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Board Composition and Evaluation
Structuring your board to maximize efficiency.
A board is made up of individual directors who each bring unique skills, knowledge, experience, and networks with them. Together, these individuals make up the whole board and define its composition.
Board composition, including the size and structure of the board, as well as the diversity and skill sets represented within it, can have an impressive impact on a corporation. Because of its influence, board composition has come under the spotlight of investors in the past four years. Board diversity has been an especially influential factor.
Board Composition — Laying the Foundation
The optimal size and composition of a board of directors is determined by a company’s individual needs. Given the uniqueness of each board, board structures can have different pros and cons, depending on the board type.
To best understand your board’s needs, answer the following six questions:
- What is the depth and complexity of the issues faced by the board?
- Is the board functioning well as a governing body?
- Are individual board members overburdened?
- Is individual board member engagement and involvement inhibited?
- How effective and nimble is the group decision-making process?
- How strong is the supporting committee structure?
Use these questions in conjunction with board assessment results to evaluate the current state of your board. The more in-depth your understanding of your existing board of directors, the more equipped you will be to make effective recommendations for your board’s composition.
The Basics of Optimal Board Composition
Board Composition is made up of a variety of elements. Consideration must be given to all to create an effective board, the foundation of a company’s governance.
- Board Size
- Board Structure
- Board Skill Mix
- Board Independence
- Board Diversity
- Board Age and Tenure
The number of directors on a board can have a significant impact on board effectiveness. Most boards are made up of four to twelve directors. Best practices recommend having an odd number of directors to support efficient voting.
Four to twelve directors is a relatively wide range, so here are some pros of different board sizes to help you determine your board’s ideal size.
Benefits of larger boards
- Varied expertise
- Each individual director brings a unique network
- Higher chance of institutional memory
Benefits of smaller boards
- Easier communication
- Efficient decision making (less time spent in discussions and faster decisions)
- More likely to have frequent meetings due to ease of scheduling
- Increased ownership and accountability for individual members
In general, board structure refers to the type and makeup of board committees. Board committees are groups of directors who oversee specific board functions.
The majority of boards have
- Audit Committee
- Compensation Committee
Public company boards almost always have
- Disclosure Committee
Additional committees within a board may be
- Finance Committee
- Risk Management Committee
- Governance Committee
- Special purpose committees (cybersecurity, crisis management, etc.)
Board Skill Mix
A board of directors’ effectiveness is enhanced when board members have the right balance of skills. Advisory boards, which are informal groups that focus on advice rather than governance, may provide the board with access to highly specialized skills and expertise. However, every board of directors should have a basic foundation of skills with which to govern.
The most sought-after skills for a director include
- Financial expertise
- Industry awareness
- Technical knowledge
- Risk-management experience
- Information technology/cybersecurity expertise
- Global business/marketing experience
When independence is discussed in relation to board governance, it signifies that a director does not have a relationship with the company. Independent directors are less likely to have a conflict of interest or other commitments that may impair their judgment.
Many companies seek independent directors to help ensure objective governance, which is a requirement for public companies.
Why is Board Independence Necessary?
Most effective boards are made up of a majority of independent directors. Independence is needed for objective judgments on topics such as:
- Strategies and major plans
- Board composition
- Governance framework
- Audit, financial reporting, and financial objectives
- Risk management
- Succession planning
- Evaluation of management performance and compensation
Boards are increasingly responsible for taking into account diversity when considering their board composition. Research indicates that there are multiple benefits to diverse backgrounds and expertise within a board.
In fact, 76% of respondents believe that board diversity enhances a company’s performance. Board directors have also said diversity can help achieve a broader vision, improve relationships with investors, and help a board make higher-quality decisions.
Key diversity factors include
- Educational background
Board Age & Tenure
Maintaining the same board members—or the same type of board members—for long periods of time can stagnate the progress and innovation of corporations. While it’s true that long-time board members contribute institutional history and experience, some turnover can be an effective practice.
Some boards impose age and term limits for directors in order to facilitate board turnover. These term limits can sometimes force high-functioning and highly valued board members to retire, leaving more junior, less experienced directors in their place; but they can also refresh ideas and policies and remove under-performing directors.
Boards may benefit from inviting outsiders to address changing business needs and closing gaps in relevant expertise and knowledge.
Alternatively, boards can implement a robust evaluation process that results in the removal of ineffective directors. Recently, corporate boards have witnessed a slight decrease in average board tenure.
Director Attributes & Characteristics
The above factors are not the only ones to consider when creating a new board or recruiting new directors. It’s common for boards to set minimum standards for directors. These may include excluding candidates who have been convicted of a felony or who had been deemed unfit for a position by a court under the Securities Exchange Act.
There are several additional criteria when considering selecting new directors, including
- Integrity, accountability, informed judgment, and independent thought
- Proven record of business experience, practical knowledge of the industry, and financial literacy
- Geographic distribution of the board’s membership
- Gender, race, age, experience, and educational diversity
- Ability to communicate ideas, debate issues, and interact with other members of the board in a manner conducive to promoting goals and decision making
- The right mix of attributes and competencies changes as the company evolves and circumstances change
Good governance requires a periodic review of the composition, skills, and other qualities that directors bring to the boardroom. Regular board assessments can help boards review the performance of individual members and the effectiveness of the board as a whole.
The Importance of Independent Directors
Boards often adopt independent directors’ standards as part of their governance framework. In addition to a standard that addresses material relationships between directors and the company’s executives, boards often establish criteria specific to the company’s business.
- Whether certain competing professions or board services would interfere with the exercise of independent judgment in carrying out the business of the company
- Past employment (or employment of close friends or family) by the company
- The company’s audit firm
- Commercial relationships between a director and the company
- Relationships between organizations with multi-affiliated directors
Public companies must adhere to NYSE and Nasdaqindependence requirements and general standards for a majority of independent directors. Written criteria for determining independence, transparency, and a consistent process to apply the criteria to all directors is key to effective governance. Directors are typically asked to complete conflict of interest questionnaires as part of the process.
An effective board of directors should include a diverse set of individuals to compose a proper governance framework. Imposing term limits for directors has positive and negative effects and should be handled carefully, always keeping the organization’s goals in mind. Finally, adopting independent directors is a key attribute of an effective board.
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