Boardroom Diversity & Innovation Key to Creating Long-Term Value

02/28/2017
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Progress toward improving diversity in business has been slow and stilted – not least in the boardroom. Boards of Directors have a fiduciary duty to act in the best interests of shareholders, in order to create long-term value. Their ability to innovate and navigate through today’s challenges – from emerging technologies, to the threat of climate change – and steward their organisations to long-term success requires fresh approaches and new ways of thinking.

The best way to bring a variety of perspectives into the boardroom is to ensure it reflects a diversity of backgrounds, ages, genders, ethnicities, and experience. Our Senior Advisor for Net-Zero by 2050, Tanuja Dehne, offers businesses some substantive advice on how to bring diversity to corporate goverance in the following article:

By Tanuja M. Dehne

Corporate governance encompasses the rules of engagement, the infrastructure, and the language spoken by the many players in and around the boardroom. Most importantly, however, corporate governance embodies the role of the boards of directors—the decision makers at the top of an organization. A fundamental tenet of corporate governance is that a board of directors makes informed decisions as it carries out its fiduciary duties in the best interests of its shareholders in order to create long-term shareholder value. It then follows that to make the most informed decisions, a board of directors should possess a diverse mix of business attributes, backgrounds and skills so that it can properly carry out its fiduciary duties.

Much has been written and studied about various aspects of diversity in boardrooms across the globe, including in the United States. The data continues to show that the pace of change in the boardroom remains painfully slow. Pressures to accelerate the pace in service of value creation is coming from all directions including investors and CEOs.

This article highlights the confluence of corporate governance tools that impact demand for board seats, such as board succession, board performance evaluations, and tenure limiting mechanisms; as well as the supply of potential director candidates by diversifying the business attributes required to ensure that a board is equipped to make decisions that ensure the long-term viability and profitability of an organization. Despite the many mechanisms that would facilitate regular turnover and allow for the diversification of talent and dialogue in the boardroom, there is not enough demand by boards to accelerate the pace of change. This article challenges corporate boards to make board composition a priority. Boards should remove from the analysis the personalities and rationalizations to maintain the status quo, and implement, with fortitude, existing corporate governance mechanisms to ensure that the mix of backgrounds and skill-sets necessary to maximize long-term shareholder value gets into the boardroom.

Create the Demand with Increased Turnover

Board seats are limited, coveted and, in many cases, treated as well-paid tenured positions for life. Boards appear to be striving for more diversity, yet low director turnover rates stymie meaningful change. There is a clear disconnect between rhetoric and results. According to the Spencer Stuart index, women ranked first and ethnic minorities ranked fourth (behind CEOs and COOs) on boards’ “wish list for new director backgrounds.” Yet, there was a mere 1 percent increase of women joining S&P 500 boards between 2015 and 2016, and minority representation decreased 3 percent. In addition, low turnover rates between 2015 and 2016 resulted in the number of available independent board seats declining from 376 to 345 (of over 4,000 director positions).

Opportunities such as board evaluations, succession planning, and tenure limiting mechanisms can allow boards to refresh their composition in a thoughtful and strategic manner, and should create demand for new talent pools to join the boardroom dialogue. However, not enough boards employ these available tools to make the hard decisions necessary to replace and re-staff their boards with new types of business skills that are in line with the opportunities to create long-term value.

Improvements to board composition can be fostered through mechanisms such as:

  • Board Evaluations: Boards are required to conduct their own performance evaluations, but boards have discretion as to how to act upon the results, if at all. Some companies are crafting robust board evaluation programs, yet fewer are using them to critically evaluate individual and collective board performance that results in directors stepping down or not being reelected to serve.
  • Succession Planning: Boards spend a great deal of time on succession planning for their management teams. Unfortunately, many boards do not use succession planning as an opportunity to refresh their own performance talent pipeline to keep up with business demands, but instead fill vacancies on an ad hoc basis. The Spencer Stuart index outlines ways a board can inculcate succession planning into their board performance program, by, for example, thinking like an activist and identifying and addressing weaknesses proactively.
  • Tenure Limiting Mechanisms: There are no specific rules or regulations that require term limits or retirement ages. While more boards are disclosing information in their proxy statements about director tenure, according to the Spencer Stuart index, only 19 S&P 500 boards, or 4 percent, set an explicit term limit for nonexecutive directors. The same study reports that most boards have mandatory retirement ages, but such ages are rising to allow for sitting directors to serve longer, with 39 percent of S&P 500 boards setting a mandatory retirement age of 75 or older.

Lack of director turnover can be attributed to collegiality, consensus building and the need to retain wisdom and knowledge in the boardroom. While these are important qualities of effective board culture, they also can be barriers to making tough decisions about a board’s own composition. If a board approached the existing mechanisms through the lenses of its fiduciary duties, strategic planning and long-term value creation, what were once difficult and emotional decisions could become part of the normal course of business and expectations in the boardroom.

Increase the Supply by Diversifying Business Attributes

Boards need experienced individuals to join their ranks, but the traditional criteria of prior CEO, CFO, and board service experience have turned into threshold requirements, thus limiting the viable supply of board candidates and hindering change. With such criteria acting as a threshold, joining a public board is unattainable by many potential candidates with deep and varying experience and perspective to offer. Heidrick & Struggles conducted a study over a five-year period and found that sitting or former CEOs and CFOs claimed two-thirds of new appointments to the Fortune 500, and for the last three years of its study, almost two-thirds of new appointees came with previous board experience. (The Heidrick &3 Struggles Board Monitor: Trends in board composition over the past five years). Sitting CEOs are often limited in the number of boards in which they can serve, thus the pool of available candidates with CEO experience diminishes significantly to retired CEOs, who are more likely to be men in their sixties.

Diversity of thought which comes from diversity of backgrounds based on gender, race, ethnicity, age and experience must be more prevalent in the boardroom. New issues face boards today that will impact the future of many organizations such as: cybersecurity, digital disruption, block-chain, big data, sustainability and climate competence, and consumer and market forces. Candidates who do not possess the traditional C-level experience can add a great deal to the conversation in the boardroom. For example, if a board, as recommended by best practices and trends, was to create a committee focusing on environmental, social and governance matters, it would make sense to recruit Chief Sustainability Officers or climate scientists who could champion climate competency in the boardroom. Similarly, while recruiting for consumer facing, digital media or technology expertise, boards will have to look deeper into the executive ranks to CMOs, CIOs and perhaps even deeper to line expertise, which could open the door for demographically younger and more diverse experts joining boards.

If boards broaden the criteria for talent and expertise and increase the demand for new types of directors, the supply of candidates will expand accordingly. Furthermore, as the trends in data show, gender, ethnic and other forms of diverse board representation would increase as well. For example, the Spencer Stuart index found that new female and minority (defined as African-American, Hispanic/Latino and Asian) directors are more likely than males to be line, functional leaders or division or subsidiary presidents, and less likely to be active or retired senior leaders, such as CEOs.

Undoubtedly, tokenism, single subject expertise and unheard voices standing alone will not lead to long-term value creation. Rather, more boards should demand a broad array of experiences, capable of balancing business expertise with the needs of the business over the long term. This balance can be attained by creating an ecosystem in the boardroom that continuously reviews the existing talent and business context, and anticipates what’s next. A board of directors that fosters a culture that is intellectually honest about its composition and open to welcoming new members into its ranks will be better equipped to take advantage of the opportunities offered by the future in service of long-term value creation.

Reprinted with permission from the February 21, 2017 issue of The Legal Intelligencer© 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

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