Building Better Boards for Risk Oversight

A confluence of factors – including rapid evolution of generative AI and other technologies, shifts in capital stacks, cybersecurity threats, climate change, the energy transition, geopolitics, and demographic trends – has led to a new era in corporate governance with volatility, uncertainty, complexity, and ambiguity (VUCA) as the norm.

Corporate board members and C-suite executives need to discern strategies that maximize shareholder and stakeholder value creation in this context. Enhancing board diversity intentionally and authentically could significantly improve risk oversight and decision-making in this landscape, where change is accelerating faster than systems can adapt.

The risk profile of essentially every enterprise is increased in this new era. Though definitions vary, risk generally refers to the potential for adverse outcomes. No organization or individual is immune to supply chain disruptions, pandemics, deep fakes and other misinformation, severe weather events, or other manifestations of these global changes. Because these factors are deeply interconnected, the only viable forward path is systems-level change.

Board members are obliged to provide risk oversight as part of their duty of care. While public companies are mandated to have independent directors, private company boards (when they exist) are often composed of investors, founders, or family members, who have inherent conflicts of interest in exercising their fiduciary duties. This lack of true independence may be particularly problematic in the VUCA environment, leading to governance failures as witnessed recently with OpenAI.

It is well-documented that diversity at every organizational level leads to better business performance and greater resilience (see, for example Financial Reporting Council and Pew Research Center reports). Here, I use diversity in organizations to mean representation and inclusion of a wide spectrum of human attributes, lived experiences, identities, perspectives, and patterns of thinking.

Similarly, biodiversity refers to genetic diversity, species diversity, and ecosystems diversity; biodiverse ecosystems are significantly more likely to adapt to and survive the effects of climate change, and continue providing essential ecosystem services for humans and other living beings, such as nutrition, food, and safety. In contrast, lack of biodiversity increases the probability of both species and ecosystems-level failure (e.g., Roe 2019).

Survival is an increasingly important consideration in corporate governance when markets are unstable. Witness the March 2023 collapse of Silicon Valley Bank and the cascading impact on privately held tech and life sciences ventures: boards and executive leadership took an unplanned crash course in treasury risk.

Speaking of survival, a wave of corporate commitments to fighting racial injustice followed the May 25, 2020 murder of George Floyd. According to McKinsey, these racial equity pledges topped?$340 billion by October, 2022. Many of these financial promises never materialized. From a corporate governance perspective, the racial wealth gap limits potential for shareholder returns and overall economic growth; it is estimated that closing the racial wealth gap would add between $1 trillion and $1.5 trillion to the U.S. economy, benefiting everyone. Instead, income and wealth inequalities in the U.S. are rising, driving economic instability in historically marginalized communities.

Lack of board diversity increases enterprise risk in multiple other ways. The psychological phenomenon of ‘groupthink’ is significantly more frequent in homogenous groups; lack of diversity exacerbates the risk of groupthink and bad decisions. Katherine Phillips summarizes the science in her 2014 Scientific American article, How Diversity Makes Us Smarter. ?

Boards must also consider how demographic changes affect consumer markets and buying preferences. For example, by 2050, Latino/Hispanic people are expected to make up 29% of the U.S. population according to the Pew Research Center.? Lack of board diversity increases the probability that enterprises fail to build products that attract customers. Similarly, an increasingly diverse world also requires diversity at every level of organizations to build inclusive cultures that attract, retain, and motivate the best talent from dynamic and growing demographic groups.

Despite the potential of board diversity for reducing enterprise risk, recent studies from 5050 Women on Boards and Equilar, KPMG and the African American Directors Forum, The Conference Board, and Him For Her in partnership with Crunchbase reveal a profound under-representation of women, Black, and Latino/Hispanic corporate board directors relative to the U.S. population.

Because there is so little diversity on private company boards and they are by their very nature difficult to study objectively, it is tautological that one cannot gather data on the benefits of private company board diversity. Yet, diversity appears to be a universal good for organizations, organisms, and ecosystems, leading to better performance and more resilience. Here I explore two questions: Why do private company boards lack diversity? What can be done individually and collectively to build more diverse, and therefore better, boards?

As confirmed by the Him For Her/Crunchbase data, a 2023 peer-reviewed study (Cassel, et al.) found that in comparison to public companies, venture capital funded companies appoint fewer minorities and women to their governance boards. The Cassel study used a sample of nearly 150,000 private company board directors from PitchBook, and image processing in combination with machine learning (i.e., an AI) to classify race. The comparison public company data set was derived from ISS and BoardEx. A key finding: public firms appoint women directors and racial minorities 18.6 and 19.7 percentage points more than private firms do.

Sadly, following the murder of George Floyd, the gap in appointments of racial minority board members increased from 7% to 30%, showing that listing status influences board diversity: in 2021, minorities represented only 4.7% of new board appointments in private firms compared to 34.3% in publicly traded firms. Cassell, et al. also found that disparities in board diversity persist after an IPO, reflective of the continuing influence of venture capitalists.

From a risk oversight perspective, the diversity gap in private company governance is particularly troubling. According to the Him For Her/Crunchbase study, 20% of the companies analyzed have not appointed a single independent director. Family members who serve on the boards of family-owned businesses often have financial self-interests that by human nature take precedence over what is best for the firm and all of its shareholders. Similarly, investor board members may have difficulty discerning sometimes competing fiduciary duties to the venture and to the fund, in which they frequently have carried interest. Qualified independent directors can and should play a mediating role.

Why is the board diversity gap so much larger in private companies? Studies have demonstrated that venture capitalists are likely to have networks comprising individuals of similar demographics, and most board recruitment is through personal networks. Consequently, most new board appointments reinforce the existing lack of diversity, and perpetuate predominantly white, male governance structures for public and private firms (and other organizations).

The vast majority of venture capital in the U.S. remains controlled by white males according to the Knight Foundation’s 2021 white paper. Assets under management (AUM) by all minority-owned groups accounted for only 1.4% of the total $82.4 trillion, while minorities accounted for 40% of the U.S. population at the time. Blacks and Latinos/Hispanics are even less represented, directly correlating with documented evidence that it is more difficult for Black entrepreneurs to raise both equity and debt capital.

As noted in the National Bureau of Economic Research’s (NBER) 2022 Working Paper, ‘homophily’, i.e., investing in and elevating people similar to oneself, occurs across all VC firms as well as in board appointments. This is also true for minority-owned funds: they are 3-4X more likely to fund minority businesses, though still at a rate far below population representation. Notably, minority-owned groups face more challenges in raising their first funds and raise on average a smaller percentage of the desired capital raise; moreover, the past performance of minority-owned funds has a greater impact on their ability to raise follow-on funds than for non-minority owned funds: “poor performance is punished more harshly.”

NBER’s study also found that limited partners (LPs) play a major role in capital allocation and board appointments. Institutional investors with minority Chief Investment Officers are more likely to invest in a diversely owned fund by 16 percentage points; VCs with a higher proportion of limited partners (LPs) in Republican states are less likely to appoint racial minorities to their portfolio company boards, particularly Latino/Hispanic. While fewer studies and less data exist for family-owned businesses, it is axiomatic that ownership and board appointments are frequently among family members and their networks.

Homophily is the polar opposite of diversity. As Cassel, et al., conclude, lack of diversity among private company boards and venture capital funds is self-perpetuating. Diversity of a public company’s board of directors is correlated to whether the firm was VC-backed before going public. In other words, our capital systems reinforce the lack of diversity on corporate boards, thereby increasing risk to shareholders and stakeholders. The Him For Her/Crunchbase study found that private companies with independent directors who are women raise more capital to scale their businesses. Board diversity is thus embedded in the fiduciary duty of care.

The racial wealth gap is reinforced by homophily. Brandeis University Professor Thomas Shapiro’s book, Toxic Inequality: How America’s Wealth Gap Destroys Mobility, Deepens the Racial Wealth Gap, and Threatens our Future highlights the systems that perpetuate and exacerbate racial income and wealth in the U.S.

The average value of director-held shares of private ventures going public is $20 million; board appointments thus play a direct role in perpetuating – or if we collectively take action to diversify boards – closing this wealth gap. Moreover, venture backed private companies with Black directors hire more Black employees; effective compensation committees help remedy persistent race- and gender-based pay inequities.

What can we do collectively and individually to build more diverse and better boards?

1.??????? Open the Aperture. Use a skills matrix to assess individual director and whole board competencies, experiences, behavioral qualities, and personal demographics to mitigate groupthink and prepare for an increasingly uncertain future. Challenge old dogma. How many CEO’s do you really need in the board room? One. It’s the board’s duty to help CEOs be successful or replace them. Seek qualities that will help with talent, technology, resilience to the impacts of climate change, and serve an increasingly diverse consumer base.

2.??????? Stop Making Nonsense. The pipeline myth – the idea that there is not a pipeline of board-ready talent from underrepresented groups – is just that: a myth. Statistically, with 8 billion people on the planet, the likelihood that any one of us knows the ‘best person’ for a particular board opportunity is near zero. Indeed, Cassel, et al., found that racial minorities appointed to private company boards before the murder of George Floyd were on average more qualified than non-minorities based on objective characteristics such entrepreneurial experience and stronger educational backgrounds. For the last 3 years, I’ve had the extraordinary privilege of co-founding the Black Corporate Board Readiness (BCBR) program at Santa Clara University. With over 280 BCBR Alumni from every industry sector and across all organizational functions, I can personally attest that there is an abundance of board-ready Black talent.

3.??????? Build your Networks. How diverse are your professional (and personal!) networks? Check your LinkedIn feed. If everyone looks like you, you may be missing opportunities to build better boards, teams, and friendships. Play an active role in helping professional associations diversify their memberships. If a board you serve on seeks candidates, go beyond who first comes to mind. See who is a second order connection on LinkedIn. Reach out to organizations like Black Women on Boards, Him For Her, or BCBR to identify diverse, qualified candidates to build a future-ready board.

4.??????? Practice Systems-level Thinking. Everything is interconnected. Diverse boards can help enterprises better explore myriad convergent factors that influence success or failure in an era of accelerating change and develop appropriate, inclusive strategies to build a better world – for all of us.

Thanks to my amazing colleagues Heather Buffington Anderson and Dennis Lanham for their ideas and input on this article. My profound gratitude to the BCBR Program Advisory Board (PAB): Caretha Coleman Matrice Ellis-Kirk Mark D. Goodman Almaz Negash Robin Washington Barry Lawson Williams and PAB Emerita Desirée Davis Stolar .

The Facilitators, Mentors, and Advisors who have joined us on this journey are testament to collective action for the greater good. You are each a gift.

To the more than 280 BCBR Alumni: it is the honor of a lifetime to accompany y'all! I am truly blessed.