It's said that the most important role played by a board of directors is its selection of the right chief executive to lead the firm. The board's second most important duty is arguably determining its own size and membership. This responsibility is often carried out on the fly. But a well-considered process is far more preferable. When it comes to bank board composition, President Eisenhower had it right: "Plans are nothing, planning is everything."
Traditional methods of culling bank board nominees exclusively from a network of popular business leaders, former politicians and acquaintances of the CEO have become obsolete as regulators set heightened expectations for board oversight. Relying on a mandatory retirement age requirement to reinvigorate a board and provide it with members who collectively possess the needed skill sets has also proved to be an imprecise and relatively ineffective tool. Mandatory retirement age requirements generally work too slowly to bring about meaningful changes to board composition. Moreover, given the lengthened productivity of human lifespans, such a requirement may result in the departure of board members who possess vitally needed skill sets and strong leadership talent.
Unfortunately, it is increasingly difficult to attract new directors with the intellect, skills, business experience and good judgment to effectively oversee the responses of a bank and its senior management to today's complex technological, competitive, regulatory and broader strategic issues. This is true for all but the largest banks with the highest levels of board compensation,
As public opinion of the banking industry has declined in the aftermath of the financial crisis, the prestige associated with being a member of a bank board has also diminished. Banks are also less willing to increase director compensation as their profit margins narrow in response to higher capital costs and stricter regulatory limits on their business activities. Furthermore, as recent aggressive enforcement actions by federal and state banking agencies and the Department of Justice have demonstrated, directors of troubled banks now face dramatically higher risks of personal financial liability and public embarrassment.
The good news is that a well-composed board can help banks achieve their strategic objectives while avoiding unacceptably high levels of risk. The key is to establish and implement a composition plan in which individual board members' skill sets, integrity, judgment and willingness to devote the necessary time and attention to bank matters produce, in the aggregate, the greatest value to the bank.
First, the nominating or governance committee should assess current board members for the breadth and depth of the skill sets relevant to the bank's business model and culture, such as competence in finance, technology, compliance and leadership skills. The committee should simultaneously assess the willingness and ability of each current board member to prepare for and actively, intelligently and constructively participate in board and board committee meetings.
After completing the assessment process, the committee should categorize and prioritize the skill sets, leadership qualities and other attributes, including gender and racial diversity, that it seeks in new director nominees. The committee should also establish target dates for interviewing and selecting nominees.
In many if not most cases, it will take several years to refresh a bank board. If the most pressing need is to add a director with the skills and experience necessary to help the board work with management to address significant technological issues, that nomination should be prioritized and scheduled for action in the first year.
Rather than relying on artificial, imprecise governance tools such as a mandatory retirement age or term limits, a bank's governance committee should take the necessary (though socially uncomfortable) step of convincing underperforming directors to leave. If directors no longer have the required skills or energy or their performance otherwise falls short, they should be encouraged to retire immediately, refrain from seeking re-nomination or step down from a committee leadership post.
A board composition plan should be reviewed frequently and revised to reflect emerging challenges faced by the bank, such as changes related to the bank's addition or elimination of a line of business or concerns emanating from an economic downturn or a significant cybersecurity breach.
Admittedly, adopting a board composition plan brings with it the risk that regulators will question the board when a proposed board addition or retirement is delayed or proves unachievable. But that risk is outweighed by the benefit to the bank of having a board that has the combined strength to provide effective oversight to senior management.
Eric R. Fischer is a senior fellow at the Boston University Center for Finance, Law & Policy whose research focuses on bank corporate governance, board composition and director education.