TIME WILL TELL - JSE MAGAZINE

TIME WILL TELL

Globally, investors and regulators have begun to ask questions about long-serving independent directors. Can anyone who is on a company’s board for longer than a decade really remain truly independent?

TIME WILL TELL

Studies have shown that in the US most top firms have male directors in their 60s – and the trend shows that they are getting older. In the UK, boards are required to justify an ‘independent’ classification for any director who has served longer than the ‘nine year rule’, which comes from recommendations in King III and the combined Codes of Corporate Governance 2012.

In SA, the latest PwC Non-Executive Directors’ Practices and Fees Trend Report reveals that the overall average age last year of a non-executive director (NED) in 2013 was 50, while a chairperson was 56. In contrast, the Spencer Stuart Board Index, which measures trends in the US, found that the average age of an NED in that country in 2013 was 68. The phenomenon in SA of younger directors and chairpersons on boards is partly linked to the country’s need for transformation in the workplace in terms of BEE, experts say.

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Referring to the PwC report, Ansie Ramalho, CEO of the Institute of Directors in Southern Africa (IoDSA) says a median of 50 for two years consecutively (2012 and 2013) is very reasonable, especially compared to the average age of 68 as per the Spencer Stuart US Board Index.

‘I believe the younger average age of South African NEDs is attributable to transformation efforts and the fact that directorship is becoming a professional aspiration in SA. Traditionally, being a director would come at the pinnacle of a person’s career and would be a title added to some senior executive responsibility. With the requirement for a majority of NEDs in accordance with sound governance, non-executive directorship is now a self-standing profession.

‘The relatively young age of South African NEDs is indicative of the interest in pursuing it as a career. It is encouraging that the trajectory in SA does not appear to be an ageing directorship as it means that we have a strong pipeline for the years to come.’

Ramalho does not believe it is appropriate for directors’ maximum terms on boards to be mandated. ‘Independence is as much a state of mind as it is adherence to objective criteria. Looking at the issue in a simplistic way, short tenure also means relative lack of experience and knowledge about the company and possibly even its industry.

‘Furthermore, a director may be independent as assessed against the years served on the particular board but may, for example, be depending financially on the fees paid in lieu of services rendered as a director. Factors such as these are as likely to affect the independence of a director’s tenure. Also consider the instance where a director has served a longer term, but during his/her tenure the management team had been replaced. In this instance the argument for so-called lack of independence due to tenure does not hold water any longer,’ she says.

Ramalho says King III recommends that boards assess the independence of a director who has served longer than nine years. Boards using their judgement and evaluating the independence and contribution of an individual is a much more effective mechanism to deal with the matter than an inflexible term. This goes beyond mere criteria to assessing the state of mind, that is, from form to substance.

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‘Boards that provide guidance to management need to have the right balance between long-serving directors and new board members’

CHRIS EWING, CHAIRMAN, DLA PIPER AFRICA GROUP

Staggered rotation whereby directors’ terms come to an end at different times, rather than the whole board being replaced at once, is one way of ensuring that boards retain experience, but also provide for new appointments that will bring fresh insights, she says. 

‘Ultimately, as far as having a balanced board is concerned, there is nothing that can compensate for a competent board that is able to withstand the discomfort of having its performance evaluated as well as that of its individual members. This will include interrogating independence and robustness of its decision-making. And then to complete the virtuous circle, a courageous chairman who is willing to confront the issues, including requesting directors to step down if necessary, is essential to the process,’ she says.

Chris Ewing, chairman of business law firm DLA Piper Africa Group, says the need to adequately balance the ‘nine year rule’ with institutional memory of the company is critical. Institutional memory refers to the history of the company and key events in its past and vests mainly with long-serving directors on the board. Ewing says the need for institutional memory is even stronger in SA due to our business transformation needs in terms of BEE.

‘We need to ensure that BEE is dealt with adequately. This means boards that provide guidance to management – CEOs and finance directors of which there is sometimes a high turnover – need to have the right balance between long-serving directors with knowledge of the history of the company and issues that cropped up in the past, and new board members who may be younger with fresh ideas that give momentum for change.’

He says institutional memory is not necessarily all documented. ‘Longer-serving directors are often the sole source of knowledge of the company’s history, so it’s a question of finding the right combination between experience that comes with long service and the need for change that tends to come with fresh ideas of new board members.’

Richard Leblanc, associate professor in law, governance and ethics at York University in Toronto, explores the question of ‘how long is too long for board directors’ on www.canadianbusiness.com. He says regulators in the UK, Australia, India, Hong Kong and Singapore are imposing term limits of between nine and 10 years on NEDs, beyond which their independence gets questioned.

35% of the 934 directors who responded said someone on their board should be replaced, up from 31% a year ago

‘Regulators read the press reports of directors serving 40 years and communicate with academics on what the empirical research findings are. The fact of the matter is that boards, self-policing bodies, may be incapable of solving the renewal issue on their own because of entrenchment or self-interest.’

Leblanc says it’s an ethical and integrity issue that begs the question of when ‘hanging in’ or ‘digging in’ breaches a fiduciary duty of a director to act in the company’s best interest. If – or perhaps when – a director becomes irrelevant, or is destroying value, it is not ethical for that person to continue or for the board to allow them to stay. This is when doing what is right, putting oneself at risk, having proper succession planning, mentoring, coaching and developing the next generation of directors and letting go gracefully, matters. He says academic evidence does not support excessively long-serving directors or directors who are serving on multiple boards.

PwC explores board composition and renewal in its January 2014 NED Practices and Fees Trend Report, and finds that on average directors are getting older and fewer are leaving boards to make way for the next generation. It says the 2012 Spencer Stuart US Board Index found that the number of new directors slowed to 291 of 5 184 seats in the US in 2012, a 27% decrease from a decade earlier.

Meanwhile, the average age of directors (68), average board tenure (8.7 years) and mandatory retirement age (72–75) have all risen. Some 75% of all S&P 500 companies have mandatory retirement age policies, but sometimes they are waived. Only 4% of S&P 500 boards specify director term limits, with most setting it between 10 and 15 years. The same report reveals that besides outside critics such as investors and regulators increasingly asking questions about board composition, ‘plenty’ of members themselves show dissatisfaction with the composition of the boards on which they serve, despite directors at companies with annual elections being appointed with 90% of the vote.

Early results from PwC’s 2013 Annual Corporate Director Survey show that 35% of the 934 directors who responded said someone on their board should be replaced, up from 31% a year ago. The top three reasons are diminished performance due to ageing, lack of expertise and no preparation for meetings.

Don Keller, a partner in PwC’s Centre for Board Governance, says those who believed a change should be made also cited several obstacles that they believed would stand in the way of replacing a director. By far the biggest obstacle cited in the survey was board leadership being uncomfortable addressing the issue, according to Keller.

By Louise Brougham-Cook
Image: Fredrik Broden/reneerhyner.com