Board Composition, Refreshment and Tenure Hot Issues for Corporate Boards. October 2015

Transcription

1 Board Composition, Refreshment and Tenure Hot Issues for Corporate Boards October 2015

2 Introductions Glenn Booraem a Principal at Vanguard Group, Inc. and Treasurer of each of the Vanguard Funds Rakhi Kumar Managing Director and Head of Corporate Governance at State Street Global Advisors Charles Elson -Director of the John L. Weinberg Center for Corporate Governance, Edgar S. Woolard, Jr. Chair in Corporate Governance, and Professor of Finance, Alfred Lerner College of Business & Economics, University of Delaware Ann Mulé Associate Director of the John L. Weinberg Center for Corporate Governance, Alfred Lerner College of Business & Economics, University of Delaware, and Moderator 2

3 Introduction and Overview Shareholders are increasingly focusing on the importance of board composition both activists andlarge institutional investors like Vanguard, State Street, BlackRock, to name a few Independent oversight and more broadly, appropriate board composition is the single most important factor in good governance. ** F. William McNabb III, Chairman and CEO, Vanguard October 30, 2014 **See transcript of talk by William McNabb, Chairman and CEO of Vanguard, October 30,

4 Director-Centric Model Under State Law Current legal framework of corporate governance as created by state law is a director centric model where the Board has the responsibility to manage and direct the affairs of the corporation with its accompanying fiduciary duties The fiduciary duties of the board and its directors include: Due Care Loyalty Good Faith Board composition is one of the most important keys to an effective board 4

5 IndependentDirector Industry Expertise Independence is critically important but it is not enough Numerous boards are now comprised of independent directors, none of whom have industry expertise, and an inside CEO who is the only one with industry expertise -DANGER a management knowledge-captured board Knowledge is power you don t know what you don t know Issue is particularly acute with regard to company strategy and risk. Industry expertise is critical to understanding competitive threats and strategic opportunities Can lead to inadvertent/unknowing de facto deference to the CEO Can be just as dangerous as a management-captured board (i.e., a board that is not independent) because in both instances the board is not doing an adequate job of monitoring and advising management The Management Knowledge-Captured Board, published in 2014 in Directors & Boards magazine, is included in the course materials 5

6 Importance of Independent Director Industry Expertise The 2014 NACD Blue Ribbon Commission on Strategy Development recommends that boards become more involved in strategy issues on an ongoing basis that in order for this to be successful, the nominating and governance committee SHOULD CONSIDER DIRECTOR EXPERTISE in relation to the strategic direction of the company ONE MORE IMPORTANT REASON TO HAVE INDEPENDENT DIRECTOR INDUSTRY EXPERTISE ON THE BOARD 6

7 Activism Activist investors generally seek to effect change in a company s strategy, operations, performance, board and/or management with the goal of increasing shareholder value In making the case for change, activists focus on a company s vulnerabilities One tool in the activists play book in the last few years has been to focus on director skills and expertise or lack thereof 7

8 Activism The argument that the activist will make the board is not functioning properly because it does not have board members with the requisite industry knowledge and experience to effectively oversee management is extremely compelling in its logic and simplicity and is very hard to defend against Boards that do not focus on this issue run a risk those shareholders will do it for them Examples: Hess, Bob Evans, Darden Example of a company fighting back: DuPont 8

9 Impact of Activism In the past, activists usually put their own people (from their hedge fund) on their director slates Looking at the more recent activist interventions over the last 3 or so years -many activists have nominated extremely qualified directors who were not affiliated with their hedge fund and who had outstanding industry expertise and other extremely important functional skills (such as restructuring, capital markets, financial, governance, etc.) What is interesting is that years ago these highly qualified individuals would not have agreed to stand because of the perceived reputation tarnishing associated with running on a dissident slate. Now these people don t view being on a dissident slate as a negative. Even large Wall Street law firms don t view representing activists as reputation tarnishing. A recent Wall Street journal article reported that one of America's oldest corporate law firms is beginning to represent activist investors, betting that these investors are going main stream, while continuing to represent their corporate clients. It is becoming increasingly clear that associating with activists is becoming more acceptable 9

10 Board Refreshment The composition of the board as a whole should reflect the most appropriate director skill sets and expertise to effectively oversee evolving company strategy and hold management accountable Mechanisms to refresh the board to bring in desired skill sets and avoid board stickiness : Board evaluations Mandatory retirement age Director tenure Term limits 10

11 Board Refreshment Evaluations The PwC 2014 Annual Corporate Director Survey found the following with regard to Board evaluations (note that directors were responding): 70% of respondents noted they find it challenging to be frank in evaluating the board 63% of the respondents found it to be a check the box exercise To have a good board evaluation process, boards need to address these issues Rigorous board evaluations, including assessing committees and individual board members, are considered a best practice and an optimal board refreshment tool 11

12 Board Refreshment Mandatory Retirement Age Many boards have relied on mandatory retirement age According to the Spencer Stuart Board Index regarding mandatory retirement age 73% of all S&P 500 boards have established a mandatory retirement age for directors Of the 361 boards with a mandatory retirement age, the ages run: 92% -72 or older (versus 75% in 2009) 30% -75 or older (versus 15% in 2009) Term Limits Deloitte and the Society of Corporate Secretaries & Governance Professionals 2014 Board Practices Report: Perspectives from the Boardroom found: 82% of large cap companies have mandatory retirement age limits 4% of large cap companies have term limits 12

13 Director Tenure Board Refreshment State Street s 2014 voting policy on director tenure Concerned with long-tenured directors, which may indicate a lack of refreshment skillsand perspectives Impact of voting policy in

14 Director Tenure BlackRock Board Refreshment Effective February 2015, Blackrock adopted revised Proxy Voting Guidelines for U.S. securities that included, among other things, key changes on board composition: Expanded the scope of the guideline on board composition to explain how they take into account director tenure, diversity, board evaluation, and the relevance of directors experience, among other factors, in forming a view on director elections 14

15 Board Refreshment Director Expectations Length of Board Service Consider telling Board members up front: that it is not a lifetime appointment (or until a mandatory retirement age) that he/she is being asked to join because his/her current skill sets are needed; however, if there comes a time that his/her skill sets are no longer needed or as relevant as other skill sets, he/she will be asked or should volunteer to not stand for re-election Make it clear to the entire board that this is the new paradigm and that a board member is not doing a bad job because he/she is not asked to stand 15

16 Board Refreshment/Diversity EY noted in its 2015 proxy season insights: spotlight on board composition That the continued lack of turnover on many boards and slow progress on increasing diversity, including gender, race and ethnicity, are bringing director tenure and board succession planning under scrutiny Historically nominating committees have asked search firms to find candidates who are current or former CEOs, which creates a much narrower pool of candidates with fewer diverse candidates In the Spencer Stuart 2014 Board Index relating to the S&P 500, 60% of the respondents said that recruiting an active CEO or COO is a priority, 40% said they were looking for a retired CEO/COO In Heidrick & Struggles recent Board Monitor Four Boardroom Trends to Watch, it is noted regarding the 339 new board seats filled in Fortune 500 companies in 2014: 47% were current and former CEOs 20% were current and former CFOs 16

17 Board Refreshment/Diversity As noted in the previous slide, while companies look for board candidates who are current or former CEOs, COOs or CFOs, female directors are gaining some momentum The 2014 Catalyst Census: Women Board Members found the total number of board seats held by women at U.S. stock index companies to be 19.2% - up from 15.2% in 2009 In the recent Heidrick & Struggles Board Monitor Four Boardroom Trends to Watch, it is noted that of the 339 newfortune 500 directors recruited in 2014, 99 were female, representing 29.2% of the total This was compared to 18% in 2009 Heidrick & Struggles also notes that the percentage of Hispanics recruited to boards in 2014 was 5.0%, compared to 5.1% in The percentage of African- Americans appointed in 2014 was 8.3%, compared to 5.3% in The percentage of Asians appointed in 2014 was 5.3%, compared to 3.9% in

18 Board Refreshment/Diversity Diversity should be an outcome of a well-considered board composition succession plan based on skill sets and qualifications Diversity of thought cognitive diversity Diversity for diversity s sake can yield unintended consequences Recruiting candidates with specific skills sets rather than focusing on current or former CEOs broadens the pool of potential candidates 18

19 Engagement Engagement is increasingly occurring between companies/ directors and their investors Expect to be prepared to discuss board composition, director skill sets and experience and how it relates to company strategy and risk in company engagements with investors Expect to be prepared to discuss the evaluation process utilized by the board to assess its performance State Street Engagement Protocol See also the SDX Protocol, which provides guidance on shareholder/director engagement 19

20 Engagement/Disclosures Another way to engage with investors is through company disclosures (e.g., filings and routine communications) Use disclosures to illustrate and provide context for important points/information regarding board composition, refreshment and diversity See The Conference Board s Recommendations of the Task Force on Corporate/Investor and Guidelines for Engagement (which includes a pyramid Engagement: A Layered Approach on page 8) Company disclosure examples 20

21 Final Thoughts 21