One can learn a lot from looking at the makeup of any publicly traded or privately-owned company’s Board of Directors. In all cases the primary responsibility of the Board is to be accountable to shareholders and govern a company’s management. However, over the years Boards have increasingly come under pressure in the face of corporate scandals such as those at Enron, WorldCom and HealthSouth, in all cases the Board’s failed to act in the shareholders best interests. Even with the introduction of the Sarbanes-Oxley Act making companies more accountable, investors should still pay attention to Boards and how they operate.

When a person is approached with a Board of Directors nomination there are various factors one should consider from a personal perspective. Potential exposure to legal liability, public criticism, reputational harm and a significant time commitment are all considerations. While not all risk can be totally eliminated, serving as a director that matches an individual’s experience and expertise can be a very rewarding experience. In evaluating a Board of Directors, there are many aspects to consider – below are three broad considerations to keep in mind when evaluating if a Board of Directors is well chosen, effective and independent.

1. Board size

According to a study conducted by The Corporate Library, the average board size is 9.2 members and most boards range from 3 to 31 members on the very large side with some considering the ideal size to be seven. The number of Board members should take into account the amount of work and size of the company and diversity considerations. In terms of time dedicated by Board members, do they commit sufficient time to meeting regularly and not over stretched by being on other Boards or roles they hold? Investors would expect to see Boards function in a professional manner and that each one delivers measurable value from the start.

2. Independence and composition

According to an article published by The Wall Street Journal, independent outside directors made up 66% of all Boards and 72% of Standard and Poor’s boards with the larger number of outside Board members the better. What this means in practice is that the more independent members provide a higher level of corporate governance to shareholders especially if the CEO and Chairman positions are separated and the Chairman position is held by an outsider. Shareholders should be able to get a sense of the internal dynamics on the Board and the interaction between Directors and Management and areas of conflict and how this might be resolved, formally or informally. All directors should receive and have access to the right internal people at the company and information that will enable them to make informed and qualified decisions.

The above is a poll of a wish list for public company Boards of Directors composition. What does it show us about current Board composition considerations?

1. There is an ever-increasing need and want for women and minorities to be represented on Boards
2. There is a steady demand for current and past operating experience – financial and global experience are the most highly valued
3. An increase in demand for technology, marketing, social media and cybersecurity experience which shows a growing prevalence in today’s world
4. Specific industry experience has declined in importance slightly from year to year – with transferable skills and a fresh “outside” perspective being deemed valuable

*Above data taken from Boardroom Metrics 2017

3. Committees

Committees are important for Boards with the four most important committees being the Executive Committee, the Audit Committee, the Compensation Committee and the Nominating Committee. Composition and conflicts of interest should be avoided in committees which can take away from their main purpose. For example, the Executive Committee should mostly be comprised of independent directors, the Audit Committee should have at least one qualified financial expert which can stretch to a banker or former banker and should review items such as ensuring there are no conflicts of interest between the auditors and other consulting firms employed by the company. The Compensation Committee is responsible for setting the pay for top executives and therefore it should be obvious that no CEO or other people with conflicts be appointed to this Board. This committee should caution against members being on other Compensation Boards which might be a potential conflict of interest. The Nominating Committee holds a valuable position in being responsible for nominating people to the Board making sure it reflects the current and future needs of the Board and includes sufficient diversity, knowledge and “out the box” thinking.

The make up and performance of a Board of Directors says a lot about its responsibilities to a company’s shareholders. A Board can loose credibility when its objectiveness and independence are compromised which results in shareholders being served by less optimal governance practises. Directors are faced with a lot of detailed information but yet must keep their focus on the big picture and not necessarily the day-to-day management of the company. In today’s environment, big picture can include such varied topics as data security, cyber security, reputation management, shareholder relations and financial and strategic risk. The essential job for a Board is to make sure the company has the right CEO and strategy and to foster and set the tone for the corporate culture which filters down to every level within the company. After all company culture is vital and can really set it apart from its peers.

Sources:

IR Magazine
Investopedia
Harvard Law School Forum
Deloitte Report – Performance Evaluation of Boards and Directors