While 2017 may be the Year of the Rooster, it also happens to be the “Year of the Nominating & Governance Committee”—at least, that’s our prediction.
Earlier this month, we released a special highlights episode of our Investors Board Performance Review, a three-part series where prominent investors, proxy advisors, and activists give feedback on board performance. Across all three sessions, the #1 concern of investors rang loud and clear: board composition will be a primary focus in 2017.
Why the Focus on Board Composition?
Before we can discuss specific concerns related to board composition, it’s important to acknowledge the broad umbrella under which it sits. Investor concerns about board composition are not only focused on diversity of gender or race, but also on the diversity of skill sets, backgrounds, perspectives, and personalities—and whether boards have the right mix of these characteristics for their particular industry, company, and strategy.
Institutional investors and proxy advisors have been fervently advocating for boards and management to shed the short-termist mindset and to adopt long-term strategies for growth and value creation. At a high level, the first step towards laying this framework is quite simple: a company needs to have the right people around the board table.
In addition to this aspirational pursuit of the perfect board, trends in proxy access and shareholder engagement place added pressures on today’s board members to strike that perfect compositional balance. Yet, as Paula Loop (Leader of PwC’s Governance Insights Center) reminds us in our special highlights episode, the solution to the board composition quandary is not always as simple as it appears. The devil is in the details.
What Keeps Investors Up at Night?
As activist Greg Taxin eloquently put it in our third session, investor concerns over board composition are rooted in “the challenge of self-policing.” While there’s much more transparency in today’s boardrooms (and more input from investors), boards still largely operate behind closed doors. As companies evolve, the expertise of certain board members is no longer relevant; yet, their departure from the board is often too little, too late.
Almost invariably, where you find a problem at a company—or a company that’s not performing well—you focus on the composition of the board. The question is: ‘Why isn’t there a self-correction mechanism going on here to fix the problems with management or the strategy or the capital structure or the collection of assets? What’s missing?’ Often, those companies have a mismatch of skill sets on the board.
Additionally, CalSTRS’ Aeisha Mastagni describes a “pendulum of director independence” that has nearly swung too far. She explains that sometimes today’s boards can be too “management-captured,” meaning that there’s really no one inside the boardroom that knows how the business works or how the industry operates.
“That’s always concerning to me as an investor,” said Mastagni. “It ties into this whole issue about tenure… It’s about making sure that [you] not only have a diverse range of skill sets, but that you have at least two or three people in that boardroom who know the business and how it operates—and not how it did 20 years ago.”
Indeed, investors seem to be summarizing their concerns with the idea that today’s business environment (i.e., marketing, operations, technology, etc.) is evolving faster than the skill sets in today’s boardrooms.
“There are new risks that are posed to companies, but there’s also a lot of new opportunities,” said Mastagni. “So, just focusing on who’s in that boardroom is going to be so important going forward.”
3 Ways Boards Can Answer the Call
As Paula Loop reiterates in our highlights episode, succession planning is really at the heart of this whole thing—and it’s a deceivingly difficult task for today’s boards. Regardless, there are several proven best practices that boards can follow.
- Take action on board evaluation results. We’ve long-preached about the importance of board evaluations. Even more important, however, is the responsibility for board leadership to take action on the feedback collected. Year after year, we’re disheartened to see that more than one-third of corporate directors believe that “someone on their board should be replaced” (see survey results). In the highlights episode, Loop and Kerstetter dig into the complexity of succession planning and the important role that board evaluations play in today’s boardrooms (minute 13:10).
- Use a gap analysis to identify critical skill sets. Not only should the board sit down to assess its current needs and skill sets, but also to consider the future. What is the company’s strategy? What breadth of expertise and perspectives will be required to achieve those goals? The skills and attributes used in a gap analysis will vary widely by industry and company, and may include anything from operational or legal expertise to generational or racial diversity. For gap analysis examples, check out this resource via Harvard Law School Forum in partnership with PwC’s Governance Insights Center.
- Rethink your criteria (and method) for board recruitment. Too often, boards will limit their candidate search to CEOs or sitting directors. This is quickly becoming a short-sighted approach to board recruitment. Increasingly, the best candidates can be found within the trenches, regardless of whether the board is recruiting expertise in digital technology or talent development or international business. Additionally, boards must rethink the methods they’re using to identify and vet candidates. Our episode with Equilar’s CEO David Chun sheds light on the technology that’s now available for finding and assessing qualified, diverse candidates.
Don’t miss our special highlights episode, which we recommend board members consult before setting their 2017 agendas. These institutional investors, proxy advisors, and activists have much to say!