This blog post is an adaptation of a publication created in collaboration with Alex Baum, David F. Larcker and Brian Tayan for the Stanford Closer Look Series.
Whether non-profit or a major corporation, board books are the essential medium for effective board/management collaboration. Unfortunately, they often aren’t as useful as they could be. As noted in the paper above, the most common issue is that these books prioritize the director’s fiduciary duty to oversee financing reporting rather than understand and help shape the drivers of business performance. Below are a few considerations that boards, management teams and non-profit directors should consider in constructing these key documents
Most board books spill a lot of ink comparing performance to plan and history and then explaining the variance. This is necessary, but not sufficient. The board may see revenue 2% ahead of plan and declare success. However, if the industry is growing even faster or key customers are embracing competitors then this “success” could really be share loss. Most board books do not consistently provide such important context.
Focus on Drivers Rather than Results
As a symptom of the excessive focus on fiduciary obligations around financial reporting, board books are almost completely oriented around financial results. This is backward-looking and untimely. By reorienting pages around a set of key drivers (say the number of new subscribers for a key new product rather than revenue), financial issues can be identified while there is still sufficient time to remedy.
Organic Investment Decisions Also Deserve Scrutiny
Before making an external acquisition, board members review a large amount of information. But when reviewing ongoing expenditures that drive organic growth, they put a lot less time and attention into the task. A board might look at how the product sales and promotional payments relate to each other but aren’t given detailed information that helps them to understand how current expenditures drive future cash flow. Providing the board with return metrics gives a more comprehensive view and allows for a more informed decision making regarding organic investments.
Prioritize True Economics Over Accounting Allocations
Management is responsible for making decisions, like allocation of shared overhead, based on how profitable various product lines are. Often, these allocations are driven by external reporting requirements, which don’t always reflect the true economics of the company. Not properly allocating the cost of overhead costs can distort the underlying profitability of a business’s bottom line. Accurately tracking profit and loss statements help boards to understand how the company derives cash and how they can enhance strategic decision making.
Unexplained Outperformance Deserves Scrutiny Too
If there is an unexpected outperformance in any given quarter, most boards devote too little time to examining the factors that led to the outperformance. Board members should determine if those factors are sustainable to keep trying or if they would instead create a headwind in the future. One-time price promotions, competitor disruptions and product end-of-life are not sustainable forms of growth and can lead to disappointment and loss of credibility with investors if not acknowledged. Using a driver-based approach to a company’s performance will reveal the true reasons for outperformance, whether positive or negative.
Why this matters
Being able to access appropriate data is necessary to be able to make informed decisions on strategy, compensation and capital allocation. Improving both the structure and content of board books provides several benefits, such as better allocation of organic investment, a better understanding of segment economics, better understanding of how effective a current strategy is, and more accountability related to performance. Board books currently rely too heavily on accounting-based standards, which don’t always reflect the underlying profitability of customer types, products and divisions.