Board size: Can smaller boards make a more significant impact?
When it comes to board size, sometimes less is more. According to an article from the Wall Street Journal, companies with smaller boards are more collaborative and can outperform companies with larger boards in the vast majority of situations. But that’s not the only reason to reconsider your board size. Much of the recent focus on board size comes from changes in regulatory concerns and the increased importance of independence and diversity.
The Case for Smaller Board Sizes
A group of governance researchers from GMI Ratings performed a study in 2014 for The Wall Street Journal, which supports the notion that smaller boards are more effective than larger boards.
For the purpose of defining the size of boards, the study shows that the smallest board size had an average of 9.5 board directors. The study establishes large boards as those with 14 or more board directors. Of the companies studied, the average size of the corporate board was 11.2 directors. Boards had an average of 11.2 board directors overall.
The study revealed that companies with at least $10 billion in annual revenue that had smaller boards typically produced better returns over three years than similar-size companies with larger boards. Specifically, smaller boards held an 8.5-percentage-point lead on returns over companies with larger boards. In taking a closer look at companies with larger boards, the study states that large boards underperformed smaller boards by 10.85 percentage points.
The study also noted that banking institutions were subject to more regulatory concerns than other businesses. Such institutions often need the advice and expertise of many committees, so larger boards make better sense for many companies in the financial industry.
These numbers play out in the real world when we consider that many tech companies have small boards. For example, Netflix has seven directors on its board, and Apple has eight board directors. Bank of America doesn’t feel it can get by with fewer than the current 15 board directors.
What Factors Influence the Size of the Board?
According to The Wall Street Journal study, the board should be large enough to carry out the board’s fiduciary and other duties effectively and efficiently. For many organizations, that means five to seven board members are ideal. Up to 15 board members are acceptable on the high end to account for unusual circumstances.
Depending on the type of organization, boards may need to consider several other factors in establishing their board size:
- Diversity: How large (or small) does the board need to be to include a wide range of backgrounds and perspectives?
- Independence: How many directors does the board need to operate with autonomy?
- Functions: What will the board be responsible for, and how many directors do they need to do so effectively?
- Skills, talents, abilities, areas of expertise: Which skills, abilities or experiences should be represented on the board?
- Representational requirements: Does the organization have any requirements for board directors?
- Regulatory requirements: Does the industry have any requirements for board directors?
Another way to pare down board size is to add some non-fiduciary groups or committees, such as forming an advisory board.
Beyond looking at numbers and percentages, studies have highlighted specific pros and cons that board directors revealed to show why smaller boards are more effective.
The Benefits of Smaller Board Sizes
Here’s a snapshot of why smaller boards can produce better results:
- Small boards are more likely to identify and act on poor performance of the CEO
- Small boards spend less time in discussions and make faster decisions
- Directors have greater ownership and accountability
- Board can dedicate more time to tackle issues in greater detail
- There is less chance of a dominant member swaying the group, and problems with groupthink
- Meetings tend to be less formal, which makes it easier for board directors to open up and share ideas, and there is less chance of board directors who don’t actively participate
- Directors know each other better, and such relationships are more conducive to cohesiveness and a sense of common purpose
- Overall returns have shown stronger results
There are a few downsides to having smaller boards, although the benefits far outweigh the deficits.
Smaller boards place more work on individual directors, which may reduce effectiveness if directors don’t have the proper amount of time to commit to the board — however, board portal software can help with this issue. Lower numbers may also mean not having enough people to staff committees. With smaller numbers on a board, there may be less room for the level of diversity that today’s corporations require.
Drawbacks of Larger Board Sizes
While larger boards can more easily accommodate for diversity, they often lack the time for all directors to share their ideas. Here’s a list of some other challenges that larger boards face:
- Larger boards have less time to give issues the necessary depth
- It’s easier to staff committees with qualified members and to delegate work to committees
- Conflicting schedules can make scheduling fully staffed meetings difficult
- It’s easier to distribute the workload
- Meetings are more formal, which makes it easier to keep order
- Large boards are subject to groupthink, with one or more members dominating discussions
When Should a Board Consider Changing Sizes?
Just as today’s economics prompted changes in board composition and size, boards need to revisit their size from time to time and consider whether it’s prudent and wise to increase or decrease its members.
After the Sarbanes-Oxley Act (SOX) passed, many companies added more independent board directors without relieving current directors of their seats, and the average number of board directors rose from nine to 11.
Boards may need to revisit their numbers whenever major governance changes or when corporations grow in size and complexity.
Case Study: How General Electric Reduced Their Board Size
In 2017, GE took steps to reduce its board size with plans to reduce the number of board directors from 18 to 12. To further enhance board capabilities, GE also planned to put a 15-year cap on board director terms and use headhunters to replace outgoing board directors with those who have relevant industry experience. As tenured board directors leave, GE plans to recruit board members with experience in aviation, power, healthcare and digital manufacturing.
According to Charles Elson, director of the John L. Weinberg Center for Corporate Governance, the standard board size for a company like GE should be eight to 12. He indicated that he would have liked to see GE decide to decrease board size at least a year sooner than it did.
However, by 2019, GE did reduce its board size to 12. When two of its most tenured directors retired that same year, GE opted not to propose replacements and instead asked its shareholders to nominate only ten directors to its board.
According to CNBC, GE took reducing their board size even further, asking shareholders to vote to amend their Articles of Incorporation to require a board size of seven instead of ten.
Start Considering a Smaller Board Size
While the current trend in board composition means having fewer board directors who represent greater independence and diversity, it’s important to factor in the type of industry and the company’s unique needs when setting criteria for the number of board directors. The most recent study favors boards with smaller numbers; however, numbers can and should change when circumstances signal the need for change.
Smaller boards can save time and collaborate easier while making better decisions for their business with fewer resources. To stay on top of the latest trends in boards and governance and help your business stay agile in today’s competitive landscape, sign up for the Boards and Governance newsletter from Diligent.
