Building Boards Qualified to Grow Shareholder Value

Corporate boards can only fulfill their duty of maximizing shareholder value by embracing business strategies that improve social, environmental, and economic conditions. By finding innovative solutions to global problems, companies can mitigate risks, reduce costs, and grow profits. This is shown by dozens of case studies in A Better World, Inc.: How Companies Profit by Finding Solutions to Global Problems...Where Governments Cannot (Palgrave Macmillan 2014).

The world's leading investment firms recognize the connection between sustainability and profitability. The leaders of Carlyle, KKR, BlackRock, and Blackstone have all declared that incorporating environmental, social, and governance issues (ESG) into investment decisions helps to reduce risks and enhance returns for investors, while also improving communities worldwide. (Korngold 2016)

In spite of investors' attention to long term value creation, boards are often preoccupied with quarterly earnings. According to McKinsey, boards fail by focusing too much on short term financial results. "Most boards aren't delivering on their core mission: providing strong oversight and strategic support for management's efforts to create long-term value." (Barta 2012)

Building boards with relevant experience for the global marketplace

Boards of directors comprised of people with more limited and homogeneous backgrounds and expertise, having outlooks based on the old marketplace, are less likely to grasp the full scope of opportunity in a world where technology, innovation, and resource conservation are integral to success. Reaching a wide variety of new stakeholders in emerging markets through meaningful stakeholder engagement is essential to a company's success. Today, boards comprised of women and men with the most relevant experience and expertise can best envision the company's greater potential and the way forward to increase shareholder value.

In the next two decades, the greatest opportunities for businesses to profit are in emerging markets, where three billion people will enter the middle class. Women also represent an important growing market worldwide, as they will control close to 75 percent of discretionary spending in the next five years.

Unfortunately for shareholders, the vast majority of directors of the largest publicly held companies are still quite homogeneous. S&P500 board members are 80 percent men, with an average age of 63, older in fact than the average age of 10 years ago. (At 63, board members grew up when school materials were mimeographed; most were first exposed to the Internet at the age of 40.) Furthermore, in spite of extraordinary opportunities in emerging markets, directors of non-U.S. origin account for only 8 percent of directors on the boards of the top 200 S&P 500 companies, fewer than one per board; they are primarily from the U.K., India, Canada, France and Germany--only one of which is an emerging market country. Among the top 200 S&P 500 companies, minorities account for only 15 percent of all directors--fewer than two per board; the percentage of companies with at least one minority director dropped from 90 percent in 2005 to 86 percent in 2015. Women account for 20 percent of the total number of directors, with the average number of women per board at 2.16 (Spencer Stuart 2015). Among MSCI World companies, women hold 17.3 percent of board seats (MSCI 2014).

Imagine instead a board comprised of 10.8 people, the average board size, where directors of a variety of ages bring the necessary and relevant expertise and leadership experience, having grown up in various regions of the world, in a variety of socio-economic conditions. Such a group, some with academic credentials or particular subject mastery, others having built and led innovative ventures, climbed the ranks of multinational corporations in various parts of the world, had life experiences in emerging markets, or played and worked with the latest technologies from childhood, can truly envision what's possible and also know what questions to ask management.

Determining whether diversity at the top drives shareholder value

The ultimate test is whether diversity on boards facilitates the company's ability to grow shareholder value. To answer that, Credit Suisse's 2012 study of 2,360 companies globally showed that "companies with at least some female board representation outperformed those with no women on the board in terms of share price performance." Companies with boards with gender diversity generate a higher return on equity (ROE); lower gearing (net debt to equity); higher price/book value (P/BV) multiples; and better average growth.

The value of diversity at the top was validated by a McKinsey study in 2012. "For companies ranking in the top quartile of executive-board diversity, ROEs were 53 percent higher, on average, than they were for those in the bottom quartile." (Barta 2012) A study by Russell Reynolds Associates also confirmed the benefits of building boards comprised of people with diverse experiences and expertise. "Diversity of perspective leads to more innovation, better risk management, and stronger connections with customers, employees and business partners." (Russell Reynolds Associates 2009)

Furthermore, according to MSCI, "Fewer cases of bribery, fraud, shareholder lawsuits, and other governance‐related controversies (per USD billion in market cap) were also a feature of companies that had a greater‐than‐mandated level of gender diversity on their board." (MSCI 2014). Linda Eling-Lee, Global Head of ESG Research at MSCI states in another report that "investors are moving to incorporate recent evidence from industry studies that suggest a performance upside for more diverse boards." (MSCI 2015)

Investors understand that boards comprised of people with an appropriate mix of skills and backgrounds make better decisions. In March 2015, nine public pension funds representing more than one trillion dollars in investment assets asked the Securities and Exchange Commission to require companies to disclose more about their boards' diversity. (Pensions & Investments, March 2015). Investors also requested rules requiring companies to create matrices of board nominees' gender, race, ethnicity, skills, experience and attributes.

By increasing diversity among their board members, companies can unleash their greater potential to grow their value by finding innovative solutions to worldwide challenges. This will be good for business and good for the world.

The material for this post was excerpted from the chapter I authored for The Handbook of Board Governance: A Comprehensive Guide for Public, Private, and Not-for-Profit Board Members (Wiley 2016) Editor: Dr. Richard Leblanc. The chapter (32) is "Better Governance for a Better World."