In recent decades, retirees, dignitaries and the good ol’ boys were staples of the composition of the board of directors. That trend is quickly becoming a thing of the past. There’s an old saying that states, “Where more responsibility is given, more responsibility is expected.” There’s no question that today’s boards are facing and accepting more responsibility than ever before. Today’s economic climate is driving a board composition that relies heavily on independent directors, audit committees, ethical guidelines and other elements that ensure that stakeholders’ investments are secure.
Corporate governance best practices provide guidelines for boards to be diverse, experienced and independent, while aligning financial incentives with corporate goals. A productive board needs more than diverse and independent board members with impressive backgrounds listed on their resumes. Quality boards monitor the company’s performance, collaborate with the CEO and other managers, and diligently represent the board in all interactions. Robust board discussions, where directors ask probing questions and challenge each other, are the best indicators of strong leadership, regardless of the talents and backgrounds of the directors.
Composition of Board of Directors: Diversity and Independence Are Key
Board independence refers to having the majority of the board directors coming from outside the corporation. Best practices do allow for a small number of board directors to be salaried management directors such as the CEO, CFO, COO or President. Members of board committees should follow suit, with the majority of committee members having no connections with the company.
Independent directors are not related to owners or other significant people within the company and they don’t have any personal connections or business dealings with the company. Shareholders and others would not classify retired executives as being independent.
As board culture started to change and nominating committees began to look for diversity in gender and ethnicity, the faces around the board table began to include more women and people of various ethnic backgrounds. However, these traits by themselves don’t necessarily make for enough diversity amidst the composition of a board of directors.
Corporate headhunter firm Russell Reynolds Associates says that boards come to them looking for three different sets of attributes, including:
- Experience – functional experience within their industry, achievement and higher education
- Demographic attributes – gender, race, religion or generation
- Personal attributes – personality, honesty, integrity, character and varied interests
Today’s corporate boards are looking past labels to find responsible board director candidates who bring an array of new perspectives to the board. They are also looking for board members who thrive and hold their own during challenging discussions. Russell Reynolds Associates hold the perspective that boards are looking for directors who willingly oppose the status quo because “collaborative tension is the essence of good governance.”
Diverse boards take a multifaceted approach to evaluating risks, solving problems and understanding the concerns of key constituencies. In this way, the composition of the board of directors is an asset to financial growth and strategic planning.
The Role of Women on Today’s Boards
A 2015 report by the Deloitte Global Center for Corporate Governance states that the top industries for women in the world are:
- Financial services
- Consumer business
- Technology, media and telecommunications
- Life sciences and health care
- Energy and resources
Women from non-business fields like government, education, charities and the legal realm make up about 50% of boards of directors for Fortune 250 companies. Current boards are trending toward nominating women directors with corporate management experience. The Deloitte report netted some interesting statistics about the percentage of U.S. women who serve on boards of directors. Here are the percentages of women who serve on the top S&P and Fortune 250/Fortune 500 companies:
S&P 500 18.7% had women on the board
S&P 500 68% had two or more women on the board
Fortune 250 18.5% had women on the board
Fortune 250 22.4% had women elected to board seats within the past year
U.S. Boards 13.7% had women on boards across the U.S.
The report also shows that 76% of U.S. boards have up to 25% women directors and 24% of U.S. boards have more than 26% women directors. In addition, 18% of boards have increased the number of female directors they elected to their boards from the prior year.
Board Composition and Financial Performance: Is There a Correlation?
Many studies have been performed across the globe to determine if there is a connection between board composition and financial performance, particularly in relation to having a ratio of more outside directors than inside directors. There is currently no standardized way to do research on this issue, which makes it hard to come up with conclusive results.
A 2000 Pittsburgh State University study suggests that there is only a slight positive relationship between board composition and financial performance for boards with more outside directors than inside directors. Other studies, like one done by Victor-Octavian Muller in 2013, showed that board independence and foreign directors have a strong positive impact on current and future financial performance.
An older study, performed by Tosi and Gomez-Mejia, in 1994, explored whether it mattered if the directors were from inside or outside of the company. Their study suggested that it is the director’s diligence toward monitoring managerial activity that is really a better reflection of financial performance. Their report stated, “All outside directors are not created equal. By virtue of industry/occupation background, executive/managerial experience, time availability, and other potential skills or experience, some directors are better able to fulfill their monitoring, advice, and resource roles.”
Are We Placing Too Much Emphasis on Board Composition?
In a perfect boardroom, we would have all the right players in place – board members with the highest levels of expertise and social status, who also graduated from the best universities in the country. Ironically, Enron had such a board. In 2000, Chief Executive magazine named the Enron board as one of the top-five boards in the country. Enron collapsed just one year later.
That is not to say that expertise and education don’t count – they do. They count a whole lot more when directors encourage their fellow board members to be open in their arguments, if and when they have opposing views. The existing composition of the board directors is effective when they welcome diversity and independence. Most importantly, board composition plays a strong role in board members being persistent in monitoring the company’s assets and taking an active part in strategic planning. The long and short of it is that we can never place too much emphasis on board composition. There is simply too much at stake.