Board dynamics vs individual director performance
During proxy season, shareholders are inclined to express their satisfaction with a company's performance over the past year, or lack thereof, with a yea or nay vote for individual directors who may sit on the board's heavily scrutinized compensation or audit committees.
New research published in January and adapted this week by the Conference Board Governance Center for its Director Notes concludes that an individual director's qualifications and performance are much less critical to a company's success than the team dynamics among board members.
The research, by Solange Charas, whose consulting company provides advisory services to boards and management, finds that director candidates' behavioral attributes are typically not included in the selection criteria. While most selection processes consider the gut sense that other directors have of whether a candidate will fit into the board culture, there's no formal assessment most of the time, which can result in disappointing or even disruptive new directors.
Charas believes directors with a high cultural intelligence, or CQ, are essential to effective boards. A high CQ enables a director to listen actively in board discussions, look at all sides of an issue before making a decision and work through conflict arising from a diversity of viewpoints.
CQ, also called behavioral capital, includes the mental processes used to acquire and grasp cultural knowledge and the ability to exhibit appropriate verbal and nonverbal actions when interacting with people from different cultures. CQ, professional capital (including current executive management role and years of experience on boards) and social capital (including the number of connections to other senior executives), taken together, reflect the qualifications of individual directors, according to Charas.
Citing research by Daniel Forbes and Frances Milliken, Charas writes that 'boardroom outcomes are directly related to firm performance, as defined by the board's ability to perform its control and service tasks effectively.' Charas used a questionnaire to collect information about the board's skills, innovation and quality (defined as the level of awareness directors have of their constituents as they deliberate and make decisions).
Charas' research also assessed firm-level outcomes, measuring profitability relative to the average of a size-adjusted, comparable industry profit margin index based on three revenue categories.
'Healthy team dynamics that encourage the successful exchange of information, mutual trust, a shared mindset, and a collective belief in the board's ability to accomplish goals are associated with firms that outperform their competitors,' Charas writes. 'We show that team dynamics – heretofore never measured – is an antecedent to economic value creation.'
Recommendations that boards consider professional and social capital when evaluating a director candidate have potentially troubling implications for expanding the role of women on boards and for successfully integrating directors nominated by activist shareholders. Advocates for increasing board diversity have started to suggest that boards broaden the pool of qualified candidates by considering women executives without prior board experience.
Importantly, Charas found that collective board behavior has eight times the impact on firm performance as professional and social capital. And despite the 40 percent weight given to prior board experience in measuring professional capital, Charas says 'it's a small part of their qualifications as a director and shouldn't carry a lot of weight.' She cites research from Harvard that has found putting women on a team helps it perform better.
'What some perceive as a weakness in female or other diversity candidates, which means prior board experience, should be balanced with their ability to work well on a team, which is measured by cultural intelligence,' she told Corporate Secretary. '[To only nominate people with prior board experience is] a self-defeating argument.'
As for dissident directors, Charas suggests that activist shareholders nominate individuals with a high CQ. 'Even though the director may be viewed as adversarial, it's incumbent upon that director to work effectively on the team. If he has a high enough level of CQ, he'll understand how to read the culture in the boardroom and how to overcome barriers.'
One reason a company may fall short of shareholder expectations and attract activists is that its board doesn't work well together, she adds. Bringing in the right director nominated by an activist could be a catalyst to get the board to work well together.