Essay: Neutralizing the Board of Directors and the Impact on Diversity
24 Pages Posted: 4 Oct 2011 Last revised: 21 Mar 2012
Date Written: October 4, 2011
Boards of public companies are not diverse. As this piece explains, the lack of diversity can be traced to a rational strategy by management of neutralizing the board in order to reduce the risk of intervention in corporate affairs. Neutralization in part involves the designation of directors who will “reliably” support the policies of management.
At one time, reliability was assured through the appointment of officers and other persons with significant economic ties to the company. With the rush toward board independence, however, these types of “reliable” directors have largely been eliminated. Instead, they have been replaced by other categories that meet both the porous definition of director independence and the criteria for reliability. These categories include friends of management and current or former executive officers, particularly other CEOs.
The need for “reliable” directors explains the lack of board diversity. Directors are not chosen for their unique perspectives or diverse backgrounds but for their predictability in supporting management. The absence of diversity, in turn, largely prevents boards from assuming any meaningful advisory role. Providing managers with effective advice requires directors who are informed and who possess diverse viewpoints. Both are inconsistent with the goal of neutralization.
Boards have the authority to impose an advisory function on management. An advisory function will only be effective, however, if accompanied by structural reforms to the board. In particular, this requires changes in the selection criteria for directors. To ensure the effectiveness of any advice provided, directors must be informed and diverse. Diversity encompasses gender and race, two categories heavily represented among consumers but not among directors. It also includes persons with views and backgrounds at variance with management. Diversity, therefore, must replace reliability as the most important criteria for board membership.
The impact of neutralization on diversity likely explains a conundrum with respect to board membership. Data has not consistently shown that racial or gender diversity on the board improves performance. These studies, however, examine diversity in the context of monitoring boards that do not exercise a meaningful advisory function. Diversity will be the most valuable for boards performing a meaningful advisory function. Until the function becomes mandatory, therefore, diversity is likely to have reduced impact on performance.
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