by Paul Strebel

“We have the best opportunity ever to advance corporate governance,” said Joe Dear, the head of the Californian pension fund, Calpers, in the middle of the financial crisis. Two years later, the crisis is over, but the governance of banking firms seems stuck in the past. Banks still have to fully clean up their balance sheets and really increase their lending to Main Street. Bankers are again giving themselves outsized compensation packages, despite the fact that many owe their survival to a bail-out with public money. Little wonder that public trust in the banking industry and, by extension, trust in business as a whole is very low.

Board RoomWhere are the bank boards? Many of them have been recomposed with new directors who have much more financial markets’ expertise. So why do they remain so out of touch with society and critical stakeholders who can make or break the company as well as out of touch with what’s needed to re-establish the social legitimacy of their firms? The problem is that the world of CEOs and board directors is made up largely of other CEOs and top executives who in a repetitive routine interact mainly with one another, with management, and occasionally with analysts, consultants and government officials.

Board directors in many widely held companies owe their loyalty to those who nominate them – people from the  same world. In the words of Nell Minnow, head of The Corporate Library, “There’s only one thing that matters, and that’s who gets to decide who sits on the board.” As long as directors are nominated by existing board directors on the Nominating Committee, which often includes the CEO, they will continue to empathize with the CEO of the company on whose board they are sitting. Fellow CEOs are not going to raise the red flag because of a little societal criticism, nor will they deny the company’s CEO and his top people an increase in compensation, since they are in a similar position relative to their own board. There needs to be fundamental change.

We are seeing some steps in the right direction. For widely held companies in the U.S., the SEC now has the legal authority to require shareholder nominees to be included with management’s nominees for election to the board. In the U.K., the Financial Services Authority has been given veto power over the nominees to big bank boards. In Sweden, large shareholders form the nominating committee of listed companies. When minority shareholders are legally protected, as they are in Sweden with strong rights to block certain decisions with a minority vote at the shareholders’ meeting, the net performance advantage increases of having large owners nominate the board directors.

Beyond the owners, bringing direct stakeholder representatives on to the board itself is not the obvious next step. Indeed, the experience of NGOs, partnerships, and other diffusely held organizations shows that too many stakeholders on the board often leads to gridlock. The chairmen of some Northern European companies, I have spoken to, believe that the effectiveness of their boards could be greatly improved by having the employee representatives sit on the nominating committee rather than on the board itself. In fact, the contribution of employee representatives on northern European boards is marginal, because management and the directors elected by the shareholders usually meet before board meetings to settle key agenda items.

Membership of the nominating committee, rather than the board itself, more easily can be extended to include the representatives of other critical stakeholders, to ensure that the directors selected are in touch with stakeholder interests and risks. For example, in investment banks, the nominating committee should have members with direct contact or recent experience in frontline trading, back office risk management and the public oversight of the industry; for oil majors, members with subcontractor, drilling platform and NGO experience or contacts.

There are important advantages to a shareholder/stakeholder-based nominating committee:

-It ensures that the shareholders as a whole elect directors from a list of nominees with the societal, industry and other essential expertise and contacts, desired not only by the owners, but also by other critical stakeholders.

-It requires only a limited time commitment (to the nominating committee) from high-powered stakeholders.

-It breaks the monopoly of power that develops on boards and nominating committees dominated by a CEO/Executive Chairman.

-It increases the chances of getting strong sparring partners onto the board, because the directors owe their loyalty, not to the CEO/Chairman, but to the stakeholder representatives on the nominating committee.

A shareholder/stakeholder-based nominating committee would need specific rules of committee governance to integrate the different perspectives on desirable nominees. Moreover, the increased diversity on the board would complicate the life of the chair in getting the board to work together. However, the board does not have a management role; it does not have to be an integrated team. It has to perform the conflicting roles of both supporting and monitoring management. Especially for the latter role, sadly lacking during the lead up to the crisis, more useful diversity and less harmony is needed on the board.

To improve public trust in business, the search for board directors has to extend beyond the world of top executives, to look for other kinds of nominees in touch with the critical stakeholders, who can bring their perspective into the boardroom and involve management in creating long term value, rather than short term gain. To get this in a systematic way, the nominating committee needs a transformation.

This article was first published on February 14, 2011.

strebel_paul_VIS5Paul Strebel is the Sandoz Family Foundation Professor of Governance, Strategy and Change at IMD, a leading global business school based in Lausanne, Switzerland. He directs IMD’s High Performance Boards program.

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