The fast pace of the marketplace demands that companies evolve to stay relevant and competitive, which means refreshing board seats when necessary. Stale boards of directors that have multiple directors with overly long tenures can no longer serve in their positions effectively. Board directors not only need wisdom, continuity and institutional knowledge, they also need diversity, independence and refreshment. A refreshed board is an asset to every company. The lack of board refreshment poses significant risks to board performance and effective oversight of the company.
Examples of Corporate Problems with Static Boards
In an ISS 2016-2017 Global Policy Survey, 120 institutional investors were surveyed and 68% of them responded that they were concerned about long tenures on their boards.
Since 2017, Wells Fargo has changed or retired four of their board directors who had tenures of 12–15 years after the recent scandal proved they had established fake accounts. Nike has had five board directors with over 12 years’ tenure. One Nike board director began his term in 1991 and served for 27 years on the board. Other boards have recently asked their high-ranking executives to resign after receiving allegations of inappropriate behavior, including Wynn Resorts, Ford Motor Company and Lululemon Athletica.
Recent regulatory authorities have encouraged board diversity, board independence and board performance. Publicly listed companies must have a certain number of independent board directors, as defined by various stock exchanges, on their boards. Independence refers to employment, compensation and other service relationships for board directors and their immediate family members. In addition, the term independence also refers to board directors who are independent thinkers.
According to the UK Corporate Governance Code, board directors lose their independence after nine years of service to one board. The underlying assumption is that they either become too close to management to be objective or they become too defensive regarding how things are typically done. It’s difficult to find any justification for extended board director tenures anywhere. Overall, good governance suggests that board directorship shouldn’t be longstanding.
Regulatory authorities have taken some good first steps toward ensuring strong board performance, but many investors and others would like to see more. Listed companies are required to disclose their findings of whole board evaluations annually. For some companies, this isn’t enough to ensure strong board performance. Good governance standards hold that boards should also be doing individual board director self-evaluations or peer evaluations every two or three years, or whenever they feel it’s necessary.
Deloitte reported in the 2016 Board Practices Report that 93% of large-cap companies were performing full board evaluations and only 21% of the same companies do individual peer evaluations. The underlying concern is that boards need to have an understanding of the performance of their individual board directors if they’re going to meet the demands of the complexity and pace of the competitive environment.
A board’s composition must reflect the company’s current strategy. Strategy changes along with changes in the marketplace and so the board composition must also change. While the concept is simple on the surface, boards face the challenge of how to execute it.
Board Refreshment Best Practices
Across the globe, many national governance codes recognize the importance of board refreshment. Many countries consider the fact that long director tenures compromise independence. Certain governance codes require companies to explain why board directors have served on their boards for extended periods. The United Kingdom set the pace for board refreshment in the early 2000s and many European and Asia markets followed their lead. Where boards haven’t taken the lead to reduce board director tenures, investors have created screens to flag excessive board tenure as part of the whole board composition or at the director level.
ISS reports that 28% of board memberships in Singapore have board directors with zero to three years’ tenure and 60% of board memberships in Brazil also have directors with zero to three years’ tenure. ISS attributes the change in these and other countries to revised governance codes.
Many of the new governance codes have linked board tenure to board independence, which has also encouraged board refreshment in some areas. Recent government laws and rules have also responded to investor pressure for greater gender diversity. Corruption scandals in Brazil and South Korea have prompted a public outcry to overhaul boards of directors in some of the larger corporations.
By contrast, the United States and Mexico lack regulations that restrict tenure and tend to have directors with longer tenures as a result. Countries where corporations are held by family members, such as in India, Thailand, Mexico and Singapore, also have high percentages of tenured directors due to the inclusion of the founding family and representatives of controlling shareholders.
Navigating the Right Balance on Refreshment
Market forces have been the driving force behind board refreshment in the United States rather than regulation. Pressure from investors, stricter voting policies and the directors’ commitment to good governance have increased the focus on board refreshment. This strategy has also proven somewhat effective. Directors with up to three years of board service in the US increased from about 25% of director nominees in 2012 to about 33% in 2018. On the flip side, the percentage of board directors with 12 years of board director service or more has remained steady throughout the same time frame and it’s still higher than it was 10 years ago.
The statistics demonstrate that companies in the US are still struggling with how to find the right balance of retaining tenured directors and bringing new nominees on board who bring fresh skills and perspectives into the boardroom. The new goal for board composition reflects a healthy balance of experience and refreshment.
The Relationship Between Corporate Performance and Tenure Balance
In a study on the relationship between corporate performance and tenure balance by the Harvard Law School Forum on Corporate Governance and Financial Regulation, the results show a positive connection between balanced boards and financial performance and risk profiles. Also, companies that have directors who are concentrated on one or two tenure categories ranked the worst in performance and the highest in risk profiles. In other interesting results, boards that were poorly balanced in tenure ranked the worst in performance and risk where the bulk of board directors were new. We’ve seen this play out in cases where an entire board needed to be overhauled, such as in the case of Wells Fargo.
Fortunately, there are lots of things that boards can do to get board refreshment right. Board Refreshment 101 requires getting back to basics by considering the board’s composition in relation to performance, tenure, diversity and independence, among other things.
This is the best time for boards to review or implement mandatory retirement age policies and maximum tenure limits. To meet the pressures from investors and regulators, boards should also be looking at gender diversity, cultural and ethnic diversity, board independence and IT expertise, in addition to experience and skills.
Board self-evaluations are a good first step to measuring whole boards and individual directors. Diligent Corporation’s Evaluations tool is the modern way to assess the board’s performance. As part of Governance Cloud, Diligent Board Evaluations assist companies in following best practices for good governance, refreshing board composition, and ensuring that practices and policies are up-to-date and working effectively. It’s the best alternative to unwieldy spreadsheets and templated surveys. Most companies find that they can administer the program and get great results without the help of a third-party administrator.
The Evaluations tool helps boards to review and assess board director skills as they relate to long-term strategy and the evolving changes within the marketplace. The design of various question types can help to cast a special focus on skills that are relevant to the changing needs of the company so that nominating committees can recruit directors with the capabilities to handle new problems. Solid evaluations pave the way for boards to recruit directors who have experience in data security, human resources, risk management and sexual harassment policies.
Boards can use Diligent Evaluations to monitor submissions, create visual graphics and Excel reports, and automate averages.
From Board Self-Evaluations to Effective Succession Planning
It’s a good practice for boards to set medium- and long-term goals for board refreshment and succession planning. A fairly new concept in Board Refreshment 101 is to establish a board renewal program with defined goals that set the board on pace for regular board refreshment. As an example, boards could work toward nominating at least one new board director every three years.
Diligent Corporation’s Nominations is a digital tool for succession planning that streamlines the process for identifying viable board and executive candidates. Nominating committees can use the tool to access over 125,000 profiles of potential candidates from over 5,500 companies. The search engine sorts profiles by experience, demographics, region, sector and discipline.
Diligent Evaluations and Nominations tools fully integrate with the rest of the board management software solutions that comprise Governance Cloud. These tools reflect the concept of modern governance where boards can keep their board compositions continually refreshed with a little help from technology.