Keith Davies, Chief Risk & Compliance Officer, International at Federated Hermes
Chief Risk & Compliance Officer, International at Federated Hermes
Boards that contain diverse views have a strong advantage because they offer a holistic perspective as well as bringing a range of ideas and challenger perspectives into strategic decision-making, countering ‘Groupthink’. It also fosters an organisational culture of inclusivity which can enhance employee satisfaction and promote a firm’s reputation in the eyes of internal and external stakeholders. Identity and cognitive diversity of thought will both only become more important as corporate culture, social purpose and the need to understand all stakeholders rise up the Board agenda.
Several studies show the positive correlation between Board diversity and company performance. McKinsey & Company (2018)1 found that diverse Boards were 43% more likely to see above-average profits. Similarly, BCG (2018)2 showed that six dimensions of diversity demonstrated a correlation with innovation and Goldman Sachs (2020)3 concluded that firms with ‘at least one diverse Board member saw a 44% jump in their average share price within a year of going public, versus 13% of companies with no diverse board members’.
Recent years have seen an important focus on identity diversity; and progress has undoubtedly been made in the areas of gender and race: 44% of NEDs on FTSE 100 Boards are now women4 and the number of FTSE 100 companies without ethnic Board representation has fallen from over 50% in 2017 to 37% in 20205. However, progress is patchy – particularly in smaller companies – with just 7.5% of all FTSE 350 Directors6 known to be people of colour and the number of female Chairs, CEO’s and Executive Directors remaining low. As a result, further progress in these areas will rightly remain the overriding priority for firms, and increasingly, for regulators.
This article however, explores the aspects of cognitive diversity only and the recent developments that also make consideration of skillset and experience a necessary factor in Board composition and succession planning.
The need for expertise with respect to digital transformation is one obvious area where appropriate modern-skills are required and indeed has intensified further since the pandemic. Virtually all Boards now need to make sure that they have the contemporary skills, experience and importantly, mindset necessary for firms to survive and prosper in the modern digital world, which is evolving at an ever-increasing pace. However, whilst MIT Sloan Business School (2019)7 found that organisations with three or more ‘digitally savvy’ Directors had on average, 38% higher revenues and 34% higher market cap growth, currently only 2% of FTSE 250 firms have NEDs with a background in digital and technology. Such skills typically (but not exclusively) are held by millennial executives who have grown up with the technology revolution and understand the evolving consumption preferences of a modern digital world, but whom may not yet have had the opportunity to be involved at Board level. Consequently, firms are adopting a range of techniques to bring the insight required to the Board context where it can be overlayed with the NED experience necessary to drive the corporate solution. This may include creating Board sub-committees to focus on technical matters; or appointing expert digital ‘advisers’ who only attend relevant sections of Board meetings.
The pandemic has also accelerated the need for Boards to have the expertise to address several non-financial risks that are increasingly key for most firms; including culture, marketing, brand and reputation and ESG/sustainability – all of which require expertise not-typically recruited onto Boards and indeed not often in the direct skill set of many NEDs.
All such factors suggest that an increasing consideration will be diversity of Board experience and relevance for the rapidly-changing business environment. While traditional Directors may have been chosen for their long tenure and governance experience, the increasing need for forward-looking and evolving skillsets may shift the mix of NEDs towards those serving as Executives in other companies where they are facing contemporary challenges every day. The pandemic has already highlighted the advantages of an appropriate mix of plural and current Executive NEDs. On one hand, the need for many companies to take material commercial and operational decisions increased the need for the Board to undertake its traditional role of challenging strategic decisions and underlying assumptions: a role perhaps best fulfilled by ‘career’ NEDs with the ability to stand back and provide longstanding commercial acumen. On the other hand, the need for firms to take reactive measures to remain operationally resilient meant that firms also benefited from having Board members who were also serving Executives and could offer crucial real-life, peer-to-peer advice to management regarding operational, people, technology and supply-chain issues.
The emerging issue load, acceleration of disruptor topics and new stakeholder expectations facing firms in a post-pandemic environment are all likely to further increase the need for Boards to acquire this ‘live’ experience of contemporaneous issues that serving Executives can provide. This will further increase the number of Executives serving as NEDs; arrangements that have – if the risk of ‘over-boarding’ is managed – already been shown to benefit both companies by offering cross-pollination of ideas and experiences from different business environments and industries as well as motivating and developing the individual concerned.
Ultimately, Nomination Committees should be looking to actively structure Boards and succession planning to consider the cognitive diversity needed for the Board of the future; one which is required to fully understand and adapt to rapidly changing markets, customer needs and other stakeholder expectations, as well as actively seek meaningful, decision-useful information from a broader range of viewpoints. This will require further gains in gender and ethnic diversity and disability as well as consideration of skillset, age and experience to supplement the insight of plural career NEDs.
For further information on Federated Hermes International’s position on governance, see our EOS team’s Insight Paper on Guiding Principles for an Effective Board.
The views and opinions contained herein are those of the authors and may not necessarily represent views expressed or reflected in other communications, strategies or products. The information herein is believed to be reliable, but Federated Hermes does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient.