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39 study from 2005, Professor Øyvind Bøhren stated, “the board’s value creation increases if large owners are represented on the board”. The analysis shows that
“greater diversity on boards reduces the efficiency of decision-making and thus value creation”. He further wrote “board members with professional business ex-perience and who sit on several boards contribute to greater value creation”.
“Shareholder activism” has increased in scope in recent years. Activist inves-tors, a relatively active type of owner, are often concerned with short-term goals that are often achieved by restructuring the company’s capital structure. Even though this type of financial manoeuvring may seem short-sighted, value may still be created with a more effective capital structure. Buy-back of shares can also be a way to generate shareholder value, al-beit only as a method if the capital cannot be used for other activities that create value.
Strategy and risks
Given that a board of directors consists of competent board members as discussed above, how can the board contribute to value creation? The first criterion is that the board, together with management, draws up a good strategy for the compa-ny’s activities. The compacompa-ny’s market de-termines how demanding this will be.
Some companies operate in markets that change quickly, and where detailed knowledge is necessary for the board.
The IT sector is a good example of this.
Other companies operate under more sta-ble framework conditions and markets, while a number of companies depend on commodity prices that can fluctuate con-siderably. A good example these days is the petroleum and gas sector. Who would have thought on 1 January 2014 that oil prices would fall by over 50 per cent dur-ing the year?
In order to create value, boards do not only need to help draw up a good strategy for the company, but also assess the risk in the market in which the company oper-ates. This requires that the company, to-gether with the board, defines the risk to the company, and assesses macroeco-nomic trends.
Very few people are likely to have fore-seen all of the changes that took place in 2014. It is almost impossible to predict abrupt changes in markets. The board
© Entra ASA
should therefore know at all times how to respond to any changes, even though it cannot predict them. This means that the board, together with management, must assess different scenarios at any given time. The “Roads to Resilience” report by British analysis firm Airmic studied com-panies that both create value and with-stand crises. One of the conclusions is that “Resilient companies have exception-al ’radar’. Radar helps an organisation consider risks in aggregate, collate differ-ent types of information and respond ef-fectively in a controlled and considered manner.” A board that creates value is aware that sudden changes in the market can provide substantial opportunities for value creation for those who are prepared.
The Norwegian Institute of Directors has discussed risk at several conferences and meetings. By creating such discus-sions between board members, others can learn from how difficult situations are handled and how new opportunities can be exploited. Another conclusion from the report in question is that “Resilient com-panies do not just manage risk within their organisational boundaries – they proactively manage risk throughout their networks of suppliers, contractors and franchisees.” Board members should be a resource group for management, a net-work that brings external information and opportunities to which management itself does not have access. In this way board members is used as a valuable resource in companies in our neighbouring country Sweden, and in other countries, but per-haps not as much in Norway.
The board’s participation in strategic processes
Regardless of the industry in which a com-pany operates, it is important that the board of directors is involved in the strate-gy process at an early stage. There was a Swedish company where the management considered investing in what was a new in-dustry for the company, so the manage-ment obtained a detailed external assess-ment of the industry in question. This as-sessment was presented to the company’s board, and the board was asked whether it was willing to consider entering such an industry if there were investment opportu-nities. The administration thus did not waste time evaluating an industry to which
the board was not positive, and the board and the management shared ownership of the strategic process.
When the interaction and the distribu-tion of roles between the board and the management work effectively, such exam-ples of a shared strategy process allow val-ue creation over time. The board and the management work together to develop the company’s strategy and projects, according to the above-mentioned “Roads to Resil-ience” report: “Recognising that no one in-dividual, no one function, no one organisa-tion is as smart as many thinking together.”
Long-term perspective
A long-term perspective is one of the basic factors for successful value creation. Sev-eral reputable communities refer to the long-term perspective with a view to creat-ing value.
The article “Ten Ways to Create Share-holder Value” by Alfred Rappaport, pub-lished in the Harvard Business Review in 2006 pointed out ten excellent principles for value creation, stating: “Make strate-gic decisions that maximise expected val-ue, even at the expense of lowering near-term earnings.”
The following appears in Berkshire Hathaway’s Ownership Manual: “If we have good long-term expectations, short-term price changes are meaningless for us except to the extent they offer us an opportunity to increase our ownership at an attractive price.”
The long-term perspective is always important to Investor AB’s board in Swe-den, in line with the company’s business concept: “We are a long-term owner, fo-cusing on doing what we deem best for each company. Through our international network, strong brand name and active ownership, we create significant value.”
Acquisitions
Value creation through mergers and ac-quisitions requires in-depth assessments by the board of directors. It is necessary for the board to have competence to con-sider such strategic measures if value is to be created. Many studies show that most large mergers do not create the expected value. The management’s self-interest can also block the best decisions. This is why the role of the board is extra important in this form of value creation.
For companies that regularly make small or large acquisitions, it is important that these transactions are assessed later, so that the board can determine whether the acquisitions actually contribute to value creation. What was the plan of the acquisition? What were the greatest prob-lems with the process? Boards must ask these important questions, so that a transaction can be executed in an even better way next time. Again, the long-term perspective is important to value creation. The third principle for value creation from the above-mentioned Har-vard Business Review article is: “Make acquisitions that maximise expected val-ue, even at the expense of lowering near-term earnings.”
External factors
The board of directors’ job during the company’s strategy process is to consider the company’s competitive position in light of market conditions, risk and mac-roeconomic trends. The company should own assets that maximise future earnings.
History is full of examples where the board and the management did not realise that precisely their product was not strong enough to withstand changes in the mar-ket and competition (for example Nokia and Kodak). The Norwegian Institute of Directors has had meetings on the strate-gy process and how to handle crises that arise. A measure that has been success-fully used has been to establish board sub-committees if the company has a difficult strategic challenge or is considering mak-ing major changes.
Development of the management Value creation through good board work is naturally impossible without good cor-porate management. The board of direc-tors’ involvement in the companies’ devel-opment of the management will therefore be an important aspect of a board that cre-ates value. At Statoil, the name of the com-pensation committee was changed to the compensation and executive development committee, as much of the attention was on management development and plan-ning who would replace executives who left (succession planning).
Greater attention to succession plan-ning means that the board must be very familiar with candidates for executive
po-41 sitions within the company, and must
have an overview of external candidates.
Through board evaluations and in dia-logue with the Norwegian Institute of Di-rectors, board members state that there is still not enough attention on succession planning and management development.
The boards of many companies do not know the internal candidates well enough.
Consequences
Many organisations in large companies are organised in matrix form. This means that the company’s management is not al-ways responsible for cash flow. It is diffi-cult for all companies to get executives to think commercially and to think on behalf of the whole company, and not only their part of the business.
Many companies lack a clear culture where failure to achieve goals has conse-quences. An important factor for the work to create value is to ensure that the com-pany has a “performance culture” and a functioning reward system. The following appears among the principles in the above-mentioned article in the Harvard
Business Review: “Reward CEOs and oth-er senior executives for delivoth-ering supoth-eri- superi-or long-term returns.”
Several leading stakeholders in Nor-way place limitations on the board of di-rectors of big companies in terms of re-ward systems, which means that the best executives, who have created the greatest value, do not necessarily choose to be ex-ecutives in Norway’s largest companies.
The Norwegian Institute of Directors has also discussed this topic on several occa-sions. Many people believe that even though compensation plays a big role, it is also necessary to change the culture, so that executives become more concerned with delivering on their promises.
Communication
Demand for shares helps increase a com-pany’s value. This is why the board of di-rectors should make sure that communi-cation to shareholders is clear about, for example, the company’s objectives, its capital structure, and what remains on the bottom line.
Shareholders must gain an understand-ing of the company’s value drivers and
how the company delivers on its goals. If this information is not provided, there may be uncertainty regarding the ability of the board and the management to cre-ate value.
Expectations towards the board Owners can help create value by present-ing the companies with clear expectations.
Here I will present an excerpt of Folketryg-dfondet’s expectations towards board of directors at companies in which they have invested:
“We expect the companies’ boards to:
•
Draw up clear goals and strategies for their operations within the frames of the articles of association.•
Draw up clear goals for the company’s return on capital and growth.•
Establish capital requirements and al-location based on clear financial goals and criteria, such as return on capital, growth and capital costs adapted to the company’s general strategy.•
Draw up goals for the capital structure, adapted to the company’s strategy and risk profile.”© Jarle Nyttingnes
STATENS EIERBERETNING 2012 – CompanySOMTALE