The reality of the modern board is that directors don’t just come, but also go.
They might choose to leave of their own accord, or they might need to be removed or replaced. Regardless of the situation, preparing for the inevitable departure of board members is almost as important as recruiting them in the first place.
Alternatively, they might leave because the company decides it’s time for a refresh. Board composition is critical to board success, and assessing the makeup of the board and actively refreshing a board by replacing some of its members can help ensure the board’s success.
Every director influences the way the board executes its duties and serves the company’s stakeholders, while also bringing personal experience and a unique perspective to the table. Even a small adjustment to the composition of a board can have a big — and often positive — impact.
There are a number of situations that may call for a board refresh or the removal of one director in particular, and a number of options as to how to do it.
Director Performance and Behavior
With power comes responsibility. Sadly, not all directors are able to perform at a level that meets the board’s and the organization’s standards. Misconduct and unethical behavior are obvious reasons to consider the removal or replacement of a director. Diminished performance, an inability to operate as expected, and/or the lack of time that’s needed to serve effectively can also lead to a director’s removal.
As a result of its 2016 Annual Corporate Directors Survey, PricewaterhouseCoopers (PWC) found that 35 percent of directors believed that someone on their board should be replaced. Whether said board member is ill-prepared for meetings, lacks the necessary expertise, is aging out of the role, or is overstepping boundaries — all of which were cited as primary factors affecting the need for their removal — directors felt the board would be better served by releasing a member from their duties. At the same time, the PWC survey revealed that investors are becoming “more vocal about who’s sitting in the boardroom,” reporting that in 2016, 61 percent of executives serving on a board added a director to satisfy the need for a particular skill set.
If a director is unable or unwilling to produce the outcomes the board and the organization are looking for, companies often have no choice but to seek a replacement.
Conflict of Interest
Given that many executives hold a C-suite-level position with a separate organization while serving on a board of directors for another company, the possibility of a conflict of interest is relatively high. A director may have a vested interest in a firm that makes a competing product, or prior knowledge of an upcoming merger or acquisition that could affect how the board votes on a key issue.
It’s important that boards introduce a conflict-of-interest policy, which the National Council of Nonprofits explains should “require those with a conflict (or who think they may have a conflict) to disclose the conflict/potential conflict,” and “prohibit interested board members from voting on any matter in which there is a conflict.”
Even with such a policy in place, potential conflicts related to personal financial interests, family ties, ethics or conduct might arise. If it becomes clear that a director isn’t voting with the company in mind, the board must be committed to putting its own interests first.
The Growing Need for Diversity
Board diversity remains a hot topic among companies at all levels, but according to Deloitte’s 2016 Board Diversity Census of Women and Minorities on Fortune 500 Boards, “gains made in recent years with regard to the inclusion of women and ethnic minorities on boards have been negligible at best.”
For example, Deloitte reported that the presence of black women board members at Fortune 500 companies has increased by about 18 percent since 2012. However, the number of black male board members only grew by 1 percent. Caucasian women saw an increase of 21 percent while Asian/Pacific Islanders “have shown continued growth,” but the latter only represents 3 percent of all board seats today. And although there are more Fortune 500 board seats held by Hispanic men today than there were five years ago, the number of Hispanic women serving on boards has recently decreased.
The need for more diversity on corporate boards is a driving force behind the decision to replace a board member. Boards increasingly recognize the value of diversity. According to the Harvard School of Public Health, adding women to a board can improve company performance, produce a more diverse employee population overall, and generate more diverse viewpoints and perspectives, the benefits of which include a stronger corporate focus on long-term priorities. Appointing both women and ethnic minorities is also widely considered to be a corporate governance best practice that can “alleviate the problem of ‘director shortage'” and make better use of all available talent, according to the Association of Chartered Certified Accountants.
In order to diversify a board, though, there needs to be space for new members. The PWC’s Corporate Directors Survey states that 46 percent of directors brought on a new member to diversify the board last year based on pressure from investors. This may require the board to secure a director’s resignation.
An ongoing focus for investors and shareholder activists, according to the Harvard Law School Forum on Corporate Governance and Financial Regulation, director tenures have their benefits and their downfalls. While a long tenure can result in “deep knowledge of the company acquired through service,” Steven Haas, a partner with law firm Hunton & Williams reports for the National Association of Corporate Directors, it can be an issue if a board member lacks industry or technological expertise, as well as if the board needs to diversify its membership. In fact, a survey conducted by Institutional Shareholder Services Inc. determined that 68 percent of institutional investors and members of the corporate community believe “a high proportion of directors with long tenure is cause for concern.”
Part and parcel with the issue of director tenure is youth diversity, which can help companies identify and address key business issues affecting Generation X and millennial customers, and remain relevant in an exceedingly sophisticated digital world. PWC’s Annual Corporate Directors Survey noted that 34 percent of directors added a younger director to the board in 2016, again to meet the demands of their investors.
There are times when a company may find that it isn’t necessary to remove a director because the board member resigns voluntarily. Whether due to the inability to keep up with board demands, or the fact that the company’s values and interests clash with their own, a board member may have no choice but to take their leave.
This opens up an opportunity to address some of the board composition concerns mentioned above, including diversifying board membership and inviting younger directors to accept a seat at the table.
How to Remove a Board Member
Voluntary resignation aside, there are several ways in which a company can remove a director from the board.
Leave of Absence
One approach is to offer the board member a leave of absence. This is a good choice if the director in question has been underperforming due to a personal issue like a family conflict or a health concern. Implementing a leave of absence provides the director with the opportunity to address urgent matters and, if successful at mitigating them, return to the board with renewed focus at a later date.
Should a company choose to take this tack, business resource Nonprofit Hub recommends that the board implement a policy that outlines how it intends to treat leaves of absence; how long they should last; what powers, if any, the director will have while on leave; and how their temporary departure will affect quorum numbers — the minimum number of board members needed for a vote — as a board with no quorum will need to adjourn its meetings until the director vacancy can be addressed. “Before granting a leave, have these discussions with both the board and board member,” wrote Lincoln Arneal, senior editor at Nonprofit Hub.
The Boston Globe reported in late 2015 that term limits and their role in removing long-time board members remain “one of the touchiest topics in corporate America.” At the same time, columnist Shirley Leung noted, “While every board needs veterans, it’s just as important to cycle in the new blood who have kept up with all the changes in business.”
Implementing a term limit offers more control over board composition in general, and may come in handy should a board feel the need to cycle out one of its members. It also has its benefits as a preventative measure, as it can encourage directors to remain passionate and engaged in their work for the board, thus decreasing the odds that they will need to be removed later on.
Term limits can vary dramatically from one company to the next. In an article on board best practices, management consulting firm McKinsey & Company pointed out that some organizations invite non-executive directors to serve on the board for a full 10 years, while others limit membership to six or seven years.
It isn’t the length of the term that matters so much as the fact that a limit has been placed and members know that, at some point or another, they will be rotated out. As noted by nonprofit resource GuideStar, serving on a board can be grueling work, and after multiple terms, a director can grow weary and even apathetic. “Automatically providing for an ending time frame allows the effort to stay focused during the term(s) of service [and] then insures there is time away to recharge the batteries,” the organization wrote. “It also insures an outside perspective is gained prior to possibly returning to board service later.”
While it should be considered a last resort, impeachment can be used to remove a member from the board through a vote. Every board’s bylaws should outline a course of action for petitioning for the impeachment of a director who has egregiously abused their position and is causing the organization, its shareholders or its stakeholders harm. Failing to meet their fiduciary responsibilities by not acting in the company’s best interests, engaging in fraudulent or illegal activities like the embezzlement of corporate funds, and obstruction of justice are also reasonable cause to consider impeachment.
Financial and investment resource The Balance recommends that directors avoid rushing into the decision to impeach a fellow board member, and consult the company attorney in an effort to prevent a lawsuit and ensure that they have allies on the board who will vote with them. “Afterwards, make changes carefully,” author and business coach Jean Murray writes. “Do you need to replace this board member? Ask the board to consider what can be done differently to avoid this type of issue in future.”
Difficult though it may be, removing a board member can be an unavoidable by-product of building and maintaining an effective board of directors. Understanding why removal might be necessary and making prudent choices with regard to how the director leaves the board, can assist in keeping operations running smoothly and preserving vital director relationships.
Interested in taking further steps to improve your corporate governance and board operations? Contact Diligent for a demo of our board portal solution today.