In addition to the traditional priorities for any company board, each year brings new challenges to complicate strategic planning. Today’s directors must also give due consideration to matters such as ESG, diversity, and cybersecurity if they want to succeed in these turbulent times.
But a 2023 survey by PwC and The Conference Board found that over half of boards were still only rated as “fair”, with a mere 29% marked as good or excellent.
As a follow-up to its successful board effectiveness event earlier this year, the M&A Community invited 3 prominent experts to discuss what might have changed since last year, when the key trends for 2023 were listed as:
- board composition and skills
- technology and cyber risk
- strategy and risk
- climate change
- workplace and workforce matters
- corporations’ role in society
- general board effectiveness
The event was chaired by Caroline Davis Schoenecker, Experience Director for the Deloitte’s Center for Board Effectiveness, who also took questions from the audience.
As we near the end of 2023, what are the key things influencing board effectiveness?
Today’s event is called Navigating towards effectiveness, and in practice you never arrive; there are always changes along the way that you may not even see coming.
So last year we didn’t even mention inflation, geopolitical risk, or AI, three things that I suspect are now some of the most common search terms among board directors.
ESG strategy is still a hot topic and one that’s evolving. Electrification, supply chain disruptions, and even economic stability are affecting us. We’re in the environmental solutions industry, so the direction of climate change legislation is always front of mind for us.
Republic has had a sustainability and corporate responsibility committee since 2016. So we’ve been thinking about it for a long time, it’s just that investors are now taking more of an interest. For me, ESG is a strategic initiative that should be embedded in everything you do.
I think it’s great that you see it as an opportunity, rather than, as is all too common, a risk to manage. Of course, it is a risk/compliance issue, but it also has to be intrinsic to strategy.
It’s interesting that the SEC was widely expected to suggest that boards should include a cybersecurity expert (as well as climate issues) and this wasn’t even mentioned. This is good because trying to come up with a one-size-fits-all approach would just be asking for trouble.
Looking towards 2024, not a day goes by where I don’t have a conversation with a board member about AI. Another ongoing topic is geopolitical risk and its impact on economies around the globe.
How do we get better representation, not only for gender, race, and ethnicity, but also in terms of skills and demographics?
Deloitte’s annual Fortune500 survey for the Alliance for Diversity shows that representation has continued to improve. But if you compare the percentages with the U.S. population as a whole, only 16% of Fortune 500 boards have a 50:50 gender split even though women make up half the population. And given the growing importance of the Latino/Hispanic community, both in terms of numbers and buying power, it’s somewhat surprising that only 13 companies in the Fortune 500 have 18% plus Latino/Hispanic board members (which would reflect the 2022 census data).
Even more surprisingly, the percentage of both men and women on Fortune500 boards from Latino/Hispanic backgrounds is either flat or declining, whereas, in the last 2 years, there has been a big increase in African American and Black Board members. Interestingly there is a gap in terms of African, American, and black women on committees versus those in leadership roles.
The sector with the best board gender diversity is consumer products and the one with the greatest racial diversity is life sciences and healthcare.
Has the conversation changed in the past few years?
Republic’s board is about 34% diverse and our nom/gov committee has 2 ongoing conversations. The first is the capability matrix and ensuring we’ve got the right skills to represent the shareholders. But, more importantly, how do we find a good pool of candidates?
When you look at retiring and sitting CEOs, diversity is probably around 10%. So you need to recruit beyond people who may only be there because of their CEO role or their financial role. CFOs are always going to be in demand, but you also want executives who have built their careers in cross-functional roles so they can bring not just a different perspective but also their experience to help guide the leadership team. And succession is really important.
Diversity is improving, but once a board believes it has good representation, what else do they need to think about?
Firstly, I think it’s not so much about representation as strategy. The board needs to understand what the strategy is, agree with it, and understand its implications for the composition of the board. For instance, if your company is moving into a new sector, is there anyone on the board who knows anything about that sector? What skills and experience do you need?
Secondly, it’s about cognitive diversity. One of the reasons for ensuring gender and racial diversity is to disrupt the all-white male perspective by having different people in the boardroom.
But then we need to look at what skills and experience you need in today’s world. In the last few years, digital transformation has taken center stage: this doesn’t mean I need an AI expert on my board but I do need somebody at a company that is using AI in their digital transformation as part of their business strategy so we can learn from their experience.
After the pandemic, a lot of boards focused far more on workforce wellness and wanted access to HR expertise. That’s an area with excellent diversity in terms of gender and race so this brought in a vital skill set and improved diversity at the same time.
I think just going for diversity as an end in itself is pointless and can be seen as tokenism. You have to start with the business need and then look in the right places to make sure you’re getting a very diverse list of people to consider for upcoming roles.
Have the skills and qualifications needed on the board changed? And how does what’s happening inside the boardroom differ from what shows up in their proxy?
I would say that boards are a lagging indicator of strategy. So when the strategy changes, the company transforms long before there are any new board members.
There is very little churn, especially in public companies. The Russell 3000 for 2023 listed the number of new directors up for election as 8.7% of the total. If you think about the sweeping changes that have occurred in businesses in the last 5-10 years and then you see the average age of directors, and how many are in their 70s or even 80s, you realize how long it is since some of these people were making executive decisions and how far removed their experience is from where companies are today.
Boards don’t change, I think because they prize collegiality. So while they are happy to fire a CEO or criticize the management team, they don’t want to suggest that one of their number should make way for somebody with new skills/experiences. For me, board ossification is the biggest single issue.
What kind of conversations do you have in your boardroom around capabilities, skills, and expertise?
We have recently introduced an age limit for our board as a way of keeping it up to date. We had some churn and as a nom/gov committee, we thought about the gaps in what we needed, for instance, expertise in acquisitions, not necessarily in our sector.
But sometimes investors don’t understand your choices and you have to explain how they add value and help us get the return that they’re expecting.
And CEOs always think they are good at everything but it has to be about their core competencies and how they add value to the board compared with somebody else with different capabilities.
How do you know when it’s better to have an expert on the board or to bring in consultants to advise the directors?
Cybersecurity is a really good example. The board has to have a good grasp of cybersecurity because sooner or later there will be an incident.
You don’t necessarily need an expert on your board but you do need access to professionals who can inform and educate you, to ensure that the organization is prepared for an event when it occurs.
How can you ensure that the board has sufficient knowledge to oversee the management of digital technology?
Clearly, in the current environment, pretty much every company is now a technology company. In some cases you would put a chief information officer or chief technology officer on the board because they are more strategically oriented, have an enterprise leadership perspective, and can think across silos. But what you really want is leaders who have successfully transformed their own businesses through the use of technology because they can address general business issues but still have enough familiarity with technology to ask the right questions in the boardroom.
I know in the sporting world the gentleman amateur lost out to the professional but I think boards do still need generalists who can challenge, guide, and support management, in a thoughtful way. You don’t want a board where everybody’s an expert in one very narrow area, because that’s not a recipe for success. Michelle Edkins, Head of BlackRock’s Investment Stewardship team, has a great quote: “A board made up of one-trick ponies is nothing but a circus.“
I like that! The other thing that happens when a new topic comes up is the board just decides to create another committee. But you may not need an AI committee or a climate committee. One of the stories that I heard was about an executive in a technology company who was invited to join the board of an agricultural company because they wanted somebody who could understand tractors as a digital platform, and not just a piece of farming machinery.
How do boards learn all they need to know? What does good board education look like?
We recommend our board members take classes each year. For instance, I’m on the sustainability committee, where ESG is a hot topic but I didn’t know all the debates or what regulations were in the pipeline so I needed to learn more about it.
Then for those that haven’t attended training, we bring experts into a board meeting to talk about a particular area so everyone understands it enough to help advise the leadership team.
What does a good relationship between the board and investors look like both in good times and bad?
First of all, the organization has to have a good investor relations group to engage with investors, especially the largest/most vocal, and find out what they worry about, what their priorities are, and what they want to know.
As a board member, I need to really understand our strategies and be able to explain them. Even when investors don’t agree, if you can explain how the board reached a decision, they will still respect you. It’s about transparency, having the facts, careful preparation, and keeping the conversations going. That’s what’s given us a good ongoing relationship with our investors; nothing’s a surprise and we can disagree because they know we’re not hiding anything.
How does the board evaluate the CEO’s effectiveness? And is that linked to succession?
This is an area that many boards find very challenging. It’s one thing to set and agree goals and metrics, a different thing altogether to have the conversation about performance: how will it be assessed, by whom; how are you going to handle the feedback and ensure that the CEO understands the board’s thinking.
And part of that conversation has to be about what plans the CEO has to develop potential successors within the organization. Some boards are very good about holding their CEO and management accountable, but others struggle.
How are boards thinking about using AI in terms of better governance?
It’s early days, but we’re talking about it with the leadership team who have some fantastic ideas on how to utilize AI within the organization. I think we all need to know more about it because it’s not all good, but we do see AI offering opportunities in many areas, at least for investors.
We were talking about education earlier and I’m sure there are roles, for Enterprise AI in particular, to help directors find out things like their competitors’ strategies in a particular space. I say Enterprise AI because you don’t want to be asking that kind of question on ChatGPT.
We’ve been using it ourselves recently as board consultants, just experimenting. It’s a brilliant way of editing content because you can put paragraphs in and ask it to improve your English. But I also asked how I might persuade an 80-year-old board director it was time to move on and it produced some very warm and engaging text for me!
Summary
Boards today face several relatively new challenges, with geopolitical instability perhaps the one to watch next year. ESG is evolving as more investors, clients, and customers use it as a differentiator. Diversity, while broadly improving, is still patchy and some way from reflecting the U.S. population at large. Cybersecurity is a growing concern as the digital transformation shows no signs of slowing and now AI promises/threatens to affect board management as well as everything else. And traditional preoccupations persist, such as inflation.
Ensuring your directors can cope with the latest tribulations (and opportunities) means taking a long hard look at your board’s composition, not just its diversity (or lack of it) but also its range of skills and experience. You don’t need an expert for every topic sitting on your board, but you do need board training and access to professional advice. And don’t forget that it is not only senior management whose performance affects the business, you need a succession plan for your directors too.
