Deconstructing Diversity: Accountability for Effective Board Composition
New Zealand has a history of leading the way in many different areas, from giving women the vote, to introducing screw caps on wine bottles. However, it appears we are lagging behind on numerous best practices associated with corporate governance.
Diversity is an area that has been given a great deal of attention over recent years, however the debate is often limited to gender or age, and progress in New Zealand is somewhat underwhelming. For example, NZX report that in 2016 only 17% of company directors are female, with no increase on 2015 (PDF). Admittedly these elements are easily measurable, and allow boards to be seen to be active in this area, but they don’t get to the heart of what diversity is about – that a board comprised of a truly diverse group of individuals, bringing different life experiences, education, expertise, perspectives, communication styles and so on, can encourage more open-mindedness, create a platform for greater innovation, improve problem-solving, and reduce the risk of ‘group think’.
Perhaps the debate could more usefully be broadened to a fuller discussion on board composition and its impact on the effectiveness of the board.
As advisors to boards and directors, we often play a part in the composition of boards either through our board appointment or board review services. Our approach is always grounded in the strategic context of our client’s organisation, however, on the occasion where boards have reviewed their composition and have produced matrices, we find these often lack clarity and depth. A recent KPMG review of ASX 200 disclosures found that 93% of surveyed companies had published a board skills matrix in 2015, and while functional skills were considered important, other skills such as technology, human capital and international experience were not considered by most entities (PDF).
IESE’s Professor John Almandoz has a useful perspective in regards to the value of non-experts on boards. His research along with András Tilcsilk, published in the Academy of Management Journal, says that too many experts on a board can be dangerous and lead to business failure, particularly when the business is engaging in uncertain or unfamiliar activities (Link to Article). The study identifies that expert-dominated boards are more likely to suffer from ‘cognitive entrenchment’ (thinking inside the box); ‘overconfidence’; and the ‘suppression of alternative views’. They conclude that a counterbalance of non-experts from different fields is good for governance, especially in times of challenge and uncertainty.
This is a valuable warning, however the discussion on board composition can be broadened still. Professor Richard Leblanc, one of Canada’s leading experts on corporate governance argues that independence, competency and behaviour are the three foundational elements that make for an effective director, and should therefore be components in assessing board composition (Link to Richard Deblanc's The Handbook of Board Governance).
Interestingly, he argues that a regulatory focus on independence has had undesirable consequences in populating boards with too few experts, and cites the example of JP Morgan which, at the time of its risk failure, did not have a single non-executive director who possessed banking experience. He also points out the difference between independence of mind and independence as measured by regulators. Arguably, there is not enough focus on the importance of true independence of mind, despite the obvious consequences of loss of objectivity and holistic oversight. Practically, ensuring true independence is particularly challenging given the size of the New Zealand market.
Competency and behaviour, Professor Leblanc’s other foundational elements, are equally ‘underdone’ when it comes to a discussion on effective board composition. He argues that matrices often rely too much on ‘experience’ as a static notion. He defines competency as “a collection of skills, knowledge, experience, education and training that can be assessed, and that contributes to the effectiveness of a director.” A director’s level of competency in any given area, therefore, can either be developed or it can diminish if it is not maintained. This reinforces the importance of regular reviews of board composition, both in terms of ensuring the competencies outlined are still relevant to the strategy of the company (which is dynamic), and with respect to the assessment of directors’ level of proficiency in any given competency. A good example of a board disclosing the rationale for competencies included in their matrix, and when and how each competency was developed by each director occurs in Prudential’s 2015 Proxy statement, pages 10-16 (Link to Statement).
Equally, desired behaviours can be included in discussions of effective board composition. Professor Leblanc refers to behaviours as a “collection of qualities, characteristics, traits and attributes that can be assessed and that contribute to director effectiveness.” He reinforces that behaviours, like competences, can be strengthened or weakened through various interventions. Behaviours such as commitment, capacity to challenge, and willingness to act can - and should - be self and peer assessed as part of a regular effectiveness review.
A key point with these discussions, of course, is that boards need to take accountability for working towards a truly effective board composition, otherwise the discussions remain academic. Given that the context in which boards operate is dynamic, the required competencies and behaviours are dynamic, therefore board composition should be equally dynamic. Taking accountability for effective board composition means committing to a thorough and regular review of the composition as it pertains to the company strategy; and board and individual director performance evaluations. This will inevitably lead to some renewal, where directors do not meet the performance threshold or have competences that are no longer relevant. We believe effectiveness reviews (ideally conducted by an external party, as prescribed in the UK)(Link to the UK Corporate Governance Code) are the fairest and easiest way to improve the true diversity of a board, where underperforming or out-of-date directors can be replaced with others who will add to the variety of experiences, education, perspective, expertise and so forth that create a step-change in board effectiveness. These conversations do not need to be hard or personal, they are merely a reflection of the increasingly dynamic environment we are faced with. That said, changes of this nature don’t occur overnight and many New Zealand boards have a long way to go in putting theory into practice.
Director of Board Practice
Kerridge & Partners