Rotman Executive Summary

How to build a better board

Episode Summary

With challenges including continued upheaval from the pandemic, political and global instability, a changing workforce, new technology, and more, the makeup of the board of directors — and its ability to shape and influence organizational responses when things go wrong — is more important than ever. And it's crucial to ask: do boards have the right talent at the table, and what it will take to build a better one? 

Episode Notes

With challenges including continued upheaval from the pandemic, political and global instability, a changing workforce, new technology, and more, the makeup of the board of directors — and it's ability to shape and influence organizational responses when things go wrong — is more important than ever. And it's crucial to ask: do boards have the right talent at the table, and what it will take to build a better one? 

Show notes

[0:00] Drama is best kept out of the boardroom because when you hear about it, it’s probably no small issue

[1:03] Meet Aida Sijamic Wahid, a professor who studies board makeup 

[1:30] It turns out who sits on a board influences how companies manage flux. So, do boards have the right talent at the table? 

[2:18] What exactly does a corporate board do? 

[3:33] Aida started studying board dynamics in the wake of the Enron scandal

[3:55] How the Enron fallout impacted its board, and why did no one notice? 

[4:46] The roll of director homogeny in the scandal 

[5:33] What is groupthink and why is it bad?

[6: 09] Aida’s research shows that when you change the variables – such as introducing a woman to the directors table – fraud and accounting mistakes decline

[7:14] Diversity improves board effectiveness by increasing perspective diversity

[7:35] Digging into different types of diversity – such as diversity of tenure or gender diversity – and the role it plays on board effectiveness 

[8:23] Exchanges are now compelling organization to report on board makeup

[8:59] What is tokenism and why is it bad for a board? 

[9:27] But increased diversification makes tokenism harder as the board becomes more balanced

[10:00] Director diversification is improving, if slowly, and there are still stumbling blocks 

[10:29] Do we need to prove that diversification is needed to demand more balanced representation?

[11:21] What skills did directors need in the early 2000s? 

[11:50] And today, they need tech know-how and an understanding of ESG – or environmental, social, governance. 

[13:12] ESG is complicated and will have big ramifications on businesses, and not every board feels they’re ready for the ESG revolution 

[13:38] And if a board doesn’t have the right talent, it doesn’t necessarily take a crisis to shake stakeholder confidence – just ask Amazon

[14:25] Industries that have a diverse talent shortage – like energy – will have a harder time making sure their directors reflect the broader population; and that’s a problem for innovation

[15:08] But not all hope is lost. “It's now that these industries are attracting people with different skill sets in different backgrounds because they have no choice but to if they want to evolve and survive.”

Episode Transcription

MH: Who doesn’t love a good drama? Well, the company boardroom for one. 

While organizations often find themselves in the news for both good and bad reasons, rarely do you hear about a company board…unless something has gone terribly wrong. 

Just ask Hockey Canada, which in 2022 saw its entire board resign following numerous alleged sexual assault scandals. Or take Rogers, and its namesake family, which viciously – and publicly - fought over the replacement of the company CEO in 2021. Even Disney - home to the happiest place on earth – was embroiled in a messy dispute as a major investor fought for a seat at the table earlier this year. 

ASW: When the disagreements are more minor, they usually never bubble up to a point where the general public like you and me know about them, because all the discussions are supposed to stay behind closed doors. It's only when it's something really major that we hear about it.  

MH: Aida Sijamic Wahid has spent most of her academic career studying boardrooms. 

The associate professor of accounting wrote her PHD thesis on the make up of board members, and has since advised trading bodies like the NASDAQ on diversity reporting requirements. She’s explored everything from how directors’ past experience can influence companies’ valuation to how demographic diversity – particularly gender – influences board decision making.

Unsurprisingly, who sits on the board can have a huge impact on how organizations move forward – particularly when a company is in flux, whether that’s a crisis or a period of growth. As we move through a time of unprecedented technological change, potential economic upheaval and as we continue to grapple with the legacy of the pandemic, we should be asking: do boards have the right talent at the table? And what will it take to build a better board? 

Welcome to the Executive Summary - I’m Megan Haynes, editor of the Rotman Insights Hub.

Music fade up

MH: Let’s start with a simple question: what exactly does a corporate board do? 

ASW: So board has two main roles. One role is to monitor the management and the other one is to advise it on key issues.

Monitoring includes a review of financial reports, hiring of auditors, oversight of risk management process, hiring and firing of a CEO, determining the compensation structure of the CEO and setting governance policies, and even recruiting new board members. The advising role is more strategic in nature and involves helping the top executive team by reviewing or approving strategy, providing advice or expertise on strategic issues and so on. 

MH: It is a relatively straight-forward role. Boards hold companies, particularly their CEOs, to account, and they provide their expertise on big-picture decision making. 

Usually, a board will split off its duties into smaller committees – say a committee to determine CEO compensation, or one that reviews an organization’s ability to meet its governance requirements. Committee members will discuss and debate the issues, and make decisions, which they bring back to the whole board to approve or reject.  

Boards hold a lot of power over organizations, so what happens when things go wrong on the board itself?  

This is actually what prompted Aida to start studying these dynamics in the first place. 

ASW: When I was in a PhD program, it was just after the Enron scandal broke out and around the time when the financial crisis was unfolding in the US. 

MH: In 2001, it was discovered that, through a variety of shady accounting practices, Enron hid billions of dollars of its debt. The company faced a 40 billion dollar lawsuit, its accounting firm was dissolved, and a number of executives were charged with fraud. And its board was found to have failed in its duty to shareholders, knowingly allowed the company to engage in high-risk accounting practices and failed to properly monitor the activities of Enron executives. 

ASW: And at that time, people were wondering how we got to the point that these corporations fail without anybody in the boardroom noticing along the way that something is wrong. So there was this collective question mark as to where the boards were when things were happening, when things were going down.

MH: Aida started to look at board composition – who actually gets a seat at the vaunted table? 

ASW: There was a lot of talk of the board environment being overburdened by groupthink mentality and lack of critical questioning of executive decisions. And so I was naturally curious if that groupthink mentality had something to do with the fact that everyone in a boardroom looked the same.

MH: It’s likely not a surprise to learn that the back in the early 2000s, the majority of board members – including those at Enron  - were predominantly older white men. 

ASW: So when you have the majority of any given board composed of men from the same ethnic background around the same vintage, who socialize in the same circles, it's really no surprise that there's not much pushback in the boardroom. 

Musical interlude

MH: The big issue comes down to what Aida calls groupthink – a phenomenon which happens when a group of individuals reach a consensus without critical reasoning or evaluation of the consequences or alternatives. 

In effect, they all just kind of agree with each other without any real discussion. 

That’s not to say consensus is bad – smooth-running boards might work well when everyone agrees and gets along. And too much disagreement can cause an otherwise cohesive board to break down. But, when people are naturally inclined to agree with each other, it also means no one asks tough questions. 

Aida’s early research showed that when a company added women to its board, fraud and financial reporting mistakes declined.  It’s not that women are inherently more honest – when even more women were added to boards, fraud didn’t miraculously disappear. 

ASW: So increasing the number of female directors is associated with an incremental decrease in the likelihood of fraud, but only to a point, and after which the benefits of this start to diminish. So this finding along with other analyses that showed the difference in the likelihood of fraud is not attributable to the differences in effort or skill, to me, that implies that this is likely driven by a change in board dynamics. And that's what really leads to us to observe this decreased likelihood between fraud and restatements and increased gender diversity.

MH: What happened is a new variable was thrown into the mix to counter groupthink. Suddenly, not everyone looked like each other, so the conversations at the boardroom table changed. 

ASW: The idea behind diversity is that it improves board effectiveness by increasing perspective diversity, which in turn counters that groupthink mentality and complacency and hopefully leads to better deliberations and decision making.

MH: It’s that diversity of perspective that’s important to counter groupthink. One of Aida’s papers showed that diversity of tenure – how long someone has sat on a board – can have an impact on hiring and firing decisions. 

Boards with a mixed make-up of newer and more seasoned directors tend to perform best when it comes to governance thanks to the mix of fresh perspectives and those with in-depth organizational knowledge.  But, of course, diversity for many means gender, race, and sexuality. So let’s dig into that a little bit. 

One 2003 study found that gender-diverse boards were better at disciplining CEOs, while another study from that year found that they had higher stock valuation. More recently, a 2011 study found that they had improved governance records. 

Exchanges like the NASDAQ used these findings as well as Aida’s other work to compel organizations to report their board make ups. Today, the NASDAQ requires companies listed on the exchange to publicly disclose board-level diversity stats, such as age, gender, race, disability status and sexuality. (15:16) By the mid-2020s, companies will have to defend why they have not met diversity targets on the board. 

Opponents say this type of policy runs the risk of introducing tokenism, which Aida explains as...

ASW: ... adding a member of underrepresented group to check the box really, without real intention of improving board dynamics, through enhanced or expanded conversations that come from having unique perspective. Unfortunately, tokenism was very real in the early days of board diversification when a female director would be added to a board just for optics.

MH: If an organization isn’t committed to actually bringing new voices to the table, then yes – tokenism can be a big problem. But as Aida says: 

ASW: The good thing about increased diversification is that it becomes more difficult to engage in tokenism as the number of underrepresented members on the board starts to increase and composition of the group is more balanced. It becomes more difficult to marginalize opinions of someone we disagree with if we have multiple people who have different opinions, and we have to kind of listen to each other's opinions and engage in conversation. 

MH: Today, women hold nearly 34 per cent of Canadian board seats on the TSX index- up from 30 per cent in 2020. In the U.S., they make up 32.3 per cent of directors at S&P 500 companies. Racial and ethnic minorities hold 14 per cent of seats in Canada - nearly double the rate in 2020. So representation is improving - though there are still stumbling blocks. 

Part of the issue Aida points out is that opponents to diversification often rely on the argument that there’s no real way to prove that a diverse board will outperform a non-diverse one, since you can’t really create control groups to test that theory.

But on the flip side, that also means you can’t actually disprove the theory that diversification improves effectiveness.

ASW: Do we really need the ultimate proof that relatively short-term shareholder value will improve if we diversify for us to be willing to go down this path? Is really the onus on the underrepresented individuals to prove that they are more valuable, not equally valuable, mind you, they are more valuable to the firm shareholders for us to move in the direction of more balanced representation? 

Musical interlude

MH: The needs of boards often follow the trends in the world. When Aida was first starting to look at director makeup, the top skills needed were financial in nature. 

ASW: The emphasis was really on having directors with financial expertise, because at that time, you had all these financial and accounting frauds. And as financial crisis was unfolding, just couple of years later, the focus shifted towards having board members who had risk management expertise.

MH: Today, we’re looking at a big tech shift, which means directors need more tech know how. 

ASW: And that's anywhere from general tech background to actually having a background in E-commerce. And even more so now cybersecurity, because if you just look at number of cybersecurity incidents that companies are faced with, it's something that every director has on the forefront of their mind: what are the risks to the organization if it comes out that we are hit by a cybersecurity breach, and then we have to deal with consequences of this.

MH: So what’s next? Well, ESG – or environmental, social, governance - is on everyone’s lips. 

ASW:  Being able to contribute as to how boards and organizations can improve their ESG performance, but also understand how they can practically measure and relay those actions they are taking to the stakeholders, how can they convey their path? So board members with expertise in this area are really sought out at this point.

MH: ESG investing generally speaking, evaluates organizations for their social conscientiousness – whether that’s looking at a company’s commitment to environmental issues and green standards or whether they fairly treat their employees and communities in which they operate. 

It’s a contentious and complicated topic, with governments and organizations often pushing back – divesting investments from areas that are not ESG friendly, such as the fossil fuel industry – aren’t straightforward issues.

A 2022 study of 700 board members by consulting firm PWC found that less than half of directors believed their peers had a good grasp of these ESG issues. 

But adding new blood can be a challenge. 

Aida points to Amazon, which in 2018 received a fair bit of flack after a shareholder pushed the board to diversify its then all-white, mostly male 10-person board. The board rejected the proposal.

ASW: And that really shook the stakeholders of Amazon, they felt that Amazon wasn't taking seriously the issue of diversity and didn't really care about their concerns. And so when stakeholders start questioning the company, that's when companies start losing legitimacy. So things don't have to go spectacularly wrong for organizations to possibly suffer from a lack of diversity, even small things like that can actually start other individuals questioning whether firms are committed to social issues and issues that concern them.

MH: Building a better – more diverse in thought – board will be a challenge, particularly for industries that have historically struggled to attract and retain diverse talent in the first place – like the energy industry

ASW: To your question of what happens to industries that don't really diversify, some of them are changing because they're dying industries. And it's because they haven't been diverse enough on any of these dimensions that they really missed out and were lagging behind in terms of innovation.

MH: Without new blood, and with more homogeneous boards there are fewer fresh ideas, fewer compelling conversations. But, not all hope is lost and some of these industries that were lagging are catching up. 

ASW: It's now that these industries are attracting people with different skill sets in different backgrounds because they have no choice but to if they want to evolve and survive.

Music fade out

MH: This has been the Rotman Executive Summary, a podcast bringing you the latest insights and innovative thinking from Canada's leading business school.  

Special thanks to associate professor Aida Sijamic Wahid. This wraps our first season – we’ll be back in September with new research and insights from our esteemed faculty. 

This episode was written and produced by Megan Haynes and Jessie Park. It was recorded by Dan Mazzotta, and edited by Avery Moore Kloss.   

For more innovative thinking, head over to the Rotman Insights Hub, and subscribe to this podcast on Spotify, Apple Podcasts and Google podcasts. 

Thanks for tuning in.