Boards need ability not diversity

Corporate governance thinking does not evolve: it skips from one topic to the next.  Ideas in corporate governance are like memes: they convey ideas just as genes convey physical characteristics, as I wrote on this blog some time ago.  These memes permeate thinking, and with today’s instant communication flash around the world, become the conventional wisdom.

A couple of years ago the theme was risk.  Cadbury and the early corporate governance codes had nothing to say about risk. Now boards needed to recognize their responsibility for identifying their company’s risk profile, assessing long-term strategic risk, and ensuring that appropriate risk policies were in place and working.  Risk had become a central issue in corporate governance.

More recently, it was culture- although commentators seemed unable to agree on what they meant by culture.  In March this year, I wrote in this blog that culture ‘can be thought of as the beliefs, expectations and values that people share’.  Like the skins of an onion, culture has many layers – national, regional, corporate cultures, and the culture of the board room.  Recent commentary about culture in corporate governance thinking has focused on board-level culture, which sets the tone throughout the organization and provides its moral compass.  Board-level culture reflects the experience, beliefs and expectations of the board members, particularly the leadership style of the board chairman and the effect of any dominant personalities on the board.

Introducing the concept of culture into corporate governance adds new dimensions, with behavioural, political, and psychological aspects that are difficult to identify, let alone quantify.  In February 2017, the UK Department for Business, Energy, and Industrial Strategy (BEIS) published a report on corporate governance reform that identified culture as ‘the central tenet of good corporate governance (which) should be embedded in the culture of all companies, so that it permeates activity at every level and in every sphere.’  Fine: but what does that actually mean?  What are boards expected to do to make the concept operational?

On board diversity

Now the focus has shifted again: board diversity has come into the spotlight. Again, however, ideas differ on what board diversity means.  The time has come for some clearer thinking.

It seems that most people, when talking about board diversity, mean gender diversity: the need to have more women directors.  That case seems clear and, around the world, efforts are being to increase the proportion of women on boards through mandatory quotas or voluntary targets. The challenge is to increase the pool of women with executive management experience. The BEIS report, mentioned above, recommends that ‘the UK Government should set a target that from 2020 at least half of all new appointments to senior and executive management level positions in all listed companies should be women’.

To others, however, board diversity means something quite different.

The UK’s Financial Reporting Council; welcoming the Hampton/Alexander report in November 2016, wrote that it:

‘looked forward to working with the review team to improve reporting on diversity. In light of the current public debate on corporate governance, we stand ready to revise the UK Corporate Governance Code following the Government consultation. Our work on succession planning this year suggested that nomination committees should take a more active interest in talent management, in particular that initiatives are in place to develop the talent pipeline and to promote diversity in board and executive appointments. To better inform boards about the link between diversity, strategy and developing the business, more consideration should be given to the nature, variety and frequency of interaction between the board and aspiring candidates at all levels.’
The BEIS report also refers explicitly to ‘ethnic diversity’ and recommends further measures ‘to ensure that diversity is promoted at all stages of careers to broaden the pool of talent at the executive level.’  The report further calls for ‘companies [to] recruit executive and non-executive directors from the widest possible base’. The report concludes with a rallying cry: ‘Overall, [our] recommendations are aimed at permanently ingraining the values and behaviours of excellent corporate governance into the culture of British business.’

Before we all rally to this banner, more clarity of thought is needed.

 

What is the purpose of the board of directors?

The role of the board of directors, indeed the role of the governing body of every organization, is to govern.  To put it in the vernacular, corporate governance means ensuring that the enterprise is being well run and that it is running in the right direction.  This is quite different from managing the business, as I have written many times in this blog. In essence, the governance of a company includes overseeing the formulation of its strategy and policy making, supervision of executive performance, and ensuring corporate accountability. Overall, the purpose of the board is to ensure that the company meets its objectives.

But that exposes a deeper question: what is the real purpose of a profit-orientated company?  The answer has not changed since the classical nineteenth century model of the joint-stock limited-liability company was invented: to create wealth, by providing employment, offering opportunities to suppliers, satisfying customers, and meeting shareholders’ expectations.

Companies meet their societal obligations by paying taxes, adopting socially responsible policies, and obeying the law of the lands in which they operate. Companies should not be seen as vehicles for social engineering.  The board does not need to reflect the structure of society.

Admittedly, the UK Companies’ Act does call for companies to recognize the interests of other stakeholders, including employees, suppliers and customers: though it is hard to see how a company could survive by ignoring them.   Stakeholder Senates, which I suggested in this blog preciously, could provide employee, market, and societal input to board deliberations, could include representatives of young and old, poor and rich, ethic and other minorities.

To fulfil the company’s primary purpose of creating wealth, a board does not need to reflect society. It needs people who can contribute effectively to its governance. In other words, the qualities needed to be a director are the experience, knowledge, and ability relevant to governing that company, backed up in a fast-moving business environment with the ability to continue to learn and adapt. Companies are often competing with other companies around the world, whose directors are experienced professionals, in China for example.

Attempts by the UK’s FRC to revise the corporate governance code needs to be clear on the proper role of the board of directors.  Ability at board level is vital for corporate success; social diversity has nothing to do with it.

Bob Tricker, October 2017

The views expressed in this blog are those of the author and are not necessarily those of the Oxford University Press, or fellow blogger Professor Chris Mallin.

 

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