As the financial sector begins to enter a stage of regrowth and rebuilding, financial experts, regulators and other stakeholders are casting a fresh set of eyes on best practices for corporate governance in order to improve the financial markets and the economy.
Board refreshment and board composition have been among the most challenging aspects of corporate governance to tackle. Up until recent years, board director tenures lasted for many years and age limits rose with age. With the new pressures from regulators and shareholders, new trends for best practices in board refreshment and board composition are emerging. The quality of board composition is getting as much attention as selecting, overseeing and compensating the CEO and other senior executives.
Shareholders, stakeholders and regulators seek greater board turnover and diversity in order to keep up with the evolution that’s taking place in the financial realm.
As the expectations and best practices for board composition begin to change, boards need the right tools to fill their boardroom with the best that board directors have to offer.
Balancing Board Positions With the Needs of the Corporation
Just as the trend began to sway in the direction of smaller board sizes, the pressures and expectations of boards began to increase. Today’s boards face a major balancing act as they seek to balance stakeholders’ expectations of diminished size with the same group’s expectations to meet the growing pressures to develop a well-composed board that’s capable of meeting the evolving needs of the corporation.
The average number of board directors used to be between 14 and 16 members. The financial crisis of 2008 shed a strong light on board composition and its role in the downfall of the financial industry. Suddenly, governance experts were asking all kinds of questions about who filled board seats: whether they were qualified; whether they were active; how old they were; how long they’d been there; and whether certain board directors were needed at all. These questions caused boards to decrease in size to numbers more along the lines of 10 to 12 directors. As directors retired or resigned, many boards simply didn’t replace them.
Beyond the obvious impact of the financial crisis, board composition is also being affected by such issues as cybersecurity, pressures to add diversity and insistence on having a majority of independent directors. According to an article by the American Bar Association, today’s financial arena is influenced by many different factors, including:
- The Internet
- Communications technology
- Social media
- Complex financial transactions and products
- Rising business sustainability
- Increased reporting obligations
- Demands from regulators and stakeholders to improve risk recognition, assessment and mitigation skills
- Increased recognition of the need for better industry experience on boards
- Recognition that board performance may suffer from lack of gender, ethnic and age diversity
Smaller boards may make it difficult to form a board that has the necessary skills and diversity that today’s corporate governance demands.
Is It Time to Revert to Larger Board Size?
Finding the right board talent and still keeping the number of board directors under a dozen may prove to be an impossible task. It’s a generally accepted belief that smaller boards inherently have better communication, more focused discussions and more deliberate decision-making. It may take a slightly larger board to also fill the needs of IT expertise, risk management and diversity as it pertains to ethnicity, age, gender, independence and other factors.
If boards take a realistic approach to the true needs of board composition, we may begin to see a slight upswing in the size of boards. We can hope that boards will make those decisions on a case-by-case basis and keep boards small whenever it’s possible and practical.
Time for a Cultural Shift
In any case, it’s certainly time for a cultural shift in how we view board composition. The old culture assumed that board directors would be continually renominated. The new culture assumes that each board seat serves a specific purpose in meeting the board’s needs at the time of the nomination.
Succession planning shouldn’t contain room to assume that any board director be automatically renominated for any reason. The primary question for nominating committees should relate to whether the board still needs that board director’s skills and whether other skills should take priority. While boards need some degree of continuity to be effective, board directors who remain on the board long term should be the exception rather than the norm.
The culture of board composition simply must shift toward the needs of the corporation in favor of hanging onto board directors who’ve been staples of the organization.
Boards must emphasize this cultural shift as it relates to director expectations. Board directors should change their assumptions to believing that their seat is more likely than not to be up for grabs rather than assuming renomination. Board directors should place the needs of the corporation above their own desires, even if it means giving up their own seat. The way that boards can get ahead of this cultural shift is to assess board director candidates’ expectations for tenure during the recruitment and nominating process.
Board Evaluations Are an Instrumental Tool in Board Composition
Annual board evaluations are a valuable tool to help boards identify and revise the company’s needs. Personal characteristics matter as much as other qualifications because boards are a peer-oriented environment. Every board director should be evaluated to see if they have the special skills, personality and experience to serve as a lead director or an independent chair, so that any board director can step into that role if necessary.
Diligent’s Board Assessment Tool allows board directors to set up various types of customized questions to help boards get to the heart of whether they need to replace a particular board director and whether they need to downsize or upsize. Evaluation results should reveal which board directors are lagging in their performance and identify those whose skills are no longer relevant.
Succession planning, recruitment, nominations and orientation all provide opportunities to screen board directors for their views on the culture of board recruitment. As boards move toward the right cultural approach, they can be more responsive to the changing needs of the corporation, even when changes need to happen fast.