Creating a Balanced Scorecard for the Boards of Directors
The recent catastrophic corporate governance failures at Enron, Tyco, WorldCom, Parmalat and other entities triggered an equally cataclysmic collapse in the confidence that shareholders, and wider stakeholders, held in our organizations. People simply stopped believing what companies told them.
Consequently, to regain public confidence, legislation such as Sarbanes-Oxley (which all US traded companies must comply to) was introduced to demonstrate that corporate governance was being catapulted back to the top of organizational agendas. Yet such legislative and regulative interventions have thus far had little real effect. One survey found that 72% per cent of board directors and 88% of fund managers believed the flurry of reforms had hardly, or not at all, improved corporate governance (1).
Such a finding is unsurprising. A major analysis of poor performing firms for a report in 2004 found that in just 13% of cases shareholder value destruction was a result of compliance failure. Fully 60% was attributed to strategic mistakes such as misjudging customer demand or competitive pressure. The remaining failures were the result of operational blunders (2).
The message is clear. Although oversight of the compliance with accounting and other financial rules and regulation is a key responsibility of the stewards of our corporations (the Board of Directors), to properly dispatch their duties they must pay even more attention to assessing the likelihood of strategic failure.
Align the Board of Directors
The third of Kaplan and Norton’s five principles of the Strategy-Focused Organization (align the organization to the strategy) has as a sub-component: align board of directors. Doing this effectively requires the creation of a Balanced Scorecard for the Board of Directors that complements that of the Enterprise.
As shown in Figure 1, from an internal management perspective, the Balanced Scorecard provides a framework for describing strategy and managing its execution, while from a governance perspective the scorecard provides a framework for aligning the governance process and promoting greater transparency. The scorecard therefore aligns strategic management with corporate governance.
Moreover, creating both a Board and Enterprise Scorecard enables a clear description, and delineation, of the roles of the Board and Executive Committee. These often get blurred within organizations, culminating in negative impacts on corporate governance.
A Governance Tool
There are several key reasons for using the Balanced Scorecard as a governance tool. These include:
Clarity: The scorecard describes how an organization will create value and provides a way to manage and monitor the delivery of this value.
Accountability: It clarifies the role of the board, the executive management team and individual executives.
Information: The scorecard isolates and delivers the essential information that board members and executives need to fulfill their responsibilities.
Visibility: It enables a shift from reliance on financials to examination of the non-financial indicators that drive value creation.
Composition: The scorecard provides a way to clarify the strategic skills required by the board.
Compensation: It provides a way to clarify and assess the strategic contributions of an executive.
A Board Scorecard System
Note that when we speak of a Board Balanced Scorecard it has to be understood within the context of the Board Scorecard System, which has three mutually reinforcing components.
1. The Enterprise Scorecard.
2. The Board Scorecard.
3. The Executive Scorecard.
The Enterprise Scorecard
The Enterprise Scorecard is the corporate scorecard, which describes how value will be created for shareholders. Indeed if executive management teams just use the Enterprise Strategy Map and Balanced Scorecard to communicate with their Boards (without building a Board scorecard) it will still signal a dramatic step-forward from communicating via the impenetrable board packs that are too often typically distributed - and which provide boards with a poor guide for assessing performance.
The Board Scorecard
The Board Strategy Map clarifies how the Board contributes to the success of the corporation. The financial perspectives on the Board and Enterprise scorecards will be identical, as both share the same vision of creating value for shareholders. However, rather than use a traditional customer perspective, a Board scorecard introduced a stakeholder perspective, reflecting the board’s responsibilities to investors, regulators and communities. As a generic example, these can be translated into the stakeholder objectives of ‘approve, plan and monitor corporate performance’, ‘strengthen and motivate executive performance’ and ‘ensure corporate compliance’.
Each of these three objectives then becomes discrete themes within the Board’s internal perspective. For instance the performance oversight theme will include an objective such as ‘approve strategy and oversee its execution’.
Within the learning and growth perspective, the board will be ensuring that it has the skills, knowledge and information systems in place for it to judiciously dispatch its duties. A typical objective might be ‘ensure board skills and knowledge match the strategic direction.’
Further, given that Boards of Directors typically disaggregate into committees, themes can also be managed separately with ownership assigned.
The final aspect of the Board Scorecard System is the Executive Scorecard. This describes the strategic contributions of each of the executive committee (including the CEO) and is drawn from the objectives within the Enterprise Scorecard, thus ensuring that the executive will take responsibility for the Enterprise level strategic objectives.
The Executive Scorecard becomes the performance contract between the executive and the Board and is used to evaluate and reward senior executive performance. Moreover, an Executive Scorecard essentially serves as a job description for a senior role and so is equally valuable for selection, or succession planning purposes.
There is little doubt that corporate governance will continue as a core organizational priority for many years to come. The potential for financial fraud, coupled with the greater danger of strategic failure in today’s fast-moving markets, will lead to even more vocal demands for performance transparency, responsibility and accountability within, and deep inside, our organizations. Promising performance visibility and line of sight from the boardroom to the front-line, the Balanced Scorecard is well placed to serve this organizational requirement.
- McKinsey Quarterly, Spring 2004
- Too Much Sox Can Kill You, Booz Allen Hamilton, 2004.