Retooling The Board

by John R. Engen
Corporate Board Member
Third Quarter 2014

When it comes to ensuring that everyone on his boards brings their ‘A’ game, Robert Mittelstaedt Jr., considers himself a sort of gatekeeper. He’s the guy who takes it upon himself to help crack the whip on directors who aren’t pulling their weight or no longer have the chops for the job— and, if necessary, help them find the door. For instance, there was the Nobel Prize winner in his 90s who had seen better days and needed a nudge toward retirement, the domineering ex-military leader who got too involved in company operations, and the CEO who was too busy with his day job. When the latter bailed on the board’s annual strategic retreat to tend to his own company’s business, Mittelstaedt suggested privately that he step down.

“He was a fabulous guy—very skilled and insightful—but he was missing too many meetings,” recalls Mittelstaedt, 70, dean emeritus at Arizona State University’s W.P. Carey School of Business and a director at three companies, including Laboratory Corp. of America Holdings, a Burlington, North Carolina, medical testing firm.

“I’m kind of a son of a bitch about people doing what I believe they’re supposed to do as a board member,” Mittelstaedt adds. “An outsider doesn’t know if a person is just sitting in the boardroom yawning and collecting his fees, or if he’s actually doing the work. It’s really up to the board to monitor those things and make changes.”

America’s corporate boards could probably use a few more directors willing to take the lead in culling the deadweight. In 2013, just 339, or about 6% of the roughly 5,350 directors on S&P 500 boards were newbies, according to data from Spencer Stuart, the New York executive search firm. That was down 14% from a decade earlier.

U.S. board members are older (average age 63) and boast longer average tenures (8.6 years) than their European peers, Spencer Stuart’s data shows. Anecdotal evidence suggests directors also are busier and more distracted today than in the past—not good, since new regulations and increased shareholder scrutiny are demanding more time than ever. According to CTPartners, an executive search firm in New York, the average corporate director spends 250 hours per year on the job, compared to 50 hours just 20 years ago.

Chemistry problems are another concern. Board service is a collaborative endeavor—and getting along is crucial to success. People who are successful in their day jobs sometimes can be abrasive or uncommunicative in a group. Or they may put their needs above those of the company and its shareholders.

Peter Crane Browning, 72, a board consultant and member of four boards, including Nucor Corp., a Charlotte, North Carolina-based steel company where he is lead director, tells of one loud fellow director who was “often wrong, seldom in doubt, and never had an unexpressed thought”—attributes which forced board leadership to ask him to step aside. “It was too disruptive having him as part of the group—worse than the person who doesn’t add value.”

In a rapidly evolving competitive world, it’s getting tougher to say that this assortment of harried hangers-on represents the best interests of shareholders. “Every board has at least one person who should not be a director anymore,” says Paul Lapides, director of the corporate governance center at Kennesaw (Georgia) State University and a director at Sun Communities Inc., a real estate investment trust. “Either they’re not in touch or they’re not prepared.”

How good of a job a board does at keeping its membership current and engaged is getting more attention. A recent study led by Antonio Falato, an economist at the Federal Reserve Board, found that time-pressed directors on the board can lead to poor oversight, which can damage shareholder value. Another, by Sterling Huang of the INSEAD Business School in Singapore, concluded that director effectiveness follows an “inverted U” pattern that peaks at nine years and then declines.

“Most people will agree that there’s an effective shelf life for a director, and it tends to be in the 12- to 15-year range,” says Charles King, vice chairman of CTPartners. “After that amount of time, there’s a tendency to get stale; to have seen it all and done it all and not be able to maintain the same level of intellectual curiosity about the business,” adds King, who specializes in director searches.

This is more than just an academic exercise. Shareholders are showing more interest in which board members are contributing to the company’s performance.

State Street Global Advisors, which has $2.3 trillion in assets under management, this year became the first to include average director tenure as a factor in voting decisions—an effort that has drawn the interest of the Council of Institutional Investors and other shareholders. State Street’s policy, which was communicated via letters to some 400 companies earlier this year, states it will withhold votes against the nominating/governance committee chairman and some directors if the average tenure is longer than the norm. All members of the nominating committee face withhold votes if the board is still classified (91% of companies now hold annual director elections).

Proxy adviser Institutional Shareholder Services is contemplating making tenure a policy screen for its voting recommendations—it would potentially strip “independent” designations for directors who serve too long—and already includes tenure in its QuickScore governance ratings. “It’s a way of pushing boards to make sure they have the right skills and aren’t as ‘male, pale, and stale’ as might have been acceptable a few years ago,” says Carol Bowie, head of ISS’s Americas Research group.

Such measures, and the votes that accompany them, are blunt instruments, at best. The nature of corporate governance, with its strict rules on confidentiality, dictates that fellow directors are the only ones truly capable of saying who among their ranks is performing up to snuff.

“A lot of times, a board member is just a photograph and a biography on a [proxy] page. We’re not privy to what’s happening in board meetings,” says Rakhi Kumar, head of Corporate Governance for State Street. Given the dynamics, “we have to depend on the board to police and refresh itself.”

Yet self-policing, says Paul Winum, senior partner and global practice leader for RHR International’s Board and CEO Services, is effective only to the extent that the board chair/lead director is committed to leading a high-value board. “Boards that operate with a compliance or check-the-box culture will police themselves poorly, and regulations regarding tenure and board composition won’t remediate that,” says Winum. “As with any group, an explicit goal of being a great board is necessary for a board to add best value with clear expectations for the behavior and contributions of each member and for the board as a whole. Those expectations then serve as the criteria for board members to evaluate each other against.”

In an ideal world, individual directors would recognize when it’s time to leave. Suzanne Hopgood, 64, a workout consultant with experience as a director of several companies, tells of serving on the board of Richardson, Texas-based Furr’s Restaurant Group in the early 2000s when it emerged from bankruptcy.

“We went through a debt-for-equity swap and resolved major litigation. One day we looked around the table and said, ‘Huh, the company is healthy again, and we don’t have any industry experts on this board.’ We were all workout people,” Hopgood recalls. Most of the group agreed that day to step aside in an orderly fashion and make room for directors who knew more about the restaurant business.

“I grew up in an environment where it was very clear that, as a board member, you act in the best interests of the company,” she adds. “To me, that means taking an annual look in the mirror and asking if the reasons you joined the board still exist. If they don’t, you should leave.”

Voluntary resignations aren’t all that common, however—at least not without a good, solid push. Board service might be a lot of work, but it’s also a prestigious, often lucrative, gig that relatively few will willingly relinquish. In self-assessments, directors typically give themselves high marks. “On a 1-5 scale, everyone rates themselves as a ‘5,’” says CTPartners’ King. “We all think we’re above average.”

Concluding when, how, and who to refresh can be an exercise in confusion for all sides. Experienced board members often carry valuable relationships and institutional memory. For those near the end of their careers, board service might be their only tie left to the business world. Among a group of collegial directors, no one wants to be the one to deliver the final blow.

“It’s not like buying a company or closing a division. It’s personal. You’ve developed personal relationships, and you probably like each other,” Lapides says. “It’s difficult, because you know it’s probably going to hurt someone’s feelings.”

It’s not unusual to run into resistance, sometimes strident, from folks who are asked to leave the board. Occasionally, race or gender can complicate things further. Mittelstaedt recalls the Ivy League-educated minority colleague who looked great on paper, but was caught selling the stock he received as director compensation during a blackout period—a Securities and Exchange Commission violation.

The board notified the director he wouldn’t be nominated in the next election and he resigned, but Mittelstaedt says it took some doing. “Boards always tip-toe around replacing someone for misperformance, but they tend to do it more if the person is a minority or a woman.

“The board is the only entity that doesn’t have a boss,” he adds. “It’s a self-governing body, and it’s very difficult to get members of self-governing bodies to confront each other.”

That said, regularly pruning the board—whether it’s to eliminate a distraction, add needed skills, or simply get some fresh opinions into the mix— is a must. The question is, how best to do it? The task requires a deft touch and strong backbone, along with a willingness to put what’s best for the company and shareholders above personal relationships.

While there’s no set best practice or playbook for attacking a festering board personnel problem, a growing number of boards are institutionalizing the process in ways that can help identify board shortcomings, while also taking some of the interpersonal elements out of the equation.

They’re using skills matrices to align director expertise more closely with updated strategies, employing peer evaluations to identify the board’s weakest links, and bringing in outside consultants to review the effectiveness of individual directors.

Many also employ age limits, though those numbers have crept up over the past decade, and boards regularly make exceptions. In 2013, 356 of the S&P 500’s boards had mandatory retirement ages, with 88% setting the bar at age 72 or older, compared to just 46% targeting that age a decade earlier.

Term limits, popular in many other markets, remain rare in the United States. Just 16 of the S&P 500’s boards have director term limits, including Procter & Gamble Co. (18 years maximum), Walt Disney Co. (15 years), and Wal-Mart (10 years).

Such tools can help depersonalize the decision, while providing valuable ammunition if a dispute arises. Hopgood tells of a single-agenda director who served on one of her boards. “He was like a carpenter with a hammer, and everything was a nail. It was the same message over and over, no matter the conversation,” she recalls. The board conducted formal peer evaluations of individual directors, and this board member didn’t fare well. When Hopgood, who was chairman, told him he wouldn’t be on the slate for reelection, the man was upset. “But he saw the evaluations. It wasn’t just, ‘Well, Bob, I never really liked you.’ It was, ‘Here are the evaluations of 10 of your peers.’”

A good peer evaluation allows board members to voice their opinions on fellow directors anonymously, while also giving them feedback on their own contributions. It typically asks directors to rate each other numerically on a variety of topics, including the skill sets—financial expertise, international experience, etc.—they bring to the group, while also addressing more nuanced topics that can only be answered by the people in the room.

Does the director come to meetings well prepared? Does she contribute to conversations without dominating, and does she respect other directors’ opinions? Does he keep discussions on-topic, demonstrate a strong grasp of the company’s strategy, and understand how the business makes money? Does he add value to the board?

Some evaluations will include a broader question that can help crystalize the issue even more: Which two directors couldn’t the board live without, and which two are most expendable?

“Usually, the board collectively knows the one or two people in the room who aren’t as additive as the others,” says Julie Daum, head of Spencer Stuart’s North American Board Practice. “It’s just that nobody wants to do anything about it.”

What’s done with the evaluation results varies. Typically, but not always, only the individual director (along with the chairman, lead director, or nominating/governance committee chairman) will see his final tally. Sometimes simply seeing the results, combined with a probationary pep talk from the chairman, is enough to spur a director to step up his game.“An effective board and director evaluation process must result in clear and actionable feedback to board members about how they are fulfilling their duty to serve,” says RHR’s Winum. “The process for conducting an evaluation that includes both qualitative and quantitative components should be spelled out in the charter for the nominating and governance committee. That process should include the criteria that will be used to assess board and director effectiveness, how the evaluation will be conducted, and how the board and individual directors will get their feedback,” he advises.

“Finally, just as with any executive development process, some concrete action steps need to be identified that the board and individual directors can implement to enhance their collective and individual contributions. The board chair or lead director ultimately is responsible for ensuring that this all happens,” says Winum.

In some cases, these types of actions are enough to nudge the director in question out. Hopgood tells of one board meeting where the results of a peer evaluation were delivered around the table in sealed envelopes. One opened his report and exclaimed, “Oh, my gosh! People rated me really poorly!”

While his counterparts valued the director’s skills, a love of sailing led to too many absences. “He hadn’t realized how much everyone noticed every time he missed a meeting.” A few weeks later, he met with the chairman and told him that if it was a choice between the two, sailing trumped the board. “I’ll give you my letter of resignation now,” the director said, “and you decide when to use it.”

Some boards are more proactive in how they use evaluations. King says one board he consults with uses the results each year to “rank order” directors. “If you come in last, the chairman gives you counseling and lets you know what your peers are saying and how you can improve your performance,” he says.

“And if you come in last two years in a row, you’re gone,” King adds. “It sounds a little draconian, but that’s what this board does: You’re put on probation for a year, and if you don’t clean up your act, you’re asked to leave.”

Many boards employ skill matrices— either in conjunction with peer evaluations, or instead of them—to identify the expertise required for the company’s next step. Individual directors run along one axis, while skills needed by the board are on the other one, and applicable boxes are checked. Unlike peer evaluations, a skills matrix can feel more forward looking in helping directors embrace the board’s future and their place in it.

“It’s part of a conversation around the specifics of what is needed in the boardroom today and what will be needed tomorrow,” Daum explains. “Strategies change, and someone who was once a productive board member might not have the right skills today. A matrix can help illuminate that.”

As with evaluations, different boards go about the exercise in different ways. It often commences on the heels of a strategy retreat or a significant transaction, when the company’s needs are most front of mind.

If the company gets 50% of its revenues from Asia, does it have a director or two who has done business there? Are there plans to acquire in a given niche that could benefit from some additional industry or deal expertise? Will technology or social media become more important to the company, and does the board have the right knowledge base?

Some boards will hire outside help to come up with the right list. Such holes might include adding women or minority directors, or perhaps someone with experience running a large organization.

According to the Spencer Stuart study, minority board candidates were wanted by 56% of respondents, along with women and sitting CEO/COOs at 54% each. Skills-wise, financial expertise was in greatest demand, followed by international expertise and industry know-how.

Adding skills to the board generally requires making some cuts, as well. Directors usually assess their own skills as part of the matrix exercise and can be generous in checking their own boxes. Does the time you worked in London back in the 1980s really qualify you as a modern-day international expert?

“Your hope is that somebody will say, ‘I don’t have China experience, I don’t understand cloud computing, and I’m not a financial expert. Maybe I should gracefully offer my resignation,’” Daum explains.

Oftentimes, such personal skills assessments are filled out in private. But, it’s a group affair, done on a whiteboard. “I like to do it in front of everybody: ‘Tell me what skills you have that fit this matrix,’” Hopgood says. Several years back, a board with three CPAs went through the process. “After we went down the matrix, one of them said, ‘I shouldn’t be here. I’m redundant. You have two other people with my skill set,’” Hopgood recalls. The response: “Thanks for raising your hand.”

Institutionalizing the process can make asking directors to step aside easier. When it comes time for the actual send-off, however, personal often is best. Departing directors are sometimes feted with gifts and parties or invited onto advisory boards. Lapides tells of one large company that twice a year invites past directors to special dinners with sitting board members. “A lot of people just want an acknowledgement of their past contributions and a way to stay connected,” he says.

Easing the transition from the board, like the refreshment process itself, ultimately benefits everyone. In the end, the only real certainty about modern-day board service is that it will one day end.