What makes an effective board of directors?

Boards of directors play a key role in business operations, providing oversight and support for corporate strategy. But they vary greatly in their effectiveness and the question of what makes a good board is not easily answered.

Professor Ron Masulis of the Australian School of Business is a noted authority on corporate governance and has been researching the topic for many years.

In a lecture at NUS Business School sponsored by the Monetary Authority of Singapore he said there was no magic formula to create an effective board, but there are some key ingredients that companies should look for.

“There’s a check list of characteristics of directors and boards that I was suggesting that people consider based on a wide array of recent research,” he said in an interview after his lecture.

“It involves incentives such as independence, it involves their experience, their expertise (and) what types of other incentives besides financial incentives they may have.”

Strong personalities

One thing Masulis says is becoming clear is that it’s helpful to have one or more board members with venture capital (VC) experience.

masulisAfter all, venture capitalists tend to be strong personalities willing to take strong positions. One recent research paper that tracked what happened after directors with VC experience were appointed bears this out.

“Firms appointing VC directors tend to increase their R&D intensity after the appointment, they tend to increase their patent awards, their patent citations, they tend to have more acquisitions of VC-backed firms, and these acquisitions tend to be more profitable after the appointment of these directors,” he said.

“They also end up doing a lot more strategic alliance activity and increase corporate venture capital investment co-investing with other VC firms.”

One question that’s a little less clear is whether independent directors (IDs) are valuable. Studies have been inconsistent, according to Masulis, for a couple of reasons.

The first is that the definition of “independence” has been too strict or limiting. Sometimes the research ignores the social dependence that may exist between an ID and officers in a company, or ignores common values that might affect their decisions.

The second is that independence is not the only feature likely to be important in selecting an independent director.

“The director’s tenure, their experience, their training, their age and extent of their networks is also often important. A director’s reliability, their ethical standards, and their health can also affect how energetic and how diligent they are,” said Masulis.

Effective monitors

Recently he’s been examining the effect that mandated changes in board composition have on forced CEO turnover. He’s focusing on two specific changes: one requiring 50% of board members to be independent and another requiring the nominating committee to be 100% independent.

ThinkAloud4“If independent directors are more effective monitors, these two changes should raise the sensitivity of the board regarding when to fire the CEO.”

Whether gender diversity makes a difference to board effectiveness is still an open question.

Masulis says much of the research on this topic is coming from places like Sweden and Norway where gender diversity is being mandated. In the short run, he says it does not seem to help, but he adds that’s not surprising.

“Corporations are being forced to recruit a very small, limited number of candidates,” he said.

“If you’re not the first mover to recruit one of the really top female executives to your board, then you’re going to have to drop down and basically appoint someone who doesn’t have the same experience level, doesn’t have the same board background or executive background that the top candidates have.”

Indeed the potential supply of director talent in general is an issue.

Risks of serving

“These are people that are very busy, very well qualified and being able to recruit them is not necessarily that easy because these jobs have become more and more demanding over time. And the expectations of how much time and energy a director has to commit to the position has been rising very rapidly.”

It can come down to a question as simple as location. The greater the distance from the board, the more reluctant people are to join.

The risks of serving on a board include facing shareholder lawsuits, a serious issue in the United States. Other countries may be less litigious but board members can still face regulatory sanctions.

As demands on boards have risen, though, so has board compensation.

Still, not everyone does it just for the money. Masulis says many join out of a sense of obligation to someone in their business network or a commitment to helping the local or regional economy.

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