Board Of Directors – A New Era
What is the purpose of the board of directors?
Aside from the legal aspects of directors’ prerogatives and responsibilities, boards are ultimately there to steer the company in the direction of success on the long term by setting the right business strategy and ensuring compliance with the rules. The directors are responsible for establishing the adequate risk/reward ratio, for making the right strategic decisions and for respecting the law. They are also in charge of making sure that the executive people will implement their view and manage the company in an efficient and diligent manner. And they are the ones who need to step in when there is a crisis.
Boards of directors have seen major changes in the past few years. Regulators and stakeholders alike have been pressuring them for better governance through more diversity, better risk management and enhanced responsibility.
So what does a board of directors need?
It largely depends on the type of company of course, but there are a few basics.
Gender diversity, but not only
Beyond the morals of allowing for equal opportunity for men and women, there are multiple arguments in favor of female directors. Not just because today women have as much knowledge and experience as men, but because with equal qualification women can bring a different point of view and soft skills that integrate well with those of men.
One way to attain a better male/female ratio is the implementation of quotas. California has just passed a law requiring listed companies headquartered in that state to have a minimum of one female director (two if the board consists of five members, three if the board consists of 6 members). In Europe, Norway is the champion imposing a quota of 40% of women on the board of public companies since 2008, and many others have implemented similar laws (France, Spain, Belgium, Iceland, Finland…). The EU is contemplating regulation in that direction, and only Asia is far behind. The concept of quotas has its pros and cons, but in the end it forces people to accept the change and get used to the fact that the exception becomes the norm. Even if at first, women’s presence at the board may be considered a legal obligation and not a merited position, making the seat at the table a little uncomfortable. The interesting fact about the Californian rule is in the enactment rationale itself. This is the first sentence (section 1(a)):
More women directors serving on boards of directors of publicly held corporations will boost the California economy, improve opportunities for women in the workplace, and protect California taxpayers, shareholders, and retirees, including retired California state employees and teachers whose pensions are managed by CalPERS and CalSTRS. Yet studies predict that it will take 40 or 50 years to achieve gender parity, if something is not done proactively.
This new requirement is essentially not based on gender equality, or human rights, or philosophical contemplation, but on the economy (and investor protection). The bill text then goes on enumerating the various studies proving that companies with women on their board perform better. The legislator clearly establishes that this law is not doing a favor to women, but to companies and their stakeholders. Hopefully this will improve California’s female board presence average, currently lower than the other states’ average (1,65 vs 1.76 according to Equilar).
The other big source of pressure for diversity is proxy voting. This year, BlackRock amended its proxy voting guidelines to include an expectation of at least two women directors on each board and noted that it will continue engagement efforts, coupled with the threat of withholding votes for companies that ignore its comments. And they are not the only ones.
Last year already, Vanguard stated in its investment stewardship annual report (reiterated in the 2018 report) that well-governed companies perform better over the long term, and that “great governance starts with a great board”. To this end, they consider four pillars when evaluating corporate governance practices, and a “high-functioning, well-composed, independent, diverse, and experienced board with effective ongoing evaluation practices” is the first pillar. It is also mentioned in their open letter to directors of companies worldwide: “We view the board as one of a company’s most critical strategic assets. When the board contributes the right mix of skill, expertise, thought, tenure, and personal characteristics, sustainable economic value becomes much easier to achieve. A thoughtfully composed, diverse board more objectively oversees how management navigates challenges and opportunities critical to shareholders’ interests. And a company’s strategic needs for the future inform effectively planned evolution of the board”.
Geographical diversity
A diverse board also means members of different origins. But on that matter there certainly are arguments in favor of having “local” people especially for smaller, local firms. A company’s DNA is often imprinted in its initial location. Swiss banking for example has become worldly recognized thanks to the Swiss’s search for security and stability, their discretion and long-term thinking, in addition to core values such as professionalism, bid for innovation and excellence. Boards should therefore essentially consist of locals, in adequacy with the workforce and company values. But the Swiss financial sector is also very internationally oriented, and more generally any firm with growth and expansion ambitions should integrate people with other backgrounds to bring new perspectives and ideas, different know-how, and additional experiences. It would be tempting to stay among our own, but getting out of the comfort, pat-in-the-back zone can bring undeniable advantages. Make sure it is the right people though, with the same core values otherwise it can quickly lead to uncomfortable board sessions and difficult decision-making.
Diversity of skills
A well-balanced board would have directors with front or client facing experience, with management abilities, and with operational background, but in today’s environment it would also need members with risk management skills, and compliance or legal knowledge. In fact, additional experience in any area of the firm would be a plus: human resources, technical, IT, security, etc. Today compliance and risk need to be an integral part of the strategy and as such, need to be represented at the board. But preferably to a “regular” external lawyer as has been widely done so far, it should be someone that has corporate experience, someone that has held in-house legal, risk or compliance positions and understands the technicals and various business constraints. Risk oversight by the board is a key responsibility, and regulatory or legal risk is a major part of it, especially for a financial company.
Diversity of age
While it may rock the (old) boat to have a young(er) board member, if you want your company to keep up with what is going on and be innovative, you most likely need youth, even in the boardroom. And you need to listen to them. This will not just bring energy and new ideas, but also sometimes a much needed fresh look at things and some candid questioning.
Okay, but where to start?
A good start would be to assess the specific needs of the company and establish the skillset required for the directors. This can be done through a matrix. The New York City Comptroller for example launched a “Boardroom accountability Project” last year which provides a template matrix (https://comptroller.nyc.gov/wp-content/uploads/2017/09/Example-Board-Matrix.pdf) for assessing a board’s diversity level. Many companies have returned their matrix, which are available online.
More and more companies formally evaluate their board members. Directors’ skills are reviewed through a formalized process, whether internal or external, similar to the year-end evaluations so far reserved to employees. Many corporate governance standards now recommend it annually with, for example, an independent assessment by a third party every three years. Such third party, typically an external counsel on corporate governance matters, will enhance objectivity and rigor to the process. The results of a self-evaluation by the board can be presented in the annual report, or to the auditors. Note that this year 93% of proxy filers in the Fortune 100 provided at least some disclosures about their board evaluation process.
Directors’ biographies sometimes need to be disclosed to authorities, markets, shareholders, and can also be used for marketing support. Make sure they are individually adequate and collectively sensible for an efficient board, at present and over time.
Make that process transparent. Transparency is reassuring, and a formalized, reasoned selection and evaluation process for board members will be appreciated by both regulators and stakeholders.
Board refreshment is also key. While long term members bring stability and continuity, there has to be some new blood periodically. How often is really case-by-case, but the question needs to be asked at least on a regular basis.
All of these points (and more) are covered in the Commonsense Principles of Corporate Governance 2.0, just issued by a group of representatives of America’s largest corporations and institutional investors (e.g. Warren Buffett) two years after the first version. This document is a detailed road map for boards covering items such as board composition, refreshment, duties and responsibilities. See https://millstein.law.columbia.edu/content/commonsense-principles-20.
In conclusion, board composition and efficiency are now too closely looked at to be disregarded or to lack a legitimate process. Board members need to be the right people for the job and they need to be involved. Make the most out of your board, the era of useless directors brought on for appearances is over.
October 2018