Board Game: 3 Important Questions About Composition & Culture

This article was originally published on Corporate Compliance Insights and is reprinted here with permission.

Corporate leadership crises don’t just occur in the C-suite; the culture of a board of directors can also prove toxic to an organization. BDO’s Amy Rojik has three important questions for companies to ask themselves about their board composition and culture.

In the past year, notable controversies have highlighted the importance of maintaining a board composition and governance structure that is adaptive to the organization’s needs. A board culture that prioritizes continual improvement, development, mutual respect and a questioning mindset while recognizing and mitigating vulnerabilities is crucial.

To address evolving risks and market volatility, boards should proactively examine vulnerabilities in their oversight and seek opportunities for ongoing improvement. Proactive reviews of board governance structure, practices and processes, along with robust director assessments, can be valuable tools for maintaining an effective board.

Boards need culture in which fiduciary responsibility can thrive

Below are key questions for boards to consider:

1. How well does our current board composition align with our critical business objectives and challenges?

As companies and their risks evolve, so must the directors and boards that oversee them. Boards must continually review their composition concerning identified risks and implement training, succession and refreshment strategies accordingly.

Evaluate the risk landscape

Enterprise risk management (ERM) is a continual process of identifying threats and fortifying an organization against disruptions. In overseeing management’s ERM processes, boards should ensure that every director understands the relevant risks and opportunities, how they are prioritized and how they align with their established risk tolerance and appetite. Directors need to be educated and conduct independent research to remain informed about evolving risks, such as AI, the effects of geopolitical disruption and other developments. Boards should foster a culture where directors feel comfortable asking questions, challenging assumptions and addressing overlooked risks.

Review individual directors and identify gaps

Boards should assess the skills and experiences of individual directors in conjunction with defined business objectives and identified risks. While it’s impossible to have an expert in every critical area, boards should aim for a diverse and complementary compilation of director skill sets and experiences.

As a starting point, boards need directors with the knowledge, understanding and temperament to exercise good general governance practices under benign and extreme conditions, including being collegial yet professionally skeptical in carrying out their duties.

A board culture that prioritizes both peer and self-evaluation of an individual’s ability to execute the required roles and responsibilities can bring the best results. In some instances, a good director may simply no longer be a good fit for an organization, and it is the responsibility of the board to recognize that and act.

When skill and experience gaps are identified, boards should have a defined process to address them, which may include education, leveraging advisers and/or enacting refreshment plans. Such a process considers risk priority and longevity among other circumstances impacting the organization.

Today’s rapid pace of change requires more agile and vigilant governance. While directors need a baseline knowledge of financial, business and industry acumen along with the aptitude for crisis and change management, these aren’t the only areas that should be considered. Boards are now paying more attention to emerging risks and opportunities in areas such as cybersecurity, AI, human capital and sustainability.

Consider fundamentals around board composition

No single composition suits all boards, and there are key considerations to keep in mind when determining succession and refreshment needs. Important factors include:

• Are there enough truly independent directors on the board, and is there a need for more stakeholder/investor representation, including activists?
• Similarly, is there a balance between those with institutional knowledge and those with fresh outside perspectives?
• Has diversity been considered to counter groupthink and drive more robust discussions in the boardroom?
• Is there a need/desire to separate (or combine) the CEO and chair positions?
• Where is a company in its life cycle: e.g., startup, growth mode, mature, in decline?
• What are the strategic priorities and are director skills aligned?
• Are significant transactions being considered, like new product expansions or M&A opportunities, that may require specialized skill sets?
• What is the company’s size and sophistication?
• Do current directors have the capacity to effectively serve the board?

Once the board has the right people around the table, the board’s structure needs to be contemplated.

2. Does our board’s structure support its oversight responsibilities and priorities?

Sound governance practices include annual reviews of board processes, committee structures, organization and director assignments. Internal and external feedback should be obtained through surveys, interviews and other means to evaluate effectiveness, further define roles, benchmark achievements and make necessary adjustments.

Acknowledge evolving committee responsibilities

Listing exchange standards require three standing board committees: audit, compensation, and nominating and governance. While each of these committees has a core set of responsibilities, today’s governance needs necessitate expansion beyond traditional roles.

• Audit: The audit committee may now be responsible for non-financial reporting efforts, including assessments of non-financial systems capabilities and attestation readiness, overseeing enterprise risk management, along with technology and cybersecurity oversight.
• Compensation: The compensation committee is increasingly responsible for the “S” in ESG, with a growing focus on human capital management.  
• Nominating and governance: As responsibilities evolve, the nominating and governance committee is providing more oversight of the organization’s ESG/sustainability strategy and disclosures.

Organizations may opt to establish new committees to support expanding responsibilities, material business priorities or risks. For example, technological innovation is growing exponentially, often requiring a larger governance effort than one committee can absorb. The Conference Board reports that 74% of S&P 500 companies have more than the three required committees, indicating that boards are recognizing the need for structural adjustments to reflect evolving responsibilities.

However, creating more committees may not be an option for all companies — especially smaller organizations where these additional commitments may create inefficiencies for directors who serve in a more generalist capacity. In these instances, board subcommittees, ad hoc committees or temporary expansion of the board may help alleviate increased workloads.

Assess committee capacity and board size

In disruptive environments, assessing committee capacity and board size becomes crucial for resiliency. Smaller boards may be nimble but could face gaps in director skills or risk mitigation processes. Advisers or advisory boards can temporarily address gaps identified on the board while not permanently changing the governance structure.

Large boards may provide the numbers to share a heavy workload but present challenges, such as allowing all directors to have a voice, permitting adequate time for discussion and timely resolution of issues and creating strong working relationships among its members.

Capacity and size should be reviewed annually and dictated by regulation, complexity of the organization, risk and opportunity landscape and performance expectations of stakeholders.

3. Is there room to improve our stakeholder engagement?

Effective communication with management, shareholders and other stakeholders helps the board earn trust and respect while gleaning insights for continual improvement and development.

Improve engagement with management

Boards should encourage transparent communications with management through formal and informal channels. Executive sessions provide a “safe space” for open discussions and should be an expected and regular part of board meetings. Directors are further encouraged to make themselves available and reach out to different levels of management throughout the organization to better understand the business operations and culture, as well as get a sense of the future pipeline of senior leadership candidates. While directors serve as gatekeepers, they offer a wealth of experience and knowledge that management should be encouraged to tap into when making strategic decisions facing the business.

Performance assessments should be approached similarly. While most companies have boards that play an active role in the performance reviews of management (particularly when considering succession plans for the C-suite), management can provide valuable upward feedback and insights into the functioning of the governance oversight structure. Requesting both informal and formal feedback on directors, committees, and overall board performance — e.g., via 360-degree reviews — can enhance transparency and highlight opportunities for operational board and individual director improvements.

The quality and frequency of communication, reporting and performance evaluations should be assessed annually.  

Increase understanding of and interaction with shareholders and other external stakeholders

Boards should proactively seek and listen to shareholder feedback, including that of activists. Insights gleaned can reveal blindspots related to corporate performance and perceived weaknesses in governance structure, which may allow companies to address and mitigate to avoid expensive and time-consuming proxy fights.

Roles and responsibilities for this type of engagement should be clearly defined and communicated, with approval from management. The same holds for engagement with other external stakeholders. For example, today’s rapidly evolving regulatory environment needs input from corporate directors during the rulemaking process as well as post-implementation of new rules to engage regulators and provide feedback as to potential unintended consequences or unclear aspects that may significantly affect the business.  

Strengthen intra-board relationships

Mutual trust and respect are essential for effective board operations. When these are in place, the questioning and skeptical culture that best supports a board’s fiduciary responsibilities can thrive. Groupthink or going-along-to-get-along are indicators of weak board relationships.

Continual communication among directors, committees and the full board is essential. Many boards allow and encourage directors to attend other committee meetings as observers or, at least review meeting minutes to increase their understanding and knowledge of the business. While committees play an important role in focusing on specific aspects of governance oversight, the board retains the fiduciary responsibility for decision-making. For example, while the board may rely upon the audit committee for insight and recommendations on management’s financial reporting, that does not absolve directors of their oversight role in approving the issuance of public financial statements.

Conclusion

Maintaining a strong and effective board is a continual improvement exercise — as the business environment evolves, so too must the governing body that oversees it. Regular and proactive assessment of board governance structure, processes, practices, member evaluations and overall composition provides the foundation for good governance hygiene. An agile board that can navigate risks, capitalize on opportunities, maintain mission-critical knowledge and engage effectively with management and stakeholders is necessary for a sustainable business and can serve as a competitive advantage.