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Lessons in Board Reform: Audit Your Governance Structure

By Tom Watson on August 15, 2007No Comment

Lessons in Board Reform: Audit Your Governance Structure
Lessons in Board Reform: Audit Your Governance Structure
By Paul Firstenberg, 8/15/2007

Recent headlines have focused national attention on the board performance at two of the country’s premier nonprofit institutions – the Smithsonian and the Red Cross.  Article after article presented these boards as ineffective in addressing the challenges confronting their respective organizations, and, in the case of the Smithsonian, in passively enabling its chief to use institutional money for personal purposes.  The lesson to be drawn from the experience of both institutions is that effective governance requires continual attention and assessment by a pro-active board prepared to provide candid evaluations of board functions and members.

The Smithsonian
Smithsonian Secretary Lawrence Small resigned in March under pressure following revelations regarding his personal expenditures and housing expenses, which included chartered planes, luxury car services, and a $273,000 housekeeping bill.  Calling the Smithsonian an “endangered institution,” Senator Feinstein of California complained that “the oversight of his spending practices [was] lacking” and the board’s response was “lackadaisical.” The Washington Post, which published a series of reports on Small’s spending, opined that the 17-member board was partly responsible, stating that “the Smithsonian is now a billion dollar annual operation.  It needs an engaged board.” 

An independent committee appointed by the board to investigate the governance of the Smithsonian following disclosures about Small’s compensation wrote in its report on the matter, “It appears that the board reported to him rather than [he] reporting to the board.”

In reflecting on the whole process, a board member said “It is never easy to do this kind of self examination, and we wish we’d been doing it on an ongoing basis.”                        

The Red Cross
In the aftermath of Hurricane Katrina, the Red Cross was criticized for its unwieldy, 50-member board structure – a structure which has been described by some as meddlesome, overly influenced by the 35 members elected by local chapters, and too big to move quickly and efficiently.  Friction with the board is also thought to be largely responsible for the departure of the organization’s last two presidents. 

The Red Cross has announced its intention to scale down the size of its board.   

Core Functions
As Congressional critics of the Red Cross and the Smithsonian advocated,  boards must be transformed from a passive to an active agency focused on its two core functions: (1) a fiduciary role in ensuring compliance with the law and in establishing best practices to protect the  integrity of the institution (a role the Smithsonian board apparently failed to fulfill with sufficient rigor) and  (2) a strategic role in helping to guide the organization in building its capabilities to accomplish its mission (a  role the Red Cross board – dominated by the interests of local chapters—apparently did not exercise with sufficient diligence and insight).

A board fully engaged in these two functions will play a leadership role in the following areas critical to the well being of the institution:

  • Assessing the organization’s strengths, weaknesses, opportunities, and threats, and leading the organization in capitalizing and/or addressing all of the above;
  • Ensuring that financial statements and reports present a realistic picture of the organization’s financial condition, with all of the board fully informed about the nonprofit’s financial realities;
  • Understanding the organization’s compensation system, process and awards – particularly to the chief executive;
  • Establishing a transparent process for nominating and electing board members that is consistent with criteria for membership established by a committee of directors;
  • Setting the agenda for board meetings pursuant to a collaborative process between
    board leadership and senior staff executives; and
  • Ensuring that the cost effectiveness of the organization’s programs is objectively evaluated and independently documented.

Serving as a board member is a serious responsibility – a responsibility that requires active participation and self-assessment – in order to be effective.  But how can organizations assess their own governance structure?  The following questions are a good starting point. 

1.)  Are there potential conflicts of interest on the part of board members or staff?  Ask directors and officers to disclose any transaction or relationship they have had with the organization, its vendors or other stakeholders, in which they received a form of compensation.

2.)  Has the compensation of executives been explicitly approved by a board committee? Is such compensation in line with those of peer organizations, and are the arrangements known to, and understood by, the full board?

3.)  Are the expenses of senior executives reviewed at the right level and reported to the board?

4.)  Can the organization objectively document that it is fulfilling its mission on a cost effective basis?

5.)  Are financial statements, including a cash flow projection, reviewed carefully by a board audit committee with the financial experience to evaluate them intelligently? Are board members familiar with the statements?

6.)  Has the organization engaged in a strategic planning process, assessing its strengths, weaknesses, opportunities and threats, and have benchmarks for implementing the plan been established and monitored?

7.)  Do board members know what is expected of them?  Are board responsibilities spelled out in writing? Is board member compliance with such terms reviewed by the board or a committee thereof?

8.)  Is the process by which people are chosen for the board transparent and consistent with pre-established criteria?

Some may argue that such strict guidelines and responsibilities will deter would-be volunteers from serving on boards.  This may be true.  But in an environment in which nonprofits can expect increasing scrutiny from both the media and the government, it is imperative that they protect themselves from poor oversight.  Periodically auditing your governance structure is the best way to do so.

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