As the bar for director performance continues its steady rise, public company boards are expected to ensure that composition, skill sets, and core processes remain fit-for-purpose. The following infographic derived from the 2016–2017 NACD Public Company Governance Survey illustrates the different mechanisms boards are using to keep board composition and director turnover attuned to the organization’s evolving needs.
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The appropriate length of service by a company director is an emerging issue in corporate governance that yields varying responses among large shareholders, proxy advisors, and directors themselves. Recent board tenure concerns center around a director’s ability to remain independent after extended service, lack of industry expertise and technological familiarity, and poor diversity on corporate boards. Conversely, long-tenured directors can be beneficial because of their deep knowledge of the company acquired through service, the continuity and stability they offer, and their grasp of the historical perspectives that can inform current company strategy. As this issue continues to draw attention from various interested constituencies, corporations should continually assess board composition and consider their current policies on director tenure as shareholders become more attuned to extended service and its implications.
The Current State of Director Tenure in the U.S. and Abroad
No overarching law or regulation currently limits the length of board service in the United States. In fact, few United States public companies address board tenure directly in their bylaws. According to SpencerStuart, approximately 3 percent of company boards in the S&P 500 have specified term limits for directors. Only 17 companies in the S&P 500 set term limits for their directors in 2012, with no company adopting a term of less than 10 years. That same year, board turnover on the S&P 500 reached a 10-year low, reflecting the trend toward directors remaining in their positions.
Mandatory retirement ages are more common. SpencerStuart reports that 72 percent of companies in the S&P 500 have mandatory retirement ages, which reflects a 6 percent increase since 2003. Of those, the mandatory age exceeds 72 in 88 percent of corporate boards. Over the last 10 years, the percentage of boards with mandatory retirement ages of 75 or older has increased from 3 percent to 24 percent, while the percentage of boards with a mandatory retirement at age 70 decreased from 51 percent to 11 percent. Moreover, some U.S. public companies allow boards to waive the mandatory retirement age for directors, which is typically between age 72 and 75, according to David A. Katz and Laura A. McIntosh, authors of Renewed Focus on Corporate Director Tenure.
The lack of term limits and mandatory retirement ages promotes extended board service. Last year, 20 percent of U.S. corporate boards in the S&P 500 had an average director tenure of at least 11 years. The median age of directors was 63.
Director tenure limits are more prevalent outside the United States. The European Commission notes that an appropriate maximum tenure for a director is three terms, or 12 years. The United Kingdom employs the “complain or explain” model, which presumes that directors are no longer independent after nine years of service unless a company can explain why it has determined that a director remains independent after they reach the presumption threshold. France employs one of the most stringent guidelines for independent directors, capping director service at 12 years, though this does not give France the lowest average director tenure in Europe. That distinction goes to Germany, with an average director tenure of five years., Collectively, Europe has relatively shorter board tenures on average compared to the United States, which is 8.6 years. For reference, Spain has the highest average tenure in Europe at 7.7 years. In Asia, Hong Kong does not limit director service, but companies appointing an independent director to serve longer than nine years must employ a separate vote for the director using a special resolution.
Calls for Change
Recently, shareholder advocates have pushed director tenure to the forefront. Institutional Shareholder Services has been visible in highlighting potential issues with corporate director tenure, with its new Governance QuickScore 2.0 program. The product, which uses specific governance factors and technical specifications to rate company governance, takes director tenure into account. According to ISS, “[a] tenure of more than nine years is considered to potentially compromise a director’s independence.” ISS has not disclosed the weighting that each metric will actually have, so it is unknown how much impact long-tenured directors will have on a company’s QuickScore rating.
ISS has yet to alter its voting policy outside of QuickScore such that tenure can lead to a determination that a director is not independent. ISS does urge shareholders to vote against proposals to limit tenure by mandatory retirement ages or term limits, but it suggests shareholders scrutinize the average tenure of alldirectors if their tenure exceeds 15 years in order to promote independence and alternative perspectives.
State Street Global Advisors (SSGA) revised its view on board tenure in 2014 to reflect its support for board refreshment and planning for director succession. According to SSGA’s Head of Corporate Governance Rakhi Kumar, the new policy is “designed to identify companies with a preponderance of long-tenured directors, which may indicate a lack of refreshment of skills and perspectives . . . . [L]ong tenure may also diminish a director’s independence.” Though SSGA does not consider long-tenured directors to be entirely ineffective, SSGA discourages their presence on committees where “independence is considered paramount,” including the audit, compensation, and nominating/governance committees.
SSGA has indicated that it will screen companies based on whether their average board tenure is above one standard deviation from the average market tenure. If a company has a longer-than-average board tenure, SSGA will further screen it for (a) whether one-third of the non-executive directors have tenures in excess of two standard deviations from the average market tenure and (b) classified board structures. Following this screening, SSGA has indicated it may vote against the chair of the nominating committee, long-tenured directors serving on key committees, and/or (c) both the members of the nominating committee and long-tenured directors at companies with classified boards. SSGA, however, has not provided additional details on how it computes average board tenure.
The Council of Institutional Investors supports board turnover in order to guard against a “seasoned board member” losing his or her independence or thinking more like an insider over time. Further, CII’s policy highlights the high salaries that accompany director positions, and how the compensation fails to promote board refreshment. It is estimated that S&P 500 companies pay independent directors an average annual salary of $250,000. Despite an updated policy, however, CII refuses to deem its policy as endorsing a tenure limit, highlighting that removing long-tenured directors “could rob the board of critical expertise.”
Glass Lewis & Co. pushes back on the idea of an inflexible rule limiting director service. Glass Lewis believes such inflexible limits may not provide benefits or returns for shareholders. Its 2014 proxy policy thus reflects the idea that term and age limits are not in shareholders’ best interests, and that there is no evidence of a connection “between either length of tenure or age and director performance.” Nevertheless, Glass Lewis supports “periodic director rotation” through shareholder monitoring to promote fresh perspectives, new ideas, and business strategies. Glass Lewis notes that if a company does have an age or a term limit, shareholders should vote against the board waiving its self-imposed limit absent extenuating circumstances like a merger.
The Effects of Board Tenure Limits
There is no “one-size-fits-all” approach to board tenure. There are merits to imposing board tenure limits at some companies, specifically the potential to promote the independence of corporate directors by limited extensive service. Some directors may also become complacent or out of touch with the company or industry after extensive service. Replacing long-tenured directors may offer a new opportunity for the company to infuse fresh perspectives into the board, whether it may be in corporate strategy or industry expertise. In addition, boards can use mandatory retirement ages or term limits to avoid otherwise unpleasant conversations with directors whom the board believes should retire.
Despite the potential benefits of mandatory director refreshment, there is no strong indication that long-serving directors are not independent, which is the primary concern of those who criticize extended board service. A “one-size-fits-all” approach to term limits or mandatory board refreshment would restrict or remove experienced, knowledgeable board members arbitrarily and create situational difficulties for the company going forward. As noted above, long-tenured directors are often the most knowledgeable about the company and offer stability, particularly during changes in senior management. In addition, at some companies the most long-tenured directors often exercise considerable influence over less-tenured senior management. These factors balance heavily against any strict rule on board tenure. Additionally, term limits offer the potential to interfere with the development of effective collaboration among board members that have developed strong working relationships over the course of their tenures.
It remains to be seen if the increased attention on board tenure will have a significant impact on the corporate governance of U.S. public companies going forward, or if the international trends will be imitated in the United States. Mandatory term limits applicable to all U.S. companies are inappropriate. Rather, companies should continue to have the choice of whether to impose restrictions on board tenure. The important issue, therefore, is how companies make that choice. We suggest a thoughtful consideration of board composition by nominating committees, boards and shareholders on a case-by-case basis that considers tenure, expertise in the particular industry, knowledge about a particular company, diversity, director competency, and the company’s success over the director’s tenure. Boards must also carefully assess their own composition in light of various experiences, backgrounds, skills, and traits that could enhance board performance. Boards themselves, along with input from their shareholders via annual director elections and shareholder engagement, are best equipped to assess whether to retain or remove their own directors, and should not be burdened by a uniform rule that may potentially yield unintended consequences to the detriment of the company and the shareholders.
Steven Haas is a partner in Hunton & Williams’ Richmond, VA, office. He represents clients on corporate governance and M&A matters. He also regularly counsels clients with respect to corporate governance issues and fiduciary duty litigation.
The stakes are higher than ever before. Public expectations are greater than ever before. It is an immensely challenging business environment in which boards must now play a decisively stronger role to ensure the highest standards of corporate governance.
To that end, boards need to embark on a continuous process of self-assessment. We cannot do better tomorrow until we ask ourselves an important question:How are we doing today? Only where self-reflection is part of the board’s DNA can it provide the strategic guidance that defines its mission.
While many large and small questions drive self-reflection, three essential questions begin the process.
Are we independent?
There are often fundamental warning signs that a board is no longer thinking independently and that self-interest may be clouding its judgment. One is tenure. How long has each member served? Is it possible that, as a result of many years of service, some members have become too narrow in their perspective or that their own personal investment in the company might create a conflict when big decisions need to be made?
“It is generally agreed that director perspectives on a particular company can become stale and even compromised after many years of continued service,” according to the Bridging Board Gaps report by the Columbia Business School and the University of Delaware. “It may be difficult to remain objective about a company one has served for a long time.”
In other instances, circumstance simply makes independent judgment impossible. If a family business goes public, for example, family members cannot function as independent-thinking board members.
The self-reflection that a board needs to assess its own independence has to be a tough-minded, conscientious process. Hard questions need to be asked. But the board that has the courage to ask itself the hard questions is all the more likely to have the courage to act decisively to address critical problems in the future.
Do we have chemistry?
There has to be some real chemistry in the boardroom if discussions are to be open and free-wheeling. Board members have to trust each other. They have to feel free to float new ideas and challenge others. They don’t have to be best friends, but board members need a sense of camaraderie to assure a creative group dynamic.
An attentive, enthusiastic and engaged board means more efficient decision-making. Are your board members attentive, engaged and active? Are there certain directors who are not? Is there some adjustment, some way to change the chemistry to ignite a higher level of enthusiasm?
Do we have the right team?
Having the right team means building a well-constructed board, with members from a variety of backgrounds who are ready to meet the challenges ahead. Having the right team means a broad range of skills, talents and perspectives that can feed the company’s strategy in multiple contexts. It is a competitive necessity, reflecting varied work experiences, personal backgrounds and educational training.
Really think about your board composition. Do the directors around the table offer a diverse mix of industry experience? Do you have expertise across various disciplines such as operations, marketing and finance? Watch out for too much expertise in any one industry. Whatever the company’s business, independent input is essential if the board is to advise on the multiple opportunities and problems that confront management.
In fact, board members are often all the more valuable when they can see the company as other stakeholders see it.
Self-reflection is a never-ending process. Questions about your independence, chemistry and diversity must be constantly revisited and broadened to ensure optimal service.
Self-reflection is also a challenging initiative. Performing an objective, holistic evaluation of your board may require the engagement of independent professionals who stand ready to provide the benefits of their significant experience and intellectual capital.
Sometimes others need to see you before you can really see yourself.