Director “refreshment” has become a very hot topic in the governance community. Investors increasingly are calling for replacing longer-serving board members with newer directors, possibly in order to achieve greater board diversity, possibly to get some fresh blood (or fresh thinking) on the board, or possibly to achieve other goals. There is also increased talk about the use (and appropriateness) of age limits, term limits and other processes to assure regular board turnover. For example, Institutional Shareholder Services has suggested that a director serving more than nine years may no longer qualify as independent. As part of this discussion, questions have also been raised about the need for “committee refreshment” – rotating directors off and on committees to keep them fresh and receptive to new ideas.
Governance practitioners have been grappling with the issue of board and committee refreshment for many years, even though the objective may not have been called “refreshment” until recently. For example, corporate secretaries and others have scratched their heads as to how to enforce age limits, how to decide when those limits should be waived or raised, how to grapple with the political and personal issues that can arise when the age limit is waived for one director but not for another, and whether term limits would be preferable to age limits. Recent discussions have also generated pushback from companies and their directors that age and/or long tenure may generate greater, rather than less, independence; after all, a director with 15 or more years of service who has overseen two or more CEOs may feel far less dependent upon the current CEO than a director who has joined the board only recently.
These and other concerns are challenging enough at the board level, but they can be far more challenging at the committee level. In an era when much of the substantive, detailed work of the board is handled by committees, and committee service increasingly calls for subject matter expertise, refreshing a committee is not as simple as putting Mr. or Ms. X on the committee when Mr. or Ms. Y retires. The qualifications and abilities – and, in some cases, expertise – of the replacement need to be considered before he or she can be used to fill the vacancy or simply “rotated on” a new committee.
Audit committee rotation
The most obvious – and likely best – example of the challenges surrounding committee refreshment relates to the audit committee. Rightly or wrongly, the audit committee is viewed as the guarantor of many aspects of the public company – financial reporting, ethics and compliance, and risk assessment, to name just a few. (Recent challenges to the qualifications of certain members of the audit committees of JPMorgan Chase and Target serve as reminders of this reality.) In order to properly execute the audit committee’s responsibilities, its members arguably have to come to the committee with a variety of skill sets in these and other areas (e.g., financial literacy, in the view of the exchanges), and on-the-job training is not deemed acceptable. As a result, if an audit committee member retires, or some “fresh blood” is called for, it’s not simply a question of having Director A or B step into the role; instead, the company must assess his or her skills, experience, and interests – and the public perception of these factors – before deciding on a replacement. In the case of the audit committee, this assessment may be complicated by the desirability of having at least one “audit committee financial expert” on the committee.
However, the audit committee is not the only committee where these types of concerns abound. Consider the compensation committee, which may have replaced the audit committee as the center of investor focus. To serve on the committee – or, rather, to credibly serve on the committee – a director arguably needs to have some familiarity with matters such as the company’s existing compensation and benefit plans, trends in executive compensation, taxation, and other technical areas. Moreover, it is increasingly important for compensation committee members to be able to speak directly with investors when questions are raised about the appropriateness of a company’s executive compensation program. In the view of many, a CEO should never respond to challenges of or even questions concerning his or her compensation, and if a director isn’t “ready for prime time” when it comes to doing so, he or she may not be the right one to serve.
Similar concerns exist with regard to other committees. In a period of intense focus on each director’s specific qualifications to serve on a board, the corporate governance and nominating committee has emerged as yet another focus for shareholder inquiries. And committees dealing with risk, sustainability and other matters are also in the limelight.
In other words, there’s no such thing as an “easy” committee replacement or rotation. The levels of thought and deliberation that go into selecting the members of each committee are (or should be) as high as those that go into selecting new board members in the first place.
Before we get into some practical suggestions to dealing with these concerns, it’s worth noting that they are even more sensitive when contemplating who should serve as chair of a committee. At the risk of stating the obvious, the chair sets the tone for the full committee, and in addition to the technical skills he or she must have, it’s also important that the chair possesses organizational ability and an indefinable quality – leadership.
So we see that there are numerous challenges associated with refreshing board committees. Are there any tools or tips that can help a board to execute this important responsibility better? Here are some suggestions:
- Use a skills matrix for each committee as well as the full board. A skills matrix can help identify the skills needed as well as the skills possessed by current committee members. It stands to reason that if you don’t have a handle on the skill sets that you need for each committee, it will be hard for you to determine which skills are needed when it comes time to refresh the committee membership. Among other things, it’s probably a good idea to rank your committee members by their retirement date (or another date on which they’re expected to rotate off the committee) so that you can factor the timing into your succession planning.
- Use board and committee orientation and education to help fill skills gaps. Board orientation programs are often used – quite properly – to educate onboarding directors about the company, its operations and its culture. However, orientation can and arguably should also be used to inform the directors what is expected of them, such as their fiduciary and other duties, including that they may be called upon to serve on committees and to rotate on and off committees from time to time. If a new director is informed that service on a committee that may require some new skills or knowledge, he or she is likely to learn more about the necessary skill sets before they are actually needed.
Informal committee rotation can also be implemented as part of an orientation program. For example, establish a policy requiring all new directors to attend, in an informal (i.e., non-voting) capacity, meetings of committees on which they are not serving. Informal attendance will give them a feel for how these other committees execute their responsibilities and will likely impart some knowledge of the subjects for which those committees are responsible.
Director education, like weather, is something we talk about but don’t do much about. However, it shouldn’t be overlooked as a means of providing directors with the skills they may need to join a new committee. For example, there are conferences and other educational programs on executive compensation, financial statements for non-financial executives, and other topics that can help them prepare for new committee positions.
- Develop mentoring programs within your board. Your current committee members have a wealth of knowledge about their committee responsibilities. Ask those committee members to mentor newer directors, or any directors not serving on a particular committee, as to what will be expected upon joining that committee. Giving all committee members this opportunity may also yield information about committee members’ leadership abilities, helping to make better decisions as to future committee chairs.
These suggestions will not eliminate the challenges in dealing with committee “refreshment,” but they should reduce those challenges and make them more manageable.
Reprinted with permission from Directors & Boards, Third Quarter 2014.