Most company directors don't know what their role is or what their legal responsibilities are. E&T talks to the author of a book calling on organisations to build board competence.
'As we move into tougher economic times you'll find that a lot of people are being told that they won't get a pay rise, but they can have a fancy new title.'
Bob Garratt, author of the influential 'The Fish Rots from the Head', is discussing a trend where workers are made 'director of this, or director of that' instead of given a salary increase when there's nothing in the pot. The idea is to raise the status of the employee without giving him money. It all sounds like a harmless vanity. But it's a high-risk strategy because 'unless that person is made a statutory director, then in accepting the title they might be breaking the law'.
And it is this relationship between the company director and the law that forms the basis of Garratt's book. Without a clear understanding of the legal territory a director occupies, the board performance can go rotten. And so the fish, to borrow the Chinese saying, rots from the head.
'The trouble is,' says Garratt 'that many companies have director indemnity insurance policies, but that only covers statutory directors.' And it's a big problem. Garratt doubts if more than 10 per cent in corporate governance understand what a director is or isn't. Put simply, if you have the word director on your business card – 'director of operations', 'design director', 'marketing director' – you are exposing yourself to the legal liabilities of a statutory director. 'This would become a problem if something went horribly wrong, when the people taking action against the company would look at who the directors are. The statutory directors are clearly identifiable, but a smart lawyer would go for anyone styled director. It's your personal wealth that will be at risk.'
We hear a lot about executive and non-executive directors, so what's the difference? 'None, actually. You're either a statutory director or you're not.'
Getting in on the act
Garratt knows his stuff and he has a string of credentials as long as your arm. Apart from being a best selling author, he's a 'pracademic' and an international consultant on board evaluation and development, corporate governance and strategic thinking.
He's professor or visiting professor at universities around the world (including 'professor extraordinaire' at the University of Stellenbosch Business School, South Africa). Garratt helped set up the first Chinese MBA programme, has advised the IMF, is an external examiner for the Institute of Directors and is a past master of the Worshipful Company of Management Consultants.
Somehow, in among all this, he managed to squeeze in a decade as the external director of the Lloyds TSB Director Development Programme. It was in this last role, under the influence of Sir Brian Pitman, that Garratt gained some of his most profound insights into the role of the board director.
The new edition of 'The Fish Rots from the Head' has been published not because the way boards work has changed, but because the economic and political contexts in which organisations work have led to changes in the Companies Act, which is now an 1,800 page document consolidating some 350 years of 'bits and pieces of legislation'.
Prove your future
Garratt explains that there are two fundamental changes. First, a statutory director now has to demonstrate their duties of care, skill and diligence. Second – 'which will come as a shock to most people' – is you now have to state personally that your organisation is a going concern. Until now the chairman signed the annual reports to the effect that the accounts were true and accurate, but was under no obligation to make the statement that you 'have a future. And that's tricky in a recession,' says Garratt. 'Now you have to say that there are future contracts and a reasonable prospect of getting future contracts, and that you have prudent control over the business, before you can sign. And that's not just for the chairman either. Each director has to have the ability to sign that their organisation is a going concern.'
Board vs management
Another key theme is the difference between directors and managers. In operational terms, directors generate strategy, which is then implemented by management. 'Eighty per cent of business strategies don't work because there hasn't been the development between the board and the executive.
'By the time management comes to implement, which is their major role, they don't really understand what's going on. As a consequence, I came to understand that most organisations, as you get nearer the top, are increasingly inefficient and ineffective.' Garratt found himself wondering 'why the hell these people were paid to do a job that they don't do. That's why I originally wrote the book.'
Given the extraordinary title, it's tempting to ask Garratt if there is simply something fundamentally wrong with the way organisations are managed. 'There is something fundamentally wrong in the way we think about the design of our organisations.'
When pushed further on the question of whether the wrong people are becoming directors the answer is 'yes. Most people who become directors are executives of other companies and I think that's wrong too, because unless they have really good directorial selection and induction their behaviour and thinking stays in the executive mode. In effect, all you've done is to appoint a group of executives – some from inside and some from outside (so called 'exec' and 'non-execs' – without getting them to reconsider their roles or thinking processes. The result is they tend to replicate what they do in their own companies on that board. They're seen as, and are said to be, outsiders. But they're not, and that can create a self-fulfilling oligarchy that simply sits on each others boards'.
But doesn't the new version of the Companies Act nip the problem in the bud, by updating a legislative framework to prevent further bad corporate governance? 'Yes it's there, but it's not being applied. Most of what's needed in this area in structural and process terms already exists. The reform of the Companies Act has helped enormously, only it's not being policed and it's not being implemented.'
Garratt goes on to say that 'the best solution of all' is the annual appraisal of the board itself as a unit, followed by each of its committees and then by each individual director. 'Most boards are now trying – often half-heatedly – to do that. In the UK we have this notion of 'comply or explain'. What we need to do is stop ticking the boxes and give examples of what we've done to apply the Companies Act.'
There are plenty of examples to show that once the head has gone rotten the rest of the body corporate will follow. 'I found the phrase in Northern China and it follows the Silk Road through Russia, the Islamic world, down to the Mediterranean and across North Africa to Morocco. There's a whole series of global cultures that use the phrase and it's pretty well tested. It's also biologically true too. It's a malaise where you might think that the fish rots from the gut, but it doesn't. The gut follows pretty quickly, but it starts at the head.' *
'The Fish Rots from the Head', by Bob Garratt, is published by Profile Books, £9.99