Board refreshment: are evaluations preferable to retirement policies?

Cooley LLP
Contact

Cooley LLP

A new report from The Conference Board (together with ESG data analytics firm ESGAUGE) , Board Refreshment and Evaluations, indicates that, in pursuit of board diversity—in skills, professional experience, gender, race/ethnicity, demography or other background characteristic—companies must overcome one key impediment: relatively low board turnover.  One approach is just to increase the size of the board; another is through “board refreshment.” To that end, the report observes, companies are relying less on director retirement policies based on tenure or age—which may sometimes be viewed as misguided and arbitrary—and looking instead to comprehensive board evaluations, sometimes conducted by a facilitator, as a way to achieve board refreshment. The Conference Board advocates that companies foster a “culture of board refreshment” that removes any stigma that could otherwise attach to an early departure from the board. In any event, The Conference Board cautions that “companies should expect continued investor scrutiny in this area. Indeed, while institutional investors may defer to the board on whether to adopt mandatory retirement policies, many are keeping a close eye on average board tenure and the balance of tenures among directors and will generally vote against directors who serve on too many boards.”

The report contends that, with current low turnover rates, companies may find it especially challenging to enhance their board diversity. Among directors of companies in the S&P 500, only 9% are newly elected—and that percentage has been the same since 2018.  In the Russell 3000, the percentage increased from 9% in 2018 to 11% as of July 2022. The report suggests that there are a number of different approaches to achieving board diversification through board refreshment, including policies that mandate retirement as a result of age or tenure, limit overboarding or require retirement upon a change of primary professional. However, The Conference Board considers promoting “a culture of board refreshment” to be the “most important step that boards can take.” What does that mean? It generally refers to cultivating a climate in which it’s fully acceptable for directors to rotate off a board before they are required to do so. A culture of board refreshment “can be created not only by establishing guidelines on average board tenure, but also through setting initial expectations for director tenure through the director recruitment and onboarding process, as well as having candid discussions during the annual board evaluation and director nomination processes about how the current mix of directors matches the company’s needs. Such processes reinforce the message that no stigma is associated with rotating off a board before one is required to leave.”

According to the article, the current trend is away from mandatory retirement: as of July 2022, among companies in the S&P 500, only 6% have mandatory tenure-based policies (4% in the Russell 3000), with the most common tenure limit being 15 years, followed by 12 years. The report indicates that the average departing director tenure has increased slightly at larger companies in recent years and decreased at smaller companies.

And, although mandatory retirement policies based on age are “still common,”  they are on the decline: among companies in the S&P 500, 70% had a mandatory age-based retirement policy in 2018 compared to 67% in 2022, and the percentage decreased from 40% to 36% in the Russell 3000 over the same period. Moreover, the article reports, more flexibility is being included in retirement policies in the form of exceptions and increases in the retirement age: “the share of S&P 500 companies whose policy permits no exception declined from 41 percent in 2018 to 34 percent as of July 2022, and from 24 to 18 percent in the Russell 3000[, and] the share of S&P 500 companies with a retirement age of 75 rose from 39 percent in 2018 to 49 percent as of July 2022, and from 42 to 52 percent in the Russell 3000.” Notwithstanding these policies, however, the average director age has remained the same in recent years: 63 years in the S&P 500 and 62 years in the Russell 3000, according to the report. Some contend that mandatory retirement policies are arbitrary, requiring directors to retire “even when they are still valuable and strong contributors.” On the other hand, permitting boards the discretion to make exceptions may “not only be viewed as favoritism but also impede board turnover.”

The Conference Board cautions that investors are attentive to these issues, even though they may defer to board policies in general.   Investors are nevertheless attuned to board composition in terms of tenure, and many institutional investors will vote against overboarded directors. The report suggests that larger companies are more likely to have an overboarding policy that applies to all directors, and smaller companies more likely to have no policy at all: 72% of companies in the S&P 500 have an overboarding policy, up from 64% in 2018 (50% in the Russell 3000, up from 45%). Limits are most often set at three or four additional board seats. The report also observes that, while the number of directors that serve on more than one board has grown recently, most hold only one additional board seat. The authors suggest that an overboarding policy is one way to “prompt a thoughtful discussion between companies and their board members as to whether the director should step down from a particular board.”

Instead of retirement policies, which seem inevitably arbitrary—what is the right age to mandate retirement for all directors?—The Conference Board suggests that periodic individual director evaluations can promote board diversity and refreshment. Based on discussions with in-house corporate governance professionals, The Conference Board concluded that “individual director evaluations and/or the use of independent facilitators allow companies to have fruitful discussions about many challenging topics, including the skills and expertise needed on the board in the current environment, and in fact can lead to changes in board composition.”  This practice has been increasing in popularity, together with the use of independent facilitators. The report indicates that, as of July 2022, 99% of companies in the S&P 500 and 97% in the Russell 3000 disclosed that they had conducted board evaluations. The Conference Board found that 52% of companies in the S&P 500 in 2022 were “conducting a combination of full board, committee, and individual director evaluations,” compared with only 37% conducting this combination in 2018, whether through self-assessments, peer evaluations and/or with the use of an independent facilitator.

Disclosure of the use of independent facilitators for board evaluations is also a growing trend, more commonly among larger companies. The report found that, as of July 2022, 29% of companies in the S&P 500 and 15% in the Russell 3000 disclosed engagement of an independent facilitator compared with only 14% and 6%, respectively, in 2018. In addition, in 2022, 42% of companies with annual revenues of $50 billion or more disclosed use of an independent facilitator, compared with only 5% of companies with annual revenues under $100 million.  The report notes that companies “have found that they do not need to evaluate individual directors or use outside facilitators every year; indeed, these reviews can be more effective and less disruptive if conducted every two or three years.”

In conclusion, the report perceives particular value in “tools that focus on triggering discussions of turnover or reinforcing a culture of board refreshment.” The tools identified include “overboarding policies, policies requiring directors to submit their resignation upon a change in their primary professional occupation, guidelines on average board tenure, individual director evaluations as part of the annual board self-evaluation process, and informal discussions that set an expectation that directors do not need to serve until they are required to leave, but rather should consider whether their contributions are still relevant to the needs of the company. Unlike policies that mandate turnover, such as term limits and retirement policies, these more flexible tools can lead to a more thoughtful process in proactively aligning board composition with the company’s strategic needs.”

[View source.]

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.

© Cooley LLP | Attorney Advertising

Written by:

Cooley LLP
Contact
more
less

Cooley LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.