The Shifting Tide of Board Expertise?

What types of skill sets do directors need for corporate boards to be effective? Over the past couple of years, this question has jumped onto the top of the list of important issues in corporate governance. 

There has always been a consensus that corporate boards matter. But there has never been a consensus about what makes boards effective. Corporate legal scholars have traditionally approached the board effectiveness question by focusing mostly on directors' incentives. That is, we counted how many directors are independent, or in how many companies the roles of Chair and CEO are separated. By now, however, the board independence debate is largely over. Independence won. In the S&P 500, for example, almost all companies have boards that consist mostly of people coming from outside the company. Further, even fully independent and motivated directors will need some experience and skills to ask the right questions, process the answers, and anticipate future developments. Unsurprisingly, then, investors, regulators and courts around the world are increasingly focusing on board expertise. 

Once we turn our attention to board expertise, we notice indications of an important shift. Until recently, corporate boards consisted almost entirely of “generalists”: former CEOs in their 60s and 70s with general experience in running businesses on a large scale. Today, the emphasis is shifting to adding directors with specific expertise in environmental, social and governance (ESG) issues. More and more companies now feature a “cyber” director, a “diversity” director, a “climate” director, and so on.

In a new article, titled “Specialist Directors,” Yaron Nili and I hand collected data from companies’ disclosures on directors’ skill sets over the past six years, and interviewed board nomination committee members and their search consultants, to try to gauge the magnitude of the shift in board expertise, and evaluate how it is likely to affect corporate behavior going forward.

The first finding to jump out of our dataset is that companies have started putting heavier emphasis on board expertise disclosure, as evident by the adoption of image-based “skills matrices.” Skill matrices are basically a table where the rows are the types of expertise, and the columns are the individual directors. Back in 2016, only a small minority of companies adopted such image-based disclosure; nowadays, an overwhelming majority of them do. Companies have also started regularly tracking new types of expertise, as evident by the addition of new rows to skills matrices. To illustrate, over the 2016–2022 period, 215 of the S&P 500 companies started tracking “technology” expertise, and 143 started tracking more specifically “cybersecurity.” 

Aside from documenting a shift in how companies report board expertise, our dataset also reveals a shift in the types of expertise that companies have on their boards. For example, back in 2016 the number of directors designated as “cyber experts” increased from 25 in 2016 to 200 in 2019 to 723 in 2022. 

But it was precisely the magnitude of the jump in the new types of board expertise that gave us pause. Knowing just how glacial board turnover can be, we wondered where all these specialist directors came from suddenly? To find out, we started examining director by director, and learned that there are at least three different factors contributing to the increase in domain-specific expertise. Some of the change is due to shifts in disclosure. The same director with the same expertise was not designated as a “cyber” or “ESG” expert back in 2016; but is now. Another part of the change is due to training existing directors. Say that the company sent its directors to a cyber boot camp over one weekend in 2021, and now all of them check the “cyber” box in the skill matrix. Finally and most obviously, some of the jump is due to companies adding new directors with domain-specific expertise, including by reaching to different “pools” of candidates than they normally would.

Each one of these channels corresponds to different promises and perils. The “shifts-in-disclosure” channel illustrates a broader problem with the quality of board expertise disclosure. As things currently stand, there is no benchmark or definition of what counts as being a “cyber expert” or a “climate expert” or a “DEI expert.” The lack of standardization too often turns expertise disclosure into “cheap talk.” Indeed, we provide several examples of directors who serve on multiple boards and are listed as ESG experts in one company but not in another. 

The ”rookie-directors” (additions of new “specialist directors”) channel raises questions about the desirability of targeting individuals for a specific, narrow skill set. When the demand for, say, “cyber directors” suddenly increases (perhaps because of regulatory disclosure requirements), the supply of quality candidates does not automatically rise to meet the demand. As a result, some companies are bound to compromise their director selection and onboarding processes. For example, companies may bring an individual with a particular skill set who lacks general understanding of the business or lacks the necessary bandwidth to be a good director. 

To revisit our opening question, the point is that board expertise is highly company specific. Changes to it should generally come in a firm-by-firm, organic manner. Cyber directors can add value to some companies but not to others. Climate directors can add value in some industries but not in others. Even within the same company, the issues that are on the board agenda may vary widely over time. Yet too often regulators and judges are treating board expertise as an unalloyed good (“what bad can come from adding more types of expertise?”). Our article ends with several concrete policy implications that recognize the problem with one-size-fits-all type legal interventions. 

As the discussions in the recent GCGC (Columbia, June 2024) illustrated, the shift in board expertise is hardly a U.S.-only phenomenon, as markets in Europa and Asia grapple with the same trends (which are usually driven by larger trends like the rise in compliance and ESG pressures). Our article represents a first modest step toward injecting much-needed evidence and theory into this discussion.

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By Roy Shapira (Reichman (IDC))

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