Shareholder activists have long found success in running slates of candidates whose expertise and backgrounds appeared stronger and more relevant than those of the incumbent board members; CP Rail is a classic example. But now, board composition is becoming a focal point for proxy voting. Last year, State Street Global Advisors sought greater engagement at companies with lengthy board tenure; Blackrock is expected to follow suit in 2015. Even Institutional Shareholder Services has begun to factor both director tenure and board diversity into its governance ratings.
Regulatory measures, like the OSC’s new disclosure requirement around board tenure and diversity policies, are also focusing on board composition. British governance regulations go even farther—they now consider any director with a tenure over nine years to have lost his/her independence.
The only real protection any board has from challenges to its make-up is company performance; if the stock’s doing well, nobody asks any questions about who’s sitting at the board table. But the minute it slips and the more it slips, scrutiny on board composition is inevitable: by the media, by rank-and-file shareholders at the AGM or by activists pushing an alternate slate. And once a company is facing the latter situation, it’s too late to start recruiting.
So, what’s a board to do? Here are three things that can help reduce boardroom vulnerability:
1. Identify board skill gaps. If you were facing a proxy contest with a shareholder activist, they’d be quick to see the gaps in your board composition. So, get out ahead of this issue and be honest about what’s missing: Do you lack industry expertise? Do you continue to renominate directors whose backgrounds no longer align with the company’s business and strategic direction? Or those who have clearly passed their “sell by” date that no one will be honest with?
When I work with boards on this issue, I ask both directors and senior management one key question: “If you were going to bring just one new director on to your board, what expertise or background would you consider a priority?” Then, go out and get someone who has that background and bring him or her onto your board NOW. Don’t wait for your next retirement; you can manage down the size of the board later on.
2. Develop a vibrant board talent pipeline. The quality of board talent out there is staggering. Yet while most boards realize they need to go beyond their own rolodex to find high-calibre talent, many are reluctant to hire a search firm, given that most director searches involve retainers with no guarantee of performance. However, different fee structures are now emerging to enable boards to expand their reach into interesting talent pools at far less cost than a retainer-based search.
3. Take a 21st-Century approach to board performance management. The Institute of Corporate Directors’ recent white paper, “Beyond Term Limits: Using Performance Management to Guide Board Renewal,” makes the point that performance management is a far better approach to board renewal than term limits. Who can disagree? If you’ve got a great director who’s contributing significant value, you should renominate that person even if they’re 75 years old and have served for more than a decade.
The problem, however, is that many boards aren’t actually doing a very good job on performance management: a recent PWC study of over 800 U.S. directors found that 36% felt one of their fellow board members should be replaced. So what kinds of board and director evaluations have real merit? Internally led director evaluations lack credibility; so do survey style board evaluations. The UK’s 2014 Corporate Governance Code requires British companies to disclose in their annual reports how they conduct performance evaluations of the board and individual directors—and the code requires board evaluations for FTSE350 companies be externally facilitated every three years.
BOARD COMPOSITION is probably the single most important factor in any board’s overall effectiveness. As such, it’s no wonder that shareholders are now seizing on this issue. Nominating and governance committees need to have a tough discussion about this issue in 2015 and get out ahead of it—before someone else comes up with a new slate for your board that holds more shareholder appeal.
Beverly Behan is a New York-based board consultant who has worked with more than 100 boards of directors in the U.S., Canada and internationally in the past 17 years. E-mail: firstname.lastname@example.org.