According to Ian Goldin, Professor of Globalisation & Development at the University of Oxford and former Vice President of the World Bank: the pace and scale of change affecting all of us is unprecedented since the Renaissance.
With this unprecedented rate of change comes an extraordinary requirement that businesses evolve to stay relevant. And this evolution must begin at the top with the board of directors.
Interestingly though, corporate board directorship is still often thought of as a lifetime engagement. Much like Supreme Court Justices, directors of corporations once appointed, are often assumed to serve for the remainder of their lives or very nearly that. In fact, it is safe to say that we reside in a corporate culture that still assumes there is a problem when a director tenure is anything less than perennial.
This is not to say that institutional knowledge, wisdom, seniority and continuity are not good for a company and its board of directors. Indeed, they are, but to a point. In the aforementioned ever-changing business environment, it can be a great disservice to have a board that does not evolve as a business necessarily must. The best boards and the companies they serve view themselves as a strategic asset and as company strategy evolves they must adjust accordingly.
The opposite is also true. There are numerous boards with too many long-serving directors and this can cause or exacerbate issues. For example, since August 2017 Wells Fargo has changed or retired four directors with tenures of between twelve and fifteen years. This was of course after their debacle with fake accounts.
These days board of directors evolvement is commonly referred to as board refreshment. Corporate leadership as well as investors are waking up to this concept while hotly debating the specifics of why, when and how. According to Institutional Shareholder Services’ (ISS) 2016-2017 Global Policy Survey among 120 institutional investors, 68 percent pointed to a high proportion of directors with long tenure as cause for concern.
The “why” has already been discussed above. In terms of “the when” there are two major considerations. One is director independence and the other is director performance.
Regarding director independence, U.S. listed companies are required to have independent directors as defined by the various stock exchanges. This independence typically pertains to employment, compensation and other service relationships for the director and their immediate family members. The independence I am referring to here is independence of thought and it is important to realize that this is not static. Even when a board director starts off as independent, with time and the ensuing relationships that develop, this independence erodes.” “The UK Corporate Governance Code assumes that directors lose their independence after 9 years of service, on the theory that they become too defensive of the status quo or too close to management to effectively fulfill their oversight role after that. Most stand down before that point.” “CalPERS, the Californian pension fund, sets a cut-off of 12 years, after which it deems directors to lose their independence.” No matter the exact number of years, the underlying concept is the same. Directorship should not be infinite.
Director performance is another idea whose time has finally come. It used to be that director performance was taken for granted and as such evaluation was not necessary. This was the case despite the preeminence of the role and even though we are all very accustomed to regular evaluations from the time of report cards in elementary school. According to the 2016 Deloitte Board Practices Report, 93% of large cap companies perform a full board evaluation while just 21% do an individual peer evaluation. If boards are to evolve to meet the requirements of the ever-changing competitive environment, then we need to begin with an understanding of the performance of the current directors.
The “how” of board renewal typically comes down to age limits and term limits. 81% of large cap companies have age limits while just 5% have term limits according to the previously mentioned Deloitte survey. Hopefully we get to a point where more companies conduct individual director evaluations and performance and effectiveness are used to determine whether a director continues to serve. Finally, as Activist Investors have increased in size and predominance, and since they often use director replacement as a strategy with the companies they are invested in, this too has become another way in which boards evolve and improve (even if sometimes they do not agree.)
The composition of the board must reflect the company’s current strategy. Strategy evolves and as such, so must the board. As more begin to appreciate this simple concept, the complexity of executing on it will seem well worth the challenge.
Thank you to Patricia Lenkov, Senior Managing Director at Teneo, for giving us permission to reproduce this article.
