30 JUNE 2012•FinancialExecutive www.financialexecutives.org

Corporate Governance Read for CPE credit

Boards of Directors

Trends, Challenges,

OpportunitiesThe market is demanding increased transparency and

accountability. New compliance mandates, regulations and shareholder activism are the drivers, but governance is

more than just compliance.

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www.financialexecutives.org FinancialExecutive• JUNE 2012 31

By Susan F. Shultz

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Boards of directors matter — and now they mattermore than ever. The market continues to

demand increased transparency and accountability.New compliance mandates, regulation and share-holder activism are the drivers. Boards and theirconstituencies are clamoring for more strategicengagement and value-add by the directors. Yet thistrend seems to be in stark contrast to the drumbeatfor compliance and regulation.

How can boards balance the pressures from theirattorneys, auditors and regulators to be risk averse(Read: safe) with Wall Street calling for creativity, in-novation and job creation? Challenges and opportu-nities for boards have never been greater, and goodgovernance is more than just compliance.

Here are 11 key issues confronting today’s boards.

‹ BOARD COMPOSITION ›Good governance means good people with unwa-vering integrity. When building their boards, leadingcompanies are moving from friends of friends andcelebrities to board members who will meaningfullycontribute to the business. The trend is to “matrix”the existing board, catalog future needs and proac-tively recruit the best directors to fill the gaps.

Boards are now required to specify directorqualifications in their proxies. In addition, NYSEEuronext requires boards to disclose not only whothey recruit, but how they were recruited.

The first preference is to recruit active CEOs andsecondly, retired CEOs. Yet 54 percent of all S&P500 CEOs do not serve on an outside board. Today,the average CEO sits on only 0.7 boards, comparedwith an average of two outside boards 10 years ago.

More than half of all companies limit the num-ber of public boards on which their CEO may serve.With the need for increased oversight and financialaccountability, this trend might presage more boardopportunities for financial experts. However, theSpencer Stuart Board Index records the smallestintake of new independent directors since 2001.

Still, one-third of all directors recruited lastyear were financial experts, and half of all boardsresponding to the Spencer Stuart survey are seekingdirectors with financial expertise. Forty-eight per-cent want industry expertise and 37 percent arelooking for international experience. Regulatory,risk, technology and marketing expertise are also instrong demand. Despite common perceptions, theoverwhelming majority of directors serve on onlyone board.

Only a quarter of new appointees are activesenior executives, down from over half a decadeago. Twenty-one percent of the new independentdirectors are first-timers on outside public companyboards and more new directors are retired CEOs (17percent, up from 9 percent in 2000).

Globally, 40 percent of boards have no women,according to GMI Ratings’ 2012 Women on Boards Survey, and diversity has stagnated, despite thenew requirement that boards disclose how theyhave addressed the issue. In its 2010 Global Board-room Study, Heidrick & Struggles notes that only13 percent to 16 percent of all U.S. directors todayare women, and a mere 162 minority directors siton the boards of the top 200 S&P companies.

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32 JUNE 2012•FinancialExecutive www.financialexecutives.org

‹ SUCCESSION PLANNING ›Succession planning is increasingly recognized as a crit-ical board challenge, both for executives and boardmembers. Fewer than two-thirds of directors are satisfiedwith management succession plans, and well over halfwant to spend more time on succession planning. Thetrend is to make succession a recurring agenda item.

A textbook example of smooth succession was atAvnet Inc., the $26 billion electronic components distri-bution company, where Rick Hamada, the successor toCEO Roy Vallee, was identified a full year prior to thechangeover and took over as CEO in a seamless transi-tion. Too often, in cases such as at Hewlett-Packard Co.,CEOs and their boards simply do not have effective suc-cession plans in place. As CEO tenure is shortened, theneed escalates proportionately; 13 percent of Fortune500 CEOs turned over in 2011, a six-year high.

‹ EVALUATIONS ›Beverly Behan, former head of governance at MercerConsulting, states in her book, Great CompaniesDeserve Great Boards, “Assessment is one of the mostpowerful interventions available for turning a goodboard into a great board.” Behan also finds that inde-pendent evaluations objectively benchmark board anddirector effectiveness and provide accountability tostakeholders and shareholders.

According to the Korn/Ferry Institute, 96 percent ofS&P 500 company boards of directors conduct a revieweach year, but fewer than half evaluate the effectiveness

‹ BOARD TURNOVER ›The most popular subject in corporate governance todayis how to fire a director. There is nothing wrong withthanking an underperforming or less-productive directorfor his or her service and bringing on a new directorwho can add more value. Various factors can compli-cate how the board handles underperforming directors,such as those who made exceptional contributions in the past or those subject to external pressure for re-moval, perhaps from shareholder groups.

Because this is such a difficult issue, nearly three-quarters of S&P 500 boards have adopted mandatoryretirement policies for directors — up from 58 percentin 2000 — but the retirement age is rising. Spencer Stu-art finds that 79 percent set it at 72 or older versus 37percent in 2000.

Ideally, directors should be retained — andremoved — on merit, not on age. At 70 years of age,former U.S. Secretary of State George Shultz was auto-matically removed from the board of Bechtel Corp.Think of the value a powerful global leader couldbring to a global construction company like Bechtel,even after the age of 70.

‹ GLOBALISM ›Boards of directors now recognize the importance ofglobalism in the makeup of their boards. The SpencerStuart study reveals that 11 percent of the 302 new inde-pendent directors in 2010 were from outside the U.S.

If a company has a significant investment in a re-gion, it can gain a tremendous advantage from a boardmember who has deep and relevant experience in thatmarketplace. Interestingly, industrial companies addedthe most international directors this year, comprisingone-quarter of their new board members.

There are additional considerations when recruitinga foreign director. Among them: Are there conflictedallegiances, such as could be the case in China withstate-owned enterprises (SOEs)? Does a potential direc-tor understand and subscribe to good governance prac-tice? Are they capable of discussing and voting on all theissues, not just those affecting their region.

The 2,000-page Dodd-Frank Wall Street Reformand Consumer Protection Act calls for 11 new regula-tory bodies to oversee implementation of new regula-tions. One of the most potentially burdensome rulesis to disclose how the pay of the CEO compares tothe median employee, but the rule does not prescribehow to account for part-time, international or low-wage differentials.

Executive compensation continues to receivethe greatest focus, but director compensation isgaining attention.

‹ COMPENSATION ›Akin Gump, an international law firm, notes thatdirectors rank executive compensation as their num-ber one concern. The say-on-pay vote, though advi-sory, gives shareholders a vote and tremendousinfluence on executive compensation practices.

Ten companies have been sued because of neg-ative votes on pay, despite the fact that these are“advisory” votes. All of these “no” votes followedInstitutional Shareholder Services (ISS) recommen-dations, according to Michael Reznik of compensa-tion consultant Frederic W. Cook & Co. Inc.

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www.financialexecutives.org FinancialExecutive• JUNE 2012 33

‹ COMMITTEE MEETINGS ›Has too much work been delegated to committees?What sorts of functions are best left to the entire board?

The full board is responsible for key decisions,including selecting the CEO, risk oversight, executivecompensation and succession planning. Committeesappropriately dive more deeply into these issues.Some of the tension revolves around boards tendingto cross the line into micromanagement; the numberof committees a director can effectively serve on; ro-tation and leadership of committees; the number ofcommittees; and access to committee meetings bynon-committee members.

To accommodate these concerns, more boards arescheduling key committee meetings so that board mem-bers who are not on the committee can attend.

‹ BOARD LEADERSHIP ›The role of the board’s chair is to facilitate, manage,engage and guide the board process and the directors,allowing the CEO to focus on the substance of the busi-ness, its mission and strategic plan and execution.

Forty-six percent of companies separate CEO and

‹ SHAREHOLDER ACTIVISM ›Law firm Latham & Watkins reports that, as presentlyconstituted, proxy access will allow shareholders hold-ing 3 percent or more of a company’s stock to bypassthe board’s nomination process and nominate directorsdirectly. Proxy access could disrupt the boardroom asgroups lobby for candidates who support their positions.

The danger is that the process of director recruitmentwill be politicized and skewed against truly balancedboards that include strategic industry experts and direc-tors who are global, female, new to board service orotherwise diverse.

The best alternative seems to be to fold shareholders’nominees into the existing process, evaluating the pro -spec tive directors against mutually agreed-upon objec-tive criteria and other qualified candidates.

Shareholders are increasingly influencing board dy-namics and processes, the most obvious area being exec-utive compensation. Objective evaluations can helpval idate the board to shareholders, and boards will beginto communicate more directly with shareholders, as well.

‹ RISK ›Risk is an escalating, hugely multi-faceted challenge for boards that must address external, global, internal,reputational, product, competitive and technology risks.There are growing numbers of risk managers, typicallywith financial expertise. The year 2010 was the first year for companies to comply with U.S. Securities andExchange Commission rules that require disclosure ofthe board’s role in risk oversight and the relationshipbetween a company’s compensation policies andemployee risk-taking.

Dodd-Frank headlines the regulatory changes put inplace to allegedly control future meltdowns. Boardmem-ber.com finds that 88 percent of directors expect govern-ment regulation to increase next year. Advisen Ltd. notesthat SEC investigations and enforcement actions willalso increase, due, at least partially, to the rich whistle-blower incentives enacted by the Dodd-Frank Act,which provides that whistleblowers can collect be-

of the audit committee. To address this critical perform-ance metric, Financial Executives Research Foundation(FERF) partners with The Board Institute to develop andupdate the content for The Audit Committee Index, aweb-based, independent education and evaluation tool.

The next frontier will be individual director evalua-tion. Today, less than one quarter of public companyboards evaluate individual directors.

As noted in a recent study by accounting and auditfirm PwC, only 11 percent of board members respondedthat their whole board evaluation process is “very effec-tive;” 43 percent feel that there is significant room forimprovement, rating their current process only “some-what effective” or “not at all effective.”

On using comprehensive, independent board evalua-tions that address risk management and validate the per-formance of the board to its constituencies, 79 percent ofdirectors say an effective board evaluation is the “mostimportant technique for ensuring that directors improveor continue to perform at peak levels.” The trend is tomove away from ad hoc, cumbersome, in-house ques-tionnaires cobbled together and assembled by hand.

chair positions. However, just over half of those boardchairs are considered independent. The Dodd-Frank Actrequires companies to disclose whether the CEO andthe chair are separate, and if the chair is independent.The concern is whether it is appropriate for the CEO tochair the very board that has responsibility for his or herevaluation, compensation and succession. When under-performing and overpaid CEOs are controlling theboard, reform is extremely difficult.

Making the annual board, committee and directorevaluations more robust and independent helps identifyperformance issues at an early stage.

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34 JUNE 2012•FinancialExecutive www.financialexecutives.org

‹ STRATEGY ›Boards are expected to review, discuss, challenge andenhance the strategy presented by management in aneffective and coherent manner. Yet, in the face of compli-ance and regulatory demands, boards must carve outtime on their agendas to make strategy discussion a pri-ority. KPMG reports that only 50 percent of directorsbelieve their board’s involvement in corporate strategy isboth “ongoing and substantive.”

The challenge is to generate ample discussion whilelimiting the board’s role to oversight of, and not intrusioninto, the development and implementation of corporatestrategy. At the same time, boards must engage earlyenough in the process that their discussions can be sub-stantive and influential.

The financial crisis exposed many cases of inade-quate governance. Yet, according to the latest McKinseyQuarterly survey on governance, directors report thattheir boards have not increased the time spent on com-pany strategy since early 2008 — seven months beforethe collapse of Lehman Brothers. Moreover, 44 percentof respondents say their boards simply review and ap-prove management’s proposed strategies.

Just one quarter characterize their boards’ overallperformance as “excellent” or “very good;” even so, theshare of boards that formally evaluate their directors hasdropped over the past three years.

Nevertheless, the dramatic untold stories are thehundreds of companies both public and private that haveavoided crises and have succeeded because of the ad-vice and counsel of strategic boards of directors.

tween 10 and 30 percent of amounts that are recov-ered over $1 million.

Ultimately, crisis management is about people andabout trusting the board to do the right thing. Moralityand performance cannot be legislated. Increased regula-tion raises the specter of overreliance on complianceand dampens initiative. More than half of audit commit-tees could be more effective in linking risk and strategy,according to a recent study by accounting and auditfirm KPMG.

Crisis management today is a critical aspect of riskmanagement. Apart from the financial services compa-nies and others required by Dodd-Frank to have sepa-rate risk committees, most companies are choosing toaddress risk at the level of the full board.

A looming aspect of risk is technology exposure. Forexample, employees at Honeywell International bringclean laptops and PDAs into China and send emails inpackets, so key communications are not transmitted intheir entirety. A KPMG study reports that cyberrisk is thesecond highest systemic risk companies currently face.

In addition, in a KPMG forum, less than one-fifth ofdirectors said they were satisfied with their discussionswith management about the impact of social media andemerging technologies on the company’s strategy.

Though audit committees have responsibility forinformation technology security at about 70 percent ofboards, 62 percent of audit committees say they are notbriefed on the company’s cloud plans, and 77 percentare not briefed on the company’s social media activities.Only 8 percent of audit committees are satisfied withtheir readiness to respond if a crisis “goes viral” on so-cial media.

Obviously, there is a serious disconnect relative todigital and social media. What are the policies relating toemployee emails? Seventy percent of companies restrictuse of social media, but how can that be enforced? It canbe segmented into internal risks and external, anticipatedand unanticipated. But, how to manage these risks?

Information is no longer closely controlled andmeted out by the board and top management. Boardsare in the uncomfortable position of reacting to theforces — and onslaught — of social media.

A second concern is the glut of data. Companieswill generate more data in the next two years than in all of history. It is estimated that only some 5 percent ofthe information now collected in databases is useful.Loss of control is a tremendous hazard. In December,“Anonymous” hacked Stratfor (Strategic ForecastingInc.), ironically a global intelligence information com-pany, stealing hundreds of credit card numbers.

Susan F. Shultz, CEO of The Board Institute Inc. (www.theboardinstitute.com), is an internationally recognized gov-ernance expert who speaks and writes on the competitiveadvantages of strategic boards. She founded SSAExecutive Search, which recruits directors, and is authorof The Board Book (AMACOM).

To receive CPE for this article visit www.financialexecutives.org/magazineCPE to complete your review, test and evaluation.Instructional method: Self-Study | Recommended CPE Credits: 1.0 | ExperienceLevel: BasicField of Study: Regulatory EthicsPrerequisites/advance preparation: None | Advanced Prep: Reading article

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