Corporate Governance
It's a common boardroom refrain these days. How can we make our governance process more efficient? Can we reduce demands on volunteer directors and management? Can we lighten board members' burdens without compromising quality of leadership?
Governance doesn't work well when it puts unnecessary demands on key participants. The complaints are fairly consistent: too many corporations, too many committees, too many meetings, too much repetition in those meetings and too many board members. A board bogged down by its administrative structure is less likely to produce the informed, responsive contributions required from its members.
So what's the solution? The good news is the law offers many ways to reduce the administrative burden on volunteer board members and the management staff that supports them. These strategies work without violating the boundaries of basic fiduciary principles and governance best practices. And, while some streamlining measures are invariably controversial, they're not too complex to quickly implement.
Still, the board should tread cautiously when evaluating these options. While the ultimate goal should be to improve governance, the board should not send mixed messages, either internally or externally. Governance efficiencies work well when designed to increase board members' "quality time," such as time spent on checks and balances such as devoting more time in meetings to open management and board discussions. Efficiencies implemented for less noble reasons—such as intentionally marginalizing the role of the board—are going to spook the regulators. Public policy today is all about enhancing the role of the board, not limiting it, so any governance streamlining effort is bound to arouse some suspicion. It requires a careful balance of legitimate efforts in reducing boardroom burdens against regulatory interests in preserving board engagement. The larger the board, and the more sophisticated the organization, the greater are the streamlining opportunities and risks.
As your general counsel will tell you, efficiencies can come from four key areas: the corporate structure, the board size, committee use and the board's own practices.
THE DOs
Reconsider corporate structure: Does your health care organization have more corporations than it needs? In the early 1980s, when corporate reorganizations were all the rage, many businesses were rushing to implement these now-ubiquitous, parent-subsidiary corporate structures in order to address real legal and operational risks. Today, it's fair to ask whether this kind of structure still makes sense.
An obvious source of governance efficiencies is to rid the system of unnecessary corporate entities and the boards that serve them. Boards should ask themselves: Do we need that particular holding company? Must we have separate corporations for every one of our hospitals and our various physician groups? Are small, separate foundations more effective than a larger consolidated one?
In some cases, the answer will be a resounding yes; there are valid legal and financial reasons for keeping certain activities in separate corporations. Yet, in other cases, the answer won't be so obvious. The reason that prompted the formation of a separate corporation several years ago may not be so clear now. It might not even exist anymore. Corporate structures don't come with a "sunset" provision, and they tend to grow in size and complexity. For every corporation that is dissolved or rolled up into another, a governing board, its committees and related processes are retired. It is reasonable to kick the tires of the corporate structure to see what is still needed. This becomes particularly important given many systems' use of overlapping boards where the same basic director pool populates all the boards in the system.
Remember, though, that both the general counsel and the auditors must be included in this process. This kind of corporate tire-kicking can't be done on the cheap if it's going to be effective. Consolidating a corporate structure involves significant legal, financial and tax traps so in some cases, getting rid of one or more affiliates and their boards may not be worth the associated costs. While trimming the corporate chart offers tremendous benefits in terms of governance efficiencies, it should be approached with caution.
Reduce board size: Whittling down the size of the board can yield efficiencies. The nonprofit sector has tended toward large boards, such as the community hospital that reaches out for representation from every local constituency, the big-city entity with its "celebrity" directors and the academic medical center with representation from every dean and department head. Many boards are so large that it's difficult to meaningfully incorporate every member into the governance process. Reducing the board size is an easy decision when some members are more interested in writing contribution checks than in active governance. It's also time to reduce the board size when, for whatever reason, board control has for all practical purposes devolved to the executive committee. That's never sustainable on a long-term basis, for both legal and practical reasons.
The measuring stick is whether the board is big enough given the size and sophistication of the organization it oversees. In some organizations, however, board reduction may not be the right answer. More and more, some boards are increasing their size in response to the challenges posed by health care reform, operational and competitive issues, compliance oversight, the economy or other reasons. Once you raise the question of board size, don't be so sure the answer will be going smaller.
Modify committees: Can efficiencies be gained by tweaking the role, number and composition of certain committees? There are two approaches. First, the board can enhance its ability to rely on committee action by ensuring that committee charters enable them to operate with board-delegated authority. Second, the board can reduce burdens on those board members who serve on multiple committees and on the management team members who staff those committees by combining committees and consolidating duties. Questions to consider include: Can the board's audit and compliance committees merge? Can one committee effectively deal with both executive and physician compensation? Can the executive committee also handle nominating and governance-related duties? Does state law allow us to use non-board members as voting members of a committee?
Explore the little things: Boards can gain efficiencies from taking advantage of certain legal provisions. Most state nonprofit laws authorize a series of seemingly minor administrative actions that, taken collectively, can go a long way to taking the edge off board member burdens. For example, every board and committee should be authorized to meet not only by teleconference, but also through videoconference and even Web-based conference, if allowable under state law. The board should also make effective use of the consent agenda.
Other questions to consider include: How often does the board or a committee act informally through unanimous written consent? Does state law allow voting by proxy? Should the board consider asking for waiver of notice? Can the number of required board and committee meetings be reduced to somewhere north of the statutory minimum? Is this board taking full advantage of the executive committee? Your general counsel can come up with a number of creative measures that are legal under state law.
Additional streamlining concepts that fall in this category include increasing education on fiduciary responsibilities so directors have a greater understanding of their roles; enhancing the clarity, quality and timeliness of board briefing materials; and establishing clear and understandable lines of authority between the board and executive management so both groups have a reasonable understanding of the issues that will be presented to the board for vote, ratification or informational purposes.
THE DON'Ts
Erode the corporate walls: Avoid the temptation to consolidate the board meetings of all the corporations into one giant system meeting, even if all of the right people are in the room at the same time. It's important under the law to maintain the bona fides of separate corporate status. If the board doesn't respect corporate separateness, an inquisitive regulator or aggressive plaintiffs' attorney is unlikely to do so, either.
Meet only the bare minimums: Don't shrink the number of board and committee meetings down to the minimum required by state law, except for the smallest of corporations in the system. Such "playing to the minimums" severely hampers the board's ability to provide effective oversight and sends a bad message to regulators about the corporation's commitment to effective governance. It would be a red flag in any kind of examination, audit or investigation.
Overburden committees: In considering committee consolidation, be careful not to assign responsibilities beyond the ability of the committee members to fairly and adequately address them. This is especially relevant to the audit committee, which can become the dumping ground for all sorts of marginally related duties and responsibilities, including compliance and enterprise risk management. Any increase in committee responsibilities due to the consolidation of committees should be done with the input of members and of the general counsel, executive leadership and the auditors.
Overuse management boards: Populating subsidiary boards with members of the parent organization's management team helps reduce the burden on volunteer directors but creates other significant legal risks. The law views management boards as incapable of exercising independent oversight because in most cases they are employees of the parent and subject to the supervision and direction of the parent CEO and board. Thus, management boards work only in the most limited of circumstances, such as in small or single-purpose corporations or joint venture interests.
Cede responsibilities to a mega-executive committee: A well-functioning executive committee can affect substantial governance efficiencies, especially by addressing important business issues between regular meetings of the full board. But it can be a slippery slope. When the executive committee enÂcroaches upon the duties and responsibilities of the full board—that is, it effectively functions as the board—it becomes counterproductive for governance purposes. Further, this behavior can expose the nonexecutive committee board members to criticism for failing to provide attentive and informed oversight. When some board members are cut out of the governance process, the regulators get concerned.
Ignore tax implications: Any reorganization of system boards may trip some tax exemption wires you might not have initially thought of. Consult with the general counsel to make sure that the new, streamlined board structure won't bump up against Internal Revenue Service concerns with director independence and those always-tricky nonprivate foundation rules.
Proceed Carefully
It makes great sense for the board to periodically conduct a bit of self-examination and explore streamlining its governance processes. Measures that make decision-making and oversight more efficient and reduce the burden on volunteer board members usually enhance the overall effectiveness of the governance mechanism and make board service more attractive. However, boards should take care to make sure that the individual streamlining measures don't boomerang either by sending a message of actual indifference to the board's role, or by creating legal issues where none previously existed.
Michael W. Peregrine (mperegrine@mwe.com) is a partner in the law firm McDermott Will & Emery, Chicago.
