The New Board ABCs: Analyzing Board Composition
The Corporate Board article, "The New Board ABCs: Analyzing Board Composition," was written by Russell Reynolds Associates Consultant Anthony Goodman and featured in the January/February 2020 issue of the magazine. The article is excerpted below.
Investors and shareholder activists increasingly study your board’s makeup and talents for weaknesses and gaps. Why not get the jump on them with your own study of board composition? Uncover your talent flaws, lack of strategic fit, and poor diversity issues from the inside—before an outside activist does.
Public company boards are under pressure from investors. This stems not just from the usual focus on performance, but increasingly from questions and concerns regarding the quality of the board itself.
Board composition has become a focus both for institutional investors pushing for long-term thinking and for activist investors demanding short-term performance uplift. There are demands for gender and other forms of diversity. Finally, there are more combative campaigns for directors who bring a better value-creation track record.
One way that investors judge board quality from the outside is to scrutinize the membership of the board. They consider such factors as industry experience, diversity, tenure, and overboarding.
Yet when it comes time to fill an open spot on the board of directors, it is far too easy (and far too common) for boards to fall into the trap of short-term planning and “who do we know” candidate identification. Board search can easily become purely transactional, with the nominating and governance committee issuing an order to a search firm: “Get me one of these.”
The order-giving approach often ends up with disappointing, if not failed, searches that have been overloaded with requirements that any single candidate cannot hope to meet. Search consultants joke of the mythical “Purple Unicorn” candidate. For example, a 35 to 45 year old woman of color who is both a digital expert and a P&L leader reporting directly to the CEO of a large cap public company, with hefty board exposure, if not actual board experience.
Companies have improved with regard to thoughtfully identifying and recruiting senior leaders who are best positioned for long-term success. Now, the same transition is taking place in the boardroom. Director searches today often involve a candid analysis of the board’s current composition, identifying future needs, developing a long-term strategy for board recruitment, and seeking a number of directors over time, who can, between them, add the desired characteristics without overloading a single search specification.
Boards are often lagging indicators for changes in strategy for no fault of their own. They were built for a different time and to deal with different problems.
Boards that have successfully managed the refreshment process typically start by analyzing board composition. Then, that analysis is tied to a strategic planning process comprised of four primary activities led by the nominating and governance committee.
1. Understand the corporate strategy. The first, foundational act is for the nominating and governance committee to leverage its understanding of the company’s emerging strategy and related changes, as they will play out over the next three to five years. This provides the essential context for the board composition analysis.
The objective is to identify what kind of board will be required to provide effective oversight of the company in the long-term, instead of simply supplementing the board of today. One client in the oil and gas services business had begun pivoting to shipbuilding, yet no one on the board had any direct experience in that sector. A bank board was equipped with amazing strength in risk and compliance, yet the business was evolving to a growth strategy.
Boards are often lagging indicators for changes in strategy for no fault of their own. They were built for a different time and to deal with different problems. Since boards cannot practically zero-base their composition (unless forced to by losing a contested proxy fight), taking a longer-term view of board evolution is the next best approach.
A board candidate with an international background should be more than someone with “an accent” who is not from the country where headquarters is located.
2. Agree on the skills and experiences required. If the nominating and governance committee senses the direction of travel for the company, it will be easier to decide who needs to be on the bus, to invert Jim Collins’ famous edict in Good to Great. Collins’s metaphor comes close to a description of what the committee needs to do as part of this process, “getting the right people on the bus, the wrong people off the bus, and the right people in the right seats.”
The second phase of the board succession planning process focuses on developing a clear, agreed-upon set of definitions for the skills and experiences needed at the board level. The committee then takes a hardheaded look at each director’s skills and experiences against those definitions.
For example, the committee may want directors with an international background. They need to be clear if they value someone who ran an international component of the business from headquarters, someone who has lived and worked for periods outside their home country, or, as one client memorably put it, someone with “an accent” who is not from the country where headquarters is located.
Adding dimensions of time and scale is also important. The board is probably interested in a CEO who retired in the last five years, not one who retired 20 years ago. They may also need someone who managed a P&L measured in the billions and not millions. The definitions will also come in handy when there is inevitable pushback from current directors.
3. Create consensus on future plans. The third phase is to work with each director and review the matrix with them. It is important that everyone feels the process has been fair and transparent. The nominating and governance committee needs to explicitly ask each director about their personal plans regarding the board for the same three-to-five-year time period. Do they plan to stay on the board? Are they thinking about retirement? Are they planning to stay, but are open to stepping down if asked?
An accurate forecast of when vacancies may occur is essential, though the committee may also need to make tough decisions to create vacancies in order to refresh the board.
During a board composition analysis, one director often confesses to have been looking for an opportunity to step down from the board, but did not want to let the rest of the board down. Often that director is also the one singled out by colleagues for no longer contributing to the board. A director survey from PwC shows that almost half of directors think at least one fellow director should be replaced. Nearly a quarter say two or more should go.
Boards often take the route of least resistance in allowing “spent” directors to fade away rather than asking them to step down to create an opportunity to add to the board’s skills and experiences. In one worst case example we have seen, the primary form of board refreshment was literally death (natural causes, not homicide, lest you be worried). Fair-minded people can argue the merits of retirement ages and term limits, but boards need something more responsive than a pine box.
To read the full article, subscribe to The Corporate Board here.