More isn’t necessarily better when it comes to board size. In fact, a study showed that in the vast majority of situations, companies with smaller boards are more collaborative and outperform companies with larger boards. Much of the attention to board size comes from changes in regulatory concerns and the focus on board compositions needing increased independence and diversity.
Companies can point to the results of a recent study to demonstrate the effectiveness of smaller boards. Beyond looking at numbers and percentages, studies have highlighted specific pros and cons that board directors revealed to show why smaller boards are more effective.
Board Size: Research Shows That Smaller Boards Outperform Larger Boards
A group of governance researchers from GMI Ratings performed a study in 2014 for The Wall Street Journal, which supports the notion that smaller boards are more effective than larger boards.
For the purpose of defining the size of boards, the study shows that the smallest board size had an average of 9.5 board directors. The study defines large boards as those that have 14 or more board directors. Of the companies studied, boards had an average of 11.2 board directors overall.
The study revealed that companies with at least $10 billion in annual revenue that had smaller boards typically produced better returns over a three-year period than similar-size companies with larger boards. Specifically, smaller boards held an 8.5-percentage-point lead on returns over companies with larger boards. In taking a closer look at companies with larger boards, the study states that large boards underperformed smaller boards by 10.85 percentage points.
The study also noted that banking institutions were subject to more regulatory concerns than other types of businesses. Such institutions often need the advice and expertise of many committees, so larger boards make better sense for many companies in the financial industry.
These numbers play out in the real world when we consider that many technical companies have small boards. For example, Netflix has seven directors on its board and Apple has eight board directors. Bank of America doesn’t feel it can get by with fewer than the current 15 board directors.
An Example of Reducing Board Directors: General Electric
GE recently announced that it planned to make several changes regarding the composition of its board. It plans to reduce the number of board directors from 18 to 12. To further enhance board capabilities, GE plans to put a 15-year cap on board director terms. It plans to use headhunters to replace outgoing board directors with those who have relevant industry experience. As tenured board directors leave, GE plans to recruit board members with experience in aviation, power, healthcare and digital manufacturing.
According to Charles Elson, who is the director for the John L. Weinberg Center for Corporate Governance, the standard board size for a company like GE should be eight to 12. He indicated that he would have liked to see GE make the decision to decrease board size at least a year sooner than it did.
Benefits of Having Smaller Boards
Here’s a snapshot of why smaller boards can produce better results:
- Board directors arrive better prepared and ready to dig deeply into important issues
- Small boards are more likely to identify and act on poor performance of CEO
- Small boards spend less time in discussions and make faster decisions
- Directors are more committed, candid and engaged
- It’s easier to prepare materials for meetings
- It’s easier to schedule meetings with fewer people
- Directors have greater ownership and accountability
- Board can dedicate more time to tackle issues in greater detail
- There is less chance of a dominant member swaying the group and problems with groupthink
- Meetings run more smoothly and efficiently because there is less to manage, coordinate and facilitate
- Meetings tend to be less formal, which makes it easier for board directors to open up and share ideas — and there is less chance of board directors who don’t actively participate
- Directors know each other better, and such relationships are more conducive to cohesiveness and a sense of common purpose
- It’s easier for small boards to reach a consensus
- Overall returns have shown stronger results
There are a few downsides to having smaller boards, although the benefits far outweigh the deficits. Smaller boards place more work on individual directors, which may reduce effectiveness if directors don’t have the proper amount of time to commit to the board. Lower numbers may also mean not having enough people to staff committees. Smaller numbers on a board don’t always allow for the level of independence and diversity that today’s corporations require.
Deficits of Having Larger Boards
While larger boards can accommodate the need for independence and diversity, they often lack the time for all directors to share their ideas. Here’s a list of some other challenges that larger boards face:
- Larger boards have less time to give issues the necessary depth
- It’s easier to staff committees with qualified members and to delegate work to committees
- Conflicting schedules can make scheduling fully staffed meetings difficult
- It’s easier to distribute workload
- Meetings are more formal, which makes it easier to keep order
- Large boards are subject to groupthink, with one or more members dominating discussions
How to Arrive at the Right Number of Board Directors
The Wall Street Journal study states that the board should be large enough to carry out the board’s fiduciary and other duties in an effective and efficient manner. Five to seven board members is ideal. Up to 15 board members is acceptable on the high end to account for unusual circumstances.
Besides looking at numbers, boards need to consider several other factors in choosing board directors:
- Skills, talents, abilities, areas of expertise
- Representational requirements
- Regulatory requirements
Another way to pare down board size is to add some nonfiduciary groups or committees, such as forming an advisory board.
What Circumstances Signal a Change in Board Number?
Just as today’s economics prompted changes in board composition and size, boards need to revisit the size of their boards from time to time and consider whether it’s prudent and wise to change the number up or down.
After the Sarbanes-Oxley Act (SOX) was passed, many companies added more independent board directors without relieving current directors of their seats. After SOX was enacted, the average number of board directors rose from nine to 11.
Boards may need to revisit their numbers whenever there are major governance changes or when corporations grow in size and complexity.
Smaller Boards Are Worth Considering
While the current trend in board composition means having fewer board directors who represent greater independence and diversity, it’s important to factor in the type of industry and the unique needs of the company when setting criteria for the number of board directors. The most recent study favors boards with smaller numbers; however, numbers can and should change when circumstances signal the need for change.