The board selection process in family companies at times can appear rigged to perpetuate incumbent directors. Is this a good or a bad phenomenon? That depends on many factors.

Imagine the frustration of a family shareholder who believes the company’s board is not functioning well but feels powerless to effect change. Though such feelings sometimes reflect sour grapes about a past issue, not being selected for the board oneself or a family squabble, they can also arise from legitimate worries about the board.

The problem is much more prevalent in the family business world than most people realize. I have witnessed it several times in my family business experience, and whether the issue is real or perceived, it is very troubling. Loss of faith in board selection causes serious rifts in families, as well as in boards and companies.

On the bright side, addressing this problem or perception has many ancillary benefits. Taking action can not only help increase board effectiveness but also lead to greater family harmony and a stronger, more open relationship among family, board and company.

Root cause of the problem
Shareholder votes for directors are simple and not very democratic. Owners vote on a presented slate or on individual directors in an up-or-abstain manner. There are no alternatives. Without alternatives, any affirmative vote for a director, even much less than a majority vote, results in his or her election to the board. (This is why in public companies, disgruntled shareholders wage proxy battles with alternative slates.) Furthermore, the slate of directors is chosen by the board itself, usually via its governance or nominating committee. The risk of self-perpetuation is obvious.Unhappy shareholders can gripe at the annual meeting, but they can do little to impact board composition without a groundswell of support.

As I’ve seen several times in different families, shareholders get frustrated when they feel the board has become a self-perpetuating old boys’/girls’ club.

Board selection of slate: The benefits
Although board self-perpetuation can present problems, there are several advantages to this system. The board knows best which directors perform well. If a director is not prepared or not effective (and it happens), the other directors know it. Board members are also more experienced in management oversight than typical shareholders in a family-owned company and should, in theory, be better judges of effectiveness. Furthermore, boards know the skills needed for the company. Well-functioning boards often have a matrix of skills and experiences desired to ensure board composition is well-balanced and manage the selection process accordingly.

These are good reasons for the traditional system of board selection, but there still exist risks of mutual back scratching that could lead to underperforming directors and frustrate shareholders.

Avoiding the pitfalls of board selection
I’ve seen several interesting strategies to avoid the old boys’/girls’ club problem (or the perception of a problem).

• Using professional recruiters to find directors. Most midsized-to-large family companies use professionals to help find and evaluate independent directors. This helps comfort family shareholders that outside directors will be well-qualified and not rubber stamps for management. The approach is highly recommended but not without shortcomings. First, recruiters usually do not evaluate prospective family member directors. As a result, they can’t prevent old boy/girl tendencies among family — and family director selection can be the source of huge strife.

Second, heavy CEO involvement in outside director selection can bias the board toward directors hesitant to challenge the CEO.

Though using recruiters is highly beneficial, in every case where I’ve seen the old boys’/girls’ club issue arise, the company was using professional recruiters for outside directors. This is because once directors are on the board, recruiters are no longer involved in evaluating them. Directors can become too cozy with management or each other, or fail to adapt to the company’s changing needs. In addition, the potential for family shareholders not on the board to resent family board members grows, whether over board fees or influence. Recruiters have no bearing on this.

• Using the family council or a non-board member family leader. Involving representatives from the family council or other non-board family leaders in slate development serves two purposes. First, it increases trust in the ultimate slate. If non-board family representatives understand the selection process and endorse it, other family members will likely be satisfied. Second, if the slate nomination process is not working objectively, the family council or leader can voice objections to the board or alert the family.

This tool is very situational. It generally is not needed with a relatively small shareholder family or one where a very trusted family leader participates in the board selection process.

• Requiring board members to receive a majority vote. Another technique is requiring directors to resign if they do not receive a majority vote of shareholders. Keep in mind that in most corporate elections, unlike political ones, there are no alternatives, so any affirmative vote technically results in victory. Even a majority vote is a low bar, since director approval in family companies is usually unanimous or with an overwhelming majority. However, requiring a majority vote makes shareholder votes potentially more meaningful, causing more discussion among shareholders, sharing of concerns, and full and honest voting. I’ve seen it work very effectively in a family where there were perceptions of unfair board selection. It gives solace to shareholders that if they object to a director, they have a simple recourse. If the family wants a higher percentage than a simple majority, they can request it.

• Giving shareholders a vehicle to nominate additional directors to the slate. A new innovation that I’ve seen in a progressive family business is allowing shareholders to nominate additional directors to the slate if there is sufficient support. To make this effective and avoid undermining the board’s nominating process, companies should set a non-trivial threshold of support to add a candidate, such as 50%.

Adding a nominee turns the election from an up-or-down choice on the slate to a vote of the top candidates, with the candidate who receives the fewest votes losing.

• Developing family members for board service. In many family businesses, prospective family directors do not have the experience or résumé of those in the outside director pool. Requiring equal qualifications for family and independent directors is not a practical approach. Even if family directors lack the outside experience of independents, they play a critical role on the board. They ensure the independent directors and management serve the family’s interests; they keep the family’s values and philosophy in the business despite having more professional management, which maintains the “secret sauce” of family ownership; they provide a critical communication link between the board/company and the family; and they can develop into very good directors.

Despite these benefits, it hurts the board if family members distract the board from its work or are ineffective. And if the board ends up disrespecting family representatives, it’s not a good thing.

To make family members far more effective as directors and help generational succession, I’ve seen and worked on several family development programs. The gist of these is to accelerate the development of younger family members into board-ready shareholders. The best programs are managed by a family education or employment committee and use tools such as executive education, family council education sessions and, most importantly, non-voting directorships with mentors from the board. In one family transitioning to its fifth generation, the process has resulted in several younger-generation family members becoming board ready in five to seven years and contributing significantly to the success of the company and family.

Building trust in the process
Any of these techniques can work to avoid an old boys’/girls’ club problem with your board or the perception of such a problem, and they are often complementary. None of them undermines the significant benefits of having the board create a slate of directors for approval by family owners. Instead, these measures help foster greater trust in the process and better family and board harmony — a very worthy goal.        

William B. Goodspeed currently serves as a director on five midsized-to-large family business boards.

Copyright 2020 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.