not be an impediment to good management but usually is. And this is especially so in complex industries like wealth management. This is not just true of boards, but also executives and right down to managers of small teams.

One of the problems with institutional cultures everywhere (not just banks) is the insistence that to become a leader all you need is management skill and that this is infinitely transferable. Knowledge is almost considered irrelevant. Consequently, we get politicians, chairs, CEOs, executives and team leaders whose roles seem little more than making speeches, managing narratives and holding endless meetings.

Banks have struggled to run wealth management businesses successfully because they have tried to run them as if they were banking businesses. "One size fits all" is easier to manage but also more prone to blow up.

Rob Little
May 17, 2018

Hi Graham,
With due regard for Carlo's comments (which suggest he has gained considerable experience in business across a broad range of sectors), I'm writing to say I strongly support your assertion that boards and chairs benefit greatly (indeed, desperately need) more people with hands on experience in the sector in which their company operates. Of course, this is not to say that boards cannot also benefit from the presence of outstanding individuals drawn from other sectors to occupy independent, non-executive directorships but, for my money, such members should be in the minority.
I also believe that if your views on this matter were extended to government ministers in charge of major portfolios we would witness a huge improvement in the quality of political debate and action in Australia. By way of just one important example (and with no criticism intended of Josh Frydenberg who is doing his best under difficult circumstances), consider how different things might be if energy policy was in the hands of a highly respected individual who had spent the better part of his or her career in the energy business and was able to apply his or her knowledge, experience and wisdom to guide the development of future energy policy to balance the sometimes conflicting objectives of reliability, affordability and impact on our environment.
Regards,
Rob Little
PS. Congratulations on an outstanding "Cufflinks" today. For the record, I found Hugh Dive's "Bank scorecard" and Michael Hutton's "Strategies if imputation credit rules change" highly relevant and most helpful.

Graham Hand
May 17, 2018

Rob, thanks for the kind comments. I agree re government ministers. It's a poor system when the most powerful person in the relevant industry may be someone with little or no background, making decisions worth billions of dollars. Of course they have (highly paid) advisers, but ultimately the decisions rests with a minister who may not even have any business background. A good example is the Sydney Light Rail, where we have a delay of at least a year and a $1.2 billion claim going to court, and the underbidder says that moving the utilities was always the biggest risk in the project. Who knew?

Jane Bridge
May 17, 2018

It's good to see some measured discussion about this issue which is an old chestnut that comes to life every now and then. As an independent firm who sources and identifies potential candidates for boards, we have some views about the highly varied consideration that boards apply to recruitment of Non Executive Directors. Generally far less than for executives and often by dusting off what was used last time.
Efforts by the regulators to encourage skills matrices and regular review have moved board practices some distance, but diversity must be a foundation principle - let's not have seven directors from the same industry or seven all from outside, but let's really consider the challenges the company faces and the sort of experience (and qualifications and skills) that are going to be relevant at board level.
Diversity needs to be considered from a whole of board perspective - and the gender issue which seems to have given license to the loony fringe to get on the attack again, is in there as one important dimension, not the sole driver. Actively looking for intelligent people with relevant yet different backgrounds who have enough time and interest to commit to being effective NEDs is a worthwhile exercise.
Expecting to find these in any narrow group (a single industry, or more likely 'who do we know?') will continue to lead to second rate combinations of folks with no cognitive diversity and little interest in questioning wisely and penetratingly, as Carlo has identified as being an essential responsibility.

Chris
May 17, 2018

Agreed. Just like most of our politicians (who it seems are lawyers), there's no scientists or engineers on boards that I know of except in resources companies, and even then, they aren't the majority.

 

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