The document discusses the issue of whether boards of financial institutions should have more directors with industry experience. It notes some potential advantages such as understanding business drivers, risks, and the competitive landscape. However, it also discusses downsides such as the risk of "groupthink" and the difficulty of recruiting current industry executives. It concludes that while industry experience can be valuable, it was likely not a lack of it that caused governance failures during the financial crisis. Sound judgment, common sense, and independence will remain most important for effective boards going forward.

1. CORPORATE GOVERNANCE | EXPERIENCE AND BOARDS
Industry Experience and
Board Composition
BY ALAN R. HIBBEN, ICD.D
Partner, Blair Franklin Capital Partners
I N MAY OF 2010 TED PRICE, ASSISTANT
Superintendent of Financial Institutions for Canada,
gave a speech1 in which he postulated that “… now
I can identify a number of possible advantages to
deeper industry knowledge on boards, especially
financial institutions:
would be a very good time for boards and regulators • a more nuanced appreciation of the drivers of
to reassess the skill sets required of directors”. He business success and failure within the corporation;
also indicated that regulators and supervisors such as • an appreciation for the role of regulation and
Canada’s Office of the Superintendent of Financial supervision and the obligations of the corporation
Institutions (OSFI) and the U.K.’s Financial Services to statutory and other bodies;
Authority intended to focus much more on the role of • an appreciation for the way business decisions do
governance at financial institutions in the future. and do not get made and the roadblocks to effective
information flow upwards in the organization;
Mr. Price also questioned whether directors with more • a more refined strategic sense of the competitive
industry experience might be the key to improving landscape – both threats and opportunities –
governance (and especially risk management) at that may have been developed through previous
financial institutions. This question appears to be competition with the corporation;
relevant for Canadian financial institutions. At the large • particularly in a small market such as Canada’s,
banks and widely-held insurance companies in Canada, an appreciation for the individuals who make
I can find only 12 directors in a total of 104 directors up executive leadership in the industry and the
who could be said to be industry participants, under availability of management talent;
the broadest definition possible. However, Canadian • especially in financial institutions, a better
financial institutions have performed better through the appreciation for the risks involved in specific
current crisis and perhaps board composition was not products and business strategies; and
the critical factor in their relative success.
... do we give too much or too little
weight to the industry background
of directors?
All of this raises issues that boards need to grapple
with – whether financial institutions or commercial
concerns. Boards typically spend substantial effort on
the development of a skills matrix for directors and
on preparing a list of potential candidates who can
fill identified gaps. But, do we give too much or too
little weight to the industry background of directors?
Are there downsides to too many or too few industry
participants on boards?
1 “Defining the New Agenda for Governance at Financial Institutions”, May 10, 2010
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2. CORPORATE GOVERNANCE | EXPERIENCE AND BOARDS
• having made their own share of prior errors and even though CEO experience is a major qualification
likely “having seen this movie before”, insights into often sought. Foreign directors may be quite useful in
the avoidance of “potholes” that seem to strike even many contexts, but may not bring the level of sensitivity
the best governed of companies. to local competitive positions.
All this would appear to suggest that significant While OSFI and other supervisors are right to raise the
industry experience is of very substantial benefit. In issue of industry experience on the boards of Canadian
some industries such as mining and energy in Canada, financial institutions, it would not appear obvious that
we find major representation of current and former industry experience alone is a necessary or sufficient
industry executives on boards. criterion for governance success. Further, if taken too
far, one could see some negative implications to such a
However, I believe there are considerations that suggest board composition strategy.
instead that an “over-population” of industry executives
might not be in a board’s best interest: Finally, let me address more directly Mr. Price’s
• Very few businesses today have stable competitive questions about Canadian financial institutions
and operating environments, and it is easy for and the potential impact of industry participants on
executives who have had deep experience in markets improved governance. If we were to attempt to assess
to fall out of touch with rapidly changing dynamics. the recent failures of governance in certain financial
• One of the most insidious issues for boards is the institutions, five aspects would likely be mentioned by
potential for “groupthink” and a failure to challenge most supervisors:
accepted norms. Industry participants may have 1. An excessive reliance on historical models of market
“bought in to the world view” of the CEO in such behavior, including unrealistic correlation matrices;
a way that direct challenge to the status quo is less 2. An excessively open and accepting attitude to
common. increasing complexity;
• A corollary to the above issue is the potential 3. An under-appreciation for the degree of inter-
for deference from other board members to the connectedness of financial institutions globally;
“industry experts”. There are already too many 4. An under-appreciation of the inter-connectedness
times where the “argument from authority” is used of liquidity, market values and mark-to-market
and non-industry board members have chosen to accounting; and
be silent rather than engage those whose authority 5. A mis-estimation of the drivers of liquidity and
appears to come from experience. investor confidence.
• A further consideration is for the proper separation
of management and governance roles. There may be While the potential causes of the crisis are much more
a tendency for industry participants to be willing to complex and may never be fully explained, it would
put their hands into operational and management seem to me that institutions that got the above five
issues, especially in more turbulent times. items closer to “right” did better than others.
There are real practical issues that will likely limit Would more bankers or more actuaries on boards have
industry participants on boards in Canada. Excluding been better able to deal with these five issues than
the energy and mining sectors, where competition is other well-experienced directors? I highly doubt it. The
somewhat less direct, most industries have to recruit management and boards of financial institutions had
ex-competitors or ex-employees to their boards or built such a substantial amount of “group-think” that
attempt to attract foreign directors. Recruiting former very, very few individuals were dramatically outside the
competitors can sometimes be awkward, especially consensus (despite revisionist history since the crisis).
as senior industry players tend to accumulate large While many of us might have said privately “this cannot
quantities of stock in their company, creating perhaps go on”, very few financial services executives stood up
conflicting economic loyalties. On the same basis, against the consensus. In addition, the complexity of the
current CEOs and other sitting senior executives, once issues that had grown in financial markets over the last
again excluding from the resource and selected other ten years left many career bankers behind.
sectors, are not feasible candidates for most boards,
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3. CORPORATE GOVERNANCE | EXPERIENCE AND BOARDS
I do not see the need for significant • Can a business model be altered rapidly to deal
with new market realities, including substantial
change in the composition of the
systemic risk?
boards of financial institutions. • Can the management team refocus outwards to
customers, instead of inwards to internal systems
Looking forward, I do not see the need for significant and supervisors’ requirements?
change in the composition of the boards of financial
institutions. There is and will be a tremendous amount While industry participants can be strong board
of effort undertaken in fighting the “last war” now members for the future environment, I believe
dubbed the “financial crisis”. Board members will that such experience is not a necessary condition
become far more schooled in the arcane mathematics for governance success. Sound business judgment,
of risk management and behavioural economics that common sense and an independent attitude will
proved so troublesome to most. Process will multiply. continue to trump other qualities for an effective
But the next challenges of financial institutions are director.
likely to be completely different than the last:
• How to deal with an environment that has become Mr. Hibben can be reached at (416) 304-3977 or
completely politicized? ahibben@blairfranklin.com
• How to make a large financial institution nimble
enough to deal with conflicting and rapidly changing
This article originally appeared in the Director Journal, a publication of the
supervision and regulation? Institute of Corporate Directors (ICD). Permission has been granted by the ICD
to use this article for non-commercial purposes including research, educational
materials and online resources. Other uses, such as selling or licensing copies, are
prohibited.
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