How can boards diversify to manage change? Is the CEO Pay Ratio rule going to be effective? When should the CEO and Chairman of the Board roles be separate?

During a wide-ranging and informative interview, veteran board member and venture capitalist Betsy Atkins and Bloomberg Radio host and former SEC Chairman Arthur Levitt discuss these important topics, and more. We divided their interview into three separate articles and posted Part 1 last month. Part 2 is presented below.

Arthur Levitt: What is the best case for diversity in the boardroom and what should diversity really mean? It’s not just about gender, right?

Betsy Atkins: Correct, it’s about cognitive diversity: how people think differently and problem solve differently. Diversity should be the diversity of backgrounds in the board room, diversity of domain experts in the company’s industry, and diversity of functional experts such as financial experts for audit committee, digital experts, and geographic diversity. It should not simply be gender. I’m not a believer in affirmative action. Hire the best people who bring you diverse thought, as that brings the best business judgment for the shareholders.

AL: You write about how companies should “manage” diversity. What do you mean by that?

BA: What I mean by managing diversity is to really look into your board composition and think about how to forward hire the optimal set of differentiated and complementary perspectives required for effective oversight. The board should be an asset that the CEO and management can leverage to help stress test future plans as well as perform broad oversight for current plans. Just as management refreshes their leadership team frequently, the board should be refreshed to meet the challenges and opportunities the company will face during the next five to seven years, given the velocity of change.

AL: BlackRock recently updated its proxy voting guidelines, adding a stipulation that it expects companies to have at least two women directors on their boards. When it comes to more women on boards, are you in favor of quotas or targets?

BA: I don’t like the idea of quotas. I’m certainly supportive of embracing aspirational targets, but it has to be based on qualified people—the board shouldn’t lower the quality bar to achieve a quota. Fortunately, there are plenty of qualified women and minorities out there.

AL: Why is the U.S. so far behind in either quotas or targets for getting more women on boards?

BA: While the U.S. is behind, they have made incremental progress. The 2017 Spencer Stuart U.S. Board Index reported that the percentage of women serving on S&P 500 boards in 2017 increased to 22% of all directors from 17% in 2012, and that 80% of boards now include two or more women, which represents a significant increase over 61% in 2012. The U.K. has been more aggressive, and has set a target of 33% for the number of FTSE 350 board seats held by women by the year 2020.

AL: Will companies find women for their boards if they don’t specifically go looking, with some kind of pressure to diversify?

BA: I expect big changes this year, because the large index funds are now pushing gender diversity, which is going to be a huge accelerant. If boards are serious about diversity, they need to mandate that for every board seat they are going to fill at least one-third to half of the candidates on the board search panel are female. But again, diversity should be broader than gender diversity.

AL: What do you think of NYC Comptroller Scott Stringer’s Boardroom Accountability Project?

BA: It’s hard to establish a quantitative matrix that truly identifies diversity of thought. The concept is sound, but what boards should really be looking for is diversity of experience, so the board has multiple business models to call on from their past to solve current and future business challenges. For example, if you spent your entire 35-year career in one company, you would only have that company’s model of how to approach and solve problems, only that company’s “cycle time” and sense of urgency in problem solving, which is probably too slow today. The goal should be to build a high performing board that is able to access the contemporary director’s business judgement ability.

The matrix is a reasonable starting point for the conversation, but ultimately the matrix is a quantitative concept and the board makes a judgement that is more qualitative than quantitative.

AL: This will be the first year that the ratio of a CEO’s total compensation as compared to that of a median employee must be disclosed. What do you think of this rule?

BA: This rule will prove to be more of a media event than a driver of change. It’s going to be confusing and create noise without driving valuable and actionable insight. CEO pay thresholds are completely different industry to industry: there will be a profound difference in pay ratios between a company that has the bulk of its workforce in India and that of a company with an all-American workforce that is far more highly paid. Even when comparing a company with its own peer set, again, it’s a challenge to find the right peers outside of a company’s direct competitors.

AL: Do you think consultants are helpful to boards in setting CEO compensation?

BA: I think compensation consultants are helpful in gathering factual data.

AL: How would you advise companies to structure CEO pay to encourage long term growth?

BA: Practical reality is that companies have to pay their CEOs relatively competitively in comparison to direct competitor peers. The long-term growth part of compensation should be based on a small number of very specific quantifiable metrics such as market share, new product introduction, and geographic expansion. The metrics are long-term and measurable, versus the typical short-term annual metrics of revenue, profit and total shareholder return.

AL: Where are you on the question of whether it is ever a good idea for the CEO to also serve as Chairman of the Board?

BA: I think it’s very specific to each company. Although a majority of companies still combine the two roles, it currently stands at just over the 50% mark and that statistic is falling. In a situation where a company has a first-time or new CEO, it is a better governance practice to separate the Chairman from the CEO. When the CEO has been serving for a long time, or is successful, recognized and acclaimed, it can be viewed as a major issue by an incumbent CEO if he or she doesn’t get the chairmanship when the sitting Chairman exits the board.

Every board should have a strong independent lead director, with a mechanism in the by-laws for annual review enabling rotation. All boards should have a method for orderly chairman replacement to be prepared when the need arises.

AL: You believe the most important role of the board is to choose the CEO. What do you look for in a CEO?

BA: The key thing to look for in a CEO is to match the company’s CEO profile to the stage of the company. For example, if your business model is perfect, and all you need to do is a little bit more revenue, a little more profit a little faster, it would point you toward an internal candidate who can continue to implement the current strategy. If your company is going to face big transformation and change in its competitive landscape, you may want to look outside for a candidate with a transformational growth skillset and experience.

AL: What is your best advice for a new CEO faced with a new board?

BA: You need to create a rhythm of being in touch with each board member at least once a quarter. You would be well served to engage the committee chairs in working with you to create an annual board calendar of important topics that the board wants to review annually. Start every board meeting with a state of the union and clearly identify one or two topics you want the boards input and engagement on each meeting. They came to contribute and participate, and you’ll lose control of the meeting if you don’t point them to where you want their input.

Be sure to get a thorough debriefing on every executive session and memorialize back to the board any topics for future follow up.

For more information, read Betsy Atkins Talks to Arthur Levitt about the Current State of Boards: Part 1

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Betsy Atkins serves as President and Chief Executive Officer at Baja Corp, a venture capital firm, and is currently the Governance Chair at HD Supply. She is also on the board of directors of Wynn Resorts, Schneider Electric, Cognizant, and a private company, Volvo Car Corporation, and served on the board of directors of The Nasdaq Stock Market LLC and as CEO and Board Chairman at Clear Standards.

Arthur Levitt is currently the host of Bloomberg Radio’s “A Closer Look with Arthur Levitt” and serves on the board of directors at Bloomberg LP. Levitt was the 25th Chairman of the U.S. Securities and Exchange Commission, and in 1999, became the Commission’s longest-serving Chairman until his resignation in 2001. He also serves as a senior advisor to Goldman Sachs & Co. and an advisory board member of the Knight Capital Group.