Corporate board structure in 2017 and beyond

November 2017  |  COVER STORY  |  BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

November 2017 Issue

Building an appropriate and skilled board is integral to the day-to-day operations of an organisation, defining its corporate governance and setting the tone for its wider operations.

Corporate governance interests a wide spectrum of stakeholders, including policymakers, investors and regulators, all of whom want to see greater transparency in organisations’ board practices and functions, as well as increased director accountability and effectiveness. Ultimately, it is the responsibility of the board to protect shareholders’ assets and deliver a return on investment. The right board structure will help generate value while remaining compliant with relevant legislation and regulation.

Boards must be capable of displaying flexibility and dynamism. They must tackle issues such as technology implementation, cyber security, diversity and social responsibility, incorporating these issues into their day-to-day operations. In order to achieve this goal, corporate boards must be appropriately structured.

Individual companies are of course responsible for their own board structure. There can often be a disparity in the number of directors among companies even within the same industry, for example. There is no standard answer to the question of board structure and composition. In certain jurisdictions, such as the US, companies must appoint a certain number of independent directors to the boards, but they are largely left to their own devices when it comes to board composition.

Managing risk from the top

Since the financial crisis, there has been an increased focus on risk management, according to Anthony Goodman at Russell Reynolds Associates. “The focus has been on boards with deeper expertise in financial services with an emphasis on risk management,” he points out. “This has been partly a response to regulators but mostly to do with the complexity of issues facing financial services. More recently, the focus has been shifting to directors with more breadth, such as former chief executives of large, global, typically non-financial, companies. The other trend has been to add technologists to deal with cyber security and the digital customer experience.”

Risk management is ultimately the board’s responsibility. It is an integral feature of all business activity and boards need to manage it effectively to avoid distress, sustain their strategies and safeguard shareholder value. Failure to identify, assess and manage all types of risk – including business risk, operating risk, market risk and liquidity risk – can have significant consequences.

Risk management must influence board composition and board processes. The board sets the tone at the top, which must be embraced by senior executives and others throughout the enterprise. The board plays a vital role in overseeing executives’ approach to risk management, and determines the enterprise’s appetite for risk. Without board oversight, risk management may not be embraced from the top down. Individuals with a strong understanding of risk management and risk opportunities are therefore a welcome addition to any board.

Board influences

Shareholder activism in recent years has created additional headaches for organisations. As the general awareness, involvement and influence of shareholders on corporate governance has increased, activists have begun to play a visible role in determining board composition. There is increasing scrutiny over who is sitting in the boardroom, and institutional investors in particular often push for change. Some investors may file shareholder proposals in order to gain proxy access to nominate their own director candidates to boards. According to a PwC report, ‘Board Composition and shareholder activism’: “Directors with very long tenures or who lack deep industry knowledge may be targets for activist investors. Others may go after perceived governance weaknesses as a means to gain support from other institutional investors concerned about board composition. Shareholder activists often seek board seats at investee companies – and many are winning them.”

Investors are increasingly concerned with diversity, social impact and governance structure, reflecting shifting priorities outside of the boardroom. With more millennials interacting with brands via social media, and seeking employment with organisations, there is a heightened focus on corporate social responsibility – and companies are starting to listen. For some, companies should be embracing the millennial voice and appointing younger board members. According to the 2016 SpencerStewart Board Index, the average age of board members in the S&P 500 is 63, two years older than in 2006. While the voice of experience is vital, the populations of many of the world’s biggest potential growth markets, across the Middle East, Africa, Latin America and parts of Asia, are much younger; people under 30 constitute 66 percent of the population in those regions. As such, companies must ensure they remain in touch with the core values of a younger demographic. Appointing younger board members may provide a fresh perspective on a raft of new issues.

Technological developments, as well as changing consumer preferences, business strategies and models, are all areas in which companies should be looking to embrace vibrant new voices. “Issues like cyber security, artificial intelligence, global geopolitics and generational shifts prepare directors for active participation in important conversations and collaborative dialogue,” says Stuart R. Levine, chairman and CEO of Stuart Levine & Associates LLC. “The current reality is driven by the question, can you learn as fast as the world is changing? Boards that are totally populated with retirees may have difficulty engaging in the right conversations going forward.”

The push for diversity

Beyond generational gaps, boards can also be undone by failing to embrace other forms of diversity. To date, the majority of boards have failed to fully embrace the concept. According to Green Park, 58 percent of FTSE 100 boardrooms still have no ethnic minority representation. Although that is up on the 62 companies that recorded all-white boards in 2016, there is still room for significant improvement. Companies should aim for greater representation for a number of reasons. “Demographic trends around diversity of customers, employees and shareholders imply continuing shifts in diversity,” says Mr Levine. “Ensuring that these groups reflect contemporary markets and opportunities for products and services and evolving realities is the role of the board. A dedicated conversation with the nominating committee reinforcing the belief that a diverse board enhances shareholder value, is an important calculus to this narrative.”

In 2016, a government-backed review of ethnic diversity recommended that Britain’s top companies bring an end to all-white boardrooms by 2021. However, increasing diversity in board composition should not be considered a mere box-ticking exercise designed to fill quotas and appease government bodies. There is genuine value to be found in incorporating a more diverse and inclusive approach to board structure, and, as such, investors are championing this process, says Mr Goodman.

“The evidence shows that diverse boards make better decisions and their companies outperform others. That is why large institutional investors are making an issue of gender diversity. Boards need to respond, regardless of whether there are formal quotas or targets in place in their country of origin. That means thinking more expansively about the criteria used to find new directors and the real skills and experiences that could add value to the board, rather than just looking for more of the same. Ensuring the nominating committee is as diverse as possible is important since they are shortlisting and selecting candidates. It is also the case that boards that do not let their own C-suite talent, particularly the women, gain non-executive board experience outside financial services are diminishing the development of their own people and restricting the supply of talent available for others. That is a lose-lose for everyone,” adds Mr Goodman.

Companies can take steps to improve board diversity in many ways, such as setting new principles for decision making, shortlisting female or minority candidates for every board position and changing mindsets by committing to diversity via sustained action throughout the company. Furthermore, organisations should be creating and cultivating an active pipeline of female and minority candidates for board positions. When conducting a search, this means relying on both personal networks and search firms to identify candidates. Creating a solid pipeline of ‘non-traditional candidates’ will allow companies to move away from the perception that the boardroom is an ‘old boys’ club’.

More must be done to improve diversity in the boardroom. In the US, there are concerns that the progress made in recent years may be unravelling. The percentage of female directors appointed to Fortune 500 board seats fell in 2016, after seven consecutive years of growth. Furthermore, according to a new report from Heidrick & Struggles, women were appointed to only 27.8 percent of director seats that turned over or were added to the boardroom roster in 2016 – a 2 percent decline from 2015.

There is some progress being made in Europe, however. Guidelines published by the European Banking Authority and the European Securities and Markets Authority will require diversity to be considered at boardroom level from June 2018. Under the guidelines, there will be “quantitative” gender goals in the boardroom.

The 2011 Davies Report in the UK has also championed greater boardroom diversity. Originally, the report set a target of 25 percent of FTSE 100 board positions to be held by women by 2015. Though this target was achieved and the growth of women on FTSE 100 boards has since slowed, the report has subsequently extended its target of 25 percent female board representation to all FTSE 350 companies by 2020.

Additional action is required if boards are to be more representative in other areas, however. Ethnic minority board membership remains low. In November 2016, the Parker Review released its consultation report entitled ‘A Report into the Ethnic Diversity of UK Boards’, and recommended that each FTSE 100 board should have at least one director of colour by 2021; and each FTSE 250 board should have at least one director of colour by 2024.

The talent pipeline

Companies can help prepare their talent pipeline by positioning viable candidates in areas of the business where they will gain valuable experience – roles with profit-and-loss responsibility, for example – as well as providing them with committed mentors and sponsors. Prospective board candidates also need to acquire the knowledge and skills necessary to confront the governance and strategy issues they will face.

Preparing this pipeline should form part of every company’s long-term plan. Driven by calls from shareholders for strong quarterly earnings expectations, companies often neglect their long-term plans in favour of short-term gains. Resisting short-termism can be difficult, but does bring advantages. “Financial services boards are starting to think more long-term about the way they appoint new directors,” explains Mr Goodman. “Instead of treating each search as an individual event, they are analysing their composition in light of the longer-term strategy, identifying the gaps and the potential candidates to fill them, and playing the long game in terms of getting to know individuals, often before they are available to serve or there is a vacancy to fill. This can often be a rolling three-year process which creates more options and alternatives for the canny board.”

Nurturing ties with the C-suite

Such thinking requires a holistic approach, and a strong relationship between the board and the C-suite, says Mr Levine. “A transparent, metrics-driven relationship between the board and the CEO is critical. Clarity around strategy and accountability starts at the top and in many ways defines the culture of the corporation. Embedded in this conversation is a structure on the board that allows for honest discussions around succession planning at the board level as well as the CEO of the organisation.

“The relationship with management is critical and has to balance being supportive with constructively challenging management. Boards are putting more effort into getting to know the management team beyond the C-suite by visiting operations. This enables them to do a better job of managing succession planning: verifying that a realistic plan is in place. Wise directors know that interacting with management requires tact and discretion to avoid overstepping the bounds between informed oversight and operational decision making. Former CEOs understand that line very well from interacting with their own boards,” adds Mr Levine.

The nomination committee has become an important cog in the machinations of the boardroom. According to EY, many companies are beginning to expand their nomination committees and widen their remit. Committees are delving deeper to find and nurture future candidates and factor them in to the company’s long-term planning, under the guidance of the board. By allowing the nomination committee to be more proactive, boards will be better equipped to find ‘board ready’ individuals with a clear view of the needs of the business.

With greater attention paid to improving corporate governance, we have seen the emergence of better board structures, the implementation of more rigorous checks and balances and a greater emphasis placed on risk management in recent years. The emergence of millennials and social responsibility programmes will also likely have an effect. In order for organisations to not be caught out by these issues, it is vital that they appoint and empower forward-thinking directors. There is too much at stake for companies not to be dynamic and considerate about the long-term economic, technological and demographic trends that are radically reshaping the global economy.

© Financier Worldwide

BY

Richard Summerfield