Change in the Boardroom: Evolution or Revolution?: Commission seeks to transform boards into high-impact strategic assets

Monday, November 7, 2016 - 22:42

Every year, the National Association of Corporate Directors (NACD) prepares a major report by a Blue Ribbon Commission composed of leaders from the corporate governance community. The NACD board debates three possible topics and picks one. This year it was unanimous: “Building the Strategic-Asset Board.” Below, the leaders of the effort, Bonnie Hill and Richard Koppes, discuss the commission’s watershed report, which tackles a series of fraught topics with a heavy dose of tough love aimed at boards too sluggish or passive to change to meet changing times. Their remarks have been edited for length and style.

MCC: The Blue Ribbon Commission report, “Building the Strategic-Asset Board,” is a loud and clear wake-up call for boards facing a rapidly evolving governance environment with less urgency than some deem appropriate. What prompted the project, and did you anticipate it would be the watershed event that it appears to be?

Koppes: It was pretty much the unanimous view of the NACD board that this topic needed to be the focus of our annual Blue Ribbon Commission report. There was a lot of sentiment that we needed to look at the subject and move the needle.

MCC: The report begins by setting the stage with objective symptoms – low director turnover and the age and tenure of board members – suggesting to investors and other stakeholders that there might be a problem. Recognizing that boards should be treated individually, how bad does the commission think the general problem is that it chose to address?

Hill: Stakeholders and investors are asking for more from the board, which they should. In many ways, they are asking boards to hold themselves accountable in the same way they hold the management team accountable for performance. Director evaluations are one way to determine whether someone is doing the job they were elected to do, which includes showing up prepared and staying current with the changing environment within their industry.

There tends to be a belief that we need to keep the old-timers on the board because of their institutional memory. As a commission, we agreed that it’s important to have board members with the history, so the same mistakes are not repeated, but it is important not to keep doing the same things and expecting a different outcome, especially in light of the challenges we face today in high-risk areas such as cybersecurity and social media. We began to question whether those of us who are “veterans” understand this changing world in a way that’s going to be in the best interest of our investors and our stakeholders. We determined it was an issue that needed to be addressed and that we needed to call on different types of engagement and involvement – and perhaps even a different type of board in some instances.

Koppes: I would stress what Bonnie said earlier: Boards need to hold themselves accountable because, frankly, the large institutional shareholders are definitely going to hold them accountable. Boards need to do that themselves.

MCC: The commission acknowledged the ongoing discussion of board refreshment from institutional shareholders and others. It stopped short, however, of a full-throated endorsement of term or age limits, instead favoring an approach designed to assure that boards remain “fit for purpose.” One commissioner worried aloud about refreshment for refreshment’s sake. Can you discuss the commission’s nuanced view of board refreshment?

Hill: It is often said that one size does not fit all. That is very true, but there are directors who have passed what we would consider the age of retirement who are still very productive, current in their knowledge, and contemporary in their thinking. There are others who see board service as an entitlement and believe they belong because they’ve been there for so long. We wanted to get beyond that. Each board has to determine for itself who is productive and who is not.

It’s disheartening to the management team to make a presentation to a board, having sent all the material well in advance so that it can be discussed, and then have directors ask questions that were answered in the materials, clearly demonstrating that they did not take the time to read and prepare before showing up to the meeting. When that happens repeatedly it calls into question why you are serving on the board. We are trying to get boards to review those directors carefully and determine whether or not they are fulfilling their obligations – their duty of care to investors and other stakeholders. That’s what prompted us to get a little edgier, while still recognizing that no one size fits all. There are boards functioning very well and, we hope, evaluating directors on a continuing basis. We’d like to say that it’s the majority, but obviously, based on all the studies we have seen, that’s not the case.

Koppes: Unfortunately, whenever you deal with law or regulation change, which is what we are trying to avoid, you get a one-size-fits-all approach. We want boards to have these vigorous discussions within the confines of the board. The board itself knows when certain people need to move on, when the nature of the company is changing and some of the board members aren’t keeping up. You need to have those discussions.

Hill: One size does fit all, however, in the sense that every board needs to evaluate itself and its directors and make certain they are doing what they were elected to do. What their end result is, and how they decide to manage it, is up to them, but they need to evaluate themselves and hold themselves accountable to assure that each director is actively involved and engaged.

MCC: The commission recognizes that board seats are hot commodities. They are not often voluntarily relinquished. Because of that, there can be a stigma attached to turnover. One way to deal with that, the commission says, is to make turnover more routine. How can a board make turnover routine?

Koppes: From the very beginning, when a new board member is being considered, make sure there is an understanding that it is part of the board’s natural flow that people will move on. Then it has nothing to do with sleeping in a meeting or being a bad person. It’s the nature of the dynamic of companies today. If the board is going to be a strategic asset, it has to be vital and contributing to the whole business enterprise.

Hill: Boards need to acknowledge that they’re excited about having new members with a particular expertise that, right now, is in line with the company’s strategy. But as strategy changes and different expertise is needed, the board may need to change directions and bring new expertise on board. People should understand that, so they don’t think they are taking a board seat in perpetuity.

I know it’s hard to give up a board seat. I just aged off of three boards myself, and even with an opportunity to continue, I felt it was important to move on so that younger people with more technologically current expertise could be brought on. We also have to think about whether when we bring on someone who is in their 40s, and the board has a retirement age of 75, they will really want to hang around for that long. I think not; I would hope that that’s something the new generation of directors is bringing with them – a willingness to serve only as long as they are a strategic asset.

MCC: Most of our readers are general counsel who play a key role in the boardroom. Give us some sense of the role you think general counsel can play in making the strategic-asset board a reality. Where can they have the greatest impact?

Hill: The general counsel role is very important to the board. The GC has their finger on the pulse of the regulatory environment. They guide the board on major governance issues by keeping us abreast of current issues in the governance environment, and they make every effort to ensure that we are doing things ethically and in a principled way that help us avoid major lawsuits. Their guidance is critical.

Koppes: I have a bias because I was a general counsel, not at a corporation but at the California Public Employees’ Retirement System (CalPERS). I understand the dynamics of boards. GC are at most or all board meetings. They probably know the strengths and weaknesses of the board even better than the CEO or CFO. The GC can play a crucial role in guiding the board to have discussions about change, refreshment and evaluation.

Hill: I can’t imagine any director who wouldn’t see GC involvement as important. They can help us make sure we are being diligent about the things we are obliged to do.

MCC: The commission says in the report that directors should prepare for the possibility of shock treatment if they are too passive or too slow to act in the face of a changing environment. It even raises the possibility that without sufficient and timely evolution, boards could face a revolution. That’s a strong statement. How real is that possibility?

Hill: Shock treatment seems like a very strong phrase. If we look back a number of years to when the Sarbanes-Oxley Act sent shockwaves through boardrooms, boards suddenly started spending more time making sure they were doing all of the things the ruling said they should do. Not too much later there was Dodd-Frank, and now there’s a need to do more to articulate why we have certain directors and what they bring to the board – not just the nice little résumés that are put in the proxies. When you start getting requirements to do things that in many ways we should already be doing, that’s probably what brings about the shock treatment. “Oh, you mean we’re not doing that?” No, you’re not. It’s a prod. You’re not just sitting on the board to have a nice time and listen to reports. You’re expected to bring something to that board. You have to be able to advise and counsel and make certain things are moving in the right direction.

We as directors need to be activists in our boardrooms in the sense of actively involved and engaged. I’ve worked with a lot of directors who are engaged and very active and involved. I’ve also worked with directors who sat there and I didn’t even know if they were breathing. I think all directors have had some of those experiences, and sometimes it does take a shock treatment to bring about change.

Koppes: Another possible shock treatment can come from the media. I don’t think many directors want to see their name on the front page of a story about how they have fallen down on the job. We can go through a list of companies that seem to be constantly in the news these days. Directors need to work harder to make sure those things don’t happen, or that they’re dealt with properly when they do happen. People are looking to boards because the buck stops with the board.

Hill: “Where was the board?” That’s the kind of the question we hear all the time.

Koppes: I heard it last week from several media people. “Where is the Wells Fargo board? Where is the Mylan board?” Those were the ones in the media just in the last week.

MCC: There is much discussion of board self-assessment, and the commission cites some telling statistics – 50 percent of public company boards don’t conduct individual director evaluations, and 40 percent of private company boards don’t do any evaluations at all. It is hard for organizations or individuals to assess themselves. How can boards address this?

Hill: It’s interesting because in major corporations boards are the only ones that assess themselves and don’t get evaluations from anyone else. That’s because boards are the top of the food chain. That is all the more reason to be diligent about this. A great deal of it goes to board leadership, whether it’s the nonexecutive chair or the lead director. They need to make sure that the process is a diligent one. I’ve been in meetings where we go, “We’re all good. We’ve done a great job. We read our material.” And then it’s over. In others, the evaluations are written and conducted by a third party. They are summarized and discussed in the board meeting in an executive session. With that approach to evaluations, people tend to be pretty candid about what they think about the board, its interaction and its engagement. With regard to self-assessment, directors are less likely to criticize another director.

As a lead director, I would call each director independently and ask how things were going. How they felt about the board. How they felt about everyone’s participation and so forth. Then I would ask that they call either the chairman, CEO or the head of audit to give an evaluation of me. This is what leaders should do. We have to be evaluated also. Even though those evaluations aren’t written, they are probably more candid.

I think every board needs to find a way to assess its directors’ performances – and not just on an annual basis. If there is a director who is not involved and engaged, you don’t have to wait until the end of the year or a time of evaluation. But someone needs to have the discussion and see if everything is OK. Are they still feeling like this is where they want to be? Is there something wrong as to why they are not engaged? Otherwise, we end up with what’s come out of these reports. No evaluations or limited evaluations.

Koppes: Director positions are for the most part well-compensated. As Bonnie said, they are one of the few groups that are not evaluated. We need to get away from this idea that people in these highly responsible, well-compensated positions shouldn’t be evaluated. They are not federal judges, and they are not tenured university professors.

Hill: That’s true. It’s very hard because there are excellent directors who would disagree, for whatever reason. That’s kind of left up to them.

MCC: One area where directors are being asked to do more is communication with various stakeholders. The commission cites the Council of Institutional Investors, which said that companies too often fail to provide compelling rationales in proxies for their choice of board candidates – just a standard bio. Why is this particular aspect of communication important?

Hill: There is a tendency to think that the bio is enough. We don’t agree that’s enough. There has to be a reason that you selected a particular director, and most often there is. But I think there are a lot of people who would say it’s a form of arrogance to simply say we selected this person to be on our board and therefore you should be happy to have them, so vote yes on this nomination.

Koppes: We’re asking the shareholders to vote or to withhold their vote in favor of these directors. Most boards have a lengthy discussion about what kinds of skill sets they need and why this particular candidate fits that. Why not share some of that? It doesn’t have to be in detail, but don’t assume people can pull that from the bio.

Hill: The vetting of board candidates is very intense, engaged and involved. It could be that the board is so exhausted by the process and they know so much about this person that they think the bio is enough for everybody else. Sometimes the board works to exhaustion to get new directors, and the vetting process is intensive. I can recall processes that have taken a year, a year and a half. We have to pull back and say yes, we’ve been through all this and we understand the value this person brings to the board, now let’s make sure our shareholders and investors understand why we believe this person will be an asset to the board. It’s just another way of thinking.

MCC: If a traditional board were to undertake one change that will get it started down the road to repositioning itself as a strategic-asset board, what should that change be?

Hill: Assess the skill set of the board meticulously. By that I mean you have to understand the competencies that are needed for today’s environment – not what was needed in the past or the thinking that we should do things the way we’ve always done them because it’s worked before. The world is changing rapidly. We need directors who understand the risks brought about by cybersecurity, social networks and global volatility – people who understand that a single tweet that can take a company’s stock price down overnight. Then don’t hesitate to change the board to reflect reality.

Koppes: Don’t be content with what you have, and look at what you need to have in the future. What can we expect in the next two, three, five years, if we can think that far out these days. What are we going to need then?

Bonnie Hill, who has had a wide-ranging career in business, government, education and philanthropy, has more than 23 years of experience serving on corporate boards, including Yum! Brands, California Water Service Group, and The Home Depot, where she served as lead director. She is a faculty member of the NACD Board Advisory Service Program and was recognized by the NACD Directorship 100 as one of the most influential people in corporate governance. She was awarded the 2015 recipient of the NACD’s 2015 Lifetime Achievement Award. She can be reached at bonnie@iconblue.com. Richard Koppes is the, former Deputy Executive Officer and General Counsel of the California Public Employees' Retirement System (CalPERS), the largest public pension fund in the United States. He, currently has serveds on the four boards, including of NACD and the Investor Responsibility Research Center Institute. In 2007, NACD presented him with its Lifetime Achievement Award for contributions to corporate governance – its highest honor. He can be reached at rich.koppes@gmail.com.