'Pale, Male and Stale:' Corporate Boards Still Lack Perspective In the Modern Era

Governance is no longer considered a subversive topic. Its contribution to value creation - and risk management - has been established. But has anything changed since the financial crisis? Steven Davidoff offers this analysis in the New York Times' Dealbook:

"Directors can be trouble. Just ask Goldman Sachs and Morgan Stanley.

The Securities and Exchange Commission has accused a former Goldman Sachs board member, Rajat K. Gupta, of facilitating insider trading while he was on the Goldman board. A current Morgan Stanley director, Howard Davies, has resigned as head of the London School of Economics because of his dealings with Libya.

The news about the two men throws a spotlight on the boards of the two firms for the first time since the financial crisis. Goldman and Morgan were, of course, the two Wall Street investment banks that survived the crisis and that not so coincidentally had better corporate governance than their peers.

But has anything really changed in the boardroom since the crisis?

Heightened scrutiny, to be sure, has led these firms, as well as others, to shake up their boards. Morgan Stanley has three new directors. Goldman also has three new directors and has shrunk its board to 11 members from 12. Citigroup and Bank of America, which together received over $90 billion in federal help, have a majority of new directors.

In all four companies — as well as more broadly in corporate America — there is now a preference for operational experience, for people who have run companies.

The recent changes on the Goldman board reflect this trend. Goldman’s three new directors are Lakshmi Mittal, the head of the global steel maker Arcelor Mittal; H. Lee Scott Jr., the former chief executive of Wal-Mart; and James J. Schiro, a former chief executive of Zurich Financial Services.

These are seriously accomplished people. We are long past the days when O. J. Simpson could serve as a member of the board and the audit committee of Infinity Broadcasting.

Boards are now required to have independent members and separate compensation and audit committees. And in financial institutions, there is certainly a renewed focus on risk, with many boards holding separate breakout sessions on the issue.

Peter R. Gleason, chief financial officer of the National Association of Corporate Directors, said recently that a single board membership could take 225 hours a year. It has become less of a perquisite or a way to build client relationships and more of a job.

Sidney J. Weinberg, the legendary chief executive of Goldman, sat on more than 30 boards, including that of General Electric. But this is no longer possible. According to a recent survey by the corporate directors association, 37 percent of companies limit the number of other directorships a member can hold.

So if directors are more dedicated, is change still needed?

Boards may be more focused, and the names may have changed, but the type of director is increasingly the same: men, and about 15 to 20 percent women, with operational experience.

Despite the experience of the financial crisis, no one expects a board member to be able to price a complex derivative. In the case of a financial institution, the job of a director is about asking good questions and monitoring. Those who want or expect more from a financial firm would end up having a board of math Ph.D.’s to the exclusion of all else. This concept applies to other types of companies like General Motors, which, before its bankruptcy, suffered because its board was unwilling to challenge management.

But if it is good questioners we want, is it appropriate to put only members of the same club on the board?

There have been hundreds of studies on corporate board composition, but there is no consensus on what works. It is unclear whether independent directors add value, though evidence shows that they do bring more independent decision-making. There is also evidence that separating the chairman and the chief executive can add value. And at least one controversial University of Michigan study found that a Norwegian law requiring boards to be at least 40 percent women reduced a company’s market value.

There is also little agreement on whether people from different backgrounds add value. In his book “Fault Lines,” the University of Chicago economist Raghuram G. Rajan argues for a diversity of perspective and background, and that directors should come from academia, public interest organizations and other fields.

The idea is that these people will bring independent thinking. It also may affect things like compensation. European companies are required to have labor representatives as directors, and this may be one part of the reason that compensation is lower for European chief executives.

But boards need to be collegial places, and a more diverse mix of people may upset this need. This is Goldilocks’s porridge, a hard mix to get right, one that varies with each company.

But it is important. If the same type of people are always appointed to corporate boards, will anything change? When the next bubble comes along will these directors critically question industry practices? Or will new directors with more diverse backgrounds continue the perceptible improvement in corporate board decision-making and add value?

The rush to appoint operational people with the same skill set is an obvious response to the financial crisis. Certainly, operational experience is valuable, but if everyone is the same, it may spur group-think instead.

In many banks currently, the only debate is whether board appointees should have an operational background or an operational background specifically from a financial company. Seven of the 13 members of the Bank of America board are from finance companies and two are from financial regulators.

The boards of Bank of America, Citigroup, Morgan Stanley and Goldman may be more focused these days on risk and compensation, but their directors largely have similar backgrounds. Adding two or three board members with more diverse backgrounds could spur more critical thinking — a type of introspection that was absent before the crisis.

And these four are the leaders in reforming governance. General Electric, which also was in a perilous state during the financial crisis, has added only two new members to its 16-member board since. Many financial institution boards remain unchanged.

As we enter proxy season, this type of re-examination is a step that all financial institutions should take and shareholders should request. Deadwood needs to be removed, and directors penalized for their companies’ poor performance.

For all companies hiring new directors, perhaps it is time they told their search consultants that some diversity in background is appropriate. As of last year, the S.E.C. requires companies’ to state the “experience, qualifications, attributes, or skills” that led them to choose a director. Operational experience may be valuable, but so is critical thinking. People from other backgrounds may be just the right ingredient to perfect this difficult mix.