The “New Insiders”: Rethinking Independent Directors’ Tenure

Yaron Nili is a fellow at the Harvard Law School Program on Corporate Governance. This post is based on Mr. Nili’s recent article, The “New Insiders”: Rethinking Independent Directors’ Tenure, forthcoming in the Hastings Law Journal.

Director independence has become a key element of modern corporate governance in the United States. Regulators, scholars, companies and shareholders have all placed a strong emphasis on director independence as a means to ensure that investors’ interests in their companies are well-served. Surprisingly, however, their treatment of director independence has generally failed to consider the impact of director tenure on the independence of boards. Indeed, although legislation, listing rules and state law mandate director independence, none of these rules take into account director tenure.

Recently, however, board tenure has been getting increased attention from investors, companies and shareholder advisory firms. Investors are becoming increasingly concerned with the potential negative impact that long tenure of directors may have on their independence. In a recent survey, ISS found that 74 percent of investors were concerned with the negative impact that long tenure may have on independent directors. Similarly, several institutional investors have recently amended their voting policies and guidelines to address the issue of director tenure. For instance, the Council of Institutional investors (CII) now encourages boards to weigh whether a “seasoned director should no longer be considered independent.” Similarly, on December 16, 2015, CalPERS’ Global Governance Policy Ad Hoc Subcommittee approved proposed revisions to the pension fund’s Global Governance Principles to require that companies take a comply-or-explain approach on the issue of long-tenured directors. Under the proposed revised principles, a company would have two options with respect to a director who has served on the board for more than 12 years: either classify the director as non-independent or annually disclose a basis for continuing to deem him or her independent.

In my Article, The “New Insiders”: Rethinking Independent Directors’ Tenure, forthcoming in the Hastings Law Journal (volume 67), I explore these issues and the potential impact of director tenure on director independence. The Article starts by delineating the key channels through which long director tenure may impact director independence. I demonstrate how longer tenure of directors can tighten their social ties and further augment the structural bias they may suffer from; how longer tenure increases the financial stake that directors have in the company, which in the context of director independence may not be optimal; and how the option to serve for long tenure increases the dependence of directors on management for re-election.

In addition to arguing that long tenure may, in itself through the aforementioned channels, directly impact the efficacy of current board independence standards, I also provide new empirical evidence regarding the significance, scope and prevalence of long tenured directors in large public companies. The data presented in the Article reflects that not only a significant portion of S&P 500 boards have long tenured directors but also that the tenure of directors has seen a steady and significant increase over the last twelve years. This documented increase in average tenure, juxtaposed against additional changes to board structure—such as the increased hiring of directors with strong “insider” background, including retired executives and insiders from other corporations—further underscores the importance of addressing the issue of board tenure and its potential impact on director independence.

The Article then situates this trend in the larger context of transformations in board structure. Specifically, I suggest that the rise in director tenure reflects a market attempt to push back against the regulatory emphasis on director independence that has forced companies to remove many of their high ranked executives from the boardroom. This reaction is manifest in the prevalence of what I term the “new insider,” a hybrid board member who complies with current independence requirements but, through longer tenure and other attributes, possesses many of the traits that corporate insiders previously brought to the board table.

By allowing directors to accumulate specific business knowledge and to develop social and professional investment in the firm, public companies can now retain many of the benefits that inside directors possessed, while still appeasing regulatory and public requirements. However, at the same time, these long tenures and insider backgrounds might also erode the true independence of the board that the independence rules were intended to ensure.

This transformation in the composition of corporate board rooms and the need for truly independent directors in some key positions begs a rethinking of current independence standards. Coupling this market movement with the impact it might have on board independence, I explore the benefits and risks of this “new insider” model as well as the potential need for regulatory intervention. Specifically, I suggest that the current trend of increasing tenure on the board as a whole, and on key committees in particular, might threaten director independence. However, recognizing that increased tenure also carries with it several advantages for companies, particularly in light of the regulatory push for independent directors, I advocate for a soft regulatory fix that would allow companies to retain long tenured directors but would ensure that key committee members do not continue to increase their tenure. By limiting the amount of time a director could be considered independent for purposes of serving on key committees, namely the audit and compensation committees, the proposed solution balances the concerns regarding the impact long tenure might have on board members’ independence with the benefits such directors might provide to the board as a whole.

The full article is available for download here.

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