Director Tenure Draws Increasing Investor Attention

by Akin Gump Strauss Hauer & Feld LLP
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The Wall Street Journal recently highlighted director tenure in an article titled “The 40-Year Club: America’s Longest Serving Directors.”1  While the article noted that fewer than 30 public company directors have at least 40 years’ tenure,2 the article also made clear that many public company boards are having difficulty refreshing their ranks.  According to the latest Spencer Stuart Board Index, the boards of S&P 500 companies elected 339 new independent board members this past proxy season, down 11 percent from five years ago and 14 percent from 10 years ago.3  Last year they elected just 291 new directors, the smallest number in more than a decade.4  At the same time, the average age of directors continues to climb.  The average S&P 500 director is now 62.9 years old, compared to 60.3 ten years ago.5  In addition, mandatory retirement ages keep rising.  Of the 72 percent of S&P 500 boards that have a mandatory retirement policy, 88 percent now set their retirement age at 72 or older (compared to just 46 percent a decade ago) and almost a quarter set the retirement age at 75 or older (compared to just 3 percent ten years ago).6  At 20 percent of S&P 500 companies, the average board tenure is 11 years or more.7

Low director turnover is drawing the attention of activist investors and governance advocates who question whether aging boards are keeping pace with the rapid technological advances and other new challenges companies face.  Critics also charge that the limited availability of new board seats hampers opportunities for achieving greater racial and gender diversity on boards and compromises board oversight since long-serving directors are more likely to align with management.8  The Council of Institutional Investors, whose members consist of pension funds with more than $3 trillion of assets under management, recently revised its best-practices corporate governance policies to include tenure as a factor boards should consider when determining whether a director is independent.9  In addition, while ISS decided not to revise its 2014 proxy voting guidelines to add tenure to the factors it considers when assessing director independence, 74 percent of institutional investors responding to ISS’ request this past summer for comment on its guidelines viewed long tenure as problematic.10  In sharp contrast, 84 percent of responding issuers said that long tenure was not problematic.11

Recent academic research lends some credence to the critics’ position.  According to a recent study, the value of companies rises as the average tenure of outside board members increases to nine years, after which company value begins to decline.12  The study’s author posits that as directors gain firm-specific knowledge early in their tenure, their companies experience better performance, but once a threshold is reached, director oversight declines and company value slips.  The author notes, however, that a one-size-fits-all approach to board tenure may not be appropriate since the relation between board tenure and firm performance varies across industries and firm characteristics.  For example, at companies with complex operations and many intangible assets, the study found that optimal average board tenure is closer to 11 years.13  Earlier studies, however, on the effect of board tenure on corporate performance or governance have reached conflicting results.14

While term limits and mandatory retirement age policies facilitate board refreshment, they do so at the risk of loss of directors with highly valued firm knowledge, expertise or perspective.  Even boards that have set a mandatory retirement age implicitly acknowledge that the key focus should be on performance rather than age as the board typically retains discretion to waive the requirement in order to retain a valued director.

Of course, addressing an underperforming director, whether it be due to age or some other factor, is a delicate issue.  Nearly half of directors responding to a recent survey cited difficulties in replacing an underperforming director, with the most common reason being unwillingness on the part of board leadership to deal with the issue.15  To align board composition with company needs, a board’s nominating and governance committee should determine the optimal mix of talents and experiences that will help the company achieve its strategic plan and manage its risk profile and then identify any gaps in board composition.  By focusing on the company’s future and the attributes and skills needed to get the company there, this approach avoids criticism of any individual director’s experiences or skill set and provides a clear path towards achieving greater board competency.16  A robust board evaluation process that includes individual director assessments can help identify any performance issues.

This post was excerpted from our Top 10 Topics for Directors in 2014 alert.

1   J. Lublin, “The 40-Year Club:  America’s Longest-Serving Directors,” The Wall Street Journal (July 16, 2013).

2   Id.

3  2013 Spencer Stuart Board Index at p. 6.

4  Id. at p. 8.

5   Id. at p. 6.

6  Id. at p. 16.

7 Id. at p. 17.

8 K. Gladman and M. Lamb, “Director Tenure and Gender Diversity in the United States: A Scenario Analysis,” GMI Ratings (June 2013).

9  Council of Institutional Investors, “CII Members Approve Two New Corporate Governance Best Practices” (Sept. 27, 2013).

10   ISS, 2013-14 Policy Survey Summary of Results (Oct. 2013) at p. 11.  ISS currently recommends a vote against management and shareholder proposals seeking to limit the tenure of outside directors through mandatory retirement ages.  ISS also recommends against management proposals to impose term limits on outside directors.  However, in this situation, ISS will “scrutinize boards where the average tenure of all directors exceeds 15 years for independence from management and for sufficient turnover to ensure that new perspectives are being added to the board.”  ISS, 2013 U.S. Proxy Voting Summary Guidelines (January 31, 2013) at p. 17.

11  Id.

12 S. Huang, Zombie Boards: Board Tenure and Firm Performance (July 2013), available at Social Science Research Network.

13 Id. at pp. 17-18.

14 See summary of studies in G. Berberich & F. Niu, “Director Busyness, Director Tenure and the Likelihood of Encountering Corporate Governance Problems” (Jan. 2011) and in S. Huang, supra.

15 PwC’s 2013 Annual Corporate Directors Survey at p. 7.

16 See Deloitte, “Creating the board your company deserves:  The art – and science – to choosing directors.”
 

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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