Institutional investors are increasingly looking at today’s boards of directors with a critical eye to make sure that they have the knowledge and expertise to meet the demands of strategic planning and oversight in today’s marketplace.
Investors express vast concerns about corporations that cling to long-standing governance practices that allow boards to become stagnant and unproductive. As the push continues for independence and diversity among board directors, board refreshment is becoming the norm. New boards bring fresh ideas, perspectives and strategies that strengthen the board’s expertise.
The age of directors and the length of their terms are prime factors on refreshing a board. Investors and other stakeholders are taking a closer look at individual director terms, as opposed to looking at average director terms, as they’ve done in the past.
Board directors are starting to realize that they need to reassess whether their current nomination processes need a contemporary facelift to give them the level of freshness and independence they need. Today’s regulatory climate calls for evaluating alternative governance policies and practices that lead to polished and productive boards.
A QUICK PEEK AT THE HISTORICAL VIEW OF BOARD FUNCTION
Boards of directors have historically served as little more than financial fiduciaries and stewards for the shareholders. A random few boards still view themselves as fiduciaries, but today’s boards truly have many more responsibilities. Their main roles extend to strategic planning, monitoring, oversight, planning for the competition and evaluating threats.
TAKING A FRESH LOOK AT TERM LIMITS AND AGE LIMITS
With rare exceptions, endless term limits and term extensions are quickly becoming a thing of the past. Board directors are often willing and able to serve longer terms than in the past. People are healthier and more active than ever before. They work longer before retiring, and they’re living longer in general. The average age of directors who serve on boards has increased over time. As a result, many boards have formed policies that state mandatory retirement ages and have increased the ages as they see fit.
Several European countries have taken the lead and placed caps on term limits at 10 years or less. The United States is on the front end of following that trend. According to our latest research, the average term of board directors is between six and 10 years. It’s gradually becoming accepted within the financial industry that term limits are a viable way to promote director independence and keep board director skills fresh.
As long-term board members begin to age, sometimes their talents become outdated. Many corporations are finding that they need to set age limit guidelines for board members so that they can cycle in fresh talent that has the skills and abilities to effectively make decisions for the corporations of today. We live in a highly technical world, and boards need board directors who understand the technological terms and issues like cybersecurity. While boards need to establish age limits, the guidelines should allow some amount of flexibility to waive or increase the age limit on an as-needed basis. There are times when board members rely heavily on older, long-term board members who have unparalleled expertise. It wouldn’t help the board to prematurely end the term of a valuable board member, regardless of his or her age.
ISSUES THAT DRIVE RECRUITMENT
Many boards of directors lack a formal plan for board refreshment, preferring to let it occur passively. Board turnover often happens passively because of shareholder activism or elective retirement, but those are less effective ways of revamping a board.
Contemporary corporate governance principles encourage a natural refreshment cycle where a governance or nominating committee assigned by the board develops a specific designated plan for nominations. Board refreshment by design takes the personal nature out of relieving board directors of their terms and sets a natural refreshment cycle into play.
The preferred process is for governance committees to set a schedule of activities that leads to a board composition that follows corporate governance principles and meets the needs of the corporation. Governance committees typically begin by reviewing the current board’s composition, succession plans and rotation schedules. The next step is to map out the skill sets that the company needs according to the long-term plan, and then try to identify any gaps. Next, the committee needs to determine if they need to make any changes in the rotation schedule and recommend changes to the bylaws accordingly.
Robust board director self-evaluations and peer review evaluations play a significant role in evaluating the freshness of the board. Peer reviews often lead current board members to the realization that their skills are outdated, and they are more willing to move on voluntarily. Standardized nomination processes help to set up the expectation that board members are required to maintain competitive skill sets during their tenure on the board.
It’s acceptable to use recruitment firms to help fill the gaps in board talent. However, boards make a mighty mistake in allowing recruitment firms to drive the nomination process on their own.
In light of keeping boards refreshed and following good corporate governance, many boards are also creating policies about “overboarding.” It’s common practice for board directors to serve on multiple boards. Directors who serve on too many boards often lack the proper time or attention for any of them. Many boards are finding that they get the most from their board directors when they have a limit of serving on a maximum of five to 10 boards.
Boards that take their investors’ input into account may divert some amount of shareholder activism or unrest. Part of the process of refreshing the board may include identifying gaps between company governance and investor expectations. Taking this step gives the board the ability to develop a plan to close those gaps over time. This strategy works best when the board communicates their plans to the investors upfront.
DIVERSITY: LOOKING BEYOND GENDER AND INDEPENDENCE
There’s no question that the issue of diversity has become a hot topic in the corporate world. The subject of diversity typically takes the form of discussions about seeking directors who are independent, women, or both. This pressure is generating more women directors than ever before. While gender and independence are important factors in board composition, there are several other types of diversity to enhance board refreshment, including:
- Diversity of thought and action
- Ethnic diversity
- Generational diversity
- International diversity
- Technical diversity
Boards that take the time to develop a standardized nomination process will reap the rewards of a well-constructed board. A strategic process for board refreshment develops boards that are diverse, independent, dynamic and engaged.
What does that look like in practice? It’s a board that has the proper industry expertise and can ask the tough questions to get the answers they need to perform their duties of strategic planning and oversight. Well-composed and well-qualified boards have the necessary skills to challenge management, and also to challenge the hard issues from all different perspectives.