Too Many Experts of the same arena on the same Board, no diversity Backfires

Too Many Experts of the same arena on the same Board, no diversity Backfires

CRITICAL ISSUES

  1. The first factor is what psychologists call “cognitive entrenchment.”
  2. The second factor is overconfidence,
  3. The third factor has to do with the level of “task conflict”

 

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MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)

Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.

Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results

30+ years Board, Governance, Investment’s  experience and practice for YOUR BOARD needs and solutions

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Why boards succeed or fail and how to make them better are critical questions for corporate governance. We know that board composition—who the directors are and what backgrounds and perspectives they represent—can influence important outcomes like firm value and sales growth. But the full spectrum of these relationships is far from fully understood.

We conducted a study, recently published in the Academy of Management Journal, to learn more about a neglected dimension of board composition: the proportion of domain experts. That is, the percentage of directors whose primary professional experience is within a firm’s industry. Though companies can easily manipulate the proportion of directors with domain expertise when building a board or appointing new directors, we know virtually nothing about its effects on corporate performance.

Common sense might suggest that the more experts, the better. Domain experts know the ins and outs of an industry and are highly skilled at assessing risks and opportunities. But our interviews with board members and CEOs in the banking industry—and decades of research on experts and teams—point to three factors that can compromise the effectiveness of expert-dominated boards, at least in some circumstances.

The first factor is what psychologists call “cognitive entrenchment.” As we gain deeper expertise in an area, we acquire more accurate and detailed knowledge but also become less flexible in our thinking and less likely to change our perspective. So expert-dominated boards might be less effective in responding to new information or unfamiliar situations. Indeed, related research shows that executive teams made up of many industry experts are less flexible in responding to changes in the competitive environment. Our own interviews also confirm this idea. Many of our interviewees emphasized the “baggage” that domain experts bring with them to a board. Domain experts “brought with them habits from the other institutions and perhaps those habits were not always good,” one CEO explained.

The second factor is overconfidence, a common problem in expert judgment that affects experts in a wide range of fields, from doctors and physicists to economists and CIA analysts. In banking, for example, one board member explained, “a board which has got a lot of bankers on it, they are going to tend to reach for loans a little bit more because they believe that they have got a little bit more background and experience. Whereas other people who aren’t bankers tend to be a little more cautious.” As another director put it, non-expert directors “often play the role of devil’s advocate, taking the situation to its worst conclusion.” This means that boards with several non-expert directors tend to be more skeptical. They “demand more reporting and analytics” and often respond to proposals by saying “We are not going to make a decision today because you didn’t give us enough information to make the decision.”

The third factor has to do with the level of “task conflict”—the extent to which board members have different viewpoints, ideas, and opinions about the decisions they face. Some amount of task conflict is essential because it allows the board to explore and discuss more alternatives. But research suggests that a high proportion of domain experts can suppress task conflict because non-expert directors may defer too much to the judgment of experts. When non-expert directors are just a small minority on a board, it is difficult for them to challenge experts to justify their assumptions and consider alternatives. In such boards, a CEO told us, “there could also be some egos involved—here is the way I have done it all my life and that’s the way we are going to do it. And everybody respects each other’s ego at that table, and at the end of the day, they won’t really call each other out.” In contrast, in a board with fewer domain experts, “when we see something we don’t like, no one is afraid to bring it up.”

Our research shows that these three problems of expert-dominated boards are most likely to be damaging when a company veers off the beaten path and faces uncertainty. Dealing with changing, unfamiliar situations requires flexible thinking and a healthy dose of disagreement. And when conditions are novel or ambiguous, expert overconfidence is especially severe.

We studied 17 years of data on roughly 1,300 community banks—banks that have their own legal charter, aggregate assets below $1 billion, and a locally focused business model. The boards of some community banks include mostly domain experts, that is, directors whose primary background is in banking, typically as executive vice presidents or above. Other boards include a few banking experts but also directors with backgrounds in law, insurance, medicine, the public sector, the military, and other fields.

In our sample as a whole, there was no clear relationship between the proportion of domain experts and a bank’s financial performance or survival chances. At first glance, whether a bank’s board had many domain experts or just a few didn’t seem to matter for profits, growth, or the likelihood of bank failure.

But then we looked specifically at banks that faced heightened uncertainty for some reason—for example, because they were growing rapidly in an uncharted market territory or because they were operating in a lending market with unusual loans and atypical, heterogeneous clients. In such situations, there was a clear link between the proportion of domain expert directors and the probability of bank failure. The more banking experts on the board, the greater the likelihood that a bank would go out of business.

Our findings persisted even when we controlled for a host of other factors, including functional diversity, and they weren’t simply driven by banks appointing more experts in response to financial trouble or uncertainty.

At the same time, it’s important to note that most boards in our sample included at least two banking experts, or roughly 20% of board members. So our results don’t mean that having no experts at all is optimal. What they suggest, instead, is that it’s important to appoint a non-trivial number of directors whose primary expertise is in another industry—especially if the board is likely to face significant uncertainty.

It also may seem obvious, but it’s worth remembering that high proportion of domain experts is not the same as the absence of professional diversity. For example, a board of a telecommunications company that includes five telecommunications experts, two lawyers, and two bankers is exactly as diverse in terms of professional backgrounds as a board of another firm in the same industry that includes two telecommunications experts, five lawyers, and two bankers. But these boards differ greatly in the proportion of domain expert directors—five versus two, out of nine board members.

This is just the first study on this issue. It will require further research to confirm that the link we found is causal and that it exists in other industries as well. But it’s an important first step in gaining a deeper understanding of how boards work—and how companies can make them stronger.

https://hbr.org/2016/08/when-having-too-many-experts-on-the-board-backfires

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