In the scramble to design a new regulatory architecture, more should be said about reforming the requirements for corporate boards. No matter how sophisticated the new regulatory regime is, creative minds and egos will find ways round it. Boards with teeth are the final rampart against managerial folly and egos that run amok.

Looking at what has happened to the world’s largest financial institutions, two differences distinguish the boards of the better performers: a significant number of board members with industry expertise, or a governance structure, that prevented the emergence of an entrenched, dominant CEO or chairperson.

Citigroup, Merrill Lynch, UBS, Washington Mutual, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Bear Stearns, ABN Amro, Fortis, RBS and HBOS all had boards with very little, if any, financial markets expertise. Though their board members were eminent in their particular fields, without industry expertise they could not see through the triple A-rated collateralised debt obligations, identify the build-up of risk and act as powerful sparring partners to the CEO and top executives. By contrast, companies including Deutsche Bank, Allianz, Credit Suisse, BNP Paribas, Unicredit and Goldman Sachs had financial markets expertise on their boards and had writedowns and balance sheet problems that were much less severe than the banks mentioned above.

The data from the current crisis strongly suggest that, at board level, especially in an industry with complex derivative and structured products, expertise weighs more than diversity. In remarks to the Swiss Federal Banking Commission on the breakdown in its risk management, Marcel Rohner, who was appointed CEO of UBS in August, said the bank had missed the bigger picture, by relying too much on its risk management process: “The problem was not a failure to appreciate complexity, but rather the opposite. It was a lack of simplicity and critical perspective, which prevented the right questions from being asked while there was still time.”

Boards dominated by professional board members, CEOs and former CEOs of other companies have failed dismally. They bring no industry expertise to the table, have little of their own wealth at stake, too easily identify with the CEO/chairperson and go along with an increasing concentration of power at the top. At the financial institutions with the biggest losses, the lack of industry expertise on the board was almost always associated with a dominant CEO and/or chairperson.

Avoiding this concentration of power and getting the board to align top management with shareholders’ interests requires board members who are the true representatives of the shareholders. Nobody with meaningful money on the table is inclined to let others play recklessly with their equity. The best examples of good governance are on boards with partners or shareholders who have a big percentage of their wealth at stake.

On a widely held, truly representative shareholder board, the majority of seats would be reserved for the largest shareholders and elected representatives of the minority shareholders. The role of the nominating committee would be to apportion the seats, call for and make the nominations with a preference for industry expertise and run the voting procedure where necessary. This is similar to the role played by the nominating committee at many private universities in the US. A minority of seats would be reserved to bring in other critical stakeholders or mandated expertise to the table where needed.

A truly representative shareholder board would be fractious and unstable at times, when shareholder blocks have divergent interests. However, this would be much healthier than artificial harmony among non-representative board members, or the boardroom dramas that occur when unrepresented large shareholders try to force their way on to the board. A truly representative board would quickly see where those with the ownership majority want to take the company. Minority shareholders would have representatives to raise the red flag, or turn to regulators, if their interests are abused.

Diverse boards of notables cannot represent the owners adequately. It is time to put real shareholders back on the board

Paul Strebel is the Sandoz Family Foundation Professor and director of the High Performance Boards programme at IMD
paul.strebel@imd.ch