Board effectiveness is a direct result of the board’s composition, which is why good governance dictates that the composition should be built according to the organization’s needs. The needs of organizations change according to developments and threats within the marketplace. Today, change within the marketplace is happening steadily and rapidly. It is because of vast change that the collective skills of the board members need to continually change to ensure that an organization’s leadership will be able to continually meet its needs.
Progressive boards strive to have a composition that optimally reflects the strategic priorities of the business and the diversity of its stakeholders. Aging board directors, external pressures, watchdogs, regulators and a demand for broader skills are just a few of the things that make building a well-balanced board of directors so challenging. It’s not impossible, but it does require early and careful planning.
What Is a Balanced Board of Directors?
A balanced board of directors is a strategic asset because it helps to infuse the board with fresh perspectives. Many different skills, abilities and qualities go into the building of a balanced board of directors. Today’s boards are largely characterized by being independent, diverse, skilled and refreshed.
For all the reasons stated, boards are moving toward having expectations for being greatly independent. In 2004, around 80% of the board directors of S&P 500 companies were independent. As of 2014, that number had grown to 84%. To further support the idea of growing independence on boards, 58% of S&P 500 boards had the CEO as the only non-independent director, as compared with only 39% in 2004.
Proxy advisors and activists question whether a board member can be truly independent if they serve on a board for long terms. Many investors feel that directors who serve for long periods of eight years or longer will become so close to other board directors that they’ll lose their ability to think and act independently. In 2014, around 16% of boards had an average board director tenure of at least 11 years and S&P 500 boards had a director tenure of 8.4 years, on average.
Proxy advisors and other investors have been vocal about whether boards should consider tenure as part of what defines independence. An Institutional Shareholder Services policy survey that was conducted between 2013 and 2014 indicated that 74% of investors who answered the survey felt that long tenures for board directors were problematic and could lead to board directors losing their independence. Along the same lines, boards that allow lengthy tenures take away some of their ability to refresh the board as needed.
In their quest for board refreshment, it’s important for nominating committees to consider the benefits of keeping board directors on for long periods. Long-term board directors bring a wealth of experience and institutional knowledge to the boardroom. They also bring the historical perspective of the company’s strategy, operations and culture to decision-making that isn’t possible with newly appointed board directors. In addition, seasoned board directors tend to be more confident and better able to challenge management because of their historical knowledge.
In the interest of good governance and board refreshment, many companies are turning to mandatory retirement age limits to make way for new board directors who can add fresh skills and perspectives to the board.
Another trend that’s contrary to board refreshment is the trend toward recruiting retired executives. As of 2014, more than half of newly elected board directors were recruited after they retired from their executive positions. This is part of the reason board directors are aging. The obvious downside is that aging directors aren’t as much of an asset in our increasingly global and rapidly changing business world.
Diversity is almost equal in importance to director diversity. Today’s boards require a mix of age, experience and backgrounds to promote better debates, decision-making and perspectives while discouraging groupthink.
Shareholders, governments and activists have placed a heavy spotlight on encouraging the appointment of female board directors. There is evidence to prove the worth of women on boards. In a 2012 report by the Credit Suisse Research Institute called Gender Diversity and Corporate Performance, from 2005-2011, companies that had at least some women on their boards achieved a better share price, a higher return on equity and better average growth than companies that failed to appoint women to their boards.
In the United States, the number of women board directors for S&P 500 companies continues to grow, but it still trails behind such progressive companies in Norway, Finland, Sweden and France, where diverse boards are a clear priority. The 2014 Spencer Stuart Board Index indicates that 19% of directors for S&P 500 companies are women, which is a 16% increase over boards in 2019 and a 16% increase over boards in 2004. About 45% of S&P 500 companies had women on their boards in 2004, compared with two-thirds who had women on their boards in 2014.
In a 2014 survey of corporate secretaries from the Spencer Stuart Board Index, the most desired profiles for director recruitment consisted of women, minorities and sitting CEOs. Around 64% of those who responded said that one of their priorities was to recruit minority board directors.
Beyond looking at independence, minorities and age, nominating committees must consider the needs of the other board committees. In this era of rapid change, boards must consider the need for specific kinds of talent for the audit, compensations, executive nomination and governance committees.
Building a Balanced Board
Before a nominating committee gets started on building a well-balanced board, they need to assess the competencies of the current board. This is the first step toward building a board matrix that will identify the gaps in skills and abilities on the current board.
A matrix is a valuable tool for nominating committees that want to consider such issues as diversity, gender and independence as part of the requirements for the board, along with other board qualities and characteristics such as experience and expertise.
Nominating committees can streamline the process for assessing the current board, identifying potential candidates and reaching out to them with NACD and Diligent Corporation’s Nom Gov tool, which provides thousands of profiles of directors and executives. The tool streamlines the process and helps identify the best candidates to round out the board.
It’s common in this time for nominating committees to begin planning for board director vacancies at least 12 months in advance of a board director vacancy. Boards that have several upcoming board director retirements or vacancies may need to take a few years to plan accordingly for a well-balanced board.