NACD Directorship | Offense is the Best Defense

Our CEO Brett Stephens and Matrice Ellis-Kirk, head of our Dallas office, write in the latest issue of NACD’s Directorship magazine on how boards of directors can embrace proactive nominating processes.

NACD Directorship

 

Offense is the Best Defense: A New Process for Nominating Committees
Brett Stephens and Matrice Ellis-Kirk (@melliskirk) | October 06, 2014

Today’s public companies are facing more pressure than ever from regulators and activist shareholders–and their board compositions are the primary targets. Specifically, demand for more involvement, transparency, and access to director nominations is putting increased pressure on nominating committees to ensure they have a proactive director succession process in place. These committees, therefore, are now going on the offensive.

The 2013-2014 National Association of Corporate Directors (NACD) Public Company Governance Survey shows that 60 percent of boards replaced or added a director in the last 12 months–up 42 percent from the previous year’s survey. This annual questionnaire details 1,019 public company responses between May and July 2013. The escalating turnover has fueled a race for boardroom talent that demands increasing attention from nominating committees. Increasingly boards need to leverage all possible sources to compete for the limited number of interested and available director candidates.

As companies adjust strategies to mitigate threats to their businesses, directors see a greater need for succession planning focused on addressing future expertise gaps. Nominating committees must maintain a constant understanding of the knowledge gaps on their boards to optimize the time they spend on assessing new board candidates.

Embracing a Proactive Nominating Process

Best-in-class boards are moving away from a reactionary and intermittent nominating process and toward a more continuous, anticipatory, and inclusive director succession process. A large number of mid-cap and small-cap companies, however, are unaware or unable to implement this approach due to often-parochial board cultures.

Smaller companies are likely to add board members from within a close circle and are motivated primarily by familiarity, deferring to CEOs and their board colleagues to suggest candidates. This lack of focus on board succession prohibits its ability to pursue candidates with the absolute best skillset for the board position. These companies also typically embrace a culture of status quo, making them especially vulnerable to activists that view their corporate governance as sleepy. Opportunities for growth, expansion, or acquisition may not have been pursued, either, inspiring activists who think they can do better.

While the impacts of Sarbanes-Oxley and modified exchange listing requirements have been over communicated, the strains they put on nominating committees are progressively more relevant. Due to increased time commitments, the perception of conflicts and personal liability, and a keener focus on compliance, the pool of experienced and diverse potential board members has significantly decreased. As a result, the time required to identify, assess, and select board members with the requisite expertise has risen dramatically.

Preparing for Pressure from Activists

Activists continue to demand increased transparency and access to the director nominating process. Their goal? To more closely align company and shareholder interests via nominations of their own director candidates. The two biggest concerns shared by activists are a lack of industry knowledge and the traditionally long tenure of directors. Since most boards view the nominating process as highly-confidential, stakeholders are usually unaware of the search for a new director until a public announcement has been made. As a result, any suggestions from shareholders–especially around proxy season–have no impact. While corporations will never be completely democratic in electing directors, many companies have taken proactive steps to broaden the process. For example, some companies document new director criteria, thereby alleviating some of activist pressure.

The investment community continues to engage in board composition campaigns. A few months ago, California pension giants CalSTRS and CalPERS launched a campaign targeting 131 companies in the state. Following the campaign, at least 15 target companies added a female director to their all-male boards, and another 35 indicated a willingness to do so. As part of this initiative, the funds offered their expertise to help appoint female directors and provided a copy of NACD’s report “The Diverse Board: Moving from Interest to Action.”

Nominating committees are becoming more involved in a continuous process of assessing, courting, and prioritizing potential candidates for immediate and future board needs. Due to the increased time commitments boards face, coupled with the need for independent objectivity, nominating committees and CEOs are more routinely turning to outside firms to help them with the prioritization process. In this capacity, firms such as RSR Partners are acting more as strategic advisors rather than transactional search professionals. This relationship enables the board to better prepare for director retirements or necessary board realignment due to a change in corporate strategy. With a prioritized list of candidates in hand, the nominating committee can avoid a lengthy search process.

Board evaluation also comes into play here. The 2013-2014 NACD Public Company Governance Survey found nearly all boards using evaluations. Hence, a trend of removing board members based on a poor evaluation during the annual directors review process for the proxy has emerged. In fact, nearly 14 percent of boards surveyed had removed a director based on evaluation results. This trend is likely to increase as regulators and activists demand better board performance and accountability.

Mount Your Offense Today

In this new era of offense for nominating committees, the most successful corporate boards will adopt a proactive director succession process. The following action items are an effective way to get started:

1. Charge the chair of the Nominating and Governance Committee to develop a matrix of the board for succession planning purposes;
2. Execute an annual gap analysis of the capabilities and competencies of the board that aligns with the company’s current three- to five-year strategic plan; and
3. Begin the director succession process 18 months to two years prior to any anticipated retirement.

RSR Partners believes the new proactive nominating process will continue to take hold and effectively mitigate risk by relieving tensions between shareholders and management. With a strong offense as the best defense, nominating committees will successfully meet the growing need for directors who are able–and willing–to make a positive difference.

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rsrpartners.com

Contact: Christopher Sheeron | +1 (203) 618-7000 | csheeron@rsrpartners.com

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