Boards of directors have always been under scrutiny, but recently their obituary has been definitively written. A number of influential articles have pronounced the board as “set up to fail” and “not fit for purpose”.
The extent of directors’ outside job demands, the complexity of director roles, the power of the CEO to inhibit directors from actively making useful contributions, and the presence of certain board norms—such as deference and reciprocity—all serve to severely limit directors’ impact and value on the board.
These claims may not represent new insights but rather reflect a cumulative sense that as firms become ever more characterised by complexity through, for example, the use of digital technology, artificial intelligence, and the internet of things, understanding the business becomes very difficult indeed.
Some may say where are all these failing boards? Apart from the high-profile cases that get aired in the financial press and in business school case studies, everyone else is doing a good solid job regarding board performance. Nevertheless, the sense of unease remains. So, what can be done? Here I present five possible areas for board reform.
1. Alternative board models
When people say boards are set up to fail, they are usually referring to corporate boards, and in particular, unitary boards, the combination of executive and independent non-executive directors, and the presence of board committees.
One clear alternative is the model of private equity (PE) boards. PE boards tend to be populated by owners or their representatives. They will have significant equity (and/or debt) invested and will be keenly involved in the strategic direction of the company.
There is some support for this view. In the US, in 1989, there were 5,000 publicly listed companies; now this figure is at 3,000. In the UK, the number of listed companies has also seen a falling trend, for example in the period from 2015 to 2020, there has been a drop from 2,429 to 2,024. Some of this may be due to mergers, and share buybacks. Undoubtedly however, the regulatory burden, the demands for increased reporting and the extra scrutiny of performance of having listed status for many is too burdensome.
However, the compensation arrangements for the PE sponsors can mean that they are incentivised to take excessive risk. Further, CEO control of the private equity board is strong, which may result in over-commitment to a CEO when performance suffers, negating a vital role of the board which is to evaluate and sometimes oust a CEO.
The most common criticism of private equity is that it fosters short-termism. While private equity can provide a context that promotes long-term decision-making, many PE firms are looking towards maximising returns before exit.
2. Reduce director independence from shareholders
The thoughts about the value of independent directors inherent in the private equity model suggest that independence is overrated. Another emerging view is director independence from shareholders should be reduced. In particular shareholders should be afforded greater powers to remove directors through the elimination of staggered boards.
In a staggered board, approximately one-third of directors are elected each year, with the result that for dissatisfied shareholders to replace the majority of directors, they would have to win in two annual elections. They further argue for the right of shareholders to place director candidates on the corporate ballot. These recommendations are important and would increase the level of accountability within the board.
Another area for greater shareholder accountability is dual-class shares. Such share structures have gained increased interest due to their prevalence within the technology and the media and entertainment sectors, with companies such as Alphabet, Apple, Alibaba, Facebook, We Work among others, using them. Research from ISS shows that companies with dual-class share structures are more likely to lack independent board leadership, and appear to be more susceptible to experience ESG-related problems.
3. Improve employee representation
Employee representation on the board is of course hardly a new or untried concept. Research on firms in Europe, both with unitary and two-tier boards, suggests that employee representation increases employee engagement.
Giving employees a say at board level on decisions within the company upon which they are largely dependent would strike a much better balance regarding the board’s accountability to its stakeholders, and would contribute to the longer-term perspective now being so widely advocated.
The FCA brought new requirements in January 2019. These establish three new mechanisms for embracing employee voice within the Combined Code:
- designating a specific non-executive director who would be responsible for ensuring that employee and other stakeholder voices are heard at board level;
- forming an employee advisory council; or
- appointing a director from the company’s employees.
The response to this new provision from firms appears to be heavily weighted in favour of the non-executive designation option. Many believe that this is insufficient, and argue that option 3 really gets to the heart of employee representation.
4. Reform board directors’ duties
The formulation of the UK Companies Act 2006 section 172 articulates the primacy of shareholders’ interests with directors only required to “have regard to” the interests of relevant stakeholders.
This enlightened shareholder approach formally requires directors to consider the interests of stakeholders when making decisions, but clearly does not indicate that a separate duty is to be enacted for stakeholders. The needs of shareholders and stakeholders are not “balanced” in this sense.
Elevating stakeholders’ interests to the same level as those of shareholders would ensure greater accountability and a more inclusive longer-term view of the purpose of the firm.
5. Rethink technology and disruption
Many organisations are having to face the impact and implications of a range of disruptive technologies. In a recent survey of 826 chairs and non-executives, 41% said their organisations were already being disrupted, compared with 31% of respondents in 2016. Having digital expertise on the board is now seen as essential.
In addition to skills development and continual learning for directors, there is also the issue of how much attention is given to technology in the boardroom. A recent survey of 365 public company directors highlighted concerns that not enough time was given to the emerging technology in board meetings. Only 29% of responding directors say their board discusses emerging technologies regularly.
As with digital, so too with AI. Boards have to decide whether and how AI can improve the functioning of the organisation and also whether and how AI can support the board in their own practices and decision-making.
Having a chief technology officer on the board, or having a technology committee set up and report directly to the main board, offers ways to increase the knowledge quotient. However, as a key subset of risks facing the business, emerging and disruptive technology requires the board as a whole to understand the strategic and operational opportunities afforded by digital and AI, and also the risks involved.
Philip Stiles is an associate professor at the Cambridge Judge Business School, University of Cambridge, and director of the Centre for International Human Resource Management.