Does 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.”
One 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 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.
Many 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.
Over 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.