Board composition contributes greatly to the overall success of a business. To be effective, boards must reflect the strategic priorities and challenges of the company, the relevant areas of risk and the diversity of stakeholders. The skills and experience of the board should align with the company’s long-term strategy. While stakeholders may not know the conversations that occur within the boardroom, they can observe the outcomes of decisions made by the board.
This article examines best practices for the composition of corporate boards of directors.
Board Composition
Thoughtful board composition can ensure the proper oversight of company management, strategy and risk. Boards should be prepared to explain their choices when nominating new members, and they can utilize the following factors to demonstrate objectivity in their decisions:
- Size—There should be enough members on the board to allow for a wide variety of perspectives
and competencies, but not so many that all members’ engagement and participation are inhibited. The generally
accepted size for corporate boards is between eight and 12 directors. According to a study from GMI Ratings,
smaller boards (9.5 directors) held an 8.5-percentage-point lead on returns over companies with larger boards
(14 or more directors). As boards are held increasingly more accountable for corporate actions, closer board
engagement can ensure responsibilities are carried out correctly. - Independence—Board member independence is essential to ensure nothing impairs a board member’s
judgment. The minimum expectation for board member independence should be that most directors are nonexecutive
directors. Independent directors should:- Be free of commercial or personal conflicts of interest
- Not be a former member of the company (at least not before any given cooling-off period)
- Have no financial relationships with the company or its counterparties
- Have no interlocking directorships
- Not serve beyond the prescribed number of years Since a person’s independent status can change, it’s good practice to review the independence of nonexecutive directors on an annual basis.
- Terms—Varying director tenure is important to board composition because the longevity of a
director’s term isn’t necessarily indicative of a director’s success. Fixed, staggered terms can encourage board
refreshment and renewal, resulting in a revolving set of innovative ideas and thought processes. - Diversity—Diversity in the boardroom can improve overall decision-making by including valuable
perspectives and innovative leadership strategies. Diversity of gender, age, race, culture, sexual orientation
and identification, as well as personal and professional experience, can build a more effective board.
Keep in mind that when recruiting potential candidates, it’s important to be realistic. Instead of creating an unattainable list of attributes, desired skill sets and expertise that is unlikely for a single candidate to possess, rank which qualities are most important to make finding appropriate candidates easier. For more risk management guidance, contact us today.
This Risk Insights is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice. © 2021 Zywave, Inc. All rights reserved.
