Boards play a critical role in the oversight of risk: helping management identify, assess, mitigate and manage risks. A diverse board of directors is essential for boards to fulfill this role effectively.
In terms of risk, there are three main ways boards impact a company’s risk profile. Independent directors use their outside perspective to flag unusual risks; they use their oversight role to sniff out hidden operational risks; and they offer a second opinion on the seriousness of risks.
The board works with management to mitigate risk, to anticipate and avert crises. When a crisis happens, which it inevitably will, the board steps up to help manage the crisis effectively, minimizing any loss of shareholder value.
Diverse perspectives enhance risk oversight.
To perform this role well, boards need directors with many different perspectives sitting around the table. A diverse group brings more experiences to bear – each member is attuned to certain risks; each assesses risks differently. Each has credibility on certain topics, and brings a unique ability to communicate concerns, making it easier for management to truly hear.
It’s hard to find unusual risks when you’re caught up in the day-to-day urgency of running a company, and it’s always difficult to treat low probability risks with sufficient respect. Diversity around the table increases the probability that someone will shine a light on a blind spot.
Healthy board culture is essential.
Just having the right mix around the table is not enough: a healthy board culture is also a prerequisite. If perspectives are raised but not heard, or if they’re shut down as immaterial or silly, the benefit of diverse perspectives is lost. Directors must respect each other’s insights and follow up on each other’s lines of inquiry.
If you’re a student of lean principles, you know that the root cause (or the full story!) doesn’t emerge until after you’ve asked why five times (“the 5 whys”). In a board setting, airtime is limited, and it is rare to get four follow-up questions. It’s far easier to get the full story when multiple questioners pile on.
One of the benefits of diversity I’ve experienced arose from the willingness of fellow female directors to follow up on each other’s questions. The norm set by these women became a cultural norm for the whole board. All directors regularly ask follow up questions, and the board’s ability to oversee risk is stronger.
Observable proxies for diverse perspectives.
Stakeholders want to ensure their boards are effective. Yet neither the health of the board culture, nor the diversity of perspective, is easily observable from outside the boardroom. Stakeholders instead look at factors that, in fact, are proxies for different perspectives. Here’s my personal list of observable proxies that illuminate board effectiveness: personal attributes, functional backgrounds, prior roles and length of service.
Personal ‘inherent’ attributes – gender, race, ethnicity, age – are sometimes easier to observe (but not always!). Diversity in these areas makes a breadth of perspective more likely, but does not insure it. In my opinion, inherent diversity is a necessary but not sufficient prerequisite for full diversity of perspective.
Diversity of functional background is equally important. Businesses are built on functional diversity – imagine a company with manufacturing, but not sales. Or finance, but not HR. Anyone who has been a general manager recognizes that the worldview of each function is unique and is necessary. Functional voices on a board can dig deep into concerns and speak with credibility to ensure fellow directors and management listen.
Diversity of role is also critical. Historically a board full of working CEOs was held up as the best possible board. It’s like the principle behind jury selection: for a CEO, an all-CEO board is a true jury of their peers. CEOs have sat in the chair; they bring a holistic strategic lens and the direct experience (both wisdom and scars) from dealing with key stakeholders: Wall Street, shareholders and regulators.
But there are drawbacks to the all-CEO board: Do they have time to devote to the board? Is functional expertise crowded out? Are they too deferential to the CEO? CEO directors can fall into a trap of treating the CEO as they wish to be treated. Functional leaders from the C-Suite, such as CIOs or CFOs, succeeded in their careers by advocating for issues and challenging their CEOs. They often bring this constructive challenge to board discussions.
Finally, diversity in length of service is important. Long-serving directors bring historical context and can recognize recurring issues. At the same time, groups that work together for years slip into patterns of behavior, and — not unlike a long-married couple – they may accept things that a newer director would challenge.
Risk oversight is enhanced by a healthy board culture and diverse perspectives in the boardroom. Examine these factors and consider whether a perspective is missing from your board. The exercise may help you avoid vulnerabilities that arise from blind spots.