Bigger isn’t always better
Are Australian boards still too big? Many boards have gradually downsized by not replacing departing directors in the past five years. Top 50 listed companies typically have between eight and 10 directors, a size often recommended in academic literature. Companies such as Rio Tinto with 16 directors are rare. Even a diversified conglomerate such as Wesfarmers, which has a strong case for a large board, has a chairman and nine directors. Telstra also has a 10-person board.
It is always dangerous being prescriptive on ideal board size when enterprises vary so much across industry and by location. A charity, for example, may have a large board because it has diverse stakeholders or wants more directors to help management with networking and fundraising. A board such as that of AustralianSuper may have a chairperson and 12 directors to ensure the right mix of member and employer representatives govern the institution on behalf of its investors. Boards of government enterprises could have similar requirements.
Other boards may find having lots of directors is effective. The main advantage of larger boards, in theory at least, is more collective information, a broader range of skills and more directors to do board tasks. The main disadvantages are issues such as arranging board meetings, reaching consensus and slower decision-making from having “too many cooks”.
A bigger threat is board cohesiveness being undermined over time if having too many directors makes it a struggle to reach consensus and leads to board factions. There is also a risk that large boards could have “free riders” – directors who believe their underperformance will go unnoticed or unmeasured, or that other directors will pick up their slack.
Much academic research, mostly from the US, shows a negative relationship between board size and organisation performance. Paul Guest, an academic at Cranfield University in the UK, neatly summarises board-size research in his 2009 paper, The impact of board size on firm performance: evidence from the UK, published in the European Journal of Finance. Guest’s research studied 2,476 UK companies over a 20-year period.
He says: “Although larger board size initially facilitates key board functions, there comes a point when larger boards suffer from coordination and communication problems and hence board effectiveness and [firm performance] declines. The empirical evidence appears to support this view, with a majority of studies documenting a significantly negative correlation between board size and corporate performance.”
Guest’s research also found strong evidence of a negative relationship.
Guest believes the optimal board size is less than 10 members across all performance measures. He refers to other academics who argue that board size should be no greater than eight or nine directors.
Paul Kerin, Professorial Fellow in strategy at Melbourne Business School, goes even further. He believes boards should have, at most, four or five non-executive directors (including the chairman), and an executive director (the CEO). “They would devote more time per board, be paid more and be incentivised to develop a deeper understanding of companies they govern,” says Kerin. “This would remove the diseconomies of having too many directors around the board table.”
Six directors for a large listed company is too few in my opinion. But I do believe many listed companies have scope to reduce director numbers by one or two over time. Many not-for-profit enterprises, in particular, have far too many directors. Does a charity with $5 million turnover really need 10 directors? Would not a smaller board suffice with surplus directors being used in other roles such as advisory panels or in other networking capacities?
I agree with the broad thrust of Kerin’s argument – having fewer directors who spend more time on board matters and are paid more for their efforts makes sense. I like the idea of directors being able to delve deeper into governance issues and corporate strategy, and develop a stronger understanding of industry dynamics, simply because they have more time. Board collegiality may also improve in many companies by having a smaller group of experienced, knowledgeable directors.
Arguably the biggest benefit would be more focus on director performance, scope for more feedback from the chairman (who has fewer directors to worry about) and more opportunity for directors to build their board skills.
Some may argue that reducing the size of boards by one or two directors will not make much difference and that the trend is already towards smaller boards. Another counter-argument is that reducing board size will further shrink the director “gene pool” and make it even harder to improve female representation on boards.
I disagree. Demands on directors of large enterprises will keep growing as business complexity, market volatility and investor pressures rise. The answer is not “bigger is better”, but rather fewer directors who can develop more expertise in the companies they govern and be appropriately rewarded.
In time, that will see more competition for fewer board seats, more pressure on directors to perform to keep their positions and more pressure on boards to recruit the best person – male or female.
Tony Featherstone is a former managing editor of BRW and Shares magazines