A new trend has emerged in the nominating process of public company boards. Boards of Directors are moving away from a reactionary and intermittent nominating process towards a more continuous, anticipatory and inclusive inventorying process. Part of this trend is a result of the unintended consequences of Sarbanes Oxley when it helped destroy cronyism and promote independence in the boardroom. The other part stems from the surge of activist shareholder proxy initiatives and the demands for more transparency and access to director nominations.
Until the 1980s, corporate governance in the United States was very different from our post-Sox environment. Senior executives held only modest stock and options in their companies and were more focused on traditional performance measures such as sales or earnings growth. Boards of Directors were predominately comprised of white male, elder statesmen who had direct experience with the company including suppliers, bankers, lawyers, advertising executives and consultants. They were known well by management and were seen as trusted advisors and friends. Over the course of the 1980s, however, the LBO onslaught caused the corporate governance paradigm to change. Boards of Directors were forced to take a much more active role in the oversight of the company. In order to prevent hostile takeovers, boards implemented new compensation plans for management that became more lucrative through equity incentives in an effort to create more economic value for the company. A transition also occurred in the composition of the board as more outside CEOs and senior executives were recruited to boards to bolster companies’ intellectual capital and alleviate shareholders’ fears about objective oversight.
While the impact of Sarbanes Oxley and the Exchange’s listing requirements have been over communicated, the strains on the Nominating Committees have not. Due to the increased time commitments, the perception of conflicts and personal liability, and more focus on compliance than strategy, the pool of experienced, available and interested potential board members has significantly decreased. We have witnessed during this year’s proxy season the greatest departure of CEOs from their outside board obligations. CEOs today are now sitting on only one outside board compared to two boards a decade earlier. As a result, the timing to identify, assess and select a board member with the requisite expertise and personality has dramatically increased.
In parallel, activist shareholders continue to want increased transparency and access to the Director nominating process as they want to propose their own candidates to ensure that the company and the shareholder interests are aligned. As most boards view the nominating process as highly confidential and clandestine, shareholders are unaware of when their company is searching for a new director until the public announcement of their selection is made. Therefore, any suggestions from shareholders, especially around proxy season, always come too late.
While corporations will never allow a completely democratic process or “town hall” type vote, many companies have taken proactive steps to make the process more inclusive and alleviate some of the pressure created by activist shareholders. Many companies in the Fortune 500 now regularly include director candidate ideas from shareholders along with those from the board, management and their search firms. Companies like Dell have created a form on their website that allows shareholders to submit director recommendations. Citigroup has even gone so far as to post the director specification on their website to help promote ideas and transparency. These actions create a level playing field for the origination of an idea and allow him/her to be judged based upon the merits of their candidacy.
Nominating Committees are becoming more engaged in a continuous process of assessing, inventorying and prioritizing candidate ideas for immediate and future board needs. Due to the increased time commitments of board members and the need for independent objectivity, Nominating Committees and CEOs are more routinely turning to outside firms to help them with the prioritization process. Firms like ours are acting more like consultants than search professionals and are given the responsibility to build out, assess and rank candidates in an array of categories including sitting CEO, diversity and financial expert. This relationship enables the board to better prepare for director retirements or necessary board realignment due to a change in strategy or culture. The Nominating Committee can turn to this prioritized list and avoid a lengthy search process. This is a significant shift in the way companies think about governance as they are now forced to think and act more proactively. As companies continue to engage in a war for global talent, boards will need to leverage all possible sources to compete for the limited number of interested and available directors candidates in the marketplace.
The perception that our existing corporate governance structure has not performed better during the current credit crisis and than it did during the collapse of Enron and WorldCom will continue to fuel the fire for more regulation and corporate governance reform. As a result, this new nominating process will continue to take hold throughout much of the economy as it appears to bridge some of the tension between activist shareholders and management and the ever increasing need for directors than can and want to make a difference.
Barrett J. Stephens is a Managing Director in RSR Partners Board Service Practice. The company specializes in recruiting directors for corporate boards. The company was formed in 1993 by Russell S. Reynolds, Jr., Founder and Former CEO of Russell Reynolds Associates.