Board Evaluation Is Awkward: How to Approach the Tough Conversations

According to a 2015 PwC study, 39% of board members said that they believed someone on their board should no longer be on it. Meanwhile, investors are calling for refreshment that will help maintain independent, objective viewpoints across company boards with a long-term view, whether that be through mandatory retirement or tenure limits.

While nearly 40% of the S&P 500 discloses a mandatory retirement age for their board members, according to a recent Equilar report—and far fewer have term limits—governance experts don’t believe that setting hard parameters is always the right answer. Instead, they recommend ongoing board evaluations that objectively assess the board as a whole and individual directors’ fitness to continue serving.

At the recent Board Leadership Forum co-hosted by Equilar and Nasdaq, directors, consultants, legal experts and institutional investors gathered to discuss the most effective ways for boards to evaluate themselves, and how to decide what is the best time and who are the best directors to bring new life into the boardroom.

One-Size-Fits-Few

“Board evaluation is socially awkward,” noted one panelist kicking off the conference discussion.

As boards become more independent—that is, including fewer directors with inside ties to the company—the qualifications and activities of directors have become more highly scrutinized from company constituents. Investors want to see that boards are fulfilling their fiduciary duties to toe the line acting in the best interest of the company and shareholders, and a director that sides too closely with management could compromise that position.

The evaluation process is something that happens at almost every board, but the degree of depth varies widely. Indeed, few people enjoy being put through a rigorous evaluation process, but as former executives, most directors likely have been in similar situations throughout their careers.

“It doesn’t have to be a ‘bad’ thing to be evaluated or even removed from a board—it may just not be a good fit,” said one attendee. “So why don’t we see it more?”

Open Records

While investors and other stakeholders aren’t asking to see a detailed evaluation sheet and a numerical grade for each director, they do expect more transparency around the process from boards. According to one panelist, just 2% of the S&P 500 say they even have some sort of evaluation, let alone include the finer details in a proxy statement.

“There is internal and external pressure for clearer board evaluation processes from investors and regulators to see if disclosure is sufficient, and on the activist side, lack of clarity could be a vulnerability,” said one board member, who formerly spent years at a large institutional investor. “The larger institutional investors think this is very important, and they believe in seeing the evaluation—not necessarily the results, but whether there is a process and whether that process has been adhered to.”

The consensus was that very few boards do evaluations well, but the ones that do are very rigorous with a mutually agreeable process to repopulate the board, typically embedded in the nomination committee. It doesn’t always go smoothly, but when directors have the right expectations—who is leaving the board and when—it allows them to effectively plan for the future.

As an added feature, a detailed and agreed-upon process allows boards to address the diversity issue naturally and on an ongoing basis. Shareholders, employees, customers and regulators have made it known that they feel boards are not diverse enough in terms of gender, race, ethnicity and skills backgrounds. It’s not easy to tell directors they need to be replaced, especially if they are still contributing at a high level.

“We’re seeing boards get rid of age and term limits as they reach those ages and tenure milestones, and they just don’t want to give up the gig,” said one investor. “We’re concerned that because there will not be quotas in the U.S.—it’s just not part of our culture to do those kind of things—it will be a very frustrating and long process to bring more refreshment on the board.”

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For more information on Equilar events and board education symposiums, please visit http://www.equilar.com/equilar-events.html 

Dan Marcec is Director of Content at Equilar. He can be reached at dmarcec@equilar.com.

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