A sharper focus on board quality is needed
Michiel van Esch
The quality of a corporate board is vital to good corporate governance. Engagement specialist Michiel van Esch recently commissioned a study into board quality and nomination procedures. The conclusions will be used as a starting point for a new engagement program.Boards are there to look after stakeholders’ interests
Corporate boards are an important instrument in ensuring sound corporate governance. It is the board’s responsibility to make sure that the company’s decisions are in line with the shareholders’ interests, thus addressing the ‘principal-agent’ dilemma. Much of the criticism following the credit crisis centered on poor corporate board oversight, which led to a failure to properly identify potential risks. Board quality is therefore a topical and relevant corporate governance theme for investors. To gain more insight into the subject, we asked EIRIS, a global provider of independent research into the ESG performance of companies, to research board quality and nomination procedures as the basis for a new engagement theme.
Board diversity in the broadest sense
Board members have a supervisory duty as representatives of stakeholders in a company. It is therefore important that a board functions well. To this end, the members should be knowledgeable, sufficiently independent, and have enough available time to perform their duties. But assessing these qualities is harder than it looks. Information on board members is not always readily available and much of what investors really want to know, for example how a board operates, takes place behind closed doors. Shareholders therefore have to rely on information provided by the company itself or, in some cases, on board self-assessments.
In addition to these conventional requirements, there is growing interest in the diversity of corporate boards, especially in Europe. In some European markets, such as Norway for example, the active promotion of diverse board rooms has taken the form of gender quotas, while other countries, such as the United Kingdom, have adopted voluntary targets. Asian countries, on the other hand, appear to be falling behind in this respect. While gender equality is the principal focus of most studies into board level diversity, there are also concerns regarding the ethnicity, age and international experience of the members of the board. If the argument for diversity is that it leads to a variety of perspectives and therefore more balanced conclusions, then it also makes sense to view board diversity in a broader perspective than just gender. An example of such an approach is the Swiss Corporate Governance code, which contains a unique stipulation that if a significant part of a company’s operations take place abroad, the directors should include members with appropriate international experience from these regions.
"It is a board’s responsibility to make sure that the company’s decisions are in line with the shareholders’ interests."
A myriad of structures and guidelines
The tricky part is that there are many different structures and guidelines for corporate boards throughout the world. One of the best known differences is between one-tier and two-tier boards. Two-tier boards strictly separate executive and supervisory roles, one-tier boards less so. Theoretically, two-tier boards are less likely to mix supervisory interests with those of top management, but we believe that they lead to bigger problems resulting from information asymmetry. Another complicating factor is that guidelines change regularly. In France, for example, new rules have come into force mandating how companies should calculate the ratio of independent to non-independent directors. Under the new method, directors representing employee shareholders or employees should be excluded from the percentage of independent directors. Another example is the recently introduced Dutch rule that limits the number of supervisory directorships to five per person, with chairmanships counting double.
The financial sector has its own specific challenges. In this sector, corporate governance codes have often been developed in the wake of some corporate scandal or disaster. Often established too late to avert a financial crisis, they are enacted in the hopes that lessons have been learned and that the same mistakes will not be repeated. The recent global credit crisis can be seen in this light, with the resounding impacts shaking a number of large, and seemingly well established, banks and other financial institutions (including insurance companies) to their very core, leaving many investors wondering whether the disastrous impacts could have been avoided if more stringent corporate controls had been in place. In our engagement program, we will focus on insurance companies.
"The tricky part is that there are many different structures and guidelines for corporate boards throughout the world."
Defining best practices
Within the next few months, we will use the conclusions of the research to establish our engagement objectives. We will aim to gain insight into the quality of the corporate boards’ nomination policies, using best practice examples as a point of departure. Although we are still in the process of finalizing them, there are a couple of elements that are likely to be included. We will aim to get a clear understanding of a company´s nomination process. Companies should provide sufficient information for investors to understand the requirements in terms of skills and composition of a corporate board and the extent to which nominated board members meet these requirements. Of course a board should be balanced in terms of expertise and independence. When addressing diversity, we will look for a diversity policy that goes beyond gender equality and, in particular for financial companies, refers to age. To better assess the board quality of companies, RobecoSAM has recently included a question on this topic in the Corporate Sustainability Assessment questionnaire.