Each year, Korn Ferry examines current board practices – and change over prior years – as well as characteristics of newly added directors in the Korn Ferry Market Cap 100 (KFMC100), US companies with the largest market capitalization.
We focus on this group of companies under the assumption that they are leaders in their sectors; regularly demonstrate outstanding results, as the list changes little year to year; and that they likely have adopted successful practices that might be extended to other companies.
KFMC 2015 key findings for the Class of 2014:
- Functional/industry background — The most sought after new directors have a finance/audit background (50%), followed by same industry experience (47%), COO/Operations (32%), and Marketing/Sales (31%).
- Age — 17% of new directors are 65 and older, while 16% are 49 or younger.
- Diversity — 20% of new directors are women; 9% are African American; 3% are Asian American; and 0% are Hispanic American.
- Global experience — 35% of new directors have international work experience, and 21% were born and/or educated abroad.
Our data on the new class of directors, and developments on KFMC100 boards, is followed by a Director Hall of Fame section. Martin Lipton, founding partner, Wachtell, Lipton, Rosen & Katz, and corporate governance innovator and giant, leads off with his thoughts on how boards need to change to meet new challenges. Then legendary directors Bonnie Hill, Irv Hockaday, and Jack Krol share their views – rooted in decades of experience – on how boards work best, both as a team and as a resource to the CEO.
We make it our business to keep abreast of important board trends and best practices, and we hope you find this report of interest and value.
Corporate governance MVP
For boards and organizations, demands and risks are escalating, says a legendary expert on corporate governance, and boards need to change, too.
Martin Lipton, an innovator and titan in the realm of corporate governance, explains a “mantra” at Wachtell, Lipton, Rosen & Katz, the noted law firm he helped to found: “Each board should have the experience and expertise appropriate for the business.”
Within that deceptively simple statement, however, rests a complex challenge for boards. That’s because there is a ravenous demand for directors with the expertise, experience, and wisdom to help guide organizations toward their future, says Lipton, who for four decades has represented clients in many of the largest merger transactions, change-of-control contests, and boardroom crises.
Financial acumen, for example, is in exceedingly high demand now, as it is required on bank boards due to banking regulations, Lipton says. That demand, and knowledge about technology, cybersecurity, online retail, communications, and other areas, likely will extend to other industries and functions as boards, he says, recognize “a clear need for expertise to be added to advise management on strategy and performing their duties to pursue more appropriate risk management practices and new technologies.”
The auto industry offers a prime example: What are the management and governance implications for technology changes associated with self-driving cars, financing and leasing business changes, and perhaps even the transformation of companies, given these dramatic shifts?
How do boards, as a practical matter, add this new expertise? This is a significant issue for many boards, given the steady trend over recent decades to pare down their size, combined with relatively low director turnover. This latest KFMC100 report finds that 35% of directors on the boards of the largest US companies by market capitalization serve for nine years or more and 20% twelve years or more.
Filling the expertise gap.
As boards evolve, they may need to seek quicker turnover to add new, needed expertise, says Lipton, adding that there has to be a balance between building a board with desired expertise and not imposing turnover requirements.
He envisions one possible solution for boards to increase their required new skills and experience: expand when necessary. “A board of nine to 10 people won’t work in large, complex companies,” he says. “They may need 12 to 15 people. An increase in size may be dictated by the need for additional expertise.”
Another option may be to address the sensitive issues of director assessments and the adoption of more rigorous director qualifications. “Boards,” Lipton says, “have to focus on evaluations. Corporate governance people are watching—ISS (Institutional Shareholder Services) and major investors—are paying attention: Is the board being ‘refreshed’? Boards are feeling pressure on this now.”
Concern about board stagnation and unfettered director tenure may lessen as a new practice, common in the United Kingdom, may take hold and evolve in US governance: limits on the length of board service. But here, as with other governance practices, Lipton cautions against adhering to hard and fast rules. That’s because a board may wish to retain a valued director, perhaps someone with expertise not easily replaced. He also cautions that a crucial balance needs to be maintained between refreshing boards and allowing an effective team dynamic to flourish. “Boards function best when they are collegial and directors develop relationships, and collegiality is the antithesis of turnover,” he observes.
Lipton also sees a potential role for boards to access needed knowledge and capacities with advisory directors who would not be granted formal standing. “This person,” he says, “would most likely have a great deal of experience, and attend board meetings and give advice.” Many companies, particularly large international enterprises, already have advisory boards that provide critical knowledge and entrée in specific markets.
Finally, Lipton says, boards should have ready access to a range of experts, internal and external, on any issue requiring counsel and comment. With the global business environment constantly transforming, and becoming increasingly specialized and sophisticated, boards tap experts with increasing frequency. Most large boards have sessions where experts explain new trends to keep directors current; this practice represents a fundamental change in the way boards operate.
Board leadership: a crucial role.
What’s the crux of making boards work effectively as a team? Lipton sees it as the right board leadership, “a critical selection,” he says, “and all too often based on seniority or people coming forward, not necessarily because they’re the best choice.” He muses about how so much of what works on boards hinges on relationships, intangibles that make adhering to selection guidelines tricky.
Lipton supports separating the chairman and CEO positions “only when there are compelling reasons,” such as in a crisis or when a new CEO could benefit from a mentor for a year or so. Otherwise, there is a “natural tension” between the chairman and the CEO, and this is not always desirable, he says: “I don’t really think you need an independent board leader. But it’s handy to have, and you can’t satisfy the governance people without one. But the board leader can’t usurp the role of the CEO.”
For CEOs to be effective, he advises them to surround themselves with capable staff and maintain collegial relationships with senior managers and directors. “Scandals of the past,” he says, “were due in several cases to imperial CEOs. Many of those companies even had good boards—at least great names—but they didn’t function because they were dominated by the CEO.”
The trap of “short-termism.”
Perhaps the most troubling, and potentially damaging, governance trend Lipton sees is what he calls “short-termism,” where boards “have been deprived of the ability to make reasoned decisions.”
This problem may be caused in part by the reliance on proxy advisory firms, he says, adding, “Shareholders must recognize that they are not serving their own interests, or the beneficiaries of the funds they manage, by outsourcing their responsibilities. It’s the responsibility of shareholders to exercise oversight of the companies they’re invested in.”
Companies are under terrible pressure from shareholders to demonstrate short-term performance, which has a major deleterious effect on investing in future growth via capital allocation, research and development (R&D), and employee training. But the most significant pressure, Lipton says, is on margins, which are a key factor in Wall Street’s evaluation of companies.
On a broader, societal level, “short-termism” leads to increased unemployment and less money for R&D. “The growing inequality we’re witnessing in Western societies is a result of the damper on GDP growth caused by restraint on investing in long-term growth,” he says. The United States “is not investing in hard and soft infrastructure, so there’s a growing deferred maintenance gap, and we’re not dealing with critical issues such as education, health care, and retirement…. We’ve lost a fundamental tenet of American society, that each generation is supposed to leave things in better shape than the previous generation.”
Flexible, not rote, “best practices.”
When asked for his views on governance, especially what some deem “best practices,” Lipton likely will reply with a variation of “not necessarily.” He does not categorically endorse practices that some governance experts advocate, including smaller boards, director term limits, and separating the chair and CEO positions. To Lipton, it’s just not that simple; it depends on specific circumstances, and judgments need to be made.
He doesn’t believe that boards should be built around sitting CEOs. While the CEOs’ experience and perspective can be invaluable, given boards’ needs for a new, greater range of expertise, there must be more balance among directors, he says.
With no fear of being the iconoclast, Lipton opposes the long-term trend for boards to meet less often, arguing they should meet at least 10 times a year, with a strategic review of three to four days annually. “You really can’t function as a board without that review every year,” he says.
Lipton pauses for a moment and adds: “Standard Oil’s board, which included Rockefeller’s partners from companies he had acquired, knew the business intimately and met every morning to discuss what decisions needed to be made.” While that is admittedly an impractical governance model for large companies, the underlying goal—for directors to thoroughly understand and be engaged with the business—is essential. It is the model on which he and his own partners have built their highly successful firm.
Director Hall of Fame.
While the KFMC100 2015 chiefly seeks to welcome an incoming class of new directors, it is also important to acknowledge veteran director “athletes.” These are long-serving leaders who have contributed immeasurable value with broad operating and governance experience. They have the wisdom acquired from career-long track records to provide insight into challenges faced by boards and organizations today.
These three directors—Bonnie Hill, Irv Hockaday, and Jack Krol—have earned their elite status in the Director Hall of Fame.
Guiding principles as a director.
“Directors should see themselves as a resource for the CEO, understanding that their job is to provide broad oversight on issues including strategic planning, financial reporting, compensation, and policy directives. Equally important, the board must understand the difference between its role and management’s role, which is to run the day-to-day operations of the company.”
“Each director brings different skills to the board. I’ve served on the board of 11 companies and been through a number of CEO transitions, and it was always important to have an engaged and knowledgeable board. CEOs should be able to look to directors for certain expertise, advice, and counsel. My strong suit has been governance, building relationships within the board and with shareholders. I also believe defining the rules of engagement inside and outside the boardroom is important.”
Partnering with the CEO.
“There are two categories of new CEOs: those who have served on a public company board and know the dynamics in the boardroom, and those who haven’t. The latter may need a little more partnering in the boardroom, with the lead director or non-executive chair as liaison. But their relationship with the CEO should never be a substitute for each director’s interaction with the CEO.
All directors have the same duties of loyalty and care. The lead director’s role is defined by the full board in partnership with the CEO, and all conflicts must be resolved based on factual evidence with a goal of achieving the best outcome for the company and its shareholders.”
On new directors.
“It’s the role of the lead director to make sure everyone is engaged and included during board meetings. I had a practice of asking around the table whether anyone had anything to add, because some directors will defer to others whom they believe have more expertise, or a bigger voice. New directors in particular are reluctant to ask questions, but no director should sit silently in the boardroom if he or she does not understand what is being discussed. Companies have their own vernacular, and it takes a while to get up to speed. That may mean spending time with management between meetings.”
“Before joining a board, there should be an opportunity for the candidate to meet with other directors, learn about board governance polices, and meet other members of the management team. They should also familiarize themselves with easily accessible information on current issues, such as major lawsuits and other challenges the company is facing. Once on the board, they should expect a comprehensive orientation.”
“New directors, like all directors should show up prepared for board meetings by studying all materials that are sent in advance. It is important not to become a second-tier director, so stay engaged, ask questions, listen carefully, and seek the information you need to understand the issues. Shareholders are not expecting that it will take you three years to become productive. Remember, part of your value in being elected to the board is to add a fresh perspective, and look out for their interests.“
Irvine O. Hockaday Jr.
Lead director as mentor.
“In my experience, the most effective mentoring relationships arise rather naturally, as opposed to formally. I’ve seen both models, and the former, though elusive in happening, works better than the latter.”
“In any mentoring relationship, as parties evolve and as the person being mentored grows as a result, a new relationship may need to be created.”
“It’s really important for any relationship between the lead director and the CEO to be thoughtfully defined and understood. Both parties need to understand what the relationship is, and what it is not, as lack of definition can cause disappointments and misunderstandings.”
“I have not seen a formal process on boards I have been on where new directors are assigned to incumbent directors as their go-to person, but it’s a pretty interesting idea.”
“After a merger, the lead director can act as a bridge, unifying what may be two different cultures.”
Boards as a resource.
“Particularly when there is a shift in the strategy, directors can prove a valuable resource to the CEO and can ensure there is alignment among all relevant parties.”
“Directors who are recruited to fill gaps in board expertise can help guide the CEO, who cannot be expected to be a subject matter expert on everything. Particularly when a CEO is new on the job, the board can be the best resource he or she has.”
Connecting the CEO and the board.
“When there is a new CEO, it’s important to have a discussion at the outset about how he or she will relate and interact with directors: How can we have an efficient pipeline to the CEO and back to the board that is designed to foster transparency and openness? There shouldn’t be a creeping disconnect between the board and the CEO.”
“I’ve been on the board of a company where the CEO believed he needed a connecting rod with the board, because it was scattered in its views of important subjects. As lead director, I suggested to the full board that, in the event the CEO wants guidance from time to time between board meetings, [there would be] these three people be available to the CEO; they would relay any interim discussions to the full board. Other directors were hesitant at first, but it worked.”
“Directors who serve as this connecting rod to the CEO should be those who relate best to the CEO and also have credibility with other directors. That relationship needs to be supported by all directors so as not to create a two-tiered board.”
“I’m a director, but I was once a CEO, and the most valuable thing a CEO can find on the board is an honest broker, a sounding board. It’s hard to find that internally if you’re the CEO, and having that available from the board is enormously helpful. But there has to be the right DNA and a mutual understanding of what the relationship consists of between board members and the CEO.”
John A. Krol
Ensuring the CEO’s success.
“One of duties of the lead director or non-executive chairman is to work with the CEO. You have to be someone the CEO can bounce ideas and problems off, with a clear understanding of the roles of both parties.”
“When there is a first-time CEO, maybe that person has difficulty dealing with the breadth of the job. I was vice chair of DuPont before I was appointed CEO, but when I became CEO the shock set in pretty quickly.”
“If the lead director can help make the CEO successful, it’s an important part of making the company successful. Sometimes it’s a good idea to bring in an outside coach, if a CEO needs additional support and development in the role.”
“Lots of ideas come up in executive sessions, and it’s particularly helpful if the lead director or non-executive chairman can distill those down to one or two important things to share with the CEO. And it’s important to share those insights with the CEO as soon as the executive session is over.”
“As a lead director or non-executive chairman, you can’t become the CEO’s buddy, or you won’t be able to provide helpful feedback, like on how to improve performance. But you have to develop trust. That’s the first thing you have to do, because without that trust, the two of you won’t work together effectively. The CEO has to understand you are there to help, and building that relationship can take time.”
“I think of roles and responsibilities in boxes: The governance side is something the board has to drive. The management team is responsible for operations and results – which is not to say the board can’t help with ideas – and the results of the company. The board is responsible for oversight. While both sides have to observe boundaries, there will naturally be some overlap.”
Mentoring new directors.
“In the beginning, as a new director, it’s normally more about learning than giving to the board.”
“I’ve been on 11 boards, and it’s always a learning process. When you work with a new director, you can’t come across as, ‘I know everything, I’m here to change you,’ but you can help them think about the culture of the board and expectations as a director.”
“It’s the personality you have that makes it work—a little joking, not so serious, so they don’t see you as the guy who is running the show but as a team member. It’s the personality that helps establishes trust, so they feel free to call you and share a problem or an idea they want to propose to the board.”
“Serving as a director should be rewarding and fun, even during the toughest issues facing the company. Winning is fun!”
“People on boards are all pretty accomplished in their own right, but sometimes they have to be guided in becoming part of the team. They have to change their mindset from ‘what do I think?’ to ‘what do we think?’ ”
“Companies have different cultures, and you have to understand that there’s more than one way for a board and a company to be successful. It’s the job of a director to adapt; you might even learn something.”