Director removal: a five-point plan

There aren’t a lot of issues on which most shareholders and board members can agree. One exception: the need to make the process of removing directors from boards easier, no matter what the concern
By Richard Leblanc

Don’t let the sensational headlines fool you. If it takes an activist hedge fund’s power to oust a few directors from a listed company board, then it isn’t happening all that often. Even when you include directors dropped by fellow board members for performance issues and the like, it is exceedingly rare for a director to be removed from a board. According to Stanford researchers, only 2% of directors who step down are dismissed or not re-elected.

The vast majority of directors are re-elected and continue serving, in other words. Some directors serve on boards for up to 20 or 25 years. About a year ago, I counted 30 directors who served on Canada’s five bank boards for more than nine years. Nine years is the upper limit for independence now in the UK.

A board does not have the power to remove another director, even if that director is performing poorly. If the director digs in and refuses to step down, that director must be replaced at the annual meeting. It is rare for shareholders to remove a director at the meeting if he or she is renominated. Only 106 directors were dismissed out of a total universe of some 50,000 directors in 2009, according to Audit Analytics.

Shareholders have limited rights to propose or remove directors. A special resolution is needed, if shareholders can demonstrate cause, to remove a director, for example. HP, Yahoo, RIM, Chesapeake Energy and Bank of America—which have lost a combined $353 billion of shareholder value—are good recent examples of the difficulty of director removal.

The effect of the above entrenchment mechanisms is that shareholders are essentially shut out of the corporate governance process. They can neither propose nor remove directors without great difficulty and expense. This is a structural and systemic problem with governance—yet it can be easily remedied.

Reform can proceed on a number of fronts and on a number of levels. First, companies should begin by giving shareholders a greater say through, at a minimum, majority voting and not having staggered boards. Approximately half of public companies have staggered boards, which may insulate or entrench management. Each director should come up for election each year and be required to obtain a majority of all votes cast to continue on.

Second, performance of directors should be much more public so shareholders can make a more informed decision when they vote. The UK is the best here (disclosure of director performance) but much more can be done, in the U.S. and Canada for example.

Third, a tenure limit of 10-12 years at the long end makes sense. The UK, Hong Kong and Singapore have a nine-year limit. There should be an outer limit as this would help turnover, diversity and limit entrenchment. Ten years is a good number to retain institutional memory but not have a lifetime appointment. The Ontario Securities Commission (OSC) in Canada should give serious consideration to the effect of prolonged tenure on independence.

Fourth, the nominating committee should link the tenure of directors to the peer review. Canada started peer review of directors in 2005 and was one of the leaders here. Now other countries are following but the next step is linking the results of the peer review to continued tenure. Boards know who the nonperformers are but they should receive guidance from the OSC that it is good to link peer review to renomination. The OSC should also consider this, as it would address nonperformance. Also, the board knows the board best.

Finally, retirement age, if needed, could be set at 72 to 75, as the population is growing older (though boards may not need retirement ages if they have all of the above). And the research doesn’t support equating age and effectiveness. You can be 63 and ineffective and 74 and very effective.

So, greater performance information, majority voting, no staggered boards, a greater say by shareholders, a tenure upper limit of 10 years and linking renomination to peer review, are all practices that would enhance governance transparency, quality and accountability.

Richard Leblanc is an associate professor, governance, law & ethics, at York University’s Faculty of Liberal Arts and Professional Studies and a member of the Ontario Bar. E-mail: rleblanc@yorku.ca.

 

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