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Key6 tenure for directors is not a good idea

How long should board members serve? In 1997, CalPERS, The huge California pension fund and perhaps the most active institutional investor bent on board reform, proposed that directors should serve no longer than 10 years. There was sufficient yipping and hollering by board members and shareholders alike that the proposal was withdrawn, but the issue remains a sensitive and critical one.

The real challenge is how to insure an effective board. Some subscribe to the theory that new blood is continually necessary for the company and its management team to keep pace with a rapidly changing world. Others argue that a seasoned board member can prove invaluable so long as he continues to recognize important issues and raises them in meetings and with the senior management team.

Controlling tenure on boards is easier when the board is divided into classes of directors and their election terms are staggered. A nine member board, for example, divided into three staggered classes of three directors each, means that just one-third of the directors are up for election each year. In the glaring light of annual meeting, the performance of three directors is much more likely to be addressed than a lost-among-the-masses non-performer.

Some companies have established limits in their by-laws on director tenure. Some have mandatory retirement ages and others impose a 15-year maximum for service.

Other corporations, however, are working against getting rid of directors who don’t perform by affording them retirement plans. In 1995, 30 Fortune 500 companies had shareholder proposals challenging pension plans for directors. The question the shareholders raise in the proposals is the wisdom of affording directors benefits not tied in some way to the corporation’s performance. Directors paid in stock have motivation to keep that stock price high. Directors paid in cash get paid even when the stock dives. Directors with a vested interest in a retirement plan of the company may behave differently. Guaranteed compensation for those in charge of the company’s fate does not sit well with shareholders who must endure the slings and arrows of an often-unforgiving investment community. For example, a proposal by Philip Morris shareholders noted that such director pension plans are “management’s way to ensure their directors unquestioning loyalty and acquiescence to whatever policy management initiates. Accordingly, when viewed from this perspective, these types of retirement benefits become yet another device to enhance and entrench management’s control over corporate policy while being accountable only to themselves and not the company’s owners.” A shareholder proposal aimed at McGraw-Hill referred to such plans as “cronyism.”

Many companies, though, have changed their methods of compensating directors (see Key 7) so that remuneration is tied to results and is not an automatic reward for board service.

The clear message in all shareholder activism regarding directors is quality: is this director still making a contribution and does this director take her responsibility seriously? While many of the proposals and by-laws address stagnation ineffectively, no director should ever assume a directorship lasts forever, or even to retirement.