Composing Your Board the Right Way

Last month’s column,“Tug of War Between Board and Shareholders,” focused on shareholders’ demands for greater involvement in governance, including determining who sits in the boardroom. My message was to be careful what you wish for; there’s great danger in having board composition driven by disjointed parties with self-appointed agendas.

Here I’d like to look further at who should occupy the seats at the board table. With all due modesty, my years of first-hand experience working with many boards of directors provide a clear picture of what works, and what doesn’t.

What Doesn’t Work Well

It’s always easier to begin with what doesn’t work. If you’d like to get right to what does, simply skip this section and jump back in below.

Please note that certainly one size does not fit all, and each board must carefully tailor its makeup to best handle the company and its circumstances, management, and needs. At the same time, certain principles generally apply. With that said, for those of you on board nominating committees or otherwise influencing your company’s board composition, here are some things to watch out for.

Constituent boards. I first used this term years ago when working with the board of directors of a bank whose directors were appointed by constituent ownership bodies. Despite legal requirements to the contrary, these directors acted in what they thought were the best interests of their constituent groups. They seemed to like each other and got along well, but couldn’t agree on key issues. That resulted in lack of direction to management on critical matters, ranging from strategic direction to dealing with the bank’s regulators. Ultimately the bank failed and merged into another organization.

A more recent example is an organization whose directors are elected by constituent bodies or appointed by senior state officials. If you want the poster-child for a dysfunctional board, this is it. Not only do these board members speak to the microphone (yes, all board meetings are open to the public and the proceedings taped for subsequent publication) but they, like the bank board, fiercely support positions of their constituents. An all-too-frequent result is finger pointing—literally as well as figuratively—and vehement shouting matches during board meetings. This organization does happen to continue to operate with success, but despite what happens in the boardroom rather than because of it.

Activist membership. We’ve seen instances where a board finds itself laden with one or two directors who bring a specific agenda. Yes, sometimes this arrangement can cure a clearly identified company ill, and sometimes such directors can get a disorganized board back on track. Too often, however, these directors focus solely on their one issue, causing the board to take its collective eye off the real issues that need to be addressed. A typical corollary result is unnecessary discord and conflict, precluding the board from providing clear direction to management.

Family domination. I worked with a reasonably large public company that continued to have more than half its board seats occupied by founding family members. The company was doing well, with overwhelming market share in its industries, but the board simply was too insular to provide the far-reaching perspective necessary for long-term sustainability and growth. In this case, the non-executive chair—a family patriarch—identified the problem and asked how to manage a change, in a way that wouldn’t alienate the family. With engaging boardroom discussion of why a change would benefit the company, family directors genuinely accepted the need to restock the board, and this story had a happy ending.

The paper board. We’ve seen boards comprised of directors with great pedigrees and well-recognized names, but who don’t really connect with the company’s needs or with each other. These directors typically will do what we might call a “fly by” to board meetings, without being engaged in the company or its issues. At best, some of these boards simply don’t get in the way of management; at worst, they fail to recognize serious problems in need of quick and decisive action. Fortunately, we’ve seen fewer of these types of boards in recent years.

Venture-dominated board. Companies about to go public (or having recently done so) often change the composition of the board to gain the balance and skills needed in the next stage of the company’s life cycle. Sometimes, however, a board may continue to be dominated by venture capitalists. This has both good and bad consequences. On the plus side are directors with intimate knowledge of the company, its management, needs and issues, and a very significant stake in the company’s success. The downside can include a focus different from that of other shareholders, and depending on where the company is in the process, an eye on short-term exit strategy.

What Does Work

In principle, what does work is pretty simple. What we want in a board are directors who have the knowledge, experience and skills to understand the company’s industry, business, people and significant issues. Directors should work collegially in providing the requisite advice, counsel, and where necessary, direction to management, and carry out their monitoring role as well. The directors should think independently, raising relevant issues and debating them fully and working towards consensus. And they must have a burning desire to see the company succeed in its mission and provide the desired growth and returns expected by shareholders. This is really a 40,000 foot perspective, and getting the right fannies into the board seats requires considerable thought, care and work.

What many nominating committees, do, often with outside support, is consider what criteria they want their board directors to meet, and then determine how the current directors measure up. Typically they use a matrix. Desired criteria, including sought-after skill sets and other attributes, are listed in columns across the top; current board members are listed down the side. Then the boxes in the matrix are filled in, either with a mark designating whether a criterion is met or with a ranking to signal relative strength in satisfying the criterion.

Within this context, it’s interesting to see what trends have occurred over time in board composition.

Years ago we saw many companies’ board seats occupied by sitting CEOs from other companies, often hand-picked by the chief executive. These directors not only understand well issues a CEO deals with, but also recognize the challenges and have the perspective and experience to provide valuable counsel. That these individuals might have long associations with the CEO can be a significant advantage, in terms of fostering a good working relationship and facilitating an ability to trust one another and deal successfully with the tough issues, particularly in times of stress.

That said, recent years have seen significant change, for a number of reasons. Boards now have many more independent directors, with evolving rules and guidelines on what constitutes “independence,” and have recognized the value in bringing together different perspectives. Further, the number of CEOs on boards has diminished due to demands of the CEOs’ own companies, whose boards often limit the CEO to serving on perhaps one or two other company boards; the vast majority of the CEO’s time is expected to be devoted to his own company.

Also, with the focus of boards several years ago changing to more of a compliance or monitoring role, many active CEOs simply haven’t wanted to spend the necessary time on those kinds of matters. In many cases, those board seats have been taken by heads of business units or other senior executives, where serving on an outside board offers experience in corporate governance and helps position the executive to aim for the top job in their own companies.

Another factor is the burden being placed on audit committees. An audit committee financial expert is expected, and all committee members are expected to have more knowledge of financial reporting matters generally. More individuals with CFO or high-level public accounting experience have been recruited particularly for this purpose. And we’ve seen signs of similar movement for board members with other specialized skills, such as in compensation, international business or technology.

An increasing number of boards want to make their membership more diverse, adding important perspectives that otherwise would be absent. The result can be positive, where we’ve seen, for example, addition of a woman’s perspective providing valuable insight into key issues faced by a company’s industry, product lines or customer base. Importantly, recent feedback from female directors indicates that they see themselves adding more value in the boardroom where there are at least two and perhaps more women to reinforce each others thinking.

Bottom Line

What it comes down to is that a board is best comprised of those individuals with the background, knowledge, skills, experience and other attributes so that collectively the board is positioned to provide the most valuable advice, counsel, direction to and monitoring of the chief executive and senior management team. Board composition should reflect and be commensurate with the company’s industry, business, circumstances and needs. And directors should have the wherewithal and strength of character to do the job well, especially in times of stress.

Among the critical factors is that the directors can work together cohesively and collegially—debating without rancor, and ensuring an effective boardroom dynamic. The directors need to work together and with management to give the company the greatest likelihood of success for all shareholders.