Rob Swystun, Pristine Advisers
Board composition is in the spotlight again thanks to it being proxy season. Also in the spotlight are companies not doing a good enough job justifying their choice of directors to investors.
Ernst & Young LLP’s EY Center for Board Matters recently spoke with 50 institutional investors, investor associations and advisors on their corporate governance views and priorities and published their findings in a paper.
They found that over ¾ of these investors believed companies are not doing a satisfactory job of explaining why they think they have the right board members.
Another key finding from their discussions was that investors think companies can greatly improve disclosures by pinpointing which directors are qualified to oversee certain areas of risk for the company. Investors also want to see how directors’ qualifications align with company strategy. Added to that is a desire by investors to have the process of how board candidates are identified and vetted be made clear, along with having a process in place for how companies plan on reaching board diversity goals.
Investors also wanted to see rigorous board evaluations that assess the performance of each board member, the board as a whole, and its committees. While investors thought these would be valuable for stimulating more thoughtful board turnover, their views on approaches like mandating term limits varied widely.
From their discussions with investors, the EY Center for Board Matters pinpointed the following three ways companies can have better board composition disclosure.
- Clearly state what a director brings to the table for that specific company and how they will help that specific company.
- It’s not enough just to list a director’s resume as qualifications. They might have an outstanding record of past accomplishments, but that doesn’t automatically mean they’re a great fit for just any board. Investors want to know why a board member is a great fit for that company’s board. Their qualifications should be tied to the company’s strategy and their expertise should be tied to how they’ll help the company’s risk oversight. Companies should not assume all of this is obvious to investors. The clearer the connections are made for investors, the better.
- Also, tied to this, is a need for an overview of why the board as a whole is the right fit for the company, as many investors assess boards as a whole.
- Clearly explain to investors the entire director recruitment and vetting process.
- Investors want to know how potential board members are identified and nominated and what the vetting process entails. There can be concern among investors that the process for choosing board members is informal (ie, the CEO nominated his golf buddy), so making the entire process clear can help to dispel these concerns.
- Share with investors the company’s plans and procedures in place to diversify the board.
- Nearly 60% of S&P 500 companies say they take gender and ethnicity into account when identifying director nominees. However, this is not always reflected in the actual gender and ethnic makeup of the board, which could lead to suspicion that it’s just all talk.
- Companies should fully disclose their formal process to support board diversity. This needs to include what is considered an appropriate level of diversity and what is specifically being done to recruit diverse directors.
Conveying the Message
Companies have a few different options for conveying board composition disclosure, EY Center for Board Matters’ publication says. These include:
- a board member skills matrix tied to company strategy,
- a letter from the lead director or chairman that discusses the board’s succession planning and refreshment process and any recent composition changes, and
- general investor engagement that involves key directors in conversations with shareholders.
Triggering Board Renewal
Investors were split on the best way to trigger board renewal, but the Center took their feedback and came up with four ways to do it ranging from what investors believed would be the most effective to the least effective.
- Robust board assessment process
- This was viewed as the most effective way of stimulating renewal, but there was some concern that it also may hamper a board’s collegiality.
- Director term limits
- Having term limits, or at least guidelines in place for limiting terms, can act as a mechanism to have a conversation with a long-tenured director about possibly leaving the board and making way for fresh blood. It can also act as another assessment tool.
- Classifying long-tenured directors as not independent
- Investors were split on whether a long-serving director is too tied to the company or not. Some argue that a director has lost their independence if they’ve been on the board for too long while others say directors need only to be independent of management and since management could potentially have changed a lot throughout a director’s tenure, they may still have retained their independence in that way.
- Director retirement age
- This was deemed to be neither a thoughtful nor a regular enough way to prompt board renewal.
With investors increasingly focused on board diversity and renewal, plus the increasing push for proxy access, which would make it easier for shareholders to nominate their own directors, it behooves companies to be more forthcoming with their plans and procedures for diversity and to speed up the process of board renewal and diversification.