How the board can prevent corporate collapse

We also talked about how the board is more likely to exercise its powers better if conflicts of interests are avoided by keeping it free from the chief executive's influence. 

We now delve deeper into the role of the board.

The dominant Chief executive

A weak board will often, after a period of seemingly successful management, effectively abdicate power to a chief executive whose drive, charisma and ruthlessness have contributed to the earlier success. The board becomes reluctant to challenge the chief executive's judgement and falls into the habit of rubber-stamping his decisions. It stops scrutinising detailed performance indicators, may allow executive compensation to spin out of control and be content to accept management figures and explanation without question.

Bruggisser, the chief executive of Swissair, is a case in point. Here, a board of distinguished businessmen failed to challenge the flawed strategies that led to Swissair's collapse. At the same time, as his power base expands, the dominant chief executive begins to behave as though the company is his own creation and no longer distinguishing between personal ambitions and those of the company. Senior management becomes packed with like-minded executives who owe their position to the chief executive and are unlikely to challenge him. The problem is exacerbated if the chief executive role is combined with that of chairman, removing another check and balance.

The dash for growth

One consequence of a weak board and a dominant chief executive can be ill-judged and over-rapid expansion, often through acquisitions. Although less than half of all acquisitions actually deliver the promised returns, chief executives, often frustrated by their inability to grow their companies organically sufficiently quickly, need little encouragement to go on a spending spree.

At best, Daimler Chrysler was worth less than half the value of its former individual parts. Even more startling was the AOL-Time Warner merger, now generally recognised as one of the greatest ever exercises in shareholder-value destruction.

An ineffective board increases the likelihood of poor strategic thinking and decision making. The board is there to "stress test" strategic proposals, and ensure, through considered challenge, that they are based on proper research, analysis and commercial sense.

Value destruction can be avoided by ensuring that appropriate due diligence has been carried out, that the acquisition makes commercial sense, that the price paid is not excessive and that thought has been given to post-acquisition integration planning. If such scrutiny is not in place, then there is a danger that the company will embark on a downward spiral leading to disaster.

Reducing the risks

A robust governance structure is a must, with an independent board led by a strong chairman who can assess the chief executive's performance in running the company. An effective board must act as a brake on poor decision-making. A competent audit committee must ensure that sound internal controls and risk assessment and management are in place. The board should encourage compensation packages that focus on long-term achievement and penalise poor performance, to reduce the incentive to increase short-term earnings at the expense of the long-term health of the company.

Legislation, as manifested by Sarbanes-Oxley, will do little to prevent future failures as it cannot address the underlying causes. It will not prevent companies pursuing flawed strategies or making poor acquisitions. Nor will it rein in an overly ambitious and greedy chief executive. Only a strong and challenging board can do that.

Stewart Hamilton is Professor of Accounting and Finance, and Dean, Finance and Administration at IMD.