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Good governance starts with the right board composition

Home / Hermes EOS Blog / Good governance starts with the right board composition

Manuel Isaza,
15 September 2014
Governance

The structure of a board – in other words the mix of skills, expertise and diversity of its members and their independence – is key to defining a company’s risk profile and appetite and therefore its long-term sustainable performance. As part of their oversight function, boards of directors ought to be fully knowledgeable about the company’s strategy and its most important risks and be able to test the executive team’s ability to manage such risks.

It is therefore unsurprising that in our engagement with companies on environmental, social, governance or strategic concerns we often find that those issues could have been avoided or better managed if the board had comprised members with the appropriate skills and experience to oversee the underlying risks.

Companies must be able to demonstrate how each director is a relevant contributor to overseeing the execution of the corporate strategy and how their appointment was the result of a thorough process. As we engage with companies on the composition of their boards, we look for evidence of well-established and ongoing succession planning processes, which clearly articulate the link between the desired skills sought in potential candidates and the companies’ long-term strategic plans.

While independence and relevant industry expertise are the key points in assessing board composition, certain skills continue to grow in importance as businesses evolve. As companies expand into different business areas and markets, for example, specific operational risk management and geo-political risk expertise are becoming increasingly desired board skills. Similarly, as businesses move online and their operations progressively rely on technology, IT expertise has become a highly desired attribute and one which, based on our experience, appears to be in limited supply.

Lastly, a fundamental element in our assessment of a board’s composition is its leadership structure. A structure where the chair of the board is an independent director is at most companies likely to be more effective than combining the roles, as the chair should manage the board and the CEO should manage the business. Combining the roles can confuse these responsibilities and overly concentrate power in one person, creating not only problems with oversight, but also with accountability.

In certain markets, we use shareholder proposals aimed at separating the roles of CEO and chair as an important first step of a broader objective to encourage a structural reform of the board. This was, for example, the case in our engagement with JPMorgan during which we co-filed a resolution at the company’s 2013 shareholder meeting seeking the appointment of an independent chair, and which ultimately resulted in important structural changes to the board, such as the enhancement of the lead director role. We believe that these changes have led to a board that is overall more accountable to shareholders.

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