Optimizing governance: board types

Letter from the Editor

You've probably heard it said that "there is no single right answer to how a co-operative should be governed." While this is true - governance is situational - there are probably some wrong answers to this question.

This edition of Governance Matters focuses on governance of co-operatives, and in particular explores some of the common issues that we encounter working in that arena ... and some strategies that you can use to improve the quality of your governance.

We begin with a brief overview of what governance is, then walk through a typical governance "journey" of a co-operative or credit union from its founding, and how these stages of growth affect the "optimal" board type.

Enjoy this edition of Governance Matters, and, as always we welcome your feedback.

Debra L. Brown

Editor

What is governance anyway?

Governance is not just another word for management.

Governance is not just another layer of management, a sort of "super-management" or a sober second look at decisions.

"Governance" is a separate system, distinct from the "operational" system.

Both systems exist in every enterprise or organization, including co-operatives, although they are not always clearly defined, nor distinguishable. They should be.

The operational system is the system that develops and delivers products or services.

Governance is the system by which firms [organizations, including cooperatives] are directed and controlled.[i]

Governance systems exist in every form of social organization, at every level.

Governance exists at international (e.g. IMF, World Bank), national, provincial, municipal, corporate and social organization levels.

[i]The Committee on the Financial Aspects of Corporate Governance, The Cadbury Committee Report, "The Financial Aspects of Corporate Governance" (London: 1992)

Why are there different types of boards?

In economic "principal-agent" theory, governance is all about how scarce resources are allocated to the most effective uses.

"Principals" provide the resources - "agents" use the resources - and "governance" is the intermediary, arbitrer or referee deciding between them.

In co-operatives, the principals are the members - the legal and beneficial owners.

The agents are the CEO, management team and staff.

Governance is typically provided by a governing Board of Directors.

Boards fulfill their governance duties in different ways. It is often instructive to think of there being five different "types" of Boards.[i]

These types of board tend to evolve over time in a predictable and observable fashion, what we call the "governance journey".

When co-operatives and credit unions are first founded, their boards are often "operating". They make all the day to day decisions as well as the strategic, because they have to - there is no one to delegate to. Everyone who is central to the co-operative is sitting around the boardroom table already: the founders, funders, workers and idea people.

As the co-operative grows, the operating board strikes various committees to undertake slices of its work - e.g. staffing, business development, membership, facilities, technology, fund-raising, standards, discipline, communications. But both the committees and boards are "hands-on".

As the co-operative or credit union grows further, the board hires staff, and delegates work to the staff. The board becomes an "intervening" board, meaning that it intervenes in operations when it feels it needs to, but leaves the rest of operations to staff to run. This is usually when staff does not have the capacity or competence in specific areas, or when board members have the desire and time to do the work themselves.

Lots of organizations, including co-operatives, can survive and even prosper under an operating or intervening board. Examples include many day care, housing, worker and small cooperatives. There is no clear line between who "does governance" and who "does operations", but things get done.

Eventually, though, as a co-operative succeeds and grows further, the board will hire sufficiently senior, professional management (led by an Executive Director or CEO) that has the capacity, competence, desire and time to "do operations" entirely. They seek a complete delegation of authority for the day to day operations from the board. The board then becomes a "governing" board, a board that concentrates its time and energy on pure governance:

Strategic direction: planning, delegations, risk management and resourcing, including setting policy for ownership, standards and cooperative services
Strategic control: oversight, monitoring, evaluation and measurement

A defining feature of a governing board is that they "draw a bright line" between their responsibilities and those of the CEO and management team.

This separation of duties is central to the board exercising independent oversight and ensuring accountability of the management and staff, through the CEO.

The longer the CEO and board members remain in place, over time these relationships tend to become less formal, and this line begins to erode. The board migrates to a "collaborative" board, where the CEO is driving both the governance and operating agendas, and calls on the board to provide support, assistance and expertise from time to time.

While initially appealing, and typically the most satisfying board to serve on, the risk to a collaborative board is that it has lost its independence when it comes to effectively overseeing the CEO and holding management accountable. In practice it is difficult for these boards to have a real say in strategy and risk, and even more difficult to replace a non-performing CEO.

Which brings us to the fifth, and final, type of board, the "advisory" type. Here, all semblance of board activism and engagement has evaporated - the CEO and management team are "doing" both governance and operations, and only consult with the board when they seek input, cover, advocates, or wisdom.

The larger and more complex an organization becomes, and the more principals (owners: members) it has, the more likely it is to slip up this governance spectrum and be marginalized as a "rubber stamp" body. The risks are obvious - the co-operative and its members have put all their eggs in one basket, there is complete reliance on a potentially "imperial" CEO, and sooner or later, the operational system will hit a snag and the board will be oblivious and helpless.

A post-script to the governance journey: when these advisory-type boards are hit with a crisis, scandal or meltdown (as they almost inevitably will be), they tend to overreact. They bluster and fire the CEO and senior management, even a few board members for good measure (especially if there has been a member revolt at the AGM), and then they force themselves to re-engage in the co-operative. But instead of stopping at a more sustainable governing type, many boards let the governance "pendulum" swing right through the middle, and revert to operating boards.[ii]

This, of course, can be just as dangerous, because the board has taken over operations, which they are ill-equipped to do, and alienated their newly disempowered management team. Another crisis lies just over the horizon - a second operational failure, this time caused by an overactive, "micro-managing" board.

[i] The concept of five types of boards was popularized by David A. Nadler, "Building Better Boards," Harvard Business Review, May 2004, pp. 102-111.

[ii] The governance "pendulum" was cited by Dominic D'Alessandro during his tenure as President and CEO of ManuLife Financial.

What can I do to optimize governance?

Once you realize that governance is a journey, and that the most effective type of board depends on where your credit union or co-operative is on that journey, you can begin to "optimize" or "right size" governance.[i]

The first step is to understand what type of board you currently have - while the "Sunday School answer" to this question is a "5 - governing type" board, you may be surprised by what you discover by using this simplified diagnostic. CLICK HERE to view the diagnostic chart (.pdf format).

Then go back through the 13 questions and ask yourself what type of board you should be, what type of Board would add the most value to your co-operative, and best use the scarce time and energy of board members.

If you find that the "optimal" or "right size" answer to many or most of these questions is different from your current state, you're probably ready for a governance "makeover". You may want to bring someone in from outside to help you, or you may want to take some steps yourself. The important thing is to pick two or three areas that call for change, and to start changing.

The single most important area that can be changed is the board's composition and selection, migrating from a representative board to more of an independent, skills-based, overseeing board. But without getting so narrowly selected that arms-length independence and democratic member control is lost!

In our experience, boards of co-operatives, credit unions and all kinds of organizations ought to undertake this governance diagnostic every two years, since boards operate in a dynamic environment, and a great board and governance model even a couple of years ago may not "optimize governance" next year.

[i] This governance tool is simplified from tools developed and used by Brown Governance Inc.: www.browngovernance.com.