Impact of Diverse Independent Boards and Senior Management Teams
Introduction
Independent boards are often established by firms and management teams seeking additional guidance on formulating and executing strategic initiatives. Including members of diverse backgrounds, experiences and perspectives on independent boards and management teams can add immeasurable value. Recently, a considerable volume of research has begun quantifying the value created by diversity. While firms increasingly recognize this value, questions often remain on how to successfully expand diversity within an organization. In our latest blog, Alliance provides insight into Board best practices, including guidance on increasing independent Board and senior management diversity.
Types of Independent Boards and Best Practices
Limited Partner Advisory Committee (LPAC)
An LPAC is established by a General Partner (GP) to represent the broader Limited Partner (LP) base of an investment vehicle. LPACs are generally comprised of 3 to 12 voting LP members. The committee provides oversight of the GP and acts as a decision-making body on conflicts of interest such as a GP-led secondary transaction or modifications of the partnership agreement such as a waiver of investment restrictions.
When establishing an LPAC, a GP should ensure the composition of members selected provides an accurate representation of the broader LP base. GPs should structure the LPAC to include representatives from different geographies, investment program types and sizes. Traditionally, LPAC seats are dominated by large institutions, overlooking the LPs that may be large in number but smaller in capital committed. Adding a small number of LPs that do not qualify based on commitment size can add a valuable and different perspective to an LPAC. Given a more holistic approach to selecting LPAC participants, a GP can be certain LPAC decisions have considered issues pertinent to the entire Investor base.
Board of Directors and Advisory Boards
Whereas an LPAC governs a specific investment vehicle, a Board of Directors and an Advisory Board are two common types of independent boards at the organizational level. An independent board provides guidance and accountability to the management team, identifying methods to improve the firm and contributing diverse thought and experience. Additionally, the enhanced governance provided by implementing an independent board of notable experts can increase credibility with prospective investors; specifically, boards offer an additional layer of oversight and make certain operational and management costs are consistent with the value provided.
A Board of Directors and Advisory Board can serve similar functions, although, in practice, they have several differentiators. A Board of Directors is a formal committee that carries a fiduciary responsibility and is legally bound to act in the interests of shareholders with potential liability. It maintains the power to vote and make changes to the organization, including hiring and firing, capping executive compensation and establishing annual goals. Individuals who comprise the Board of Directors will often receive generous compensation for their service. In contrast, the members of an Advisory Board generally participate on a volunteer basis, receiving minimal to no compensation. The Advisory Board offers the CEO and senior management industry expertise and hands-on, tactical advice on growth and opportunity in a specific area, such as marketing.
When forming an independent board, firms should establish an objective tied to their mission, vision, strategy and milestones for the business. A successful and effective board will have diverse views held by industry leaders in varying fields to promote diversity of thought through unique perspectives. The needed expertise will be driven by the type of Board formed and the experience and knowledge most complementary to the senior management team.
Generally, productive boards include four to six members. As boards expand to include more members, it can become cumbersome to organize meetings, making it more difficult for members to share their collective ideas. When constructing an independent board and internal team, including members with diverse backgrounds is especially important. John McClelland, former Principal Investment Officer at LACERA, described it well: “Diversity of a Management Team and Advisory Board is vital to Investors and frequently causes better results. It is essential to avoid 'tunnel vision' and 'group think' that can be driven by a single dynamic leader.”
Why Diversity Matters
Diversity promotes an outside-the-box mindset in which problems and debates are perceived and carried out differently amongst the members. It ultimately leads to better decision-making as various perspectives and experiences generate a more inclusive and well-rounded discussion. Cloverpop, an online decision-intelligence platform, examined 588 business decisions by 184 teams in multiple companies over two years. It found that teams make better decisions than individuals 66% of the time. In contrast, teams with age, gender and geographic diversity make better decisions 87% of the time.[1]
Improving decision-making through diversity also increases a firm’s innovation and profitability. A study by Boston Consulting Group in 2018 showed a strong and statistically significant correlation between the diversity of management teams and overall innovation. Across developed and developing economies, companies with above-average diversity on their leadership teams reported revenue attributed to innovation to be 19 percentage points higher and EBIT margins to be 9% higher than those with below-average diversity on their management teams. The study showed the most significant gains came from changing the leadership team’s composition in terms of national origin, industry background, gender balance and career path.[2]
In addition to demographics, firms must consider cognitive diversity critical to creating a holistic diversity of thought on their boards and teams. Cognitive diversity integrates people with different thought patterns, problem-solving methods and mental perspectives often developed through educational and functional experiences. Deloitte’s research reveals the highest-performing teams have both demographic and cognitive diversity. Notably, it enables teams to be more impactful in risk assessment, reducing risk by 30%.[3]
In addition to improved decision-making, diverse boards and senior management teams contribute to a firm’s employee retention. Employees see themselves reflected in the leadership roles, which provides evidence of an attainable aspiration to reach that position in the Company. Regardless of a company’s size, increasing the diversity of boards and senior management teams can have a significant impact. Buck’s 2022 Wellbeing and Voluntary Benefits Survey of 218 employers and 683 employees used data analysis to measure employee attitudes toward their employer to identify factors that impact retention. It showed a direct correlation between employees’ desire to leave an organization and their belief that diversity in cultures and backgrounds are not respected; their Company is not committed to diversity, equity and inclusion (DEI); or their Company does not provide diverse offerings befitting the workforce.[4]
Most importantly, to realize the benefits of improved decision-making, innovation and profitability, firms must be committed to developing a culture that ensures the perspectives and ideas of diverse team members are heard. McClelland added for independent boards and senior management, “Diversity is only helpful if all the views of the participants are listened to. The views don’t have to be adopted, but they should be heard and seriously considered. I consider it a best practice to keep meeting minutes that reflect the views expressed and considered.”
Best Practices for Creating Impactful and Diverse Boards and Teams
Alliance interviewed Gemma Burgess, CEO of Ferguson Partners, a talent, leadership, compensation and management consultancy with a robust DE&I practice, to gain insight into the best practices for creating impactful and diverse Boards and internal teams.
Q: What guidelines do you recommend for establishing an impactful Independent Board of Directors?
“A Board should be constructed to offer a diverse range of experiences and perspectives, with everyone providing a unique skill set. Boards should have a diverse mix of gender, race, ethnicity, gender expression, sexual orientation and age (working and retired) across their Directors. An effective Board should collectively include a range of functional expertise such as finance, risk, governance, talent management (i.e., HR), legal, etc., and relevant industry knowledge.
Companies should consider developing and utilizing a skill set matrix to compare each Director’s skill set to those deemed critical for representation on the Board. The skill set matrix can serve as a roadmap to identify current “gaps” in Board expertise to drive future decisions about new director appointees.”
Q: What elements of diversity should be considered when bringing on new Board members? Should appointing firm supporters, family members and friends be avoided?
“Every aspect of diversity should be considered, including race, ethnicity, sexual orientation, gender identity, ability, age, neurodiversity, experience, etc.
We are not good at identifying people who are not like us. To overcome our affinity biases, we need to ask ourselves several questions: 1) What is for the organization’s good? 2) Who is the population we serve and how does our makeup reflect that population? 3) Are we in a state of perpetual group think and could we bring in greater checks and balances, accountability, and innovation by identifying those who look less like us?
It is always best to bring in unbiased observers who feel no allegiance or loyalty to any person or thing; having individuals solely dedicated to the organization’s mission, strategy, and purpose typically encourages better Board dynamics and greater decision-making efficiency.”
Q: How should investment managers improve their recruitment of diverse talent for Boards and internal teams?
“While diversifying the senior leadership team of an investment management platform might take time as firms wait for senior roles to open, build a pipeline of diverse talent and compete to attract senior DE&I talent in an uber-competitive market. Adding diversity to a Board or an Investment Committee utilizing external and independent / part-time professionals can be an excellent way to ensure diversity is more quickly and appropriately represented across the investment management platform.
Relationships are the foundation of many recruiting success stories. As Board and internal teams continue to diversify, a shift in mindset will be critical to success. Those who have the power to identify and recruit talent might consider how to genuinely connect with and build relationships with those who are different from themselves.
Investment managers should consider what diverse associations, organizations, and community partnerships they might sponsor, engage, and support. Additionally, firms should create more opportunities for engagement where none currently exist, which will require creativity and initiative. Much of this is in service to increasing our cross-cultural intelligence.
As a parallel process, companies must also examine their cultures to ensure an inclusive environment that attracts and retains the talent they seek to employ.”
Q: How often should Board members turnover to introduce new diversity of thought?
Board refresh is a competitive advantage. In an age where everything changes rapidly, engaging board members with skills that reflect today’s problems is essential. They should have recent experience, be a reflection of the communities they serve (i.e., their diversity should reflect that of the diverse populations of which they support) and be open to new perspectives. There is no term recommendation, but Boards should have a rigorous process, similar to an organizational talent strategy, to continue understanding the skills and behaviors needed for now and in the future. Much of this takes a courageous leap into making changes that may damage the status quo but is in service to continuous improvement over time.
However, according to new research by academic Kate Suslava of Bucknell University, the optimal tenure on a Board is approximately nine years of service. Her research spanned 3,800 companies over 20 years. It is considered that newer board members might need ramp-up time and experience, while those who have served for 10 years or more may become complacent or out of touch with the organization’s current realities.
Ideally, every Board should have a balance of tenured Directors with history and experience with the Company and newer additions bringing a fresh lens. Many Boards, particularly private Boards, struggle with this balance and, over time, become stacked with long-tenured directors. The concern with such Boards is that long-tenured Directors may have accepted a “status quo” way of operating and be less willing to challenge the management team.
To combat this issue, some Boards have implemented term or age limits as “forced exit” mechanisms. Term limits are relatively rare among U.S. companies, with about 5% of S&P 1500 firms utilizing such limits; the most common term limits are 15, 12, and 10 years, respectively. Age limits are used at more than 40% of S&P 1500 firms; the average mandatory retirement age is usually 72 or 75.
However, we encourage Boards to proactively cycle out ineffective Directors without relying on forced exit mechanisms. From an optics standpoint, term limits do suggest to Investors a rigorous governance practice and there is a benefit from that standpoint.
However, the biggest downside is that it can lead to highly valuable and productive Board members being forced out. We have found that, in practice, tenured directors are often more likely to challenge management due to the relationship and respect that has developed over time. We believe a robust board self-assessment process should identify underperforming Directors and cycle them off proactively rather than relying on term or age limits.”
Q: What data supports the evidence that diversity translates to strong governance and outperformance?
“According to the Board Ready survey from 2020 (S&P 500):
Companies with 30%+ gender diversity represented in the Board room had 54% revenue growth compared to those with 20% or less, which only had 45% revenue growth. Companies with 30%+ gender diversity also outperformed the index in 11 of 15 sectors.
Additionally, Directors with a median age of 55 years old and below saw a 10% increase in revenue growth during the pandemic versus those age 65 and above, which saw a -7.7%
While it is difficult to assess for race because Boards are still overwhelmingly white, those with 30%+ in race and ethnicity diversity on boards saw a 54% increase in revenues during the 2020 pandemic.”
Q: How will the 2022 Global DEI Survey contribute to diversity efforts within the industry, particularly at the Board level?
“By way of background, in 2021, we launched the inaugural Global Real Estate Diversity, Equity, and Inclusion (DEI) Survey in partnership with ANREV, INREV, NAREIM, NCREIF, PREA, REALPAC, & ULI. The survey collected details on best practices for DEI-related recruitment, retention, training and development, inclusivity, tracking and accountability, and pay equity, along with DEI program structure, resources, and ownership. It also provided industry-wide demographic data across organization levels on underrepresented groups, gender, and year-over-year hiring, promotion, and departure trends related to DEI. We received submissions from 175 participants across various geographies, sizes, and organization types. The survey, now in its second year, is currently underway, with the findings available in December.
The Global Real Estate DEI Survey intends to provide industry-wide benchmarks. In the years to come, we will be able to identify trends and show how the industry is progressing regarding DEI maturity. Organizations can use the data in the report to see how their DEI efforts compare to those of peers.
One key statistic we will examine is promotions, hires and departures. A higher proportion of hires and promotions must go to underrepresented groups (e.g., women, people of color and more) than the current demographic breakdown at any given organization level to increase representation over time. At the Board level, looking at the demographic breakdowns of new Board members will enable us to understand how Board composition will change over time.
At this time we do not yet have enough data from the Global Real Estate DEI Survey to report year-over-year changes in Board diversity. We have, however, collected data over the years in our Nareit Workforce Development & DEI Surveys that allow us to see these changes.
In the Nareit survey, we have seen the proportion of new Directors who are white men fall by nearly half, from 46% in 2019 to 24% in 2021. In 2019 only 7% of new Board members were women of color. Compare this to 2021, where women of color made up the highest proportion of new directors (27%). In fact, people of color made up 52% of all new Board members in 2021 (compared to 13% in 2019), and Black men and Black women represented 21% and 22%, respectively.
In the future, the data we collect from the Global Real Estate DEI Survey will allow us to report on similar trends and provide a clearer picture of how diversity in the commercial real estate industry is progressing.”
Support and Guidance
Alliance is committed to providing ongoing education to elevate industry best practices and the important topic of diversity. As such, Alliance is partnering with Institutional Real Estate, Inc. to deliver a series of Masterclasses on trending industry topics, including the impact of diverse Independent Boards and Senior Management teams. To learn about the benefits of attending the Masterclass, click here.
Alliance also encourages all industry participants to take part in the 2022 Global Real Estate DEI (Diversity, Equity & Inclusion) Survey.
Conclusion
McKinsey conducted three separate research projects between 2017-2019 into the business case for diversity. The results of each research project revealed the case for diversity remains robust. Notably, the relationship between diverse executive teams and financial outperformance has become stronger over time. The 2019 analysis found that companies in the top quartile of gender diversity on executive teams were 25% more likely to experience above-average profitability than peer companies in the fourth quartile compared to 21% in 2017 and 15% in 2014. In terms of ethnic and cultural diversity, McKinsey found companies in the top quartile outperformed the fourth quartile by 36% compared to 22% in 2017 and 35% in 2014.
As research continues to show quantitative evidence of the benefits of diversity, institutional Investors are likely to increase their emphasis on understanding an investment manager’s approach to addressing diversity on their independent boards and within their organizations. At Alliance, we work with our Clients to provide best practice guidance for establishing independent boards, including board composition, identifying the appropriate candidates for board seats and incorporating diversity within internal senior management teams. We invite you to contact us for more information on our work in this area.
About Alliance Global Advisors
Alliance Global Advisors (Alliance) is a women-owned consulting firm focused on developing strategic growth solutions for real asset investment managers. Advising clients with over $400 billion in assets under management (AUM), Alliance partners with organizations to provide an informed, independent perspective, continued education and an innovative approach to attracting capital in a competitive market environment. Our experienced team is committed to empowering the real asset investment community to elevate best practices. Our partnerships allow senior management teams to focus on what matters most: diligently managing Investor capital, creating value and delivering exceptional returns in a performance-driven market.
Disclaimer: This blog was originally published in August 2022 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance.
[1] https://www.cloverpop.com/blog/infographic-diversity-inclusion-better-decision-making-at-work
[2] https://www.bcg.com/publications/2018/how-diverse-leadership-teams-boost-innovation
[4] https://buck.com/press/dei-critical-to-talent-retention-especially-among-younger-employees-according-to-buck-hr-survey/]