Beyond Term Limits: Using Performance Management to Guide Board Renewal

The debate over board renewal is moving into sharper focus in Canada. New public company disclosure requirements demand greater transparency on such things as term limits and other renewal mechanisms, and some large investors are sending the implicit message that companies must renew the board or they will seek to do it instead. The ICD agrees that the composition and renewal of the board are vital processes that demand rigour and analysis and are best undertaken by the board pro-actively.

In the paper Beyond Term Limits: Using Performance Management to Guide Board Renewal we seek to provide a framework for boards to build a renewal process that increases accountability and achieves the right mix of skills and experience to create long-term effectiveness.

To that end, we propose that boards across the for-profit, not-for-profit and Crown sectors build their renewal processes around the concept of performance management, including effective board evaluations set within a performance culture.

In other words, boards should review themselves the way they do their management teams. This means instituting regular and substantive evaluations of board composition and board member performance, and following through when necessary by having “tough conversations” with underperforming members or directors whose skills do not align with the organization’s strategy. This will help create a culture of accountability, and foster high performing boards.

Introduction

Beginning in 2015, most provinces in Canada will require greater transparency regarding gender diversity policies for non-venture issuer boards. One new rule stipulates that companies disclose their director term limits policy or details of other board renewal mechanisms they employ.

Proponents of term limits as a driver for board diversity point to the increasing age and tenure of directors on Canadian boards as evidence for the need for change. According to Spencer Stuart, the average age of non-executive directors in Canada in 2014 has risen to 63 (from 60 in 2009) and the average tenure to 9 years (from 8 in 2009).

The ICD has been one of the strongest advocates of gender diversity on Canada’s boards. We also strongly agree that ensuring directors continue to add value to their boards is crucial. However, we are concerned that the board renewal discussion in Canada has been placed in the context of manufacturing boards that meet externally motivated criteria or targets for membership.

In our submission to the CSA regarding their gender diversity disclosure rules, we took the position that board renewal should be focused on making boards better and not with a view to achieving a homogeneous formula:

Pressures for change

The broad pressure for better board governance has come primarily from shareholders and other stakeholders insistent on improved organizational performance, transparency and diversity of director opinion and experience. The ICD shares these views. Further, we believe it is critical that, in Canada, we recognise the increasingly global environment in which our organizations compete and that, now more than ever, our boards leverage every opportunity to be the best they can be to help drive long-term effectiveness.

On the issue of term limits, the prevailing discussion in Canada has centered on their potential to foster greater gender diversity, whereas in other countries the issue of director tenure has been considered in the context of director independence from management. In France, for example, a director that serves on a board for more than 12 years is no longer considered to be independent. In the UK, the board must publicly state why it believes a director serving beyond 9 years is still considered to be independent.

The investor community has also been applying pressure on public company boards to adopt board renewal strategies. Activist shareholders, including certain hedge funds, have been vocal in demanding that the companies in which they are invested are serious about board renewal—ostensibly with a view to adding more sector experience or leadership to their boards. Some institutional investors in Canada have also expressed a desire to pursue greater proxy access—that is, to have the right to nominate a percentage of board directors once a certain share-holding threshold has been achieved. The message to boards from the large investor community is to renew or they will seek to do it instead.

Proxy advisory firms such as ISS have also begun to look at director tenure in the context of independence. For example, in their Quickscore 3.0 product, ISS considers length of tenure in its opinion of directors’ independence. These firms have grown into key sources of information, analysis and guidance on proxy votes for institutional investors and, therefore, are considered by their clients as arbiters of corporate governance practices.

Incorporating performance management into board renewal

Whether due to regulatory changes such as mandated diversity or independence disclosures or due to increased focus by shareholder groups, boards are feeling external pressure to review their renewal practices. While external pressure can sometimes bring about positive change, on the question of their future composition, it is vital that boards build a framework unique to their forthcoming challenges and that they apply a great deal of thought and analysis if they seek to maximize their effectiveness over the long term.

Performance management systems, characterized by objective-setting and supervisor evaluations are commonly applied to executives and other employees and are an effective way of ensuring quality throughout organizations and of making key staffing decisions. Indeed, boards regularly use performance management in their evaluations of CEOs. Importing this concept to the board is a useful way of building a framework for renewal.

By incorporating performance management tools, including board composition reviews and board evaluations with mechanisms such as term limits, boards can identify areas for development and/or underperformance and recognise needed skills and competencies around the boardroom table. Framed within a performance culture that expects and enforces accountability with a tone set by the chair, an effective framework for board renewal can emerge.

Term limits

Many boards in Canada feel that term limits serve a purpose, with 56% of Canadian Spencer Stuart Board Index (CSSBI) companies reporting they employ voluntary term or age limits. According to a recent Korn Ferry International/Patrick O’Callaghan and Associates survey, term limits for Canadian public companies surveyed ranged between seven and 20 years with 53% of those companies having a 15 year term limit.

The ICD agrees that voluntary term limits have their place and can act as a backstop against excessive tenure lengths, which can lead to the perception of eroding independence. They may also provide some predictability around director position openings. However, mandatory limits could also be counter-productive to the good governance of Canadian organizations.

Term limits are a blunt tool and, without flexibility, they eliminate effective as well as non-effective directors. For this reason, we believe that boards must retain discretion to preserve vital institutional memory of high performing and contributing members.

On some boards, we have also observed that term limits can have the effect of replacing “tough conversations” with directors who no longer add value to the organization, therefore obviating the accountability inherent in identifying and addressing weaknesses. Boards should not “wait out” a poor director’s term and, instead, should be prepared to ask them to resign before their terms are finished.

Conclusion

New reporting requirements in Canada demand that boards of non-venture issuers think more deeply about their renewal process, but organizations across all sectors are equally confronted with the challenges of building boards that are effective in the long-term.

Modern boards are increasingly expected to take on complex organizational oversight and governance roles. We would argue then, that renewing them should also be a process involving a great deal of thought and analysis. While term limits can be a supporting mechanism, relying solely on them to renew the board is insufficient and may be counter-productive to good corporate governance. Rather, establishing renewal around the concept of performance management within a culture that demands accountability of directors and maintains a firm view on the future needs of the board provides a more effective framework for renewal.

Endnotes:

[1] ICD Comment—Request for Comment on Proposed Amendments (Proposed Amendments) to Form 58-101F1 Corporate Governance Disclosure (Form 58-101F1) of National Instrument 58-101 Disclosure of Corporate Governance Practices (NI 58-101), April 15, 2014.
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