Investors often believe that companies are too slow to refresh their boards.  Directors and CEOs may also think that their companies do not have the right mix of directors, as strategies change and some directors’ skills become dated. 

Yet annual board turnover remains low and fairly steady, Spencer Stuart partner Laurel McCarthy tells podcast host, Skadden M&A partner Ann Beth Stebbins. Together with Skadden partner, Elizabeth Gonzalez-Sussman, Laurel and Ann Beth discuss the ways boards should approach refreshment, and the risk that they could be targeted by activist investors if they do not replace directors regularly. 

Many board policies do not encourage refreshment. The typical mandatory retirement age for S&P 500 directors, has been increasing, and is now at age 75. “We usually don’t see many stats that surprise us in our annual board index, but this one did,” Laurel says. At the same time, the number of boards with mandatory retirement ages has been dropping. 

Meanwhile, board term limits, when present in a company’s bylaws, are usually generous — 15 or 20 years. Proxy advisory services do not have prescriptive policies on term limits, but they question the independence of directors who have served for more than nine years on a board. 

As Laurel and Elizabeth explain, age and term limits can encourage turnover, but they should not be the sole mechanism. Boards need to continually analyze the skills required by the board in light of a company’s changing strategies, and develop pipelines of potential new directors to fill those needs.

Elizabeth points out that companies that have a number of long-tenured directors may be vulnerable to activist investor campaigns if the company underperforms. Demands that a company appoint new directors to improve performance often figure prominently in activist campaigns.

Some investors may favor adding younger board members, particularly where the customer base is young or if technology is central to the business, Elizabeth says. 

In evaluating potential board members, Laurel and Elizabeth suggest prioritizing candidates who have recent experience, are good cultural fits and ask tough questions that management should be prepared to answer. 

Ultimately, they advise boards to be proactive, as succession planning and maintaining a pipeline of potential directors is critical to a company’s future performance. 

💡 Meet Your Host 💡

Name: Ann Beth Stebbins

Title: Partner at Skadden

Connect: LinkedIn

💡Featured Guests💡

Name: Laurel McCarthy

Title: Consultant, Board and CEO Practice, Spencer Stuart

Connect: LinkedIn

Name: Elizabeth Gonzalez-Sussman 

Title: Partner, Shareholder Engagement and Activism, Skadden

Connect: LinkedIn

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The Informed Board is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP, and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.

Voiceover (0:00):

From Skadden, you are listening to The Informed Board, a podcast for directors facing the rapidly evolving challenges of a global market. A compliment to our newsletter for directors, our aim with this podcast is to help flag potential problems that may not be fully appreciated, explain trends, share our observations, and give directors practical guidance without a lot of legal jargon. Join Skadden partners who draw on years of frontline experience inside boardrooms to explore the complex issues facing directors today.

Ann Beth Stebbins (0:33):

When does a board tell a director that it’s time to go, and how important is board refreshment to investors?

I’m Ann Beth Stebbins, a partner in the M&A group at Skadden. I’m joined today by two fabulous guests who will be sharing their insights on board refreshment gained from years of experience in the corporate governance arena. Laurel McCarthy is a member of Spencer Stuart’s North American Board Practice and its activism, defense and preparedness groups. Elizabeth Gonzalez-Sussman is a partner at Skadden, where she heads the firm’s shareholder engagement and activism practice. I’m really looking forward to getting Laurel and Elizabeth’s insight on this episode of The Informed Board.

Laurel, a recent PwC survey revealed that a significant percentage of directors would like to see a colleague replaced. Did this result surprise you?

Laurel McCarthy (1:25):

Sadly, I’m not surprised with those results. We’ve seen that for several years with this survey. This year we saw actually a big increase in the number of directors that felt like two or more people on their board should be replaced. The thing that really does surprise me here is that it doesn’t correlate into an increase in turnover. We’ve been tracking S&P 500 director turnover at Spencer Stuart for nearly 40 years, and it’s been consistent at 7% or 8% for the last decade.

Ann Beth Stebbins (1:57):

Boards are not satisfied with their own composition, but yet they’re not doing anything about it?

Laurel McCarthy (2:04):

That’s right. Less than a third of CEOs think they have the board they need to address the issues faced by their organization, so we would think there would be an uptick in turnover, but we just haven’t seen it.

In these surveys where boards and CEOs are asked if they have the right board or if there’s someone who should be replaced, is there a why question that goes with that?

We ask, “Why do you believe these directors should be replaced?” The top reasons we see are that their skills and expertise are no longer current. A cultural mismatch is also highly ranked, and then consistent underperformance is the third-highest reason for why directors need to be replaced.

Ann Beth Stebbins (2:45):

What about tenure? Having a director on the board for a long period of time is something that I’ve been reading about recently as being in the crosshairs of activists. Elizabeth, what are you seeing?

Elizabeth R. Gonzalez-Sussman (2:58):

A long tenure has always been a major focus of activist investors. They want to make sure that boards are composed of independent directors that are actually going to hold management accountable. When companies start to underperform, activist investors will look at the drivers of that underperformance. Often you have three, four or more long-tenured directors — those are directors that are over 10 years. The activists may say that’s probably a major driver of the underperformance, and so it becomes a major focal point.

To Laurel’s point earlier, the fact that a lot of these boards are not self-refreshing in the ordinary course makes them a greater target if they have one bad quarter, or they have years of poor performance. That’s where it becomes easier for activist investors to start making a point for board change — “We need board seats in order to hold management more accountable for performance.”

Ann Beth Stebbins (4:03):

And what about proxy advisory firms, Elizabeth? What are their views on board tenure?

Elizabeth R. Gonzalez-Sussman (4:08):

They haven’t adopted formal policies that say, “If you hit the 10-year mark, you are over tenured.” But increasingly in activist campaigns, you start seeing in their reports and contested elections the issue of tenure where they focus on boards that have multiple directors sitting on the board for more than 10 years, and highlighting that these directors should be replaced with new candidates that have been recommended by the activists. You do start seeing in many of these ISS, Glass Lewis reports the commentary that independence is hampered when they’re on the board too long. And when the performance is not great, the Nom-Gov chair can be challenged and directors can be replaced.

Ann Beth Stebbins (4:54):

Is it an “and” test? In order to get the attention of activists, there has to be some underperformance. It’s underperformance and then looking for reasons behind that underperformance? One of the reasons could be long-tenured directors.

Elizabeth R. Gonzalez-Sussman (5:11):

Absolutely right. They’re always looking at and targeting underperforming companies and then they look at the drivers. The activists may say the CEO is not performing. So, who’s to blame for the CEO not performing? Is it the selection of that CEO or are you putting in comp programs, performance targets, that makes sense, that really are going to incentivize better performance and hold them accountable? It’s a combination. If every company was performing well and you had 50-year-tenured directors, maybe people wouldn’t complain, but when the performance starts to be less than stellar, that’s when this really shows a spotlight.

Ann Beth Stebbins (5:54):

So what are companies doing about this on a clear day? Are they putting in term limits? Are they setting mandatory retirement ages? Laurel, what are you seeing?

Laurel McCarthy (6:05):

Let me set the stage with some data related to the S&P 500. 67% of boards report having a mandatory retirement age. That’s compared to 73% a decade ago. Most of them are setting this age at 75, which we’ve seen steadily increase over the past decade. It used to be 70 and then it was 72. Now it’s 75. We usually don’t see many stats that surprise us in our annual board index, but this one did. We were shocked to see that the number of boards with mandatory retirement ages has been going down over the last five and 10 years.

Right now, there are only 43 boards in the S&P 500 that have term limits, but that’s up from 16 a decade ago. And compared to other countries, we set these term limits exceedingly high. We set them at 15 or 20 years. Compare that to the U.K. You lose independence after nine years of service. The average tenure in the U.K. is 4.7 years. If you look at the average tenure of departing S&P 500 directors in the U.S., it’s 12.2 years. The policies we have in the U.S. for turnover can help promote regular refreshment, but they can’t be the sole mechanism for turnover. Boards really need to be doing their job in terms of succession planning and thinking about refreshment and adopting robust assessments to help with that process.

Ann Beth Stebbins (7:31):

Especially in such a fast-moving world from a technological perspective. Do they need an AI strategy? You may need a new director with that expertise. Back to your comment on shelf life, Laurel, the shelf life of a director may be getting shorter just because the world is changing so quickly.

Laurel McCarthy (7:51):

Exactly, and I think we see in our recruitment work a real bias towards recency of experience, especially from the executive team. They want people on their board who know what it’s like to have been doing business in today’s business environment, and someone who retired even four or five years ago won’t understand the challenges they’re facing today.

Ann Beth Stebbins (8:14):

Elizabeth, how are boards and institutional investors thinking about term limits versus mandatory retirement age versus nothing?

Elizabeth R. Gonzalez-Sussman (8:22):

Laurel identified it quite well. A lot of companies have been more willing to adopt mandatory retirement ages as opposed to term limits, and I think generally it’s because nobody wants to be overly prescriptive. They want to be flexible if they get this great director who has amazing industry experience or relevancy to the company. Companies start to get into trouble when they adopt firm policies, and they want to make exceptions for great directors, they have to give waivers. When you give a waiver, you have to publicly disclose it and the rationale for doing so. If you’re faced with an activist investor, it’s an easy target.

It’s, “Wow, out of all of the available directors, you couldn’t find somebody else to fit those skill sets?” I would imagine a lot of companies are going to start moving away from these types of policies, but in replacement of them, they need to be very mindful of constant board assessment to ensure that if they remove a policy, they are nonetheless making sure that they have the right composition year over year.

And have you seen boards removing policies?

I’m anticipating it. Because of the reaction in the activist world, when waivers are granted, it really puts a spotlight on a company. “Wow, you can’t even follow your own policy.”

Ann Beth Stebbins (9:51):

What’s the frequency of waivers? How often do you see companies granting waivers to term limits? Is it mostly to retirement age?

Elizabeth R. Gonzalez-Sussman (9:58):

It really is mandatory retirement ages. That’s where I see it the most. Usually it’s at companies where they adopted the age too early, like 72, and all of a sudden you have a very vibrant 72-year-old and there’s no need to push them out. It could be the reason why a lot of retirement age policies have been moving more toward 75.

Activist investors look at how many board members have served for over 10 years or are over 70, and activists may question whether a company has different perspectives in the boardroom. There is an increasing desire to have younger, the younger generation, added to boards, particularly at companies that have a younger customer base, or maybe it’s technology —who’s best positioned to address some of these recent technological changes.

That ties into something Laurel was talking about earlier. Skills get stale when you’re not in the working world. What other reasons might a board have for replacing a director? What does a board do when faced with personalities that just don’t click?

Oftentimes, the reason a director asked to leave is recency of experience and that their skills and expertise are out of date, but the second-highest reason we see is cultural mismatch, which can mean a lot of things. It can be someone that takes the oxygen out of the room and never takes a breath. It can be someone that asks gotcha questions to management. It could be someone that doesn’t understand the role of a director in terms of noses in, fingers out. This is a tricky area where we’re really encouraging boards to have courage around these difficult discussions. This is not something that you want to have in your boardroom and it requires you to address the underperformance.

We would recommend doing robust individual assessments with a third party. Not every year, but maybe every two or three years, and acting on that feedback, and it can take multiple conversations. Sometimes we see that directors are able to change their behavior, and sometimes they aren’t able to change their behavior and they need to be replaced from the board.

Having represented activist investors for almost 20 years leading up to my joining Skadden, some of the issues about cultural mismatch often come in when an activist adds an independent director or a principal of an activist goes on the board. It can really be disruptive, and it’s balancing how to deal with that individual. It often backfires in my experience to isolate that individual. If they’re truly being disrespectful or asking questions that are not relevant or they have an interest that really differs from all the other shareholders, then certainly, boards need to take action.

But if the new independent director or the principal of an activist goes on the board and they’re asking legitimate questions about drivers of underperformance, it may warrant a different type of conversation. Of course, every director needs to be respectful, but if that’s not the issue, it’s just tough questions. Boards need to hear and respect what an individual director may be asking. You try your best to try to work with that new element that nobody really wanted to begin with but is there and we need to deal with it to avoid round two.

I completely agree. You can’t just have a rubber stamp board. There needs to be different opinions and a culture that accepts that. When we see the cultural mismatch, it’s more behavioral. I heard someone describe adding a new board director is like the first time someone in your family brings a significant other to Thanksgiving dinner. It changes the whole vibe of the dinner and how you interact and that you need to give people some time to acclimate. When you add that new person to the board, it can’t just be, oh, they had one bad meeting. We need to kick them off the board. There needs to be some conversations.

I think boards that spend time together in person and have that opportunity to build personal relationships are a more effective board. They understand where the directors are coming from, even if they’re coming from a completely different perspective.

Absolutely, Ann Beth. I mean, the in-person element is a game changer. I think everyone starts thinking more holistically about how we’re going to improve the company’s performance, or just generally, how best can we represent the shareholders drive, shareholder value? Even Zoom. Before the pandemic, a lot of boards just met over the phone. There was no Zoom. The in-person has dramatically changed a lot of board conversations.

Informal interactions and building those personal relationships makes the boardroom dynamic a much more productive and constructive atmosphere. Laurel had mentioned board assessments as a tool. How effective, Elizabeth, do you think the assessment processes for most boards in identifying areas where individual directors can improve their performance, and are the results of those assessments actually being used to improve director performance and board performance?

I think it really depends on who’s administering the board assessment. Laurel touched on this before. When you have a third party come in and ask the questions, assess and compile, and then report back to the individual directors as well as the full board, it goes a lot further than if you had a board assessment that’s undertaken and driven by the board chair. It becomes harder to have those conversations when the board chair is the one that has to have those conversations. If it can be blind as opposed to so-and-so said this, most now are anonymous. The way in which it’s structured, that’s going to be the most impactful. Sometimes the board assessments are just something that get done and nobody really spends too much time thinking about them.

There’s a lot of important information that can be communicated during those interviews, particularly if you’re using a third party assessment. Elizabeth, do you see boards giving that feedback directly to individual directors or do you see this more of an exercise in good corporate governance so we can report in our proxy statement?

I’ve seen it go both ways. Sometimes boards really do spend time giving the feedback that’s been received from these board assessments and there’s an honest discussion. But half the time, boards just circulate the responses and it’s not really discussed in depth and the board members are just left to look at it and nothing really changes.

If you’re an investor and you’re reading the proxy statement, is there any way for you to assess the effectiveness of that process, or is everyone’s disclosure pretty similar? And if you really do have a good assessment process, how do you signal that to investors?

It’s the actions taken, not so much the disclosure that really will determine for the institutional investor if this is a well-functioning board and truly assessing its composition. How many directors have served for a really long time? What are all the skill sets, and do they really have it? A lot of times, companies put in their skill matrix and every single box is checked with no real narrative as to what they really bring to the table. It comes down to actions. You don’t have too many long-standing folks. You don’t have too many with overlapping skills. That’s really what’s going to be telling as opposed to disclosure.

Laurel, what about the matrix? Can companies use the skills matrix more effectively?

We see almost all boards include the skills matrix in their proxy, but as Elizabeth said, it’s not incredibly useful if everybody checks every box. We would encourage boards to have strict definitions around each category to think about recency of experience, and maybe to limit directors to only checking two or three boxes, their top skills. The matrix is a powerful tool to think about board refreshment and succession planning. You can use the data to see what gaps might be coming up on the board. You can reorder it to look at by tenure or by age, and you can start to see where gaps will appear. It’s a bit underutilized because everyone checks every box, and that’s not incredibly helpful.

Have you seen companies include recency of experience in the matrix or as a factor in determining whether or not a board member has a particular expertise?

I don’t see it externally very frequently, but internally, when we’re having conversations about refreshment and succession planning, it’s a huge part of the conversation, especially in certain areas like technology. You could be a retired CFO for a decade and you’ll still add value. For individuals that are former CIOs or CTOs, industry technology is changing so quickly.

So what are some things that a board can do to prioritize refreshment? I’ll start with you, Laurel, and then Elizabeth.

A lot of it comes from the tone set at the top by board leaders, changing the culture to one of continuous refreshment, that this is not a lifetime appointment. Start by adopting that with the new people, setting expectations about how long they will serve on the board and understanding that their service is dependent on the needs of the board. That’s where the company’s strategy is leading. Another thing that we’ve talked about is robust board assessments. That’s what the institutional investors want to see as the driver of turnover. They want to make sure that you are using individual director assessments to make sure that you have the right people and are addressing underperformance.

The other thing that’s really important is just thinking ahead on succession planning. We’re always surprised by the number of boards who are caught flat-footed. “Oh no, we just realized the chair of our audit committee is about to hit the retirement age and nobody else wants to raise their hand.” That shouldn’t happen. You should take a long-term approach and have people in your pipeline all the time.

Do boards or Nom-Gov chairs ever socialize with investors, potential candidates for the board, or potential skill sets that they’re considering adding to the board?

Be your own activist. Act before you’re faced in a very vulnerable situation where you’ve got an activist saying your board needs refreshment. Going out to the institutional investors and your largest shareholders and saying, “What do you think of our composition, our skill set?” Putting some of your board members out there to speak with the institutional investors, get their feedback.

It’s not just about assessment. It’s about the pipeline. It’s about a thoughtful process so there isn’t a rush to try to add directors when you actually are faced with an activist investor. Or to Laurel’s example, “Oh my, we just lost our audit chair,” and nobody wants to stand up and do that. It’s being very proactive. That’s really the most important takeaway from this conversation. Be a proactive board, be your own activist, and that should hopefully help insulate you if you ever are faced with an activist investor.

Well, those are great words to take away from this podcast. Be your own activist. I’d like to thank Elizabeth and Laurel for joining me today, and we look forward to seeing you again on The Informed Board.

Laurel McCarthy:

Thank you.

Elizabeth R. Gonzalez-Sussman:

Thanks.

Thank you for joining us for today’s episode of The Informed Board. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Additional information about Skadden can be found at skadden.com. The Informed Board is a podcast by Skadden, Arps, Slate, Meagher and Flom LLP and Affiliates. This podcast is provided for educational and informational purposes only, and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.