Maximizing the Benefits of Board Diversity: Lessons Learned From Activist Investing

Jared Landaw is COO and General Counsel at Barington Capital Group LP. This post is based on a Conference Board publication. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here).

Introduction

In recent years, publicly traded companies in the United States have faced increasing pressure to improve diversity on their corporate boards. Influenced by state legislation as well as the efforts of institutional investors and other diversity advocates, companies are recruiting more female directors than ever before. Approximately 45 percent of the directors added to the boards of companies in the Russell 3000 during the 2019 proxy season were women, up from 12 percent in 2008. The percentage of new directors who are minorities is also increasing, although at a significantly slower rate, with approximately 15 percent of the directors added to the boards of Russell 3000 companies during the 2019 proxy season belonging to a racial or ethnic minority group.

One of the central arguments cited for improving the diversity of demographic characteristics such as gender, race, and ethnicity on corporate boards is that such diversity is necessary to ensure that boards are able to perform their obligations effectively in today’s competitive business landscape. In calling for an increase in gender diversity on boards, Ronald P. O’Hanley of State Street Global Advisors stated, “In a more complex, innovation-driven environment, embracing a diversity of thinking, competencies, and backgrounds is a business imperative.” David Solomon, CEO of Goldman Sachs, expressed a similar sentiment when announcing that, beginning July 1, 2020, Goldman Sachs will not take a company public unless it has at least one diverse board member: “I come from a position of my own experience where I look at the Goldman Sachs board. We have four women out of eleven. We have a black lead director. And I really value the diverse perspectives I’m getting which are helping me run the company.”

Several commentators have noted, however, that while it is commonly assumed that individuals who differ in demographic characteristics will bring new backgrounds, viewpoints, and perspectives to a boardroom, adding demographically diverse directors to a board may fail to achieve such an outcome. This could occur, for example, in instances where new, demographically diverse directors have backgrounds similar to those of incumbent directors or were selected primarily because they fit in well with others on the board. As Professor Katherine Klein of Wharton Business School noted, “If male and female board members are fairly similar in their values, experience, and knowledge, the addition of women to an all-male board may not increase the board’s cognitive variety as one might expect at first blush.” Furthermore, even if new, demographically diverse directors have different backgrounds, views, and perspectives from other board members, the benefits of their addition to a board may be muted if they are not comfortable sharing their insights with their fellow directors or if their insights are not incorporated into the decision-making process.

Given this, the question arises as to how boards focused on improving demographic diversity should select new directors. What characteristics should boards look for when adding directors to improve gender, racial, and ethnic diversity to ensure that these new directors also enhance diversity in the boardroom from a practical perspective? And once these new directors have been added to a board, what can be done to make sure that their views are expressed and considered during boardroom deliberations?

This post shares our recommendations as an activist investor on how boards committed to improving demographic diversity should approach the director recruiting process. In summary, we believe that public companies benefit the most by recruiting demographically diverse directors who also help improve cognitive diversity in the boardroom. As opposed to demographic diversity―which focuses on differences in people’s demographic characteristics―cognitive diversity pertains to differences in people’s knowledge, views, and perspectives, as well as in how they approach problems and perceive, process, and interpret information. As a frequent investor in underperforming companies with board composition concerns, we have found that improving cognitive diversity in the boardroom can meaningfully enhance the performance of a board. Among other things, enhancing cognitive diversity can expand a board’s knowledge base, improve decision-making, and help a board more effectively mentor and monitor management. Overall, we believe that a cognitively and demographically diverse board is best equipped to perform its obligations and help a company compete, innovate and respond to disruption in today’s challenging international markets.

To improve cognitive diversity, we recommend that boards recruit gender, racially, and ethnically diverse candidates who, in addition to improving the diversity of the demographic characteristics of the board, enhance diversity on two additional levels: first, by adding new professional backgrounds, skills, and experiences that help meet the company’s strategic and operating needs; and second, by introducing new views, perspectives, and approaches to problem solving. We also recommend that boards take steps to ensure that the views of new directors are conveyed and carefully considered, since diverse views are of little benefit if that is not the case. By recruiting individuals who increase diversity on several different levels and ensuring that the culture in the boardroom facilitates the exchange and consideration of diverse perspectives, we believe that boards increase the likelihood of achieving a high-performing boardroom.

The views we share were derived from our experiences and observations as an investor in eight underperforming companies subject to past shareholder activism by our firm. At each company, an employee of Barington, or one or more other individuals we nominated or approved, was added to the board. Our views are also based upon insights we obtained from interviewing directors who served on the boards of these companies both before and after changes were made to the composition of the board. Through these interviews we were able to ascertain whether the directors added helped improve cognitive diversity in the boardroom and, if so, gain insight into the impact that an increase in cognitive diversity had on board performance.

This post is organized as follows. Section I discusses the role that corporate governance plays in our investments and why board composition and diversity are important to us as an activist investor. Section II shares insights we obtained from our activist investments and director interviews, with an emphasis on the influence that an increase in cognitive diversity can have on board performance. For boards interested in improving demographic diversity, Section III presents recommendations for them to consider incorporating into their director recruiting and onboarding process. These suggestions are designed to help boards identify demographically diverse directors who can also improve cognitive diversity in the boardroom. Finally, Section IV discusses the importance of ensuring that all directors are engaged participants in the boardroom. For a board to perform at its best, we believe that it must not only assemble a demographically and cognitively diverse group of directors, it must also make sure that all of its members are comfortable expressing their views during deliberations. We therefore recommend that boards work diligently to establish a culture that embraces the benefits of diversity and develop techniques to encourage the sharing and consideration of diverse perspectives.

Because many boardrooms are likely to benefit from efforts focused on improving cognitive diversity and group participation, our recommendations may be helpful to boards in the process of recruiting any director―whether demographically diverse or not. As strong advocates for improving racial, gender, and ethnic diversity on public company boards, we are addressing our recommendations to boards focused on improving demographic diversity to encourage them to recruit directors who do not just “check the box” on desired surface-level demographic characteristics but also help achieve the substantial benefits that a more cognitively diverse boardroom has to offer.

I. Why board diversity matters to us as an activist investor

Barington Capital Group, L.P. is a value-oriented activist investment firm. Since our inception in January 2000, we have made approximately 60 activist investments and members of our firm have served as directors on over 20 corporate boards. Our strategy is to invest in undervalued publicly traded companies that we believe can appreciate significantly in value if substantive improvements are made to their operations, corporate strategy, and capital allocation. We invest in a limited number of industries where we have accumulated industry knowledge and operating insight, concentrating our efforts on investing in companies with smaller market capitalizations in the consumer and industrial sectors. We develop detailed plans to improve the performance of these companies and then seek to collaborate with their boards and management teams over a multiyear period to help increase long-term value.

A. The importance of corporate governance

We have long recognized that corporate governance plays a critical role in ensuring that publicly traded companies function properly. We therefore frequently make recommendations to improve the corporate governance of companies in our investment portfolio, in addition to suggesting measures to enhance their long-term performance. As stated by John D. Sullivan and Anna Nadgrodkiewicz,

Corporate governance is at the core of a modern company’s strategy and operations because it addresses issues vital to that company’s performance and to its very survival. From board selection and strategic decision-making to day-to-day operations and legal compliance, corporate governance is a way for companies to create a framework for sound business practices, sustained growth, and risk management.

As an investor, we look to a company’s corporate governance to align management and shareholder interests, encourage management to think and act like owners, and promote a corporate culture that supports integrity, transparency, and accountability to shareholders. In short, we believe that a company’s corporate governance should encourage the CEO of a publicly traded company with a diverse shareholder base to make the same set of decisions on how to run the enterprise that the CEO would make if he or she owned all of its outstanding shares.

The companies we invest in have typically performed poorly for an extensive period preceding our involvement. On average, such companies have underperformed their peers and the market as a whole for seven years prior to the public announcement of our investment. When analyzing a company that has underperformed for such an extended time period, we seek to ascertain why it has not been able to resolve its performance issues on its own. For example, the board of such a company could have sought to improve performance by replacing members of the senior management team, adding new directors with experience in areas where the company needs assistance, or hiring consultants to help analyze and address the company’s challenges. When such initiatives have not been taken, we typically find that corporate governance weaknesses exist that have hindered the board from taking steps to redress the company’s performance issues.

B. The public company board

The foundation of a public company’s corporate governance is its board of directors. Functioning in a fiduciary capacity for the corporation and its shareholders, the board is a company’s primary supervisory body and the apex of its decision and control system. A board is tasked with the responsibility of simultaneously advising and overseeing management with the goal of facilitating long-term value creation for shareholders. A board will seek to fulfill these important obligations utilizing various tools at its disposal, including its ability to hire, compensate, and terminate the CEO, approve important decisions, and oversee and influence corporate strategy.

How effectively a board performs its obligations depends to a great extent on how it is comprised. Because a board of directors is a governing body that is designed to work together as a team, its performance will inevitably be influenced both by the individuals that comprise the team and by how they function together.

C. Board composition concerns

The most common corporate governance weaknesses we find at the underperforming companies we invest in are issues with the composition of their boards. Many of these companies have a board comprised of a homogeneous group of directors. This should not be surprising, given that demographic diversity is typically poor on public company boards, particularly the boards of small-capitalized companies where we primarily invest. In 2019, women held just 19 percent of the directorships at Russell 3000 companies (excluding those in the S&P 500), despite the fact that women constitute over 50 percent of the population in the United States and significantly exceed men in the attainment of post-secondary degrees. There are also typically few racially and ethnically diverse directors on public company boards. In 2019, minorities held only 10.4 percent of board seats at Russell 3000 companies. As with women, the percentage of racial and ethnic minorities on public company boards is significantly lower than their representation in the population as a whole. Latinos, for example, held just 2.7 percent of the directorships at companies in the Fortune 1000 as of July 31, 2019, despite constituting over 18 percent of the population of the United States.

In addition to lacking demographically diverse directors, a board with weak corporate governance may lack directors with a diversity of relevant professional backgrounds, skills, and experiences necessary to meet a company’s needs. For example, we have invested in a food manufacturer that lacked a director with food industry experience, a casual dining restaurant company that failed to have a director with a professional background in the restaurant industry, and a specialty apparel retailer that did not have a director with recent retail or merchandising experience. The absence of directors with the backgrounds, skills and experiences that are needed in a boardroom may be a concern that is not just limited to the boards of underperforming companies subject to shareholder activism. A global survey of over 2,300 directors and senior executives found that only 36 percent of the participants were satisfied that their board was comprised of directors who had the right combination of skills, backgrounds, experiences, and perspectives to probe management’s strategic assumptions and navigate the fast-paced global environment.

Finally, a board with weak corporate governance may be comprised of long-tenured directors or directors with business or personal ties with the CEO. It may also suffer from board pathologies such as groupthink or low effort norms. Each of these can negatively impact board oversight and performance by decreasing the independence of members of the board and the likelihood that they will express diverse views or challenge management proposals. Given the important role that the board plays, this can be a serious detriment to a company and its ability to remain competitive.

D. Improving cognitive diversity

We have found that improving cognitive diversity on the boards of companies with composition issues can meaningfully enhance board performance. Given our findings discussed in Section II, we view the improvement of cognitive diversity as a critical element of our plans to help companies enhance their long-term performance. We therefore frequently recommend or formally nominate candidates to serve as directors of companies in our investment portfolio, as well as work together with the boards of these companies to identify mutually acceptable directors who achieve our board composition and diversity goals.

Often, we will seek to have a member of our firm join the board of a company we invest in because we have found that an activist investor can improve cognitive diversity in the boardroom and introduce new insights and perspectives with respect to the company’s challenges. Having a representative of our firm on a board can also provide shareholders with the comfort of knowing that there will be someone in the boardroom encouraging directors to think and act like owners who holds paramount a director’s fiduciary obligations to shareholders. We frequently also seek to add demographically diverse directors who have professional backgrounds, skills, and experiences in areas needed in the boardroom. Since January 2009, 60 percent of the directors we have helped add to public company boards who were not members of our firm have been demographically diverse.

II. Lessons learned from activist investing

As discussed in greater detail below, we have found that adding new, cognitively diverse directors to a board can expand its knowledge base, improve its culture and decision-making, and help the board more effectively mentor and monitor management. Overall, this can significantly enhance its ability to perform its obligations. We have also found that improving cognitive diversity can serve as a catalyst for positive change at a company by increasing the likelihood that a board will take steps to address the company’s challenges.

Our insights were derived from our experiences investing in eight underperforming companies where an employee of Barington or one or more other individuals we nominated or approved was added to the board. We were able to interview on a confidential basis 18 directors who served on the board of one of these companies both before and after changes were made to its composition. The directors we interviewed had a unique vantage point to assess whether the new directors helped improve cognitive diversity in the boardroom and the effects that any increase in cognitive diversity had on board performance.

Following are some of the valuable insights we gained:

Demographic diversity and cognitive diversity do not necessarily go hand in hand

Our director interviews revealed that there is not necessarily a correlation between demographic diversity and cognitive diversity. While in some instances new, demographically diverse directors were cognitively diverse from other directors on a board, in other instances such directors added little cognitive diversity to a boardroom. We also found that directors who do not differ demographically from other directors―including members of our firm who had similar demographic characteristics to incumbent board members―can improve cognitive diversity on a board. For example, our firm’s CEO, who served as a director on the board of seven of the eight companies that were the subject of our study, was judged by the directors we interviewed to have increased cognitive diversity on the boards of most, but not all, of these companies. Whether a new director meaningfully improves cognitive diversity on a board appears to be primarily based on the person’s cognitive differences from incumbent board members, including differences in knowledge, skills, experiences, perspectives, and approaches to problem solving. Given that a person who improves cognitive diversity in one boardroom may not in another, boards interested in improving cognitive diversity must look deeper than surface-level differences between director candidates and incumbent directors to determine whether a candidate will improve cognitive differences in their boardroom.

Expanding the knowledge base of a board

A number of academics have reasoned that improving demographic diversity on a board will expand its knowledge base as a result of new information assumed to be contributed by gender, racially, or ethnically diverse directors. According to the individuals we interviewed, however, the informational contributions that new directors were able to make were more correlated to their professional backgrounds and contacts than to their demographic characteristics.

Board members who brought new professional backgrounds, skills, and contacts that enabled them to share valuable insights in the boardroom and introduce helpful resources to the company were found by directors we interviewed to be the most effective at expanding the knowledge base of a board. For example, we were told that new board members with relevant industry and operating experience, particularly in instances where such experience was lacking in the boardroom, provided significant value to a board by expanding its understanding of a company and the strategic and operating issues it will likely confront. Similarly, new directors with backgrounds in areas pertinent to a company’s business or strategic plans―such as marketing, information technology, mergers and acquisitions, or corporate finance―brought in-depth knowledge of these important subjects. It was noted that directors with relevant business backgrounds also benefited boards by providing them with information and insight regarding a company other than through its management team. This was found to be extremely helpful, particularly in instances where directors felt that the CEO overly controlled the dissemination of information to the board. Finally, we were given examples of instances where new directors with strong professional networks were able to introduce beneficial resources to a company, such as potential strategic partners, financing sources, and professional advisors.

Despite receiving this feedback, we do not believe that boards should focus their attention solely on recruiting directors with strong professional backgrounds and contacts given the significant benefits that can accrue from having a demographically diverse boardroom. Among other things, a demographically diverse board is more likely to represent the composition of a company’s employees, customers, and suppliers and can therefore provide a board with a better understanding of the company’s key constituencies. This can help a board better anticipate and be responsive to the concerns of these parties. For example, a demographically diverse board may help a company identify and respond to market shifts and changes in consumer expectations more effectively than a homogenous board. A more demographically diverse board may also help a company be more attuned to, and avoid, sexual harassment and other potential workplace liabilities. It is likely, however, that demographically diverse directors with strong professional backgrounds are better able to incorporate their insights in these areas into the context of a company’s business, thereby increasing the informational contributions these directors are able to make. It is for this reason that we recommended in 2019 that L Brands―which sold its products primarily to women and was subject to criticism that the marketing of its Victoria’s Secret business was no longer aligned with women’s evolving views of beauty, diversity, and inclusion―add more female directors to its board with experience in areas that would be beneficial in the boardroom including merchandising and marketing. Cognitive diversity and demographic diversity can frequently complement one another.

Independence matters

Many of the companies we invest in suffer from a similar problem: while their boards have determined that their outside directors are “independent” under the regulatory definition of the term as established by the Securities and Exchange Commission and applicable stock exchange listing standards, some of these directors are far from being independent based on a commonsense definition of the term. Such directors may be long-tenured, have ties to the same community, or have long-standing personal or business relationships with the CEO, each of which can potentially weaken their ability to oversee management effectively. Among other things, a board comprised of such directors may hesitate to take steps such as replacing the CEO or modifying his or her compensation arrangements to better align pay with performance in instances where the CEO has performed poorly for an extensive period of time.

We have found that new directors added to a board as a result of shareholder activism are generally more independent than the board’s incumbent directors. This may be due to the fact that such directors typically are not identified using board member networks and other traditional recruitment practices. As a result, such directors tend to be from different geographical regions than other members of the board and lack personal or professional ties to incumbent directors and members of the company’s senior management team. It has been our experience that directors who lack these ties are more likely to ask tough questions and challenge the proposals of management or their fellow directors during board deliberations than incumbent directors who are long-tenured or have a relationship with the CEO or other board members. Several of the directors we interviewed shared similar observations, with one commenting that he found that a newly appointed director was able to be more effective in the boardroom than many of the incumbent directors because he was not “burdened” by having a prior relationship with the CEO. As one director we interviewed noted, “Directors tend not to be that blunt when they have to live with the CEO and see him on Sunday at church.” Another director similarly stated, “It is hard to vote against the CEO if you are going to see him that weekend at the country club.”

Engagement levels vary among directors

We have observed that engagement levels can vary significantly among directors, particularly on the board of an underperforming company. According to our director interviews, directors who were added to a board in connection with our activist engagements tended to be highly engaged directors who were active participants in the boardroom. There were, however, several notable exceptions. One was a director whose professional background was less relevant to the business of the company than other members of the board. As a result, we were told that he was not a meaningful contributor in the boardroom, even though he helped improve the racial diversity of the board. Another exception was a female director who, despite having strong professional credentials and relevant CEO-level experience, chose to function primarily as a “spectator in the boardroom.” A third was a white male director who had a strong professional background relevant to the business of the company but rarely participated in board discussions. We were told that, when asked for his opinion, he typically had valuable insights to share. In the absence of being asked, however, he was unlikely to express his views. As a result, his fellow directors often failed to benefit from his knowledge and insights in instances where it could have been helpful.

Based upon our interviews, it appears that a variety of factors can influence the degree to which a director participates in boardroom deliberations. Among other things, a director’s personality, professional background, and board experience, as well as the culture of a boardroom, the composition of the board, and the leadership style of the board chair, may all play a part.

Culture is key

In our opinion, not enough attention is paid to the culture of public company boards. Whether directors and investors focus on it or not, every board has a culture―a set of shared values, beliefs, and norms that shape the behavior of the board. We have found that a board’s culture can have a material impact on the effectiveness of the board by influencing how directors and management interact and how decisions get made in the boardroom.

Several of the companies that were the subject of our study were described by the directors we interviewed as having a poor board culture. One board was described as a “do-nothing board,” where only a few directors were engaged and the rest did little more than “show up and collect a check.” A second board was described as being so focused on maintaining collegiality that directors were hesitant to challenge the CEO. A third was described as being comprised of directors who lacked the will and, in the case of some of the directors, the background and experience, to question the recommendations of the company’s underperforming CEO. In each case, the directors we interviewed felt that the board they served on too often “rubber-stamped” management proposals, or approved them following only cursory questioning, prior to the time that the composition of the board became more cognitively diverse.

In our experience, the absence of significant debate regarding a management proposal in such an environment does not necessarily mean that board members agree that management is pursuing the best course of action. It is equally possible that the board suffers from a group pathology such as groupthink or low effort norms, or there is apathy or disengagement in the boardroom, each of which can hinder board performance.

Groupthink has the potential to significantly impede effective decision-making and board oversight. According to Irving Janis, the social psychologist who coined the term, “The symptoms of groupthink arise when the members of decision-making groups become motivated to avoid being too harsh in their judgment of their leaders’ or their colleagues’ ideas. They adopt a soft line of criticism, even in their own thinking.” Groupthink may therefore influence directors faced with a decision to “go with the flow” instead of questioning the consensus view of the board when they have reservations or to prioritize avoiding confrontation in the boardroom over ensuring that the best possible decisions are made. Furthermore, according to Janis, a common norm of groupthink is sticking with policies to which the group has already committed itself, even when those policies are working out poorly and individual members of the group have misgivings. Groupthink may therefore hinder a board from questioning a company’s corporate strategy despite a prolonged period of underperformance or from exploring new measures to improve long-term value.

Low effort norms are also a potential concern for a board, particularly the board of an underperforming company. Effort norms refer to a group’s shared beliefs regarding the level of effort each member is expected to expend or contribute toward various group responsibilities. Behavioral norms can have a strong influence on director behavior and the performance of a board as a whole. As would be expected, variations in the amount of time directors spend preparing for board meetings and the amount of effort they expend in boardroom deliberations and following up on important matters can influence how effectively a board performs its obligations. Low effort norms may arise in instances where a company has a domineering CEO, where a significant number of directors lack confidence in their ability to make a meaningful contribution in board deliberations, or where apathy or director disengagement is pervasive in a boardroom. As one director we interviewed said despairingly, “What is the point in preparing for a meeting [on a board like his], if no substantive decisions are going to be made and the board has little power or influence over management?”

We have found that, over time, the addition of highly engaged, cognitively diverse directors to the board of an underperforming company can improve its culture and help overcome group pathologies and director disengagement to the extent that either may be present. By asking questions of management and debating alternatives in a constructive manner during the decision-making process, new directors can demonstrate to a board’s incumbent directors how critical analysis can facilitate effective decision-making. As one director shared with us,

The new directors [on our board] brought not just a diversity of opinions and perspectives, but a diversity of behavior―a willingness to openly challenge management and other directors, which was missing from the boardroom. By having more open debate, it created an environment where others saw it was good and healthy to have frank discussions regarding important decisions. When members of the board began challenging each other―and listening to each other’s viewpoints―it led to positive outcomes. Good healthy disagreement led to good decision-making.

The presence of new, cognitively diverse directors in a boardroom may also make incumbent directors more comfortable asking questions and sharing their views. On numerous occasions members of our firm observed an incumbent director state, following a question they asked, “I have always wondered about that too,” and then begin asking follow-up questions. It seems ironic that adding “outsiders” to a board can have the effect of making members of a homogeneous group of directors feel more comfortable participating in board deliberations. It is possible, however, that some boards may not be as homogeneous as they seem. In our experience, the boards of underperforming companies often include a meaningful number of directors who are discontent with the state of affairs but are unwilling, or believe they are unable, to challenge the status quo. We have observed that adding cognitively diverse outsiders―particularly highly engaged outsiders―to such boards can provide these directors with the comfort to express their views in a group setting. This, in turn, can help cultivate a boardroom environment that facilitates group participation. Such an environment can have an empowering effect on directors, making them feel more comfortable asking questions, sharing their insights and experiences, suggesting alternatives, and expressing dissent.

Finally, several directors we interviewed described how the addition of new, highly engaged directors introduced “energy and optimism” into the boardroom, which helped “bring out the best” of the board’s incumbent directors and led to them “upping their game.” As one director we interviewed stated, “As the board became more engaged, directors started feeling better about themselves. Directors began taking pride in the company. We believed we were part of a team doing the right things.”

In some instances, we have found that adding just one new person to a board can materially improve its culture, particularly if that person is an experienced director who has the confidence and skill to effectively challenge the consensus view in the boardroom and be an influential participant in board deliberations. As a general matter, however, we believe that it is unreasonable to expect that one person can change the culture of a group, particularly a group that has worked together for many years. In most instances, a more significant increase in diversity is necessary to make sure all directors are comfortable expressing their views. Studies have found that diverse individuals are more likely to offer their perspectives, and their perspectives are more likely to be thoughtfully considered by other group members, when there is a meaningful number of like individuals in a group. For example, one study found that a critical mass of at least three female directors is needed to change the dynamics on a board so that women are no longer viewed as outsiders and are able to have a substantive influence on board deliberations.

Improved decision-making

It is our experience that increasing cognitive diversity on the board of an underperforming company can meaningfully improve the quality of decision-making in the boardroom by introducing new information and perspectives and by fostering an environment that encourages discussion, debate, and the exchange of information among directors. In such an environment, we have found that decisions tend to be weighed more carefully, more alternatives are considered, and potential risks are more likely to be discussed.

A majority of the directors we interviewed noted that an increase in cognitive diversity led to more open and informative dialogue, with the benefit that the quality of board decision-making was improved and there was less “perfunctory” approval of management proposals. Directors informed us that they observed “healthier debate,” “more robust discussions,” and more “focused” decision-making. We were also told that the boards they served on were more likely to request additional information and performance metrics from management and to drill down on important matters discussed in the boardroom once they became more cognitively diverse. As one director put it, “Before [changes were made to the composition of the board], the decision-making process consisted of directors simply stating their opinions: ‘I think we should do this, I think we should do that.’ Now the decision-making process is much more sophisticated and fact-based.” Several directors we interviewed told us that these changes enhanced the “professionalism” of the decision-making process and resulted in board meetings being more productive.

When asked if an improvement in cognitive diversity led to an increase in the amount of time devoted to the decision-making process, the directors we interviewed were almost evenly split. A majority of the directors felt that the length of board meetings and the amount of time devoted to the decision-making process increased after the composition of their board became more cognitively diverse. One potential explanation for this outcome is that an increase in cognitive diversity generated “cognitive conflict” in the boardroom, causing directors with different and potentially conflicting information, opinions, and perspectives to debate alternatives rigorously in an attempt to reconcile differences and reach consensus. The feedback we received from our interviews, however, suggests that the increase in the amount of time to make decisions was primarily the result of the board becoming more independent from management and directors desiring to fulfill their responsibilities to the best of their abilities. The directors we interviewed primarily cited requests for additional information from management and the exploration of additional options during the decision-making process as reasons for the expenditure of additional time.

Interestingly, almost an equal number of the directors we interviewed felt that board decisions took less time after the board became more cognitively diverse. They noted that their boards became more efficient and effective and that board meetings became more focused and goal oriented after cognitive diversity improved. One director told us that before changes were made to the composition of the board, board meetings would “go on and on,” sometimes without any decisions being made. After the board became more cognitively diverse, he felt the board “became more disciplined” and that meetings became “crisper,” with “a healthier back-and-forth with management” and “more fact-based decision-making.” This led to higher quality conversations and a better utilization of time. We were also told that once management understood that there would be more questioning by the board, they prepared more thoroughly for board meetings and provided directors with more information at the outset, both of which also helped improve meeting efficiency.

Enhanced mentoring and oversight of management

It has been our experience that improving cognitive diversity on the board of an underperforming company can greatly enhance its ability to mentor and oversee management. We have found that adding directors with different backgrounds, skills, and perspectives helps a board provide management with advice and guidance from a wider variety of perspectives and with respect to more aspects of a company’s business. We have also found that improving cognitive diversity can enhance a board’s ability to perform its oversight functions by increasing the likelihood that management is supervised by knowledgeable and engaged directors who lack a prior relationship with the CEO.

Several of the directors interviewed discussed how both these outcomes were attributable, in part, to the fact that changes in board composition added directors to the boardroom with strong business backgrounds in areas needed in the boardroom. One director informed us that the board he served on became better at mentoring and monitoring management after new directors were added because the board now “had the tools” to fulfill these obligations. In his opinion, some of the directors on the board were afraid to ask questions at meetings because they lacked the professional background and experience to oversee management effectively. Another director similarly shared with us that several of the directors on the board he served on lacked the background and experience to oversee and advise management properly. “The directors were ethical and cared, but they were not equipped to help.”

In addition to enhancing the knowledge base of a board, improving cognitive diversity often added independent directors who were not afraid to voice their opinions and question management proposals. Working together, these changes frequently led to the CEOs of the companies that were the subjects of our study confronting more knowledgeable, engaged and independent boards.

Two companies that were part of our study provided almost identical examples of how an increase in cognitive diversity in the boardroom led to an improvement in board oversight of management. We were told that the CEOs of each of these companies would routinely withhold requested information from directors, promising to provide such information in the future and then never doing so. After cognitive diversity on these boards improved, the directors of both companies found the fortitude to limit this practice before each board ultimately decided to replace its CEO.

Catalyst for change

Finally, we have found that improving cognitive diversity in the boardroom increases the likelihood that a board will take steps to address a company’s challenges. In our experience, as cognitive diversity increases and a board becomes more engaged and professional in its practices, it becomes less likely that important concerns will be ignored by directors or receive scant attention. A director we interviewed gave a simple example to illustrate this:

After the CEO of an underperforming company gave the board an update on the company’s performance that indicated that one of its businesses would again be performing more poorly than projected, the incumbent directors remained silent, being accustomed to receiving such news. A newer, cognitively diverse member of the board broke the silence and asked “OK, so what do we have to do to improve revenues? What are your plans to address this?”

“It was an obvious question,” the director told us, “but one that members of the board likely would not have asked in the past.”

We have found that adding new, cognitively diverse directors to a board increases the likelihood that it will take a fresh look at important issues, and now with the input of individuals with no emotional attachment to past decisions or ties to the people who made them. We have also found that new, cognitively diverse directors can serve as a catalyst for a board to implement changes and make difficult decisions that are long overdue. Many of the directors we interviewed described how new directors added as a result of shareholder activism “helped push the board past status quo thinkers” and take steps that many on the board knew were necessary, such as replacing an underperforming CEO or selling a noncore business. Some of these directors shared with us that the boards they served on had considered making these changes in the past, but that it probably would have taken the incumbent directors several years to accomplish what these boards did in a much shorter period of time after their composition became more cognitively diverse.

Why did these directors believe that potentially beneficial measures that a board was already aware of would not have been implemented in a timely fashion if the composition of the board had not changed? Several directors informed us that there was a sense of “comfort” with the status quo in the boardroom and a lack of urgency among directors to address the company’s challenges, even though the company had been performing poorly for a substantial period of time. As one director stated, “Our board was comprised of good, ethical people; they just were not proactive in creating value.” Other directors we interviewed pointed to the culture of their board, which sought to avoid conflict with the CEO. For example, one director told us that while all of the members of the board he served on felt that the CEO should be replaced, the board lacked the will to have a confrontation with the CEO over its decision. As a result, board members decided to put off making a CEO change for a few years, convincing themselves that things were not so bad. Several directors we spoke with expressed regret that it took the addition of new directors to spur the boards they served on to take steps they knew were necessary. “Deep down, I’m disappointed in myself,” one director said. “I should have done it; I should have been the one who started making some of these changes.”

We are sharing insights learned during our activist engagements not to advocate that companies add activist investors to their boards, but because they illustrate the potential benefits that can be achieved when cognitive diversity is improved in a boardroom. Corporate boards function by design in a collective manner. As a result, it should be expected that changes in board composition―particularly those that cause a board to think about and approach challenges differently―have the potential to influence boardroom dynamics, board decision-making, and company direction.

Given our findings summarized above, we strongly recommend that public companies seek to establish a cognitively diverse boardroom comprised of directors who have been selected for their ability to bring a broad range of diversity to the boardroom. This includes diversity in their gender, race, and ethnicity, as well as diversity in their professional backgrounds, skills, and perspectives. It is our belief that recruiting demographically diverse directors who help improve diversity on several additional levels maximizes the likelihood of achieving a high-performing board. Frankly, for boards interested in avoiding shareholder activism, recruiting such directors may be one of the most effective steps they can take.

III. The importance of the director recruitment and onboarding process

Several commentators have noted that while gender, race, and ethnicity are commonly viewed as proxies for differences in viewpoints and perspectives, improving demographic diversity on a board may fail to enhance cognitive diversity in the boardroom. This could occur in instances where directors added to a board to improve demographic diversity have backgrounds similar to those of incumbent directors, or if they were selected primarily because they fit in well with others on the board and will not be divisive. It could also occur if directors with unique viewpoints and perspectives engage in self-censorship in the boardroom, whether out of a desire to be accepted or a fear of being marginalized.

In our view, the fact that increasing gender, racial, and ethnic diversity on a board may not always enhance cognitive diversity is not an argument against improving demographic diversity on corporate boards but is instead an argument for the need for careful director recruiting and onboarding. Given the unique characteristics of each boardroom and the difficulty in identifying individuals who are cognitively different from others, it would be unreasonable to expect that adding any demographically diverse director to a board would be sufficient to improve cognitive diversity, particularly if the individual was selected primarily based upon surface-level diversity characteristics. We therefore recommend that boards incorporate the following suggestions into their plans to recruit and onboard demographically diverse directors to ensure that the directors selected also help improve cognitive diversity and board performance:

First and foremost, we believe that demographically diverse director candidates should be selected who have strong business backgrounds. More than half of the directors we interviewed raised this point unprompted. As one director we interviewed stated, “A director must have the business background and experience to ask intelligent questions and hold management accountable. Then if the director adds diversity of race, gender, or age to the board it is a plus. Without such experience, it is less likely that a new director will add significant value.”

Second, we recommend that new directors be selected who have professional backgrounds, skills, and experiences in areas that are needed on a board. The addition of individuals who have different professional training and experiences from other directors will inevitably help improve cognitive diversity in the boardroom. It should also improve the ability of the board as a whole to meet the company’s strategic and operating needs and to provide the management team with guidance on the wide variety of issues that the company will inevitably face.

To identify which backgrounds, skills, and experiences are needed on a board requires an in-depth understanding of a company’s current and anticipated strategic and operating needs. It also requires an ongoing assessment of the board’s strengths and weaknesses to determine whether its current members are meeting the company’s requirements as they evolve over time. To assist a board in assessing its needs, we recommend that it create a matrix identifying the backgrounds, skills, and experiences that are believed to be needed in the boardroom and the extent to which such needs are being met by the current members of the board. For internal purposes, we recommend that a board assess the ability of its members to meet each identified need on a scale of zero to five. This should provide the board with a more accurate assessment of its strengths and weaknesses than the more commonly used “check mark” approach, which tends to imply that each identified need that receives a check mark is adequately met by the current composition of the board.

Boards can magnify the contributions that new, demographically diverse directors make by having them replace their least productive members. To determine which members of a board are no longer making a meaningful contribution in the boardroom, we recommend that boards conduct an annual assessment of the performance of each of their directors. Many of the directors we interviewed stated that at least one of their fellow board members lacked the professional background and experience to oversee and mentor management effectively. We also received reports of directors who were hesitant to ask questions or participate in discussions because they were afraid of embarrassing themselves. These findings comport with the results of a director survey conducted by PwC in 2019, where 49 percent of the respondents stated that they believed that at least one director on their board should be replaced. Currently, however, less than 15 percent of the companies in the Russell 3000 report conducting annual director-level evaluations, despite the fact that it can help directors and boards improve their performance. Boards may find it beneficial to utilize an outside consultant to assist with the assessment process. Having a consultant manage the process can minimize the likelihood that it will be viewed as biased by any of the participants, and directors may be more comfortable receiving constructive feedback from a third party than from a board colleague.

Third, we recommend that nominating committees seek to identify candidates who not only improve demographic diversity in the boardroom but who can also introduce new views and perspectives and different approaches to problem solving. This is not necessarily an easy undertaking, given that cognitive differences cannot be identified as easily as demographic differences. Thus, a careful review of a candidate’s background and life experiences, as well as in-depth discussions with the candidate and the candidate’s references, are inevitably required. We suggest that multiple directors participate in the interview process and that questions be asked to elicit whether the candidate readily proffers unique perspectives and new approaches to resolving problems.

To help a nominating committee identify demographically diverse director candidates who are cognitively diverse from others on the board, we recommend that it seek new talent pools, and venture beyond using board member networks and recruitment practices that were utilized to find the board’s incumbent directors. Such an approach should also help ensure that candidates lack social and business ties to members of the board and the senior management team.

Finally, to facilitate the likelihood that new directors express their perspectives during boardroom deliberations, we recommend that boards emphasize the importance of participation during the onboarding process. Among other things, we suggest that new directors be told that the board not only welcomes directors sharing their thoughts and perspectives when they differ from others in the boardroom, it is counting on them to do so. In our opinion, the view that new directors should primarily be observers on a board while they learn the “lay of the land” is outdated. We also recommend that directors be encouraged to ask questions regarding matters they do not understand or that do not seem clear to them. Often others in the boardroom will benefit from the inquiry.

While it is labor intensive, diligent director recruiting and onboarding can help ensure that demographically diverse directors selected by a board also improve cognitive diversity and board performance. In the end, the goal of a board should not just be to recruit directors who look different, but to recruit directors who bring different insights, views, and perspectives and help improve the effectiveness of the board. If a board approaches addressing diversity concerns solely as a “check the box” exercise, we believe it is doing a disservice not just to itself but also to the company and its shareholders.

Embracing the benefits of diversity

The work of a board is not over once it has assembled a demographically and cognitively diverse group of directors. To make sure that a board benefits from diversity in the boardroom, it must be committed to drawing out and considering alternative views and recommendations, since directors with exceptional professional credentials and unique perspectives are of little benefit if the culture in the boardroom does not embrace diverse insights and ensure that they are incorporated into the decision-making process. As one experienced female director we interviewed stated, “You cannot underestimate the importance of a board’s culture. You can have all the diversity in the world, but it won’t matter if you don’t have the right culture.”

Strong board leadership can help a board get the most out of its members by fostering a board culture that embraces the benefits of diversity. One of the most effective ways board leaders can do this is by demonstrating a commitment to critically evaluating important decisions and considering a wide variety of perspectives to ensure that the board selects the best course of action rather than adopting the first seemingly satisfactory option identified.

There are a variety of techniques a board can use to ensure that diverse perspectives are shared and considered during the decision-making process. Some boards may find it beneficial to encourage directors to play “devil’s advocate” and challenge a proposed solution before a decision is made. Others may find a “whiteboard” approach to decision-making helpful, whereby potential alternatives are numbered and listed on a whiteboard. Such an approach encourages directors to brainstorm and spitball alternative solutions to problems. It can also help depersonalize alternatives by separating recommendations from the individuals who suggested them. Board and committee chairs can facilitate the process by soliciting the views of quieter board members during deliberations and expressing appreciation when diverse perspectives are shared. Boards should experiment with these and other techniques to determine which ones work best for its members. Ultimately, what is most important is obtaining buy-in from board members as to the importance of considering diverse perspectives during the decision-making process, not the techniques selected to achieve this end. If all directors see the value in this, boards will inevitably facilitate the exchange and consideration of diverse viewpoints just by making an effort to do so, enhancing critical analysis, constructive debate, and collaboration in the boardroom.

While we advocate that boardrooms embrace the benefits of challenging proposals, considering diverse perspectives, and exploring alternative courses of action, care must be taken to ensure that deliberations, even if at times heated, are at their core a group effort working toward a common goal of identifying the best course of action for the company. If board deliberations devolve into a sporting contest―with winners and losers, or players who dominate discussions and others relegated to the sidelines―there is a risk of alienating board members with diverse views and silencing their voices. A recent survey of 700 directors revealed that 43 percent of the respondents found it difficult to voice a dissenting view in their boardroom. These findings indicate that many boards may not be doing all they can to ensure that decisions are well made and that all voices are heard. We therefore recommend that boards embrace the benefits of diversity and seek to foster a culture that encourages and appreciates new perspectives, recognizing that doing so can lead to better board performance.

Conclusion

It makes intuitive sense that improving diversity can enhance board performance, particularly in instances where a board has overseen a company that has underperformed for many years. Studies have shown that diverse personal experiences, such as living or working abroad, are associated with greater creativity, that diverse cities are more productive and prosperous, and that diverse teams are more innovative and process facts more thoroughly and accurately than homogeneous ones. Given this, it should not be surprising that improving diversity has the potential to benefit the performance of almost any group―whether it be a team of scientists or a public company’s board of directors. We therefore strongly encourage companies to improve gender, racial, and ethnic diversity on their corporate boards. We recommend, however, that companies do so in a way that maximizes the diversity new directors bring to the boardroom. Instead of focusing primarily on surface-level diversity characteristics, we encourage boards to select demographically diverse candidates that also improve cognitive differences in the boardroom, by identifying candidates who have unique views and perspectives as well as professional backgrounds, skills, and experiences in areas that are needed to meet the company’s strategic and operating needs. Finally, to make sure that boards are able to take full advantage of the contributions their directors can make, we recommend that they work diligently to ensure that diverse perspectives are welcomed in the boardroom, drawn out during deliberations, and incorporated into the decision-making process.

If a board is truly committed to fulfilling its role and responsibilities effectively, it is our belief that improving diversity in the boardroom―both demographically and cognitively―must be made a priority. In today’s dynamic and competitive global business environment, ensuring that boards are performing to the best of their abilities and are able to help companies innovate and respond to challenges and disruption is more important than ever. The competitiveness of our companies and the long-term success of our economy depend on it.

The complete publication, including footnotes, is available here.

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