Mon 13 Nov 2017
News - Board tenure – an important issue for independent non-executive directors which should not be allowed to bubble below the surface unaddressed
Description
Board tenure – an important issue for independent non-executive directors which should not be allowed to bubble below the surface unaddressed

Introduction

The question of board tenure has long been at the heart of corporate governance policies particularly in the context of determining board member independence. In the absence of board term limits, long board tenure can engender a board culture that leads to leniency on management and inertia on the part of the board. Board term limits have been highlighted in an EU Commission Recommendation.

Considerations around board tenure

This paper looks at considerations around board tenure. It aims to stimulate debate and its main contention is that independent non-executive directors should be appointed for a specific time period (renewable) and that their re-appointment should not be automatic. In practical terms, a letter of appointment should be issued, detailing the functions and time commitment that is expected as well as the anticipated period of appointment.

First – a word of definition - Executive Directors, NEDs and iNEDS

Whilst Luxembourg company law makes no distinction between types of directors (and therefore all directors have the same duties and responsibilities), corporate governance practice tends to divide directors into different groups, usually as follows:

  • Director - any member of a board of directors of a company
  • Executive Director – a director who is also an employee of the company
  • Non-Executive Director (“NED”) – a director who is not an executive director
  • Independent Non-Executive Director (“iNEDs”) – a NED who is also considered independent

EU Commission Recommendation

The EU Commission Recommendation of 15 February 2005 on the role of non-executive directors of listed companies has influenced the introduction of board tenure into national codes of corporate governance across the EU, including in Luxembourg where the concept has been incorporated into The X Principles of Corporate Governance of the Luxembourg Stock Exchange.

Recommendation 4.11 of the EU Commission Recommendation states that:

“All proposals for the appointment of a Director submitted to the (Shareholders’) General Meeting shall be accompanied by a recommendation from the Board. The proposal shall specify the proposed term for the directorship. It shall be accompanied by relevant information on the professional qualifications (and experience) of the candidate as well as a list of the positions and directorships held by the candidate. The Board shall indicate whether the candidate meets the independence criteria set by the company.”

Although the EU Commission Recommendation refers to listed companies, boards of unlisted and/or private companies are encouraged to take into consideration the basic guiding principles of good governance in this area.

The debate - why are term limits on board director service important?
What’s the problem?


The topic of board tenure has increasingly become the focus of both academics and investors.

Arguments for board term limits

Some would argue that board tenure is an issue too significant to be left to the board itself and absent shareholder intervention a board left to its own devices could be effectively self-perpetuating. This is neither in the investor nor the public interest nor in keeping with the spirit of good corporate governance which depends on an effective and balanced board.

They would argue further that the issue with poor board succession planning is not just that one or two directors have been on the board for a longer period – perhaps due to a misplaced sense of respect or loyalty - but that the board does not refresh itself periodically enough to add new blood. The long tenure of directors and the lack of term limits on board service could therefore fundamentally be considered as an obstacle to greater board diversity.

Arguments against board term limits

The counter-argument is that there is no ideal term limit applicable to all directors and that board tenure is indeed an issue that is best left to boards to address individually. Many boards function best when working together for years and regular change, while desirable, may be awkward to achieve. Specifically, with respect to age, it could be argued that many older people have the wisdom, experience and abilities to make significant contributions to boards. The preference is often to leave the core in place and bring a few people in as replacement as the need arises.

It could also be argued that this really only applies to listed companies. Smaller unlisted/private companies e.g., family businesses, albeit at a stage of development where independent non-executive directors have been appointed, may find board term limits too formal. Succession planning may often be a much more personal process, in which family owner issues and anxieties need to be addressed e.g., tax and inheritance tax planning issues etc.

Impact on the independence of board members

Conflicting opinions exist, but the heart of this issue is that independent non-executive board members are often widely regarded as less independent-minded after long service - not necessarily in the technical sense of EU or leading stock exchange definitions – but, as has been recently suggested, more in the sense of “social independence.” The development over time of shared social connections generally has a tendency to bias such board members or taint their objectivity. Board members tend to become defensive of the status quo or too close to management to objectively fulfil their oversight role. Sound board decision-making may therefore be adversely affected.

What’s to be done?

Codes of conduct and governance codes generally recommend that boards should engage in careful board appointment and selection processes, perform annual or periodic director evaluations and self-assessments (and act on the findings) and address director succession issues as part of an ongoing process. It is frequently recommended that the board should have a policy on tenure to be disclosed in the annual report and/or on the company’s website. Terms of three times three years or, at most, twelve years are often considered to be a maximum length of service.

These recommendations are gradually filtering down from listed companies to unlisted companies as well as into the private sector where frequently lenders or external investors want an independent non-executive director on the board. “Hard” board term limits may not make sense if it would mean an owner or founder or majority shareholder withdrawing from the board but other approaches may be adopted – e.g., average tenure of all board members should not be more than x years, retirement age limit etc. Even in the absence of a hard limit, the time limit should be applied to disqualify non-executive directors from also being considered as independent.

While board composition in the sense of having directors of quality is the single most important requirement, appointing directors who are able to make a positive contribution is one of the key elements of board effectiveness. Directors will be more likely to make good decisions and maximise the opportunities for the company’s success in the longer term if regular director rotation takes place and the right skill sets are present in the boardroom. This includes the appropriate range and balance of skills, experience, knowledge, diversity and independence – a range and balance which should naturally change over time as the size, strategy and lifecycle of the company changes. The current focus on ensuring directors have or gain appropriate digital skillsets is a great example of how the needs of a board change over time. What was required yesterday may be different from the needs for tomorrow.

With a healthy culture in place - including where the boardroom is a place of constant challenge, constructive debate and dispassionate decision-making - the ongoing success of the company should be rooted in diversity (including gender balance, ethnic and geographic mix as well as appropriate skills, background and experience), regular self-assessment and good succession planning.

Strong, fair and transparent board refreshment processes also remove the need to have sensitive and subjective conversations with individual board members, whose time has come, and which might be misconstrued as a personal attack putting those individuals immediately on the defensive.

Conclusion

In line with the EU Commission Recommendation cited above, boards who have not yet undertaken a careful review of their board composition and specified proposed term limits for their directors should address this issue as a matter of some urgency.

Board tenure should not be an issue which is allowed to simply bubble below the surface unaddressed.

ILA Board Organisation and Effectiveness Committee