Typically, the CEO is the face of the company. That person gets praised or panned, depending on results. This post will look at the entity that is responsible for hiring the CEO: the board of directors (BoD). What does an optimal board look like? What is the correct board size? How important is board diversity?
BoD – Red Flags
Before we get into the optimal board size, let’s look at what you (as an investor) generally don’t want to see when it comes to the board of directors. As usual, nothing is set in stone, and these are generally things I don’t like to see when I look at the BoD.
A Bloated Board
It is common that the larger the company, the number of board seats increase to meet the increased number of gluteus maximus that occupy them. More board members does not automatically mean better. 12 members is not demonstrably better than 8. Obviously, a company can justify its board size with any argument and it will sound reasonable to the untrained eye and ear. The biggest concern (for the investor) with an oversized board comes from one aspect, namely:
Over-extended Responsibilities
It is highly likely that the members of a bloated board sit on many other firms’ boards. But why is this a problem? Doesn’t more people mean more expertise? Isn’t it good to have board members that sit on multiple boards?
The reason you wan’t a more “focused” BoD is just that: FOCUS. The BoD’s job is to represent you, the shareholder. Are you confident that a company with 15 board members will prioritize their expertise to your company (before focusing on the board duties of the other five companies they sit in)? Additionally, bloated boards come with some extra baggage for the unsuspecting investor:
Outrageous (Unjustifiable) Salaries
What justifies high 6-figure salaries for board members who meet 4 times a year and have over-extended duties to multiple companies? The only exception you should make is if the company has a great track record with said board members, and it fulfills your other investment criteria (such as moat, management, circle of competence, price, punch card).
Conflicts of Interest
Last but not least, over-extended responsibilities between multiple companies plants the seeds for conflicts of interest. This may be difficult to analyze, but since we are looking for integrity in management, there is in increased conflict of interest risk in a bloated BoD.
The Optimal, Focused Board of Directors
Now that we’ve gone through some red flags when it comes to BoD composition, let’s take a look at what we do wan’t to see. These are just my opinions, but I believe I can convince you, the reader, with my common sense approach.
The optimal board of directors is usually no more than 8 people in size. Through a bit of consultation with the Google machine, we find out that they have limited outside responsibilities. Terrific! When going through proxy statements, we are delighted to find out that the salaries are not atrociously high, and perhaps even a portion of the pay is tied to company performance. Magnifique! As a cherry on top of the cake, the board has sizable stock ownership and the company has prudent rules regarding the ownership. Bravissimo! I believe Thanos is right on the money with his famous phrase:
A Few Words on Board Diversity
We have heard for years on the importance of board diversity in terms of …(insert preferred diversity pick here). I don’t have any at hand, but I’m sure there’s been research made to support this position. A company may toot its own horn on how progressive it is in its board hires, but how should you approach this as an investor?
Once again, having a libertarian approach makes this conundrum so much easier to solve: It doesn’t matter what the board looks like, if the previously listed conditions of an optimal board is met.
Conclusion
As usual, there is no real right, or wrong answers to the question of board size. What you have just read is my personal opinion. I see it as a common sense way to approach the BoD analysis. Your criteria may differ, and that’s perfectly fine. What ultimately matters, is that your interests are mutual, and that they are working for you. If that’s not the case, why would you invest in the first place?
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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