One Strategy to Improve Board Performance

performance-4-19-19.pngDoes greater diversity improve the performance of corporate boards, or is it just an exercise in political correctness?

Cognitive diversity—also called diversity of thought—has particular relevance to bank boards of directors, which are overwhelmingly made up of older white men with general business backgrounds.

This is not an indictment against older white men per se, but rather a recognition that a group of people with similar backgrounds and experiences are more likely to think alike than not. The same could be said about other homogenous social groups. For example, a team of older Latinas or younger black men might also be subject to groupthink.

“We’re only going to get the right outcomes if we have the right people around the table,” says Jayne Juvan, a partner at Tucker Ellis who is vice chair of the American Bar Association’s corporate governance committee and frequently advises corporate boards on governance matters.

It would be a mistake to dismiss board diversity as a political issue pushed by feminists, LGBT advocates and progressive Democrats. Even some of the world’s largest institutional investors think it’s a good idea.

In his annual letter to chief executive officers in 2018, BlackRock CEO Larry Fink said the investment company would “continue to emphasize the importance of a diverse board” at companies BlackRock invests in. These companies are “less likely to succumb to groupthink or miss threats to a company’s business model,” he wrote. “And they are better able to identify opportunities that provide long-term growth.”

State Street Global Advisors, another big institutional investor, announced in September of last year that it will update its voting guidelines in 2020 for firms that have no women on their boards and have failed to engage in “successful dialogue on State Street Global Advisor’s board diversity program for three consecutive years.”

As part of the new guidelines, State Street will vote against the entire slate of board members on the nominating committee of any public U.S. company that does not have at least one woman on its board.

There is, in fact, a strong business case for cognitive diversity. Studies show that diverse groups or teams make better decisions than homogenous ones.

Companies in the top quartile for gender diversity of their executive teams were 21 percent more likely to experience above-average profitability than companies in the bottom quartile, according to a 2017 study by McKinsey & Co. The study also found that companies in the top quartile for ethnic and cultural diversity were 33 percent more likely to outperform companies in the bottom quartile. Both findings were statistically significant.

“On the complex tasks we now carry out in laboratories, boardrooms, courtrooms, and classrooms, we need people who think in different ways,” wrote University of Michigan professor Scott Page in his book “The Diversity Bonus: How Great Teams Pay Off in the Knowledge Economy.”

“And not in arbitrarily diverse ways,” he continued. “Effective diverse teams are built with forethought.”

Page differentiates cognitive diversity from “identity” diversity, which is defined by demographic characteristics like race, gender, ethnicity, sexual orientation and national origin. But striving for identity diversity, through characteristics such as race and gender, and the different life experiences and perspectives that result, can help boards and organizations cultivate cognitive diversity.

Yet, Juvan says boards also need to gain insight into how potential directors think and process information, which they can do by appointing them to advisory boards or working with them in other capacities. Banks that have separate boards for their depository subsidiaries, for instance, could use those as a farm system to evaluate candidates for the holding company board.

“I think it’s about creating a pipeline of candidates well in advance of the time that you actually need them, and really getting to know those candidates in a deeper way … as opposed to thinking a year out that we’re going to have an opening and … [working] with a recruiting firm,” she says. “I don’t think it’s something that, even if you work with a recruiting firm, you should fully outsource to somebody else.”

When Recruiting Directors, Keep the Big Picture in Mind

recruiting-1-15-16.pngOne of the most challenging aspects of maintaining a strong board is finding strong directors to serve. Most smaller banks handle this process themselves—often with uneven results—while larger banks are more likely to use the services of a search firm when they need to add or replace a director. The process should be driven by the independent directors on the board’s governance or nomination committee, and in fact, this is a listing requirement for publically traded banks that are traded on the Nasdaq or the New York Stock Exchange. At some smaller, privately held banks, the CEO still recruits new directors, although this is far from ideal, says Peter Crist, chairman of the search firm Crist|Kolder Associates and chairman of the board at Wintrust Financial Corp. in Chicago. In an interview with Bank Director Editor in Chief Jack Milligan, Crist offers his thoughts on director recruitment, including the need to look closely at the board’s composition from a demographic, experience and skills perspective when deciding to recruit a new director.

When a bank recruits a new director, who drives that process? Is it the governance committee, the CEO, the independent chairman, if there is one? Who’s in charge?
Crist: It varies. Ten years ago, it was the CEO who drove the process. Today, in a best case scenario, it’s a mutual directive from the CEO and the head of the nominating committee. The truth of the matter is, the nominating committee owns the process. But human nature being what it is, lots of nominating committees abdicate the responsibility of board recruitment if there is a strong-willed CEO. This tends to happen more often in smaller enterprises where a single person can dominate the room and the head of the nominating committee will just kind of roll over for what the CEO wants. In best case scenarios, it’s a highly-independent chairman of the nominating committee who will drive the process.

We seem to be in a period of great change in the banking industry. Are there specific skills that directors will need going forward that may not have been so important in the past?
Crist: First and foremost, technology. If you look at the types of requests that are out there for new board members, number one is technology, and that can manifest itself in a number of ways. It could be a chief information officer from another industry, or it could be someone in the consulting world who’s focused on technology. If you don’t have a person on your board who can speak the dialect and understand it and really bring the other board members along who might not understand it, then you have to get one of those people. Second is risk. There is a lot of interest in people who understand risk, understand enterprise risk management. Third, we’re seeing a lot of gender type requests, where boards are trying to balance the gender and ethnicity issues that they face. And fourth, people who are compensation experts. So we’re seeing more chief human resources officers coming on boards, and the good news is many of them are women.

How about somebody who has a greater appreciation for the demographic diversity that banks have in their customer base? Someone who understands millennials, for example.
Crist: That manifests itself in two themes that we’re seeing in the marketplace. Many boards will look for chief marketing officers who would bring to them that skill set. So think of the chief marketing officer of Target or Walmart. And the other request, which is one we are a little sensitive about, is for people who are in disruptive technology enterprises. Boards think that experience teaches people how to look at a market differently, how to think about going to a market differently—how to attack, basically. And that often means someone who’s 29 years old, which may not be the best choice for the board. They don’t have the wisdom and the experience to deal effectively with their board colleagues.

If you had to choose between experience and judgment on the one hand, or expertise in one of these specific areas, which would you pick?
Crist: The board should have a balance of both, but I lean to the former. A person who brings wisdom and judgment to the board is going to be able to assist their colleagues in getting to the right answer. But one of those colleagues should be a person who has very specific expertise in one of these critical areas. A board should have a balance of age, wisdom, experience and specific skills in areas like technology, marketing, compensation, legal and M&A.

What’s the ideal size for a board?
Crist: Nine.

Why is nine better than, say, six or 12?
Crist: Six is too small. If you have too few board members you end up putting people on [too many] committees. And if you have too many, it’s hard trying to communicate with everyone effectively. Nine tends to be that goldilocks number that provides enough people to cover all of the committee assignments, but doesn’t impact you on the communication side.

How do you handle a search? How does it start, what process do you go through and how do you work with the board while you’re doing it?
Crist: We are usually called after a board has exhausted all of its resources trying to find a new director. They’ve asked all of their friends and they’ve done their own thing, but eventually realize that they’re going to have to write a check to get this done. So if they come to us and say, “We need an African-American chief marketing officer from a retailer,” that’s what we go find.

We will advise the nominating committee, if that’s who we’re working with on the board, about the difficulty of the project. What we tend to see is that when boards come to us, there’s a great specificity to what they’re looking for. We try to get them to look at this board seat in the broader context of the other people who are already serving on the board. So when they come to us with a list of specific traits they want in this new director, we try to get them to also think about other elements that might be missing on their board and take a larger perspective.

Most board projects, though, come in multiples. Most companies come to us and say, “Look, over the next three or four years we’re going to have three directors time out. And so we’re going to do a recruitment project in 2016, we’re going to do one in 2017 and we’re going to do one in 2018. And in that three-year year cycle, those three seats have to be filled by the following,” and then there’s a very long menu of items that they would like in those. That allows us great flexibility and also helps balance the board member mix.

What do you need from the client to make the recruitment process go smoothly?
Crist: First, a clear understanding of what the target is. There can be some ambiguity about the person they’re looking for, but they can’t put 10 items onto their wish list because you won’t find a person with those 10 qualifications. Second, [we need] a process that is not cumbersome. Some boards require that every prospective board member meet every current board member, which is fine, but that is going to take a year. So you can’t call in January and say, “We’ve got to do a proxy in March,” because that’s not enough time. Usually the CEO and the head of the nominating committee are the point of the spear. In other words, they are people who will see the broad list of prospects. On a particular board search they might review 50 profiles on paper, and pick 10 to have physical interviews. Then the CEO and the head of the nominating committee will choose how many of those 10, let’s say it’s 5, to take to the nominating committee and the committee will pick one. That person will then be presented to the board. Third, we need to make sure that expectations are met appropriately on both sides. It is a game of fit, and we want to make sure that company looking for the new board member is comfortable that they’re getting what they anticipated.

You said that the CEO and head of the nominating committee are the point of the spear in a director search. How much influence does the CEO have in this process?
Crist: Look, if the CEO doesn’t like their selection of a new board member, you’re just creating a problem.

So the CEO should have sort of an implicit veto power?
Crist: No, not a veto. Think about the dynamic of the CEO and the head of nominating meeting in person and coming out of that meeting and saying, “We both like that person; that person has a very high probability of getting through the gauntlet of the other meetings and getting [to] the board.” If either one of them comes out of that session and the CEO says “Hmm, not sure about that one,” or the head of nominating says, “Hmm, not sure about that one,” there’s a low probability that person’s going to make it through the gauntlet.

So it needs to be a consensus process, someone who both the CEO and the head of the nominating committee, or the nominating committee itself, both feel comfortable with.
Crist: Absolutely.

When a new director comes on board, is there a process that should take place to make sure that that person is successfully integrated into the culture of the board and educated about the company’s issues?
Crist: The onboarding process, which is the term most use now, has gotten much better over the last 10 to 15 years. And the onboarding process is making certain that the new board member has an appreciation and understanding of the enterprise, and has extensive dialogue with his or her new colleagues. It’s the former that’s gotten so much better. Now many companies make certain that over a full day, or scattered over several days, the new board member meets one on one with the senior managers to get a full appreciation for its enterprise.

When is the Right Time to Get Rid of the Wrong CEO?

fired.jpgWhen Citigroup’s chairman Mike O’Neill spoke on an investor conference call about the abrupt resignation of CEO Vikram Pandit, he said that the timing made sense because strategic planning was underway.

“And so, if we are going to hold [the new CEO] accountable for our performance, he clearly needs to have a role in setting the targets,’’ O’Neill said.

Citigroup Inc. has had a bad year. Make that a bad decade. The company’s stock price fell 89 percent during Pandit’s tenure. But the bank is hardly alone. Many of the more than 7,000 banks and thrifts in the country have problems of their own, so the question of whether you have the right CEO on the job, and if not, how to get rid of him or her, is one that many banks are trying to answer.

Courage is step one. Is the board independent enough from management to actually fire the CEO?

The Wall Street Journal reported last week that the “shake-up amounts to an extraordinary flexing of boardroom muscle at Citigroup, a company that until recently had a board stocked with directors handpicked by former CEO Sanford Weill who rarely challenged management decisions.”

Chairman O’Neill, a longtime banker and stellar CEO at the Bank of Hawaii, has only been there since April. Several other directors are recent appointees who signed on after regulators urged a board purge following the financial crisis, according to the Journal.

In fact, O’Neill had an office within 100 feet of Pandit, according to The New York Times. In his new job as chairman, O’Neill quickly got to work learning in the ins and outs of Citigroup and visiting the company’s various trading floors, according to news reports.

“The chairman of the board is critical,’’ says James McAlpin, a strategic planning expert and bank attorney at Bryan Cave LLP in Atlanta. “If you have the chairman and the CEO as the same person, that further complicates this. That makes it more difficult for the evaluation [of the CEO’s performance] to take place.”

If the board doesn’t want a non-executive chairman, a lead independent director who meets separately with other independent directors is key to maintaining independence.

It’s also important that the CEO be judged on how well he or she has executed the strategic plan. Tying the CEO’s performance to strategic goals with a formal annual evaluation is something that bank boards often don’t do.

As shocking as this might sound, banks are more likely to evaluate the performance of their tellers than their CEOs.

“There are a surprising number of banks where the CEO doesn’t see a performance review,’’ McAlpin says. “Particularly in community banks, it’s the exception rather than the rule. That makes it harder for the CEO to know how he is doing. Concern builds over time and suddenly the CEO finds himself in a very confrontational meeting with the board.”

Geri Forehand, national director of strategic services with Sheshunoff Consulting + Services, says that all CEOs should receive an annual performance review.

“When you hire a CEO, you have to have a way to evaluate the CEO, both quantitatively and qualitatively,’’ he says. “Every board should handle this in a formal matter. You should give your CEO an evaluation on an annual basis.”

He says the CEO should be fully informed of the metrics that will be used to measure performance and how they will be used, including how the board will factor in qualitative measures.

“I think the CEO wants to know what is expected of him or her,’’ Forehand says.

It’s not only good for the CEO, it’s good for the bank. A CEO who knows what he or she is supposed to achieve will be better able to actually achieve it.

When it’s time to make a tough decision, however, it works best for there to be a strong chairman or lead independent director. The full board needs to be involved in the discussions and the CEO needs to know the entire board has made a decision.

The board should also go through the process of identifying the next CEO far in advance of an actual resignation, which will make the transition easier, says Forehand.

The actual firing (or forced resignation), therefore, is part of a long, strategic process.

“It’s a very difficult conversation to have with a CEO,’’ McAlpin says. “[The CEO] wants to know the entire board has deliberated on this.”  

Sharing Directors Brings Added Experience to Your Board, But Could Cause Problems

DropFiles.jpgMany financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution.  In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter.  In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats.  The individuals selected by private equity firms as board representatives often serve on a number of different bank boards.  As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: FDIC cross-guarantee liability.

The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).  The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:

  • the default (failure) of a “commonly controlled” insured depository institution; or
  • open bank assistance provided to a “commonly controlled” institution that is in danger of failure.

This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure.  As many of us see each Friday, the amounts of these estimated losses are often quite high.  In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year.  Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.

The concept of cross-guarantee liability was developed in response to some perceived abuses by multi-bank holding companies during the 1980s.  In those instances, one or more institutions owned by a multi-bank holding company failed, causing significant losses to the FDIC, while the other subsidiaries of the multi-bank holding remained open and viable, allowing the holding company to continue to profit from their operations while the FDIC was stuck with the losses from the failed institutions.  With authority to assess cross-guarantee liability now in hand, however, the FDIC has shown a willingness to assert cross-guarantee liability under facts that would not be considered by most to be abusive.  In this cycle, the FDIC appears to be willing to take full advantage of the assessment authority granted to it by FIRREA, using cross-guarantee liability as a “sword” to provide a recovery to the Deposit Insurance Fund.

The imposition of cross-guarantee liability starts with an assessment of control.  Whether institutions are “commonly controlled” for purposes of determining cross-guarantee liability depends upon whether each institution is under the control of a common entity under the Bank Holding Company Act of 1956, as amended (BHC Act).  Because the determination of control is made under the BHC Act, the Federal Reserve’s BHC Act control guidance is a useful guide. However, this guidance is very dense and can be quite complicated, requiring a review of the ownership structure, management practices, and other business affiliations of the two institutions.  However, one thing is clear:  In questions of control, institutions that share “management officials”—common directors and/or executive officers—are generally more likely to be found to be under common control than those that do not, all other factors being similar.

As a result, institutions with directors who serve on other bank boards or as officers of other banks should assess potential cross-guarantee risk through the director nomination process.  Nominating committees (or other committees of the board reviewing director qualifications) should ask the following questions:

  • Does the individual serve on as a director or officer of another financial institution?
  • Is there a basis for determining that the two institutions are under common control?  Answering this question will likely require consultation with legal counsel.
  • Is the other financial institution in a financial condition that is less than sound?

If the answer to all of these questions is “yes,” the nominating committee should think carefully about whether nominating that individual is a good idea.  In addition, institutions guaranteeing board seats to investors (such as in connection with a private equity investment) should consider an exception to the nomination requirement when the election of the representative could create a risk of assessment of cross-guarantee liability.

A risk assessment requires an in-depth factual, legal and financial analysis. There are few organizations that will find out this issue places them at risk, but it’s worth attention because the consequences can be severe. As a result, an assessment of this risk should be an integral part of the annual nomination process.

Part 3: Best Practices for Bank Boards

team-row.jpgOver the past several years we have seen the regulatory agencies become much more focused on board oversight and performance.  This is a natural point of focus for regulators in a time of crisis in the banking industry.  The fiduciary and oversight obligations of members of boards of directors are well established, and there is a road map in the corporate records for following the actions and deliberations of a board.  I would suggest, however, that a board could receive a gold star for the quality of its minutes and its adherence to the established principles of corporate governance, and yet fall well short of being an effective working group.

This is the third in a series of articles of best practices for bank boards.  Over the past several decades my partners and I have worked with hundreds of bank boards.  Regardless of the size of the entity we have noticed a number of common characteristics and practices of the most effective boards of directors.  In this article, I will discuss three additional best practices—meeting in executive session, making use of a nominating committee and director assessments and participating in the examination process.

Best Practice No. 6 – Meet in Executive Session

It is not uncommon for the most passionate and meaningful discussions among board members to occur in the parking lot of the bank following a board meeting.  Much more time is spent in these parking lot sessions discussing a possible sale of the bank and the compensation and performance of the bank CEO than ever takes place in the board room.  The most effective boards of directors move these conversations to the board room by means of executive sessions.  Whether monthly or quarterly, the independent (i.e., non-management) directors meet in executive session and set their own agenda for those meetings.

I have found that CEOs who welcome and facilitate such executive sessions never regret doing so.  Executive sessions provide a structured forum for the independent directors to meet as a group and speak freely regarding matters of interest and concern to them.  Many positive ideas and discussions can result from these sessions.  If the CEO is also chairman of the board, a “lead director” can chair the executive sessions.  A best practice is for the chairman or lead director to meet with the CEO following an executive session and report on the substance of the matters discussed.

Best Practice No. 7 – Make Use of a Nominating Committee and Director Assessments

No director has a “right” to sit on a board.  Members of the most effective boards of directors have an active desire to serve the bank, which is evidenced by a high level of engagement, preparation and participation.  There should be a transition from the typical practice of automatically re-nominating existing board members to a process of conducting annual director assessments coupled with a nominating committee for director elections.

The CEO should not be involved with either director assessments or the nominating committee—these are board functions and should be managed by the board under the direction of the chairman or the lead director.  Annual director assessments could initially be done by means of self-assessments, coupled with a one-on-one meeting between each director and the chairman.  These one-on-one meetings can serve as the basis for discussion of the director’s enthusiasm for and participation in the activities of the board.

The process of implementing an active nominating committee and annual director evaluation process is also about risk management going forward.  In these times of continued economic uncertainty and increased regulatory scrutiny, it is important that banks have active and engaged directors.

Best Practice No. 8 – Actively Participate in the Examination Process

Members of the board should be involved in the regulatory examination process.  The regulators really do want and expect the board to be involved in and understand the issues which the regulators believe may be facing the bank.  Involvement of the entire board or key members of the board from the first management meeting with the examiners to the exit meeting is tangible evidence that the board is actively engaged in oversight of the bank.  It can also be beneficial for members of the board to hear the concerns of the regulators directly, and to observe management’s interaction with the examiners.

I recently attended an exit meeting with bank management following conclusion of an exam.  Several of the bank’s directors were present because they wanted to get a preview of the exam findings on asset quality.  During the exit meeting the lead examiner raised concern about a risk management issue of potentially significant magnitude.  The issue clearly took the bank’s CEO by surprise, but the presence at the meeting of the board’s chairman had a calming effect.  The chairman looked across the table at the lead examiner and said in a convincing tone, “We will fix this immediately.”  The issue was then quickly resolved, and the final examination report commented favorably on that action.  The end result may well have been the same without the presence of board members at the exit meeting, but I believe their presence was very helpful and reflected well on the bank.