Business is changing. Can governance keep up?

The pandemic and social unrest are pushing management and boards to flex in ways they have never experienced. Over the past six months, we’ve met with dozens of public and private company corporate directors to understand how these crises are shaping their governance responsibilities.

While corporate governance dates back 400 years to the East India Company, the term didn’t appear in the Federal Register until 1976. Since then boards have seen the institutional shareholders’ mega deals of the 1980s, Sarbanes Oxley legislation in 2001, and the Dodd-Frank Wall Street Reform and Consumer Act in 2010. Now, with the pace of technological advances over the past decade and the wrenching changes of the past six months, the question is, can the governance function in general and boards specifically, evolve as fast as the world around them?

Drivers of change

Today’s digital-first approach is an operational equalizer across many industries. B2C business models are being increasingly applied to B2B companies. The marketplace model is radically shifting the traditional definition of what makes up an industry itself. Both management and boards need to change. Consider the following:

• 2020 has created additional pressures on management and directors. Yet, prior to these events, the rise of ESG, challenges whether shareholder primacy should remain as the cornerstone of board governance, and emerging technology (including the ethics/risks/opportunities related to it) have all magnified a shift in the experience, priorities and diversity necessary for a board to effectively govern and provide oversight.
• The director’s job has become operationally more demanding. Since the onset of the pandemic and social unrest, directors have been in more frequent communication and meetings with management to deal with a multitude of issues. A recent McKinsey article noted, “Time is a scarce asset for most board directors, requiring them to make deliberate choices about where they focus their attention.” No longer are boards meeting quarterly. Many are convening weekly to stay connected with management. In doing so, many directors are openly admitting that while having this level of interaction with management may not last, it is shining a bright light on areas that require change.
• There’s a spotlight on board composition. The experience, knowledge and perspective necessary to provide oversight on these new issues and priorities is critical. In the past, boards were quick to recruit a former CEO or CFO from their industry. Numerous board members we’ve spoken with have challenged the relevancy of general management, finance or industry experience as key attributes. One director said industries are looking more similar and there’s an abundance of management and finance knowledge already on a typical board and that boards must be open to searching in different places for different talents than they have in the past, as only then can a board get better at both seeing disruptive risks before they arise or better dealing with them when they hit.

How do we evolve to face the challenge?

Today, digital is synonymous with transformation. It’s not the exception, it is business as usual. Advancements have moved so far so quickly, and boards need to move as far and as fast in their approach to governance. In our discussions with directors, a clear theme has emerged: the issues businesses and boards are facing have not only exposed gaps in the business, but also gaps in the board. These gaps were becoming visible prior to 2020, but the massive disruptions of the year have highlighted how pervasive the gaps truly are.

1. Relationship with management
   In one roundtable, we asked directors the following question: with the rise of emerging technology, its applications to business -- much of which is still evolving -- can the philosophy with management remain, “nose in, fingers out?” Is the power of intelligent questions and process checks, formed from the ‘trust but verify’ approach, enough to provide adequate oversight on such complex topics?
   
   Reactions varied. Some felt that the role of the board is to ask the questions until satisfied. Others challenged the whole notion of the question. For example, “if you aren’t experienced in data science, not only could your questions not be the right ones, but how can you determine the quality of the answer?”
   
   Directors agreed the disconnect is clear: the gap between what we need to achieve in terms of management oversight vs. where the average board is today, is growing. To paraphrase one director’s suggestion for how we can approach this challenge: the philosophy shouldn’t change -- governance is still a “nose in, fingers out” responsibility. But unlike many boards of the past where the approach was lightly sniffing, today the director’s nose has to be in it, and in deep.
   
   
2. Board composition
   Countless thought leadership pieces have covered the need to evolve board composition across gender, age, ethnicity, capabilities and mindset – and the challenges of achieving that diversity. With efforts by organizations like NACD and state mandates on board diversity, progress is advancing but not fast enough. Because there’s been so little movement over the years, the catch up on diversifying across all the different dimensions seems daunting. Especially when you factor in how many boards have no term limitations, making it even harder to diversify without increasing the total count. But there’s hope.
   
   First, today’s virtual world opens up the recruiting base in new ways, overcoming some prior hurdles that travel may have presented. Finding candidates who can fill an experience or capability need, plus improving diversity in gender, ethnicity and age is increasingly becoming more possible as boards have shown resilience and adaptability by shifting to virtual operations.
   
   Second, many boards are using external, advisory sub-committees with diverse capabilities to address the challenge of evolving their boards’ compositions. This can start as an advisory sub-committee structure, but many boards are using this approach to improve their expertise. They can also recruit new directors from the advisory sub-committees.
   
   Last, boards are increasingly requiring existing directors to expand their own knowledge through increased training. While this is welcomed, one director noted, “I can take a weekend course and learn some really good stuff about data science, but I still know I’m not a data scientist. But that’s not how everyone is and the only thing more risky than not having a skillset on the board is someone who feels they are experienced when they aren’t.”
   
   
3. Board operations
   Too often, board operations were driven by barely changing annual agendas addressed through quarterly full- or two-day board sessions.
   
   Many boards are piloting insights learned from the pandemic. Over the last two decades, leveraging subcommittees to address the workload and matters requiring specialized expertise has been the norm. But the current environment has amplified the need for leveraging subcommittees even more. Many boards are also testing whether shorter, more frequent board meetings better allow for a variety of newer topics to be incorporated into the agenda. As one director noted, “this also starts to create an improvement in director/management knowledge and engagement given increased touchpoints and the expectation to come ready to discuss. Quality of governance can only be improved.”