United States: Is Expertise Trouncing Strategy? The Conference Board Reports On Board Experience And Diversity

In a recent report, Board Composition: Diversity, Experience, and Effectiveness, The Conference Board explores the implications for board composition of current trends toward ESG expertise and board diversity, together with the continuing emphasis on ensuring the right mix of skills and experience. This expanding list of priorities has led to increased diversity disclosure as well as greater functional expertise, larger boards and enhanced needs for board education. But while there has been a significant increase in disclosure regarding board diversity, that increase "has not been matched by increases in racial/ethnic diversity." One cautionary note from the report: as boards seek to recruit more directors with functional expertise, such as cybersecurity or climate, the proportion of board members with business strategy experience has declined. For example, among companies in the Russell 3000, the percentage of directors with experience in business strategy decreased by five percentage points in the last three years. According to the Executive Director of the ESG Center at The Conference Board, the "recent decline in board members with business strategy experience is worrisome. Directors without broad strategic experience risk hindering effective board discussions and will likely be less useful partners for management....Although boards may want to add functional experience..., directors can bring meaningful value only if they can make the connection between these functional areas and business strategy."

Director skills and experience. The report found that, while the percentage of directors with operational and financial experience increased, the percentage with experience in business strategy declined. More specifically, among companies in the S&P 500, the proportion of directors with experience in business operations rose from 5.7% in 2018 to 11.9% in 2021, in finance and accounting from 19.7% to 22.2% over the same period, and, after a decline from 25.1% in 2018 to 22.1% in 2020, the percentage of directors with technology experience increased to 22.6% in 2021 and to 23.9% as of April 2022. In contrast, in the S&P 500, the percentage of directors with business strategy experience declined from 69.7% in 2018 to 67.5% in 2021. Similarly, among companies in the Russell 3000, directors with experience in business operations rose from 7.5% in 2018 to 10.7% in 2021, in finance and accounting from 4.5% to 6.6% over the same period, and, after a decline from 16.8% in 2018 to 16.4% in 2020, the percentage of directors with technology experience increased to 16.6% in 2021 and to 17.2% as of April 2022. However, in the Russell 3000, the percentage of directors with business strategy experience declined significantly from 67.7% in 2018 to 62.9% in 2021. Experience in business strategy appears to be more in demand at larger companies: in 2021, 74% of directors at companies with annual revenue of $50 billion and above had experience in business strategy, but for companies with annual revenues below $100 million, the percentage dropped to 63.7%.

The report concludes that "boards may be attracting directors with knowledge in specific areas (e.g., cybersecurity) who do not have broad business strategy experience." The report cautions that this decline should be a red flag: although

In addition, the report advises that, although traditional "hard" skills are critical, in light of the proliferation of crises recently, "other competencies should be taken into account as well when recruiting new directors, including crisis management, the ability to listen, eagerness to learn, and openness to change."

In addition, in the face of international conflict and worldwide pandemics, along with related international supply chain issues, the percentage of directors with international experience has also declined. For companies in the S&P 500, the share of directors with international experience declined from 19.6% in 2018 to 14.4% in 2021; in the Russell 3000, the percentage declined from 10% to 8.1% over the same period.

Director education. In light of increased efforts in areas such as ESG and cybersecurity—and the related need for board oversight in these areas—companies are looking to increase director education, the report indicates. Although the most common practice is still predominantly in-house training, companies are increasingly adding outside resources to provide board education. Among the S&P 500, the proportion of companies using this hybrid approach grew from 25.3% in 2018 to 29.1% in 2021; for the Russell 3000, the percentage increased from 11.8% in 2018 to 16.4% in 2021. The report recommends that companies consider engaging outside firms "that are adept at educating both the C-suite and boards—although the breadth and depth of education for management may be greater." According to the report, only 1.8% of companies with annual revenues of $50 billion and more failed to disclose their policies on continuing director education, while 44.3% of companies with annual revenues below $100 million did not disclose those policies.

Board diversity. Both groups of companies saw a major surge in disclosure of the race/ethnicity of their directors between 2018 and 2021: for the S&P 500, the report showed, the share of companies disclosing director race/ethnicity grew from 11.4% in 2018 to 58.8% in 2021 to a whopping 73.3% as of April 2022; in the Russell 3000, the share grew from 3.8% in 2018 to 27.7% in 2021 to 45.1% as of April 2022. In addition, in 2021, there was an enormous disparity based on company size, with larger companies substantially more likely to disclose director race/ethnicity: among companies with annual revenues of $50 billion and above, 70.9% disclosed director race/ethnicity, while only 8% of companies with annual revenues under $100 million made that disclosure.

Beyond disclosure, however, the data is not quite so sanguine. According to the report, while the percentage of White directors declined slightly among companies in the S&P 500, the percentage actually increased in the Russell 3000. The report included the following tables:

Racial/ethnic diversity was more common among larger companies. In 2021, among companies with annual revenues of $50 billion or more, 25.7% of directors were non-White, compared to 20.6% at companies with annual revenues under $100 million. The report indicates that companies should expect pressure from institutional investors and proxy advisors on this issue: "investors and proxy advisors alike have begun setting targets for the racial makeup of boards and will (advise to) vote against directors, particularly of the nominating and governance committee, if those targets are not met. Companies...will want to augment the racial/ethnic diversity of their board by executing a succession plan where the focus on strategic skills and expertise is accompanied by the pursuit of racially diverse board members."

With regard to disclosure of director sexual orientation, the report showed a substantial increase from 2021 to 2022. Among companies in the S&P 500, in 2021, 6.6% disclosed sexual orientation, while in 2022 (Jan-April) 22.7% made disclosure. Similarly, in the Russell 3000, the percentage disclosing sexual orientation was 3.5% in 2021, but increased to 25.4% in 2022 (Jan-April). According to the report, "in 2021 the highest percentage of directors who self-identified as LGBTQ+ was seen at the smallest companies": at companies with less than $100 million in annual revenue, 20% of directors self-identified as LGBTQ+, while at companies with $50 billion in revenue or more, no directors self-identified. The report advises that disclosure regarding this issue "needs to be carried out with sensitivity to the directors' individual and collective views. Before adding new questions [to D&O questionnaires] about personal traits, it's important to have a conversation with board members about what additional topics should be covered and why. It's also helpful to discuss whether the company should disclose these characteristics on an individual or aggregate basis."

The report notes that these increases may reflect impetus from both Nasdaq—which requires companies to explain why they do not have at least one director who identifies as female and one who identifies as underrepresented minority or LGBTQ+—and BlackRock—which encourages companies to have at least one director who identifies as a member of an underrepresented group, including individuals who identify as LGBTQ+.

With regard to director gender, the proportion of women on boards has continued to increase, with women now holding 30% of board seats among the S&P 500. For companies in the S&P 500, the share of women directors increased from 22.8% in 2018 to 28.9% in 2021 to 30% in 2022 (Jan-April), while among Russell 3000 companies, the proportion of women directors increased from 16.6% in 2018 to 24.1% in 2021 to 26.6% in 2022 (Jan-April). According to the report, the largest companies tended to have the greatest shares of women directors. For companies with annual revenue under $100 million, in 2021, 19.5% of directors were women, while in companies with annual revenue of $50 billion or more, the share was 30.8%. In addition, in the S&P 500, the number of companies with all-male boards averaged 0.2%, compared to 1.4% in 2018. Among companies in the Russell 3000, 5.1% had no women directors in 2021, but that percentage still reflects a major shift from 2018, when 20.5% reported having all-male boards. These percentage increases reflect in part the impact of state statutes (although note that a California court has recently struck down the California board gender diversity statute as unconstitutional, see this PubCo post), new Nasdaq rules (discussed in the SideBar above) and pressure from various institutional holders. The report observes that "many companies will need to further increase their efforts to meet investors' future demands, which include having a board that is at least 30 percent gender diverse instead of merely having one or two female directors. This means, for example, that a board with nine directors will need at least three women."

Board size. Boards are getting bigger, perhaps as a result of efforts to increase diversity and provide specialty expertise—where companies considering attractive candidates may not be able to wait for a retirement-related board opening. The average size of boards of S&P 500 companies was stable between 2018 and 2021 at 10.8 directors, but in 2022 (Jan-April), the average increased to 11.2 directors. In 2018, , the percentage of companies with more than 10 directors was 73.9%, but in 2022, that percentage was 82.4%. For boards of companies in the Russell 3000, the average size increased from nine in 2018 to 9.8 directors in 2022 (Jan-April), and the percentage of companies with over 10 directors increased from 37.8% in 2018 to 51.4% in 2022.

The report suggests that these board increases are likely to become permanent because of "(1) the pressure to add directors with additional expertise will continue, particularly with the proposed SEC rules requiring additional disclosure on the role of the board and its expertise relating to cybersecurity and climate change; and (2) workload: while some boards are adding ESG and other responsibilities to existing committees, other boards are establishing new committees. In either case, boards need to be careful not to stretch their existing directors too thin by having them serve on too many committees."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.