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."
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The topic of director tenure has increasingly become the focus of both academics and investors, especially as investors and others clamor for more board diversity. Some argue that long-term directors contribute deep knowledge of the company and provide experience, historical memory and continuity to the board—along with the gravitas sometimes necessary to challenge management. Others contend that directors with long tenure are "stale" and rarely contribute fresh perspectives. What's more, having a static group of directors for a long period of time may contribute to "groupthink."
As discussed in this 2016 article in the WSJ, some have suggested that the independence of directors with long tenure may even be compromised—not in the technical sense of the NYSE or Nasdaq definitions of course, but rather more in the sense of "social independence," meaning that the development over time of shared social connections might bias them or taint their objectivity. The WSJ also suggested that this type of "longevity tends to ensconce white males, whose dominance of boards has been criticized for leading to less robust risk management, among other things." According to the WSJ, long board tenure, together with the tendency to appoint directors who are retired CEOs or other C-suite executives from other firms, has given rise to a class of director: the "new insider." One academic cited in the article speculates that the "increasing use of board members who serve for longer periods and come with a predisposed background as corporate insiders elsewhere is not accidental, but is in fact an effort on the part of companies to import the benefits that an 'insider' board would have produced." The NACD has previously identified director tenure as a critical issue for board focus and encouraged boards to consider succession planning and proactive approaches to refreshment. (See this PubCo post.) Some investors have also become more proactive in addressing board tenure. On the other hand, some experts cited in the article warned that, while potential loss of independence for long-term directors can be an issue, "any board reshuffle should be mindful of preserving valuable experience gained by length of service while bringing in a new perspective." (See this PubCo post.)
The Report of the NACD Blue Ribbon Commission on the Strategic-Asset Board has recommended that renominations of directors "should not be a default decision, but an annual consideration based on a number of factors, including an assessment of current and future skill sets and leadership styles that are needed on the board." In addition, according to one NACD Blue Ribbon commissioner back in 2016, instead of just waiting for directors to notify the nom/gov committee if they plan to leave, "'[w]e need to shift the expectation from 'serve as long as you want' to 'serve as long as you are needed.' This 'shift' includes setting appropriate tenure expectations with any directors new to the board, as well as having what can be difficult conversations with longer-tenured directors if their experiences are no longer additive to the board."
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."
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For 2021, ISS changed its benchmark policies regarding board refreshment. ISS considers board refreshment to be "best implemented through an ongoing program of individual director evaluations, conducted annually, to ensure the evolving needs of the board are met and to bring in fresh perspectives, skills, and diversity as needed." However, with the growing emphasis on achieving board diversity, the issue of board refreshment mechanisms has received more attention. As a result, ISS changed its policy on term limits, but continues to recommend against age limits. According to ISS, age limits "are arbitrary, imply an impairment to ability solely due to age, and have been used in the past to remove dissenting voices from the board." Term limits can be problematic if they are poorly designed. (See this PubCo post.) Under current policy, ISS will consider voting recommendations on term/tenure limits on a case-by-case basis, taking into account factors such as the "rationale provided for adoption of the term/tenure limit, the robustness of the company's board evaluation process, whether the limit is of sufficient length to allow for a broad range of director tenures, whether the limit would disadvantage independent directors compared to non-independent directors, and whether the board will impose the limit evenly, and not have the ability to waive it in a discriminatory manner." With regard to shareholder proposals for term limits, ISS also recommends on a case-by-case basis, considering the "scope of the shareholder proposal and evidence of problematic issues at the company combined with, or exacerbated by, a lack of board refreshment."
In addition, with regard to overboarding, ISS will generally recommend votes against or withhold from individual directors who sit on more than five public company boards or are CEOs of public companies who sit on the boards of more than two public companies besides their own (ISS recommends withhold only at the outside boards).
Glass Lewis favors "routine director evaluation, including independent external reviews, and periodic board refreshment to foster the sharing of diverse perspectives in the boardroom and the generation of new ideas and business strategies. Further, [Glass Lewis believes] the board should evaluate the need for changes to board composition based on an analysis of skills and experience necessary for the company, as well as the results of the director evaluations, as opposed to relying solely on age or tenure limits." Experience can be valuable, in Glass Lewis's view, especially "because of the complex, critical issues that boards face." However, Glass Lewis recognizes that, on occasion, "lack of refreshment can contribute to a lack of board responsiveness to poor company performance." Accordingly, it will "note as a potential concern instances where the average tenure of non-executive directors is 10 years or more and no new directors have joined the board in the past five years." Although age or term limits can be useful in some circumstances as a way to force change in those circumstances, Glass Lewis believes that "shareholders are better off monitoring the board's overall composition, including the diversity of its members, the alignment of the board's areas of expertise with a company's strategy, the board's approach to corporate governance, and its stewardship of company performance, rather than imposing inflexible rules that don't necessarily correlate with returns or benefits for shareholders. However, if a board adopts term/age limits, it should follow through and not waive such limits. In cases where the board waives its term/age limits for two or more consecutive years, Glass Lewis will generally recommend that shareholders vote against the nominating and/or governance committee chair, unless a compelling rationale is provided for why the board is proposing to waive this rule, such as consummation of a corporate transaction."
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."
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One critical aspect of board refreshment is the inclusion of directors with essential new skill sets. For example, this study from the NYU Stern Center for Sustainable Business, U.S. Corporate Boards Suffer From Inadequate Expertise in Financially Material ESG Matters, analyzed the credentials of the 1188 Fortune 100 board directors, based on company bios and Bloomberg bios to assess the level of their experience with ESG oversight. The study "found that very few sectors and very few companies were adequately prepared at the board level for issues that were already affecting their performance." While on an initial examination, the study found that 29% of those directors had relevant ESG credentials, on a deeper dive, the Center found that 21% of the directors' experience was in the "social" category—clustered around health and diversity issues—but in each of "environment" and "governance," only 6% of directors had relevant credentials. What to do? As reported in Bloomberg, the Center's director recommended that boards "have to first understand and pinpoint ESG risks, prioritize them and then bring on the expertise." Expertise does not necessarily mean climate change scientists or cyber security technicians, but rather board members who have a strategic understanding of the issues. Adding more diversity may help: according to PwC, women directors are more "likely to say that climate change and human rights should be part of business strategy." Board refreshment may also help: the study makes the observation that "[m]ost boards have a preponderance of former CEOs sitting on their boards. Those CEOs were in charge 10-20 years ago when ESG issues were not regularly considered as material and they bring that mentality to the boardroom." (See this PubCo post.)
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