Board renewal: evaluating current directors and recruiting new ones

Corporate boards face ever-expanding agendas, uncertain market conditions, lickety-split technology changes and the challenge of complying with regulations in ever-increasing numbers of jurisdictions where their companies want to do business.

Generally, business is more global and more complex. There are increasing reputational, legal and compliance risks, and increasing numbers of shareholders are scrutinizing boards’ actions and speaking out when they don’t like what they see. This higher-stakes environment is increasingly putting board composition in the spotlight. Not only are directors’ professional skills and expertise coming under more scrutiny from proxy advisers and institutional investors, but so too are boards’ gender and ethnic mixes.

Board renewal and director recruitment are hot topics in boardrooms across the country ascompanies can no longer afford to retain board members who don’t bring to the table skills and experience relevant to at least some of the risks and opportunities their company faces, and who don’t contribute consistently to the process of finding solutions for matters the board considers critical.

‘The greatest danger to effectively managing growing risk factors is failing to have the right skill sets, expertise, backgrounds and diversity represented on the board. One challenge to the board renewal process is simply making that process a priority,’ says Allie Rutherford, director of corporate governance of the EY Center for Board Matters.

New faces

According to a recent Spencer Stuart governance survey, the boards of S&P 500 companies elected 339 new independent directors during the 2013 proxy season, a 16 percent increase over 2012. This was the largest influx of new independent directors since 2008, when 380 new appointees joined boards. It’s also noteworthy that nearly 40 percent of new directors in 2012 had not previously served on a board.

Several factors have spurred this desire for fresh blood: 60 percent of respondents to the Spencer Stuart survey say their boards plan to replace a retiring director, while 22 percent say their boards want to bring in new skills. Eleven percent want to increase the diversity of their boards and 2 percent are adding directors in response to shareholder pressure.

Director recruitment is increasingly taking cues from board evaluations of current directors. Boards will generally create a grid (or matrix) to get a more comprehensive sense of the skills and industry experience of their existing directors. Gaps in skill sets and experience identify opportunities for strategic recruiting, says Lori Verstegen Ryan, a professor of management and director of the Corporate Governance Institute at San Diego State University.

‘Boards are having trouble finding the best match for the roles they are casting,’ says Keith Gottfried, a partner at Morgan Lewis & Bockius who specializes in governance. ‘Board members can’t just say, I met this guy on the golf course. It takes a lot more thought – especially with activist shareholders [intent on bringing in qualified board talent].’

Boards today look not only within their own social and professional networks and those of C-suite members, but are also starting to cast a wider net. ‘Executive search companies are more involved than they were with these searches 10 years ago,’ says Gottfried. ‘Some boards are taking the same care they would if they were hiring a CEO.’

The right fit

Given the average turnover per board in any one year, finding available, qualified, minority and women candidates to ramp up board diversity is a challenge, says Jeffrey Cunningham, a professor at the WP Carey School of Business at Arizona State University. Boards and their nominating committees are maintaining short lists of candidates deemed ready to be recruited when an opening occurs. But with the same candidates often appearing on many companies’ short lists, mid-market and lesser- known firms can find themselves at a disadvantage, he says.

The challenge of finding minority and women candidates has been compounded by a shrinking pool of top talent, says Ryan. As directors’ duties become more demanding and higher risk, many executives have lost interest in board service. At the same time, CEOs’ tougher day jobs have sharply limited their capacity for outside directorships, she adds.

The upside is that what was once a narrow pool consisting mostly of CEOs or very top-tier executives has begun to expand to include equally talented and experienced managers in lower- profile positions. Seeing such opportunities, members of ethnic minorities, women and academics are more likely to aspire to boards and prepare themselves for future openings, which will ultimately further expand the pool of viable candidates, Ryan notes.

Executive recruiters have their hands full. Lee Hanson, vice chairman of Heidrick & Struggles’ San Francisco and New York offices, sees clients widening the net and, in some cases, lowering the bar, now that it’s harder to attract top talent. ‘The door is now more open for people who have functional experience,’ she observes. ‘Companies don’t necessarily need someone from their industry, but they do want someone who has faced similar issues or challenges.’

The culture question

Amid greater demand for talent, companies that know how to articulate their board’s culture will more likely attract candidates who are the right cultural fit, says Jason Hanold, chief executive and managing partner of HR executive search company Hanold Associates.

‘Top candidates are attracted to boards either by the company’s story and business strategy, or because of their interest in gaining board experience,’ he notes. ‘Compensation and other financial incentives are not necessarily the primary drivers, unless the individual board member is retired or close to retirement.’

Many boards fall short in recruitment by not allocating enough time for a thorough search, assuming they can network adequately through existing board relationships.

Directors should take a longer-term, strategic view of the composition and evolution of their boards instead of filling seats as they become vacant. If a company plans to enter foreign markets or launch new product lines, for example, the sooner it starts eyeing potential board talent with the appropriate expertise, the better, says Kim Van Der Zon, head of the US board consulting practice at Egon Zehnder.

‘Strategic board succession planning will dramatically decrease risk and provide a pronounced competitive advantage for companies by ensuring the board has the right talent at the right time,’ she explains.

Maintaining independence

A decline in board turnover has institutional investors concerned board independence may be compromised, thereby stifling boardroom debate amid an absence of fresh perspectives, Rutherford says. Spencer Stuart finds that director turnover among S&P 500 companies dropped 27 percent between 2002 and 2012. Lower turnover is seen as a major impediment to progress on gender diversity on boards.

PwC’s ‘2014 annual corporate directors survey’ shows growing concern about underperforming board members and differing views among women and men on how critical gender and racial diversity is on boards. Thirty-six percent of directors say someone on their board should be replaced, versus 31 percent two years ago.

Less-tenured directors are those most likely to push to replace board members, much more so than those serving 10 years or more. Diminished performance due to aging, lack of relevant expertise and inadequate preparation for board meetings are the top reasons directors cite for wanting to give some of their peers the boot.

At the same time, however, Spencer Stuart’s survey finds that a growing number of directors see impediments to replacing an underperforming director – 53 percent versus 48 percent of respondents last year. The biggest reason: the board leadership’s discomfort with addressing the issue. Respondents also cite the absence of director assessments and ineffective assessment processes as roadblocks to replacing directors.

While directors mostly regard board and committee self- evaluation processes as somewhat effective, more than two thirds of respondents say they find it at least somewhat difficult to be frank in their self-evaluations, with one in five saying it’s very difficult. But company culture and the board’s chairman set the tone for self-evaluations, according to Yusuf Azizullah, CEO of Global Board Advisors.

‘In my experience, engaged directors take this exercise very seriously,’ he notes, while others tend to see it as a routine activity that serves little purpose other than to provide a veneer of regulatory compliance.

Van Der Zon firmly believes board self-assessments often lack true objectivity, and that this is what is driving the ‘trend toward agnostic, third-party board evaluations that are much more comprehensive and have specific, actionable outcomes’.
increasing diversity

In 2013, 18 percent of new independent directors were members of an ethnic minority, up from 12 percent in 2012, according to Spencer Stuart. Not surprisingly, there is a divide between men and women when it comes to attitudes to board diversity: more than 60 percent of women directors polled by Spencer Stuart describe gender diversity as very important, compared with one third of male directors. Similarly, more than 40 percent of women directors say racial diversity is very important, compared with 25 percent of men.

PwC’s most recent survey shows that 18 percent of board members at S&P 500 firms are women and 15 percent of S&P 200 directors are members of an ethnic minority. Nearly 60 percent of directors surveyed say their boards are considering or discussing recruiting more directors from diverse backgrounds, including women. PwC’s survey further finds that directors attribute slow advances in board diversity to a lack of awareness of qualified diversity candidates, board leadership that is not invested in recruiting such candidates and a general lack of interest in changing current board composition.

When it comes to women, however, there has been some progress: Spencer Stuart finds that two thirds of S&P 500 companies have two or more women on the board, compared with 41 percent a decade ago.

Don Keller, a partner in PwC’s Center for Board Governance, recommends that boards carefully consider the appropriate gender mix of directors not just for now but also for the long term, taking into account the company’s customer base, product lines, employee base and strategic direction.

EY’s research shows that gender diversity accelerates board renewal and diversification: companies with women on the board are more likely to have recently added new directors, including more women, to the board.

Only a matter of time

Term and age limits for directors are also under review. According to Spencer Stuart’s survey, only 16 S&P 500 boards (3 percent) specify a term limit for directors in their corporate governance guidelines. Among firms that do, no board limits service to less than 10 years, and the longest term permitted is 30 years.

Term limits not only provide an opportunity for a director to assess his or her own commitment to continuing on a board but
also allow the board to evaluate individuals’ contributions and replace under-performers without drawing too much public attention or rancor, Hanold says.

In the absence of personal enmity that would prompt board members to encourage a fellow director to step down, there are board members who stay on boards for decades, leaving only due to age limits, according to Cindy Burrell, founder and president of Diversity in Boardrooms.

‘If you’re on a board for more than 15 years, you could argue that there is a loss of objectivity and that maybe the board member is too comfortable and is not working as hard as before,’ she says, adding that long-time directors are less inclined to put tough questions to management.

Another hindrance to board renewal, says Van Der Zon, is that the US hasn’t adopted the rules and regulations regarding board tenure that countries such as the UK have. ‘The closest proxy is retirement age,’ she notes. ‘But most US boards have loose rules around retirement age, or don’t specify it at all.’

The average retirement age imposed by S&P 500 companies is 73, but the figure may range between 70 and 80, allowing lots of discretion for exceptions or age limit waivers, says Rutherford. ‘One challenge with forced mechanisms for board turnover is that they can result in the loss of high-performing, quality directors at times when their service may still be vital,’ she adds.

Meanwhile, average director age continues to climb. The median age of independent directors is 63 compared with 60.3 a decade ago. Today, 44 percent of S&P 500 boards have an average age of 64 and older, compared with only 14 percent 10 years ago.

Voting recommendations

Leading proxy adviser ISS is exploring making director tenure a factor in its voting recommendations for director elections, Rutherford says. The Council of Institutional Investors has adopted a new policy recommending that boards consider an individual director’s tenure as one criterion for independence.

Shareholders want to see boards that effectively represent the interests of all shareholders. Boards whose directors have significantly longer tenure than the average ‘should be ready to discuss their perspective with interested investors,’ says Glenn Booraem, head of corporate governance at Vanguard.

‘Engagement in this context doesn’t need to be exclusively one-to- one with investors. A comprehensive discussion of the issues in the company’s proxy statement or other materials may go a long way to addressing investor questions.’

As boards continue to grapple with a new business landscape, they must either adapt or face the ire of a growing army of critics – critics who are watching their every move and are increasingly capable of making their voices heard in order to insist on change in the boardroom.