As far back as the Enron crisis, governance has been evolving and changing. This has resulted in greater oversight and engagement. Today I can’t think of an industry that isn’t going through some significant disruption. Boards need to be engaged and involved as companies strategically navigate the issues and opportunities disruption creates.

— Pat Russo, Board Member, GM, HP, Enterprise, KKR, Merck

Board members are well aware that the world around them is changing. The weight of this transformation is felt each time a new enterprise risk is added to their plate. The impact is felt every time a cyberattack threatens valuable customer data.

The challenge facing today’s boards is not one of awareness—it’s one of adaptation. In this digital era, can boards evolve quickly enough to combat the challenges and capitalize on the opportunities? Do they have a choice?

At Diligent’s June 2019 Directors’ Experience event in Napa Valley, we designed a panel around this very topic, “Resiliency & Building a Better Board.” Our goal was to understand: In what ways are today’s boards struggling with composition and refreshment—and at what cost? How are high performers leveraging board composition as a competitive advantage?

Panelists:
Pat Russo, Board Member, GM, HP Enterprise, KKR, Merck
Anne Sheehan, Former Director of Corporate Governance, CalSTRS
Hilliard Terry, Board Member, Umpqua Holdings
Brian Stafford, President & CEO, Diligent Corporation (Moderator)

Understanding the Board Composition Landscape

Boards have failed to refresh themselves fast enough. According to PwC’s Annual Corporate Directors Survey, 45% of corporate directors say that someone on their board should be replaced. In addition, CGLytics’ S&P 500 Review: Increasing Boardroom Diversity shows that the needle is barely moving when it comes to diversity of various kinds: gender, race, age, etc.

“Boards are not refreshing at the pace they should be,” said Anne Sheehan. “This law in California (SB 826) is a terrible solution in my opinion, but it’s there because companies weren’t responding.”

Sheehan, who served as CalSTRS’ Director of Corporate Governance for ten years, now brings an interesting perspective to her new board seat at L Brands, the parent company to various American retailers including Victoria Secret and Bath & Body Works.

“You have to remember,” said Sheehan, “that investors look to boards as their representatives. Large investors have thousands of companies and cannot possibly engage with them all. They depend on board members to represent their interests in the boardroom.”

For this reason, investor focus on board composition will continue to sharpen. As disruption permeates industries and companies, investors will continue to assess: Are the right people sitting in the boardroom?

Obstacles to Board Refreshment

According to panel discussions, the obstacles to board refreshment are fairly straight-forward. Too often, boards fail to set expectations with incoming directors around tenure, timelines and evaluations.

“As new members arrive, board leadership should set the stage,” said one attendee. “Here’s why you’ve been recruited. Here’s how long we expect you to serve. Here’s how frequently we assess board composition…

Another faux pas is simply not devoting enough time to director succession planning on the board agenda. Evaluating board skills against long-term strategy is one of the responsibilities of the Nominating and Governance committee, emphasized Pat Russo: “I think of boards as a mosaic of skills and experiences that you have to put together based on where the company is heading. This has to be a regular item on the agenda.”

These solutions are fairly tactical (e.g., devote enough time, set expectations up front). What’s less tangible, however, is the critical role that board leadership plays in the refreshment process. It’s ultimately the role of board leadership to establish the right board culture and have the tough conversation when necessary.

Our board chair is the first person to raise her hand and is very artful in leading these difficult discussions. When the chairman sets that tone, it’s adopted by the rest of the board.

— Hilliard Terry, Board Member, Umpqua Holdings

Pinpointing the Gaps & Uncovering Talent

While the barriers to board refreshment are discernible, the solutions can be more complex. Getting the right people in the boardroom—or even knowing what skills you need in the first place—is always more difficult in practice.

As the business landscape becomes more technical, there’s a tendency to target board candidates with specialized expertise, whether cybersecurity, cryptocurrency or digital marketing. The group debated whether this is the right approach.

“You can’t populate boards with just functional experts,” said Russo. “One of the critical roles of the board is providing direction on the strategy: where is the company is heading? You need people around the table with relevant backgrounds who can ask the right questions. Each board has to use its judgement around what level of functional expertise it needs depending on its risk profile.”

Indeed, boards are gaining a better understanding of the types of digital expertise in the market. Five years ago, everyone wanted a “digital director.” Today, boards are more attuned to the difference between digital marketing and cybersecurity expertise—between a technology entrepreneur and someone who’s navigated digital transformation at a legacy company.

The group generally agreed that bringing third-party experts into the boardroom can be a great way to tap functional expertise without sacrificing board real estate. Each board will have to judge for itself the right balance between leveraging external experts vs. recruiting new directors. Yet, boards must also be cautious not to use “specialized expertise” as a disqualifier. In a recent episode of Inside America’s Boardrooms, Spencer Stuart partner Jason Baumgarten made an interesting point:

I do think it’s important to [recognize that], for many years, CFOs have been “single-skilled directors”, and somehow that’s okay. Yet, if someone is a marketing expert or a product expert or a cybersecurity expert, we worry about them. And I think, really, that comes down to the person: Are they a broad business-thinker, first, who has happened to accumulate specific experience and skills in those areas?

— Jason Baumgarten, Partner, Spencer Stuart

Evolving the Skill Matrix

Is the skills matrix still the most effective way to gauge needs and refine the succession strategy? It depends how you use it.

“Boards must make sure that these skills matrices don’t become a check-the-box exercise,” warned Russo. Boards should be able to explain the relevance of each director’s skills in relation to the long-term strategy—and this context should be included in the proxy.

“Really, you have to look beyond the skills matrix,” said Hilliard Terry. “You have to consider the personalities and dynamics. These things can’t be quantified in the standard matrix, but they’re very important in a boardroom.”

Thus, the skills matrix can be a helpful tool so long as boards recognize its limitations. Strategic succession planning extends beyond a checkmark grid.

Transitioning into a Modern Governance Era

The board diversity challenge is often one of access. How can directors look beyond their own networks to uncover diverse and qualified talent? How can technology enable and amplify these connections?

Diligent Nomination and Governance moduleDiligent’s Nominations & Governance module is taking a unique approach to this. With a global database of corporate directors, boards can run queries and explore connections. Soon expanding to untapped or next-gen talent data sources, this module is designed to build connections between boards and diverse talent that don’t exist through traditional networks or channels.

Boards also can’t ignore the risks associated with board composition. How does your composition compare to competitive peers? How are investors and proxy advisors assessing board skill sets? Is there a weak underbelly that activists can exploit?

Today’s boards must be privy to these perspectives across their investor base, but also within the communities in which they operate. In the scope of environmental, social and governance (ESG), how is the board’s composition representative of the customers, employees and communities it serves?

Like synapses of the brain, the individual function of each board member is only as powerful as the network. The greater the diversity of the nodes, the richer the network perspectives. Our goal is to get the synapses firing.

Next up! We’ll be recapping our session with corporate governance legend Rodge Cohen, Senior Chairman at Sullivan & Cromwell, and Katie Martin, Partner & Board Chair, Wilson Sonsini Goodrich & Rosati.