Future of boardroom composition

Nine trends that could change the face of boards by 2030.

Predictions about the future of board composition in Australia abound. They include smaller, more diverse boards by gender, race and skills; younger directors; more investors on boards; a preference for industry specialists; an internationalisation of boards; and ‘robo’ directors.

Some observers even tip major changes in governance processes, such as the introduction of quarterly board-meeting cycles, to attract international directors. The reality is less dynamic. Board-composition trends, like most governance issues, move slowly. It takes time for directors to serve multiple terms and retire from a board. Also, companies with effective boards tend to favour incremental governance change.

But three factors suggest board-composition trends could quicken in the coming decade. First, the appointment of female directors is making boards younger and more diverse.

Second, intergenerational change will see many baby-boomer directors in their ‘60s and ‘70s retire from boards in the coming decade, creating opportunity for board-composition change.

Third, the market is paying greater attention to board composition and its alignment with organisation strategy and Environmental, Social and Governance (ESG) performance. Pressure on listed companies with sub-optimal board composition will continue to build as investors and shareholder activists demand greater say in who serves in the boardroom.

However, the Financial Services Royal Commission and the Australian Prudential Regulation Authority’s report on the Commonwealth Bank of Australia this year could slow board-composition change if they encourage boards to be more risk averse in appointments.

Launa Inman, MAICD, a non-executive director of Super Retail Group and Precinct Properties New Zealand, and a former director of CBA, says boards will need to find the right balance between entrepreneurialism and compliance in director skills. “I’m concerned that boards could become too risk averse in director appointments as compliance requirements increase.”

Here are nine trends to watch in board composition to 2030:

1. Gender-diversity gains spread through market

Progress on gender diversity has been the most noticeable change in board composition in the past decade.

The proportion of female directors on ASX 200 boards was 27.7 per cent in May 2018, from 8.3 per cent in 2009, Australian Institute of Company Director research shows.

Gender diversity gains have slowed in the past 12 months, but women continue to be appointed to ASX 200 boards at almost the same rate as men – a trend that bodes well for future diversity gains.

It’s likely that gender diversity gains will spread to small-cap companies (those outside the ASX 100) in coming years as more institutional capital flows to this part of the sharemarket. Institutional investors are increasingly using responsible-investment filters that incorporate ESG screening, and showing greater interest in gender diversity on boards.

One of Western Australia’s leading company directors, Fiona Harris, FAICD, a non-executive director of Oil Search, BWP Trust and the privately owned Perron Group, expects gradual change in gender diversity in small-cap companies.

“Gender diversity gains in this part of the market will increase as institutional investors expect to see women on boards and as more companies recognise the benefits of appointing female directors. Change will be slow because smaller companies are often resource-constrained when it comes to board size and director appointments.”

Inman says there are many competent female directors who would add much to boards of small- and large-cap companies. “I would be disappointed if the fallout from the Financial Services Royal Commission leads to a slowdown in female appointments to boards. The industry’s challenges occurred over a long period and had nothing to do with gender, but rather because there was not the right focus on certain issues. “

2. Younger boards

The average age of ASX 200 boards has fallen below 62 for the first time since 2011, according to Australian Council of Superannuation Investors research in 2016. The average age of directors rose steadily between 2001 and 2012, peaking at almost 63 in 2012.

This trend reversal suggests generational change is on the way. An increase in the appointment of female directors is reducing average board ages. Women non-executive directors were on average six years younger than their male peers, ACSI found.

The coming exodus of baby boomers (born between 1945 and 1964) from the workforce is a key driver. By 2030, every boomer will be 65 or older, triggering major board renewal as a generation of company directors hands the baton over to younger directors.

3. Skills

Calls for an increase in the appointment of discipline specialists to boards, such as ESG or human-resource experts, overlook a governance truism: high-performing boards have directors who can govern across a range of issues, not only their area of expertise.

An exception is directors with deep technology skills and experience, and a capacity to govern across a range of issue. As the impact of artificial intelligence, automation and machine learning becomes more profound on business, demand for directors with those skills will rise.

Appointment of such directors in ASX 200 companies has so far been relatively modest. It’s likely that boards believe technology, which is everyday business for most companies, is a skill all directors must seek to possess. And that boards can “insource” technology expertise through expert presentations and/or visits to key technology hubs.

4. Industry specialists

ARPA’s landmark report on CBA, arguably more influential for Australian governance than the Royal Commission, urged boards to dig deeper in their organisation. That implies directors spending more time on each role and rising demand for industry specialists.

Directors, such as ex-CEOs who have years of experience in an industry, may be able to add value to boards faster, analyse issues more forensically and better challenge management because they are have experience in the organisation’s sector.

Institutional investors have long called for boards to have industry specialists who can govern strategy and ensure management is accountable, and fewer governance generalists, such as lawyers or accountants, who may be more compliance-focused.

Graham Bradley, AM, FAICD, Chair of HSBC Bank Australia, EnergyAustralia and GrainCorp, told the Governance Leadership Centre in June: “Inevitably, boards will be looking for directors with deep experience in the company’s industry. Unless you have a strong industry background, it can take two or three years on a board to truly add value. That is increasingly unrealistic given ARPA’s view that boards urgently need to dig deeper within the business.”

An increase in the appointment of industry specialists over governance generalists, should it occur, would affect other board-composition changes. Industry specialists tend to be ex-CEOs or C-level executives, of which there are fewer women relative to men.

Launa Inman is not convinced that boards of large organisations will favour industry specialists over governance generalists. “In this heightened compliance landscape, I suspect we’ll see more companies appointing lawyers and accountants to their boards in coming years.”

5. Smaller boards

Steven Cole, FAICD, chairman of Neometals and a non-executive director of Matrix Composites & Engineering, says a move towards smaller boards is well established.

Larger listed companies (and NFP organisations) tend to favour 7-10 directors and smaller companies prefer 4-6 directors, he says. “This seems to be the currently accepted ‘sweet spot’ for the sharing of the load and diversity of skills and perspective, yet it is still small enough for management of interpersonal dynamics. I believe this sweet spot is as much driven by the human condition as it is by skills and knowledge, and don’t see it moving materially from here.”

The average ASX 200 board had 8.3 directors in 2015, ACSI found – slightly down from a few years earlier. It’s likely that companies with large boards (above 12 members) will reduce board size in coming years as retiring directors are not replaced. But, as Cole notes, dramatic changes in board sizes seem unlikely given gains so far.

The introduction of an Office of the Board (a board secretariat with full-time resources that repots to the Chair) in ASX 200 companies could lead to smaller boards, if such a model was introduced. Remuneration consultant John Egan flagged the idea in the Governance Leadership Centre report in June.

Cole is wary of such change. He says the CEO and Company Secretary should remain the board’s main points of contact. “I do not favour a discrete function as that risks dividing the board and management into a them-and us-outcome. The (board/management) team must be united, cohesive and relatively ‘frictionless’ to optimise performance outcomes, while respecting constructive challenges and candour. “

Fiona Harris also has reservations about an Office of the Board model. “It’s not a structure that appeals to me. If boards need more information to make decisions, management should provide it. Boards should investigate how they can make better decisions through innovation; for example, utilising big data, automated flagging and machine-learning techniques to identify outlier risks for their organisation. That would have a bigger impact on board decision-making than adding full-time resources and a new structure.”

6. Institutional shareholders

Cole expects institutional shareholders to play a greater role on boards in the next decade. Smaller companies often have directors who represent key shareholders, but it’s rare for ASX-listed companies to have directors whose day job is funds management.

Cole believes this will slowly change as investors seek greater say in companies they own. That, in turn, could reduce board independence if listed companies have more directors who are substantial security holders in that entity or represent those who are.

“Institutional investors will need to show that by serving on the board they will add value to the interests of the company and its shareholders,” says Cole. “The risk is the promotion of interests of narrow shareholder groupings as more investors serve on boards. A fair balance must be maintained with those with lots of ‘skin in the game’ and those with a modest amount, to ensure prudential objectivity and independent oversight.”

7. Reduction in board meetings could drive composition change

Cole favours a cycle of fewer board meetings, with caveats, and believes such change could quicken diversity initiatives by opening board roles to other directors. For example, a company that holds 10 full day board meetings annually, plus a strategy day, could move to a quarterly cycle. Those meetings could run for at least two days, and include several company presentations, site visits, overnight social/business stimulation and “deep-dive” strategy discussions.

A shorter, half day compliance-focused board meeting that directors can attend via videoconference if needed, would complement the quarterly board meeting. “It’s not uncommon for board meetings for big US companies, for example, to run for up to a week with multi-site visits.” says Cole.

This format has three benefits, says Cole. First, it allows better separation of strategy and compliance matters in boardroom discussions. “Obviously, some timely compliance and administrative reporting matters would need to be acquitted at the quarterly meeting, but that’s manageable,” he says. “The focus of the quarterly meeting would very much be about strategy, risk oversight, industry dynamics, culture and people. The shorter in-between meeting would focus primarily on procedural, administrative reporting and compliance matters.”

The second benefit is board effectiveness. Cole believes focusing for two (or three) days on a quarterly board meeting would provide better outcomes for directors, compared to the grind of monthly board meetings. “Having time for longer, more thoughtful discussions on strategy, industry dynamics and organisation people and culture would be beneficial. It would also relieve the tedium (and interruption to productive pursuit) for management personnel in compiling monthly board reports overloaded with transient operational monthly data.”

Greater scope to recruit and engage effectively with international or interstate directors is the third benefit of this model, says Cole. “It helps overcome the logistical problems of directors from outside the company’s home city, especially in this increasing age of international business and need for diversity (in its broadest sense) on boards. It’s hard enough for directors on the West Coast to attend East Coast meetings and vice versa, let alone international directors flying in for board meetings. A longer, quarterly board meeting would make travel much more worthwhile for remote directors.”

8. Board internationalisation

Elsewhere in this issue from the Governance Leadership Centre, Dr Ulysses Chioatto calls for boards of larger Australian companies to increase appointment of offshore-based directors. He believes board composition is not keeping pace with the internationalisation of Australian business.

Chioatto says too many listed companies have boards skills that are not sufficiently aligned with their international-expansion strategies. Australian companies, collectively, have been reluctant to recruit overseas directors. That is expected to change as more companies successfully pursue international growth strategies – a feature of the Australian sharemarket in recent years.

Fiona Harris says the challenges of having offshore-based directors in Australia-domiciled organisations can be underestimated. “I’ve been on boards where we had directors in Australia, Toronto and the United Kingdom. It was very difficult finding a suitable time when all directors could meet via videoconference given time-zone differences.”

Lower collegiality among directors is another risk, says Harris. “It’s harder to get to know your fellow directors when some are offshore because you don’t have face-to-face conversations in and around board meetings. Cultural and language differences can be another challenge if overseas directors are not used to Australian directors and their mannerisms.”

9. Robo directors

The concept of robo directors seems far-fetched, even by 2030. But it’s likely that more boards will use software algorithms within governance-decision processes to better understand organisations they govern, and to add to board resources and test human-director decisions.

Hong Kong venture-capital firm Deep Knowledge Ventures in 2014 appointed the world’s first robo director as a “board member with observer status”. The algorithm, named Vital, is analysing trends in life-science companies to predict successful investments.

Ohio State University researchers have examined whether algorithms can be used to select directors of publicly traded companies. A summary of their research, led by Professor Michael Weisbach, was published by the Harvard Law School Forum on Corporate Governance and Financial Regulation in April 2018.

Their algorithm found that directors who are not old friends of management and come from different backgrounds are likelier to better monitor management.

Nobody should expect robo directors to replace human directors in Australia anytime soon, or at all. More likely is software algorithms being used as a substantial additional resource for boards, and as an input in the board decision-making processes, such as modelling executive pay outcomes.

Nevertheless, greater use of robo directors by 2030 could encourage smaller board sizes if technology can do the work of many directors, or more routine tasks.