A new SEC rule requires public companies to disclose how and why they choose directors. Diversity experts welcome the change.

Since departing in 2008 as CEO and president of Wendy's International, Kerrii Anderson has spent considerable time preparing for corporate board meetings. She's serious about her responsibilities as a director for Chiquita Brands International, Laboratory Corporation of America Holdings, P.F. Chang's China Bistro and Worthington Industries.

"Being on multiple boards allows me to focus and stay current on what's relevant," Anderson says. "I see firsthand the dynamics of successful boards. Directors today are prepared and informed. Management teams are focused on providing directors with appropriate information that makes them most effective."

With a ton of C-suite experience and a strong financial management skill set (she's a CPA), Anderson would be a prime choice for any corporate board. Factor in her gender, and she can pretty much write her own ticket.

Corporations have been seeking diversity in their boardrooms for decades, but male directors still far outnumber women, and whites still far outnumber minorities. Women comprised only 16 percent of the directors of S&P 500 companies in 2010, up from 15 percent in 2009, according to the Institutional Shareholder Services (ISS) Governance Institute. And only 9 percent of S&P 500 directors self-identified as members of a racial or ethnic minority in 2010, down from 12 percent in 2009.

Diversity isn't a new issue, but it's front and center again for publicly traded companies because of a U.S. Securities and Exchange Commission (SEC) rule that became effective in the 2010 shareholder proxy year. "Companies must say whether or not they have a diversity policy for board composition," says Eleanor Bloxham, CEO of the Value Alliance, a corporate governance consulting firm in Westerville. "If so, how is it defined? Is diversity a factor when the company considers board candidates?"

The SEC rule also addresses the quality of board nominees and directors. "Today there's greater disclosure as to why each person sits on the board," says accountant John McEwan, managing partner of Deloitte's Columbus office. "What qualities and experience do the directors bring to the table, and will shareholders feel good about those directors representing their interests?"

"Transparency is paramount," says Anderson. "Shareholders deserve to understand who's representing them and what competencies they have. Board composition is one of the most critical things for any company to get right."

Regulators have raised the bar. Investors are paying more attention. So is the public. Demonstrating diversity of gender, ethnicity and expertise helps to instill greater confidence in corporate America. And in today's world of industry bailouts, income disparity and high unemployment, that's not a bad thing.

Gender, Ethnicity and Perspective

The insights of women and minority directors can help companies develop strategies and make decisions that more accurately reflect employee, customer and stakeholder attitudes.

"Diversity is just smart business," says McEwan. "It doesn't take a lot of convincing that diversity makes sense. Just look at the changing demographics of the country. Companies need to think along the same lines as their shareholders and customers."

One recent study has linked the presence of female directors to superior financial performance. Research by Catalyst, a nonprofit organization dedicated to expanding business opportunities for women, found Fortune 500 companies with the most women directors outperformed those with few or no female directors. Companies which had at least three women directors during four of the last five years outperformed companies with few or no female representation by 84 percent on return on sales, 60 percent on return on invested capital and 46 percent on return on equity.

Why the difference? "I find that female board members enhance communication between board members and with management," says Anderson.

"Why more women aren't on corporate boards perplexes me," says attorney John Beavers, a partner at Bricker & Eckler who specializes in corporate governance issues. "They comprise half the population and often are the decision maker in certain arenas, such as financial and insurance."

Even though the recent SEC regulations require greater diversity disclosures, there's still wiggle room. "I haven't seen boards get too detailed in how they define diversity," says attorney Dan Bailey, a principal at Bailey Cavalieri.

"Many companies define diversity in terms of experience, but they don't necessarily specify gender or race," says Bloxham. "It varies, though, because some actively disclose that. Bob Evans, for example, discloses race and gender diversity and that's not very common."

While executives at Bob Evans Farms declined to be interviewed for this article, the firm's 2011 proxy statement illustrates Bloxham's point.

Paul S. Williams, managing director of Major, Lindsey & Africa, a Chicago-based legal executive search firm, has been a Bob Evans director since 2007. The proxy says he was originally nominated because of his experience as a lawyer and chief legal officer at Cardinal Health. "In addition, Mr. Williams brings significant expertise in healthcare, human resources, leadership development and executive compensation policy matters to our Board. ... Mr. Williams also brings ethnic diversity to the Board. He is a well-respected leader in the area of diversity, frequently speaking on diversity-related issues."

Williams' fellow Bob Evans Farms director, Cheryl Krueger, CEO of Krueger + Company, has served on the board since 1993. The proxy reads, in part, "Ms. Krueger was nominated to serve as a director because of her extensive knowledge and significant experience in the areas of marketing and branding, retail sales, business operations, on-line marketing and sales, manufacturing, as well as auditing and finance. ... Ms. Krueger also brings gender diversity to the Board."

In contrast, Worthington Industries' 2011 proxy statement about Anderson makes no mention of her gender. It reads, in part, "Her extensive experience in accounting and financial reporting and analysis and prior experience as a chief executive officer of a public company and chief financial officer of several public companies, in addition to other public company board service, make Ms. Anderson particularly well-suited to serve as a director and as a member of the Audit Committee."

In addition to gender and race, the SEC requires companies to explain their directors' diversity of qualifications to shareholders. "The term I hear boards use is diversity of thought," says Beavers. "Boards are looking for people with different backgrounds and expertise. A successful board has various disciplines. From a legal standpoint, the most important job of directors is to ask questions. To do that they must have a background that allows them to ask the right questions, particularly ‘what if' questions. Directors help management think through every possible scenario."

"Over the years, governance practices failed in a number of high-visibility situations," says Bailey. "One of those lessons is, in too many companies the board is a homogenous group without diversity of thought. Ideally, you like to have a broad group of people on the board."

"Different perspectives benefit the company. It's a more holistic view," McEwan says.

Age and Skills

In the last 10 years, the composition of many corporate boards has shifted toward retired executives and professionals. Retirees account for 33 percent of independent directors, according to the ISS Governance Institute. These "professional directors"--people without other full-time commitments--hold more board seats than any other demographic. Finance and accounting professionals make up 17 percent of directors, while corporate executives account for 13 percent. In 2002, by contrast, corporate executives held 33 percent of independent director positions and retirees just 19 percent.

"There's a reason why older folks comprise a large number of directors," Bailey says. "With a wealth of business knowledge and awareness of board behavior, they bring an awful lot of experience and wisdom to the boardroom."

It's possible, of course, for a board to have too many graybeards. You don't want half your directors nodding off after lunch--unless that's when you plan to slip those huge executive bonuses past the board. "Some boards have more older people than is healthy for the company," Beavers says. "In many cases, it's because of the collegiality. Once you're on a board, it's hard to rotate off. Boards are addressing that, though. About a third of the boards I see have mandatory age limits. Others use mandatory term limits."

"Older people certainly have a lot to contribute, but don't overlook youth. Different generations should be represented," Bloxham says. Relationships, she says, are often more important than age: "The bigger issue is, have you lost your independence? Are the directors too close to management? Directors can lose their objectivity because of the longevity of their service, not necessarily their age. Most companies don't have regular movement off the board. Directors are there for many years, so companies usually wait for someone to leave before bringing someone new on. But the company may need new blood before then."

Today it's common for boards to outline needed skills and then seek out individuals who possess them. "Usually it's things like understanding the industry and having C-level experience. Companies are looking broader and farther for directors, too, beyond the comparatively small pool of people they know," Bloxham says.

"As I talk to boards, we discuss that every seat around the table is a valuable asset," says Bailey. "When they decide who sits in that seat, they need to find someone who maximizes the skill set and represents what's needed to address the current issues. ... Clearly the whole notion of diversity is intended to enhance the quality of the decision-making process."

Beavers recommends starting with the strategic planning process and engaging an objective outside consultant to conduct a director evaluation exercise. "The directors rate each other and the CEO. The process gives the nominating committee objective data to work with," he says. "When the board links members' skills and contributions to the strategic plan, directors often come to see that new skills are needed, so then they don't stand for re-nomination."

Benefits of Diversity

Because the SEC proxy disclosure requirements are fairly recent, it's not yet clear if they will lead to significant shifts in board composition. Businesses that already have significant female and minority board representation may not change anything except the wording of their proxy statements.

A proxy statement, though, may give a company an opportunity to differentiate itself from the competition. "Some people say the company should look at the individual's background and skills without addressing race and gender," Bloxham says. "I say the disclosures around director expertise and the diversity policy are among the most important public relations pieces a company can have. It's one more way to distinguish your company."

And don't overlook how diversity, or lack of it, can affect the nominating and voting process. "Large institutional investors continue to be interested in and observe board composition. They can impact the nominating process and composition by nominating candidates themselves," Bailey says.

"There are organizations that hold large blocks of shares in their retirement plans. Those shareholders look at things like diversity and can vote their block of shares for or against the directors," McEwan says.

While the SEC rules apply only to public companies, privately held firms, too, are well-advised to broaden the composition of their boards. "I believe private companies should have the same diversity, but it can be more challenging to achieve," Bailey says. "Often the CEO is the founder and majority shareholder. He may be inclined to choose friendly shareholders and be less inclined [than] he should be to pick people who might stir it up a little. For all of the reasons diversity is good for public companies, it's good for private companies, too."

Public or private, it's clear that large companies are sensitive to how the composition of their boards of directors affects both their bottom line and the way they are perceived. By either measure, as McEwan says, "For the most part, companies think about diversity as good business."

Lisa Hooker is a freelance writer.

Reprinted from the December 2011 issue of Columbus C.E.O. Copyright © Columbus C.E.O.