The Importance of Board Composition, Diversity and Refreshment

Nicholas J Price
6 min read
When Wall Street takes a downturn, all eyes turn toward corporate governance in an attempt to make sense of it. The first place that investors, regulators and analysts look is at the board and how they came to the decisions they made. Boards face additional pressure to perform because of regulatory changes and shareholder activism. Such scrutiny also forces board directors to look at their composition and assess whether the board possesses the right skill set to perform their duties satisfactorily. These are compelling reasons for boards to place the topic of board composition on their agendas.

While every board should work toward developing a strong composition, board director spots were never intended to be lifelong positions. Corporations change, the economy changes and the dynamics of the marketplace change as well. The evolving landscape in the financial realm requires refreshed boards that provide new perspectives and are eager to accept the challenges of board work.

Composition Encompasses Distinct Requirements

With stricter requirements for director expectations come stricter requirements for board composition. When viewing the board as a whole, boards need the right qualifications and skills to do the job. Pressures are mounting to enhance corporate governance by making room for a majority of independent directors. Women and people of ethnicity are increasingly making their way onto boards. Most of them are receiving warm welcomes because of the new perspectives and opinions they bring to their boards. While fast turnover in board directorship isn't always a good thing, there is some value in rotating in new directors who bring fresh perspectives and new ideas with them.

Requiring and Disclosing Skills and Qualifications of Board Directors

It's not enough for boards to feel confident that they have the right composition around the board table. The SEC requires biographies of board directors, including a five-year employment history. Another SEC rule implemented in 2009 requires companies to disclose the board's experience, qualifications, attributes and skills that led each director to be appointed. Regulatory bodies also want assurance that boards have financial and managerial skills, and in some cases, international experience as well.

Boards have experimented with various ways of how to disclose the board's skills to regulatory bodies and investors. Some companies favor using a matrix of skills for each director. This format can prove too simplistic for some people because a matrix doesn't explain the director's skills as they pertain to their use in context.

Some corporations prefer to disclose the board's skill set as it relates to the collective board. The downside to this is that investors and others won't be able to discern which board directors have certain skills.

Bringing Independence Into the Boardroom

The NYSE and NASDAQ require that their listed companies have the majority of board members be independent. Having independent directors means that board directors won't have relationships between the corporation and the rest of the board that would unduly influence or impact their voting.

There is little consistency in the standards for how corporations assess the independence of their board directors. The large exchanges devised their own version of acceptable standards that define independence, and some corporations feel confident that those standards are good enough. The Dodd-Frank Act and the Sarbanes-Oxley Act strongly encouraged boards to lean toward having a majority of independent directors. These regulations prompted some companies to go a step further, building on the standards of the regulatory bodies with stringent standards of their own. When things go wrong, shareholders will certainly challenge whether the lack of independent directors led to the trouble.

In a practical sense, boards need directors who have independence as well as industry experience. Both attributes are necessary for board directors to be able to fulfill their board duties by questioning and challenging management.

In addition to being independent of people and networks, independence among board directors means having directors who are independent in thought and action. These qualities are subjective and harder to define than skills and experience.

A new controversy is arising about whether board directors with long tenures can actually be independent. Many years of serving on a board may cause them to be biased. Boards are trending toward maxing out terms at 10 or 15 years in order to preserve independent thinking.

Ethnicity and Gender Are Major Board Composition Issues

Diverse opinions and perspectives coming together enhance discussions around the board table regarding many types of issues, including technology, globalization, strategy, reputation and consumer loyalty.

Several countries, including France, Spain, Norway and Sweden, are paving the way with new laws that require boards to have a certain percentage of women on their boards. 2020 Women on Boards is a nonprofit organization that's pushing to get all corporations to have 20% or greater women on their boards by the year 2020.

Boards are also looking at diversity as it pertains to ethnicity and generation. Boards want shareholders to know that the board reflects the people they serve.

Many boards draw their nominees from a pool of former CEOs. Women, minorities and young professionals don't yet fill large numbers of CEO positions. As a result, boards will need to look outside their standard talent pools to find qualified nominees from women and minority groups.

Tenure Works for or Against Refreshed Boards

As board directors begin to show physical signs of aging, investors are pressuring boards to bring in new directors to keep the board refreshed. For many boards, their solution for board directors who don't wish to leave their posts is to simply increase the age limit for board directors rather than ask older board members to resign of their own free will.

Boards that find that some of their directors are aging may be able to offset their presence by adding new directors from younger generations.

Another idea is to mandate a certain age as a mandatory time for retirement, which hasn't been a popular decision for many boards. GE recently made changes to its board criteria by adding a policy that board directors may not serve more than 15 years. Other companies are monitoring GE's efforts to refresh its board, including reducing the size of its board.

Board evaluations are a valuable tool for paring down ineffective boards. The New York Stock Exchange requires that boards evaluate boards and management, but doesn't require evaluations of individual directors. GE says that board evaluations will continue to be an important task for determining board tenure and they plan to keep their board small.

Boards that work toward having a board composition made up of directors who are highly qualified, skilled, diverse and independent create a solid environment for well-informed decision-making.