Most would agree that a cornerstone of effective corporate governance rests with having a sufficient number of independent directors on the board. This is for good reason—boards must consider first and foremost the interests of the corporation and shareholders, ahead of everything else including executive management.
We see much “noise in the system” about whether long-serving directors—regardless of whether they meet any of a number of definitions of independence—should continue to be viewed as truly independent. Shareholder advisory services are looking at the issue, and institutional investor CalPERS recently called for a “comply-or-explain” approach for directors with more than 12 years of service. And now an article in a recent issue of a leading corporate governance journal supports and exacerbates this concern, saying “ever growing board tenure casts a shadow over many directors who are still legally independent, creating a caste of ‘new insiders’.”
The writer says the increased attention to this issue is “not without merit,” arguing that long tenure may adversely affect independence by:
Tightening ties with each other and management, thereby limiting directors’ ability to act independently and creating aversion to conflict in the boardroom
Increasing directors’ financial stake in the company, which can adversely affect independence and cause them not to “rock the boat”
Increasing dependence on management for re-election—since management holds effective control on the nomination of directors, causing directors’ reluctance to challenge their peers or management.
I’ve no doubt the writer means well. But the reality is that there is absolutely no established cause-and-effect correlation between tenure and these kinds of assertions. And for those who have indeed sat in the boardrooms of major companies, experience shows that long tenure can be and often is a tremendous positive asset in providing highly effective corporate governance. Let’s take a look.
While it is true in past years we’ve seen some directors who have faded in the boardroom and outlived their usefulness, it is more likely that directors sitting in board seats for many years provide a wealth of knowledge, expertise, and know-how that often is critical to effective corporate governance.
Strong relationships with other directors and the CEO
The more effective boards I’ve dealt with indeed do have strong relationships among the directors, where ties built up over years provide an element of trust from director to director sitting at the board table. In fact, such trust establishes a sound basis for board members to raise the tough questions and challenge one another. These boards also have good relationships with the CEO, enabling clear two-way communication such that the board is fully and timely apprised of new developments, risks, and opportunities, facilitating coming to agreement on relevant strategic refinements and courses of action. So, rather than limiting directors’ ability to act independently and creating aversion to conflict, we find the opposite is true, where long tenured directors with close ties are better positioned to appropriately challenge each other and management as necessary.
Increasing directors’ financial stake in the company
Investors and corporate governance experts have long maintained that what we don’t want are directors with little if any stake in the company. Rather, it’s become generally accepted as leading practice for directors to have significant “skin in the game,” occurring through at least part of their compensation being in stock along with guidelines for directors to purchase additional stock. Why is this? It’s simply because board members who have a financial stake in the company are more likely to carry out their responsibilities with greater care. Beyond their legal duties of loyalty and care in representing the shareholders, they also have much to gain or lose depending on the degree of corporate success. To say that a financial stake decreases independence and propensity to “rock the boat” by challenging management defies credibility.
Increasing dependence on management for re-election
I’m still trying to get my arms around this argument, which is based on the notion that “management holds effective control on the nomination of directors”! This statement might have had an element of truth many years ago, but today it is hard to fathom how it represents any sort of reality. It is companies’ nominating and corporate governance committees that control the process. Yes, many such committees seek input from the CEO on new director candidates, to help ensure the individuals’ skills and attributes are relevant to where the company is today and will be going tomorrow, as well as whether it is expected that the candidate will work well with the board as a whole and in turn will facilitate working effectively with the CEO. But make no mistake, in today’s world for public companies, management does not control who sits in the board seats.
The writer goes on to focus on board audit committees, noting with concern that almost 12 percent of S&P 500 companies have average committee tenure of 11.8 years, with three percent over 15.7 years. Hmmm, let’s think about this. First, we’re talking about a very small percentage of S&P 500 companies. Second, and much more important, is whether long-tenured audit committee members do an effective job. From my experience, it can take years for a new audit committee member to develop an in-depth knowledge of the accounting principles, estimates, judgments, and other factors going into developing a company’s financial reports. Further, directors who have been in place over time usually have significantly better knowledge of the company—and its strategy, business, operations, processes, financing, transactions, and related activities—essential to providing a sound basis for evaluation of the content of financial statements and related information. For one, give me audit committee members who have not only the technical skills—in accounting and auditing standards and SEC regulations—and experience in developing or analyzing financial statements, but also have in-depth knowledge of the company. Case in point: an individual I know well is also a member of several major company audit committees; he led the national office of a Big Four accounting firm advising the firm’s engagement partners and ruling on the most difficult accounting and auditing and reporting issues imaginable; he was a leader in setting accounting standards; he continues to keep current on financial reporting requirements, and he understands the inner workings of the companies he now serves as director. He also will not hesitate to challenge management as necessary. For my money, I’d like to have this individual or others like him serve on audit committees for many years to come.
The notion that long-tenured directors are not independent is spurious at best, and in my view fatally flawed. While it is true in past years we’ve seen some directors who have faded in the boardroom and outlived their usefulness, it is more likely that directors sitting in board seats for many years provide a wealth of knowledge, expertise, and know-how that often is critical to effective corporate governance. The reality is that the vast majority of public company directors take their role of monitoring management very seriously. This is because they truly care about the organizations they oversee—and also because they are certainly cognizant of the litigious society in which we operate. The reality is that as directors look around the boardroom and consider with whom they want to “go to war” if necessary, it’s often the more tenured directors who are first looked to as those who are wanted and needed in the board seats. Seasoned directors also know that longer tenured directors often are in a better place not only for effective monitoring of management, but also to help the board provide the needed advice and counsel to the CEO and his/her senior management team.
The writer notes that only three percent of S&P 500 companies have term limits for directors in their governance guidelines. Well, I suggest that’s for very good reason. Having tenure limitations is a blunt instrument, one that is best avoided. There are more effective ways to refresh a board, including regular evaluations of the board and its committees and individual directors. Such processes, done well, ensure that directors who might not be carrying their weight are counseled, and that a board’s membership is comprised of individuals that have the knowledge, experience, and qualities that complement one another and together are positioned to provide outstanding oversight in governing a company.