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Growing demands and an outdated operating model are putting traditional governance under pressure. How can Australian boards adapt?
Boards play a crucial role in building successful economies, with strong corporate governance delivering the confidence that enables investment and growth. But recent EY research reveals signs that a changing world and a perfect storm of pressures, are making it more difficult for board members to lead effectively and add real value to their organisations’ strategy. A trend of board governance failures is growing globally, threatening to erode trust in some of the world’s biggest organisations and deter top talent from seeking board positions.
The problem, it appears, is that traditional, 20th century governance models are not fit for purpose in today’s volatile, uncertain world. EY spoke to nearly 100 board members and senior business leaders in Australian companies to pinpoint the key flaws, consider how governance trends may evolve and identify three focus areas that can help build a board fit for the future.
About this study
The EY Global Centre for Board Matters, in collaboration with Dr Dean Blomson, interviewed board directors and non-executive directors, along with CEOs and CFOs, from 64 publicly listed companies and 29 private companies in Australia. We also spoke to teams within EY who work closely with boards and leadership.
Four challenges threaten viability of traditional board models
Leadership is never easy, but in 2021, it appears pressure on Australian board members is increasing. Interviews with almost 100 directors, non-executive directors and those who work with them, reveal that four major challenges are not only making it more difficult to govern effectively – they threaten the fundamental viability of current operating models.
1. Growing regulatory and risk burden
Those interviewed, told us of regularly being tasked with 800+ page board packs ahead of meetings. This risk, compliance and regulatory overload is distracting boards from the strategic conversations that add real value. Added to an increased threat of personal risk exposure, mean Australian boards may struggle to attract top talent.
2. Outdated operating model
'High touch, low tech' boards face mountains of historic data and content with limited use of digital tools to interrogate and unlock value. This leave them with less time for meaningful strategic conversations and a lack of actionable insights to guide better decisions and respond effectively to volatility.
3. Looming gaps in skills and behaviours
Most boards have an emerging gap in digital literacy, as well as the 'soft skills', such as behavioural science, that are critical to successfully running today’s organisation. Diversity in its broadest sense also lags. The recognition that divergent thinking will be vital to better decision-making, innovation and value creation is still maturing.
4. An identity crisis around stakeholder priority and ESG
Boards are working out how best to meet public and investor expectations on sustainability and long-term value; and to square this with short-term demand for earnings. The shift to more inclusive stakeholder capitalism has begun for some (but, by no means all) though, for many of those making the shift, it is an early and sometimes uncomfortable transition. Deciding how best to 'walk the talk' rather than 'talk the talk' is an evolutionary process.
You can explore these challenges in more depth here.
These issues are not expected to abate. Our research predicts the board of 2030 will operate in an environment shaped by five key governance trends:
- Elevated stakeholder voice from more diverse groups
- More transparent decision-making
- Greater accountability – and consequences – for boards
- Faster, more unpredictable pace of change
- Complex business ecosystems that make governance more challenging
These trends are expected to change all key elements of the traditional board operating model, leading to less uniformity. You can read more about these trends and their impact here.
As boards navigate these trends, they’ll need to break free of the homogeneity driven by a 'comply or explain' culture. Boards will need to have the courage (and be encouraged) to stand out from the herd, if they really want to create fit-for-purpose governance. We believe that three areas of focus can help boards do this, to reshape to meet the challenges of today and more adequately prepare for a different tomorrow.
Technology is an opportunity to transform
Data and digital are transforming the working world and one of the driving forces reshaping the operating environment for boards. Yet, the EY research interviews with Australian board members found that, while directors acknowledged the impact of technology on their business, many downplayed the need to improve their own digital literacy, instead preferring to draw on technology professionals within the organisation when needed. A recent survey by the Australian Institute of Company Directors and University of Sydney Business School found that only 3% of Australian directors have a background in science, technology or maths1.
This is not to suggest board members become digital experts, but the lack of a general understanding of such fundamental forces of change is concerning. Digital tools such as artificial intelligence (AI), blockchain and robotic process automation (RPA) are transforming how organisations operate, interact with customers and engage with regulators. They offer huge potential for innovation and growth, but also present challenges, including how to ensure their ethical, compliant deployment, that decisions driven by data can be trusted and vetted through robust assurance processes. Board members should develop at least a working knowledge of new and emerging technologies and consider how they can access digital expertise when required, to ensure they are ready to contribute to strategic discussions around these issues.
Greater digital literacy also offers boards an opportunity to lift their own burden of procedural oversight. AI and RPA can be used to streamline review of board packs and information, interrogating and analysing information to better spot risks and relevant data points. We expect to see companies adopt bespoke risk bots and audit bots, which will free committee members from ploughing through voluminous reports, freeing up facetime during meetings to discuss value creation. Airborne warning and control systems (AWACS) can also help boards reorient to be more future-focused, allowing them to sense and evaluate weak signals of emerging trends to seize opportunities – or head off risks – early.
Formulating a meaningful, actionable and authentic Environmental, Social and Governance (ESG) agenda
If there were any doubts as to the growing prominence of environmental, social and governance (ESG) issues, 2020 put these firmly to rest. Apart from the COVID-19 pandemic highlighting the importance of health and social equity, the year saw a renewed focus on climate change, the flashpoint of 'Black Lives Matter' and the ongoing #MeToo movement, which all demonstrated how ESG issues pose financial and reputational risks to organisations.
Investors have made it clear they are scrutinising ESG performance before awarding capital, demanding tangible evidence of outcomes, especially on the bottom line and balance sheet. Shareholder activism has also become a powerful agent for change, challenging companies to switch direction, change leadership and even defend their actions in court.
But, while ESG issues are increasingly on the radar of the C-suite – 66 % of CEOs say they expect that building trust with stakeholders will become a bigger part of their role – we found boards still grappling to comprehend the widening gap between what they are legally and constitutionally required to do and what is demanded of them. The shift from a traditional, singular focus on shareholder primacy to more inclusive stakeholder capitalism has begun for some (but, by no means all) though, for many of those making the shift, it is an early and sometimes uncomfortable transition. Deciding how best to 'walk the talk' rather than 'talk the talk' is an evolutionary process. Boards will need to understand that creating longer term value for a wider range of stakeholders can support sustainable value creation and does not come at the cost of profitability.
We see boards of the future moving from being shareholder agents and (internal) business leaders to becoming wider change agents that create value for an expanded group of stakeholders. This will require identifying those societal and/or environmental issues most relevant to the business and considering how to make a genuine and actionable commitment to these. More transparent reporting and communications can help raise awareness and understanding around these choices, as well as broader governance decisions.
Reimagining working practices
The first two focus areas lead neatly to the third – the need to reimagine the composition of boards and their operating models.
The findings of the EY report point to a looming skills gap for Australian boards. We’ve already discussed the lack of digital literacy, but we also see that the traditional focus on selecting board members based on technical expertise may be depriving boards the 'soft skills' considered increasingly important to successful governance. For example, our recent survey of CEOs in Australia and New Zealand revealed that more than one-third expect behavioural science to become a more important competency to ensure a company’s growth – but we are yet to see meaningful recognition of the importance of this skill at board level.
Equally, the rising prominence of ESG issues raises important questions about whether the cultural fit of many Australian boards is aligned to that of broader society. Diversity remains a challenge, both in terms of observable differences in board members’ gender, ethnicity, background and experience, but also in terms of divergent thinking. It’s a concept still maturing but we see a greater value being placed on cognitive diversity and contrarian thinking. Boards will actively leverage this diverse thinking to navigate uncertainty and support the innovation that will be critical to growth and transformation.
How can boards redress this imbalance, and create leadership fit for a more complex future? The solution will be neither quick nor easy, but we suggest that thinking now about how to redesign succession planning can help start the process. Considering how to build a broader, more diverse talent pool of potential board members, and using mentoring to help fill any skills gaps, can both create confidence in the readiness of the board for the future and help attract top candidates.
Board members we spoke to also highlighted a need to enhance connections to the C-suite, especially in a more volatile, uncertain and fast-changing world. Effective boards of the future will have more frequent, real-time interactions with management and key stakeholders. Traditional timing and mode of board meetings will be reconsidered in light of new demands and expectations. Evaluating how to build more effective sense-making and sense-checking mechanisms in a world where the emergence of new issues is increasingly prevalent will also be important. We expect boards to incorporate the strategic adoption of analytical mechanisms for more effective insights.
Reimagining how boards work will also have implications for how their performance is evaluated and rewarded. Based on current trends, by 2030, we expect boards to have moved towards a long-term view of performance linked to stakeholder outcomes. Board members’ remuneration may be linked more directly to these more sustainable financial and non-financial outcomes, without sacrificing balance and objectivity.
Should Australian boards consider new operating models?
But, are boards free to reimagine how they work if they continue to operate under the traditional one-tier 'unitary' model? It may be difficult to consider changing the status quo, but we see mounting evidence that the one-size-fits-all approach to board structures may no longer meet the needs of all organisations, especially as the focus on purpose grows. Expect to see the adoption of alternative models, including two-tier boards and networked structures, designed to reflect the business and its operating environment. We suggest three potential new models:
Hybrid, moderately devolved governance
- Mixes classic and new board structures
- Aligns committees to business units where most value and/or upside and risk lie
- Allows inputs from other key stakeholders.
Hub and spoke – hard core, soft edges
- Board is still the epicentre, but the workload is more widely shared
- Ideas are raised and resolved around, as well as within, the board
- Non-traditional committees support big value creation, advisory groups help with topics such as ESG
Networked – more virtual
- Instead of an omniscient epicentre, the board is a steward responsible for monitoring and facilitating long-term value.
- Satellite structures pick up stakeholder issues and feed them up to sense-making 'nodes'.
- Board delegates more decision-making to the nodes (closer to where the emergence and point of impact is) for decisions on key responses
We’ve explored in more detail how future models may look here, and how a discussion around your board’s purpose can be a starting point for change.
Summary
Let’s continue the conversation
A convergence of challenges, combined with the recent focus on the COVID-19 pandemic, raises serious questions around the continuing viability of traditional governance models. The case for change is strong, but exactly how Australian boards decide to move forward with transformation is less clear and will depend upon each organisation’s own current situation, future strategy and long-term purpose. This research does not claim to have all the answers but the hope is that this article – the first in a series – will start a robust conversation around the major pain points of modern governance, the trends and predictions about its continued evolution and, most importantly, how boards can build their own roadmap to the future. We’ll explore these issues in further articles and welcome your feedback in the meantime.