Lessons from Enron: Is a Board Right for Your Business?

By James Olan Hutcheson

The recent Enron implosion has, if nothing else, given new prominence to the role of boards of directors in corporate governance. Many have rightfully asked what Enron's distinguished current and former directors, including a member of the British House of Lords, the former dean of the Stanford University Graduate School of Business, and Wendy Gramm, wife of U.S. Senator Phil Gramm, were doing while Enron burned.

We may never know the answer, no matter how lengthy and determined the investigation. But a trend is emerging as all types of businesses are looking at Enron and drawing conclusions about the role of a board and the types of people to include as directors. This “review process” has its dangers.

There are over 20 million businesses in America, and virtually all of them are as unlike Enron as an owl is to an ostrich. Almost all these companies are smaller than Enron was, or is now. The majority trade in more tangible commodities than energy supply contracts and “special purpose entities.” Most importantly, all but a few thousand are private companies, which makes it risky to apply too much about boards from the Enron debacle.

The board for a small, privately held company is different from Enron's

Legally, a board of directors is required of every corporation in America. For most family companies and entrepreneurs, this is a mere technicality easily satisfied by including family and friends who are eager to sign off and attest to the annual corporation minutes.

A board of directors that might have served Enron shareholders and employees well would likely be of little value to the typical American company. The board of any company is designed to help the organization's management develop goals and objectives, as well as formulate strategies and plans.

Additionally, a board is responsible to ensure that the CEO adheres to certain overarching fiscal responsibilities. A board of directors in a publicly owned company chooses, evaluates and, if necessary, fires the CEO. In a family or closely held business, the ability to hire and fire the CEO won't always work because the CEO is often the owner.

Another key difference is that, as a rule, directors of publicly held companies are supposed to represent shareholders. But public company directors often are not shareholders, or at least significant shareholders. In a family business, on the other hand, it's entirely appropriate and preferable for major shareholders, including family members, to sit on the board. Since a broad group of thousands of diverse shareholders does not exist in a private company, the role of the board in such a company takes on a fundamentally different meaning.

A private or family owned company's board is not there to provide oversight or protect individuals from management depredations. Its purpose is to provide services to management, which, in this case, is likely synonymous with ownership. Board members may be chosen based on past experience, general skill at management, specific competencies (i.e., accounting, finance, etc.), insights or contacts within particular industries. They may help establish compensation, provide objective viewpoints and offer oversight of both strategy and financials. Their oversight of the CEO is more limited than in a public company because, in a real sense, they work for the CEO rather than the other way around.

Boards can be problematic but useful for small businesses

Boards frighten many owners of privately held companies because they don't like being told how to do their job. If they feel they must choose a board that would have prevented the Enron collapse, a board with a great deal of power and oversight with the mandate to use it, they are likely to have no board. In fact, only a minority of companies has any board at all.

That is a shame since boards of directors can provide tremendous benefits for many companies—if their owners understand the purpose of a board in their specific context. This does not mean that a board should be a collection of “good old boys” and family friends. The composition of a board of directors should be designed to fill in management capability gaps, not rubber-stamp CEO whims.

Once it is understood that a board doesn't have to prevent an Enron-like disaster, but is intended to help management lead their business better, they are ready to ponder who should be on the board and how to select candidates. For instance, in a public company, the board selects management; in a family company, the opposite is true. Those operating the company select the people who will give them advice.

Advice on establishing a board of directors

Since most family business CEO's don't have experience with corporate boards, it is important to think through the details of the needed skills and then design board job descriptions and responsibilities. Logistical questions that should be asked include:

• How often to meet?
• What should be discussed?
• How should we share financials?
• How much should board members be paid?
• What is the right number of people to have on a board?

When answering these questions, always remember that people tend to support what they help to create. Every board is different; there is no single “right” way to build an effective board. If the CEO is left to create his or her own board, the result will greatly increase the likelihood that board input will be absorbed into the company culture.

However, keep it small and simple in the beginning. This means start by scheduling two meetings a year and include no more than two new outside directors. Boards work best when they are small, such as four to six people. Ideally, a board should have less than one-half the members from inside the company or ownership family.

Selecting the right people to serve on a board is often difficult. Resist the urge to repay a favor or to honor a long-time friend or community leader by extending an invitation to serve. Board members should first and foremost not be encumbered by either the business or the owners. This means every board member should be objective, candid, and removed from the non-business issues of the CEO or chair.

Above all, the board candidate must not be financially dependent upon the CEO. This usually eliminates employees, golfing buddies, dependents and paid professional advisors. It includes, however, all other competent and able individuals. Always be sure that board candidates offer a needed special skill or experience that is lacking in the current structure.

Unless the business story is very compelling and the CEO so dynamic, prepare to open the corporate wallet. If potential directors will serve for no compensation, you don't want them. You want directors to take the role seriously and act the part, which means paying them for their time. Typically speaking, for a family-owned and -managed firm with sales under $75,000,000, expect to pay $2,000 to more than $10,000 per year (plus travel expenses and even stock options). Larger companies may pay more and, if the conditions are right, may offer stock or phantom stock options. Don't balk about the money it costs to assemble a board; the return of benefits will far overshadow any costs.

If properly created, a good board may be the single most important element in the long-term survival of a company. If you can collect a group of people who are highly competent and work well together while not being afraid to express differences or remain objective, you have the makings of a meaningful and effective board. Choose a good board to help you run your business, and it will do just that. Select a bad board, or no board at all, and there's that much less difference between you and Enron.

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Author Bio: James Olan Hutcheson is the president and managing partner of the family business consulting firm ReGENERATION Partners. He can be reached for comments and questions at jim@regeneration-partners.com or (972) 559-3999.