What makes for a highly effective director? The answer to that question isn’t as easy to answer as it once was.
As businesses become more complex, risk-prone, and globalized, investors are demanding that fresh blood be infused into boards that have grown stale or out-of-touch. So too are legislators with a desire to leverage Securities and Exchange Commission disclosures as a tool to bolster the ranks of directors and embed cyber-security knowledge. These efforts place a focus on board composition and succession planning, areas companies don’t always have a good grip on. The challenge is how to refresh boards without making them too crowded or losing the valuable directors they already have.
The push to reconsider director effectiveness, a charge largely led by institutional investors, is a catalyst for legislative proposals seeking to up the ante for board-related disclosures.
A January report by the Government Accountability Office found that women are underrepresented on U.S. corporate boards, with just 16 percent of directorships. It concluded that even if the rate of women joining corporate boards were doubled, it would still take until 2056 to reach gender parity. In response, Rep. Carolyn Maloney (D-N.Y.) announced proposed legislation that instructs the SEC to require that companies report their policies to encourage the nomination of women for board seats, the proportion of women on their board, and gender equality in senior executive leadership.
“At a minimum, the SEC should update its deeply flawed diversity disclosure requirements,” Maloney said in a statement. She bolsters her case with a recent report published by MSCI—a provider of stock market indexes—that found companies with “strong female leadership” (either above-average board representation or a female CEO and at least one female board member) generated a higher return on equity and valuation than companies lacking female leadership.
A 2009 SEC rule requires public companies to disclose how they view diversity with respect to their boards. Specifically, it requires a company to disclose whether diversity is a factor in considering candidates for nomination to the board of directors, how diversity is considered in that process, and how the company assesses the effectiveness of its policy for considering diversity. Critics, however, take issue with the fact that a working definition of “diversity” was left up to companies. Also, many companies “provide only abstract disclosure, often times limiting their disclosure to a brief statement indicating that diversity was something considered as part of an informal policy,” outgoing Commissioner Luis Aguilar has lamented.
“The greatest flaw today in corporate governance is rotating directors off the board. Once they are there, they are there forever.”
Susan Shultz, President, SSA Executive Search International
Institutional investors have also taken it upon themselves to ask the SEC for improved disclosures. In March 2015, the California Public Employees Retirement System, New York State Common Retirement Fund, and others filed a rulemaking petition with the SEC. Their proposal builds upon current Regulation S-K requirements requiring registrants to identify the minimum skills, experiences, and attributes that all board candidates and nominees are expected to possess. It would require registrants to also indicate, in a chart or matrix, each nominee’s gender, race, and ethnicity. New disclosures would also describe any specific minimum qualifications that the nominating committee believes must be met.
Diversity isn’t the only concern fueling new disclosure demands. In December, Senators Jack Reed (D-R.I.) and Susan Collins (R-Maine) introduced the Cybersecurity Disclosure Act of 2015. The legislation would add SEC disclosures on whether any member of a public company’s board of directors is a cyber-security expert, and if not, why having this expertise is deemed not necessary.
“The calls for disclosure are coinciding with what institutional investors are pushing for, which is an increase in board quality,” says Rusty O’Kelley, a member of the executive search firm Russell Reynolds Associates' CEO and board services practice. “They want to know more about the board’s relationship with management, more disclosure on the composition of the board, the skills people bring, and what the succession process is.”
“Congress and the SEC have very little ability to influence board composition,” he adds. “But they can use their power to shine a spotlight on it. Setting disclosure requirements will force boards to first think about these things, particularly the CEO who is signing off on the filing.”
GETTING THE SEC INVOLVED ON DIVERSITY
The following is a Jan. 4 letter to Securities and Exchange Commission Chairman Mary Jo White, authored by Rep. Carolyn Maloney (D-N.Y.).
I applaud your recent challenge to all Fortune 1000 and S&P 500 companies to set a target of 40 percent women on their corporate boards by 2025. Like you, I believe this goal is ambitious but within reach, and an imperative for American businesses to succeed in the decades to come.
In order to meet this target, I urge the SEC to adopt a proposed amendment to proxy statement disclosures to require the clear indication of each board nominee’s gender, race, and ethnicity. This proposal, submitted by the leaders of several large public pension funds, will allow investors and policymakers to evaluate companies’ progress towards the ambitious 40 percent goal.
As you know, senior leadership and executive boards continue to under-represent women. In 2014, only 19.2 percent of S&P 500 board seats were held by women. In addition, only 12 companies (2.4 percent) had boards comprised of at least 40 percent women. These figures indicate the real barriers still in place between women and these corporate leadership positions, and highlight a need for policies to encourage greater board diversity.
While well-intentioned, the enhanced proxy statement disclosure for board diversity adopted in 2009 has proven inadequate to increase the representation of women on corporate boards. Indeed, researchers have found that among the S&P 100 only about half of these disclosures referenced gender. In fact, most of these companies—the largest and most well-resourced in our country—disclosed that they lack a formal diversity policy for their board.
Even without formal policies in place, there is mounting evidence that board diversity may enhance companies’ performance. A recent report published by MSCI found that companies with “strong female leadership” (either above-average board representation or a female CEO and least one female board member) generated a higher return on equity and valuation than companies lacking female leadership. This finding follows a 2014 Credit Suisse report that found companies with at least one woman on their board outperformed other companies by 5 percent from the start of 2012-June 2014.
Because of these findings, investors are justly interested in more comprehensive information about board composition and policies to ensure a diverse slate of candidates. The proposal submitted by nine leading public fund fiduciaries would make a limited amendment to the disclosure rule but greatly enhance the transparency of boards and the ability of investors to evaluate companies’ efforts to ensure diversity.
For these reasons, I encourage the SEC to adopt this common-sense amendment, and look forward to working with you to increase the representation of women in corporate leadership.
Source: Rep. Carolyn Maloney
The goal of diversifying a board’s in-house knowledge base can be easier said than done. “You don’t want to have a sole purpose director,” O’Kelley says. “The problem with someone you select based on their IT security experience is that they also need to have a broad set of experiences so they can contribute to all of the other issues that the board is to opine on, offer guidance, and hold management responsible for.”
A particular challenge is that many directors expect to hold onto their positions until retirement age. Appoint someone in their mid-50s, and odds are good that they are going to be there until they are 74. Many companies are hesitant to have conversations about how long they expect a director to stay on. If there is an answer, it is “as they contribute.”
“But what does that really mean? How are they evaluating that? Do they have a process and a method to evaluate contributions by directors? Otherwise the assumption is that once you are appointed you are on for life unless you do something that is materially problematic,” O’Kelley says.
Assessing individual performance is another board-level bugaboo. All public company boards do director evaluations. The question is whether they are good enough, robust enough, and honest. “It is hard to upset that apple cart,” he says. “You may have people who are doing perfectly good jobs, but there is an opportunity to bring in new skill sets and you don’t want to get the board too big. Removing someone who is doing a fine job is much harder than taking someone off who is not doing well.”
O’Kelley sees a need for better succession planning for both the overall board and on the committee level. Succession planning on the audit committee is usually done well, he explains. They know the tenure of an audit chair is only going to be a few years and that they need to get somebody in place before then to ensure a good understanding of the company and committee before they take over. Such planning is typically not as robust on other board-level committees.
As companies expand globally, another area for board-level improvements is having geographical market knowledge. When a company is invested in a particular regional market, it gains a significant advantage by bringing on board members who have experience with the region and can improve operations and reduce risks, says Susan Shultz president and board practice chair of SSA Executive Search International. Only a very small percentage of companies, however, even if they generate a large percentage of their revenue from non-U.S. sources, have directors with meaningful global experience. “If your company has an investment in a particular market doesn’t it make sense to have someone who knows that market intimately? There are so many nuances to doing business in different environments,” she says.
Shultz expects more turnover on boards, and therefore greater diversification, as time commitments continue to increase. In the meantime, companies must heed calls for greater diversity and enhanced expertise. “The greatest flaw today in corporate governance is rotating directors off the board,” she says. “Once they are there, they are there forever. The longer they are there, their allegiances tend to be with management, rather than to the general success of the company.”
The solution lies in performance evaluations. “Governance committee chairs need to make a commitment that they will objectively oversee a process to evaluate the effectiveness of the directors and every year have an effective review of who should be renewed or not,” Shultz says. “That should be made clear to board members as they come onboard and they should all buy into it.”