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E-MailPamela L. Marcogliese is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Ms. Marcogliese and Elizabeth K. Bieber.
Over the past few years there has been a significant amount of attention to the issue of director tenure, particularly focused on the intersection between tenure and entrenchment and its impact on board diversity. On the one hand, certain stakeholders advocate for experience and continuity of culture and on the other, there is the fear that a lack of turnover and refreshment prevents boards from balancing skills, strategy and diversity and adversely affects a director’s independence. Institutional investors, proxy advisory firms, shareholder activists and governance advocates have all been publicly weighing in on the debate. Recently, The California Public Employees’ Retirement System (“CalPERS”) solidified its position in the recent update of their Global Governance Principles (the “Principles”). CalPERS’ revised Principles state that “director independence can be compromised at twelve years of service.” As a result, the Principles call for companies to conduct “rigorous evaluations” of director independence, which it believes should result in either (i) classification of the director as non-independent or (ii) annual inclusion of a detailed explanation regarding why the director continues to be independent. In addition to the evaluation of individual directors, CalPERS believes there should be routine discussions and succession planning regarding board refreshment to ensure that boards continue to have the necessary mix of skills, diversity and other strategic objectives over time.
While CalPERS’ voting policies have not specifically addressed this change in policy, the Principles state that CalPERS exercises its voting rights in a manner consistent with its Principles and that it will vote “against” an individual or slate of director nominees that “do not effectively oversee these interests.” In addition, CalPERS also states that companies that fail to meet the standards of conduct in its Principles can expect that CalPERS may file shareholder proposals to foster change.
CalPERS’ change to its Principles is in line with some of the recent trends regarding board tenure. Proxy advisory firm ISS does not look at tenure of individual directors, but does have a policy of scrutinizing boards where the average tenure of directors exceeds fifteen years for independence issues and to insure sufficient turnover to promote sufficient “new perspectives” on the board. In addition, the ISS QuickScore methodology notes that a tenure of more than nine years is considered “to potentially compromise a director’s independence,” and can reduce a company’s governance rating. Similarly, the Council of Institutional Investors, representing public pension funds, also urges its members to consider whether length of tenure affects independence.
In contrast, proxy advisory firm Glass Lewis, in its Policy Guidelines notes that academic literature suggests there is no evidence of correlation between length of tenure and board director performance, and is silent on the issue of independence. However, the Policy Guidelines note that director tenure will be a factor considered for director reelection at companies with poor performance.
What should companies do?
Although CalPERS has not yet amended its voting guidelines to reflect this change in the Principles, given CalPERS size and influence, along with the views of others, including ISS and the Council of Institutional Investors, companies may nonetheless decide to take account of CalPERS’ view in corporate decision making going forward. For example, companies may wish to consider the following actions:
1. Incorporate tenure review into annual review of directors, board composition and succession planning
We believe most companies are conducting reviews of their directors on an individual level as well as of the entire board on an aggregate basis to assess the mix of skills, diversity and strategic objectives, as well as to assist in preparing and reviewing succession planning for directors. As companies engage in these reviews, they should consider looking carefully at directors whose tenure approaches nine or more years with a view, in such cases, to refreshing their board succession plans and re-evaluating strategic objectives surrounding potential new board members. As director tenures increase, companies should also be particularly mindful of the average tenure of the aggregate board.
2. Consider reviewing or adding disclosure about qualifications of directors
As part of the annual disclosure process, Item 401(e)(1) of Regulation S-K requires companies to “briefly discuss the specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director for the registrant at the time that the disclosure is made, in light of the registrant’s business and structure.” Companies should routinely review this disclosure to make the case for each director’s contribution to the board and avoid defaulting to boilerplate language. In particular, companies should consider making the disclosure as part of summary discussion, using a holistic rather than a director-by-director approach, emphasizing specifically how the board was constructive from a skills, experience and overall diversity perspective. In particular, for companies that have long-standing directors or a director with more than twelve years’ tenure, companies should consider explicitly addressing such directors’ or director’s tenure in this summary discussion, including any mitigating factors, such as whether the tenure of the longer-serving directors counterbalance the tenure of a number of shorter-serving directors. This tailored approach should also be reviewed and updated annually, to the extent there are meaningful changes.
