Board Composition

Board composition is a critical issue that should concern the quality of board decision making, and not only a single selection criteria such as gender or age balance.
Gender diversity is a critical element of the board diversity debate. However, the guiding principle of board member selection is to achieve better decision making, through the application of relevant individual skills and experiences to a common problem in order to produce better overall outcomes for the organisation.

The issue many Chairpersons constantly struggle with is balancing the tensions, skills, perspectives and contribution of individual board members for the betterment of their firm.

There can tend to be an innate selection bias towards other directors whom are known to the Chairperson or board, and have similar values and backgrounds to those currently serving on the board.

This can result in better diversity of gender or age, but if all directors share a homogenous outlook, their collective decision making may produce suboptimal outcomes.

Board composition refers to the way in which the board of directors of a company is structured and the characteristics of individual board members; in terms of their age, experience, gender, tenure, outside interests and ethnicity to mention a few.

Diversity initiatives are commonplace in today’s corporate environment and range from mere tokenism to a genuine search for individuals of diverse backgrounds by merit.

Large, successful firms frequently tout their commitment to diversity, sometimes appointing women and racial minorities to their board. Why would a profit-minded firm go out of its way to do this?

Firms may wish to send a particular signal about their values in the form of a willingness to invest in a diverse workforce, in order to enhance their attractiveness to potential employees, customers and investors.

In Australia, listed firms are required to disclose their policy and progress towards achieving gender diversity, whilst in Europe debate continues on a proposal to codify a 40% female board quota.

A survey of senior industry directors indicates support for measures to enhance the transparency of corporate recruitment activities, but not for mandatory regulations, such as quota to achieve gender balance on boards. Furthermore, many senior female directors tend to oppose quotas while aspiring female directors are more supportive.

The simplistic tokenism surrounding the diversity debate undermines a wealth of research, which supports the commercial value of embracing diversity as a competitive advantage.

This discussion will introduce the many other benefits of boardroom diversity, as verified through academic research, in addition to the importance of incorporating the findings of this contemporary industry research within ones own boardroom.

Many corporate directors would agree that an increase in boardroom diversity is an important goal worth pursuing, yet most of these directors would not understand or be able to articulate why it matters. The easiest justification is the concept of fairness – that an active involvement in diversifying boards is the morally correct outcome.

However, due to the criticism and social stigma surrounding this sensitive issue, some boards have been reluctant to make the necessary changes due to the belief the impact of board diversity on corporate performance is neutral (or even negative), and may ultimately entail costs to shareholder wealth.

This straightforward but ill-informed view makes the normative case for “doing the right thing” more difficult to justify. Boards ask, “Why should shareholders incur the costs of providing a public good in the form of greater board diversity?”

The common argument against boardroom diversity is the talent pool doesn’t exist, which may or may not be the case. But if the goal is better decision making and not technical skill, at least 50% of the population might disagree.

There are a range of proven advantages in pursuing greater boardroom diversity and/or focusing on the composition of the board (e.g. in terms of size) in general, which would ultimately direct the company towards measures positively impacting financial performance, institutional investment and share price.

Some of the researched benefits of board diversity include:

• The “groupthink” phenomenon is likely to be less prevalent. It will therefore be easier to critically analyse management decisions.
• Accessing an untapped talent pool which research has proven, includes more attention-forcing directors whom add perspective to the critical decision making processes.
• Female and minority board members reduce agency costs (costs which are incurred from the separation of ownership from control). By being ‘outsiders’, they may be less likely to defer to management or the status quo, thus reducing the risk of self-serving behaviour by managers or even other board members.
• Possessing more and better information. A diverse group of people will engage in a richer discussion, by contributing multiple perspectives to a given problem.
• Operating differently from traditional orthodoxy. A more diversified board may be more likely to engage in ‘constructive dissent’, whilst female members question decisions in a different manner to male members.
• Enhance corporate reputation by conveying a credible signal to external stakeholders of corporate behaviour.
• Positive signalling. Board changes may provide important signals to investors indicating the potential for improved reputation and financial performance.
• Improving Corporate Social Responsibility ratings. Enhancing critical board processes.

Other changes in Board composition, aside from increasing gender and ethnicity diversity, which may be just as financially rewarding include:

• Appointing external and/or foreign directors is associated with better performance compared to boards which have a majority of insider executives and affiliated non-executive directors. In disparately owned companies, a higher proportion of outsiders reduces underinvestment and agency problems, which has significant economic implications
• Innovativeness of a company is found to have a positive relationship with the size of a firm’s board, especially in SMEs.

While these points may appear easy to adopt, they must be implemented in the correct manner for a firm to thrive and succeed.

For instance, while there is a positive relationship between innovativeness and the size of a firm’s board, studies have also shown that board size may have a significant negative influence on the performance of the board.

This indicates information asymmetries between directors, which thereby suggests a need for a review of the individual characteristics (i.e. personality) of each director.