Shaking Up Your Board of Directors

A series of potential legal changes that could make it easier for shareholders to nominate corporate directors is looming large. These include changes in Delaware law to permit the adoption of bylaws enabling shareholders who propose their own directors to be reimbursed for related expenses, an SEC proposal allowing investors with 1% or more in stock holdings to nominate board candidates, and a Shareholder Bill of Rights proposed by Senators Charles Schumer (D-N.Y.) and Maria Cantwell (D-Wash.).

Regardless of whether any of these changes become law, they reflect dissatisfaction with the way in which director renomination is addressed. Boards have typically shied away from an objective assessment of board composition, because this can often entail awkward conversations with loyal, long-serving board members about "freeing up" their seats for new directors with more relevant experience.

Retirement ages have traditionally been the primary means of "easing off" directors and bringing on those with backgrounds more consistent with the company's business model and strategy. In the wake of impending legislation, however, this is a bullet that can no longer be dodged—and nominating committees would do well to get ahead of this curve by conducting their own analysis and making appropriate changes in board composition.

take a good look at your board Admittedly, activist shareholders may propose their own board candidates no matter how impeccably the boards of their target companies are comprised. But how much more difficult it is to fight a proxy contest if the activist slate looks a whole lot better than yours! Part of the analysis any activist will surely undertake before attacking will be the vulnerability of the existing slate: Is it lacking industry experience, CEO experience, other experience relevant to the company's business, industry, and growth strategy? Are there directors whose background seems inconsistent if not embarrassing?

How many people have served on this board for 10 years or more? How about 20 years? And what about other boards they serve on—is there the classic AIG problem of directors sitting on so many other boards that you wonder if they can really devote the proper attention to the company's business? Board composition is about to come under the type of scrutiny previously reserved only for executive compensation

So, what's a nominating committee to do? This is going to be an emotional boardroom issue, charged with some directors' fears of being pink-slipped in the process. Three exercises will help to review this situation objectively:

1. Start with a clean slate. If you were going to form the board today as if undertaking an IPO, what would be the optimal portfolio of skills you would want around the table, given the company's business model and strategy? Compare the optimal portfolio you derive to the resident skills and experience on your board today; gaps will become immediately apparent.

2. Ask what's missing. Ask the CEO, each of your board members, and each member of your top executive team who regularly interfaces with the board this question: If we were going to add just one new director to our board, what skills and experience would you find most valuable to add to our board—and why? If you get consensus on one or two skill sets, that identifies a gap.

Avoid asking: "Do we have the right board composition?" That's a question that typically provokes a defensive response and doesn't generate the kind of constructive dialogue and suggestions that will be beneficial in this review. 3. Do some benchmarking. Take a look at the board composition of some of the companies in your peer group. How does your board composition stand up in comparison?

I've long been a big proponent of the "recruit before you shoot" approach: If there is experience you badly need on your board, go out and get it—even if the size of the board swells a little in the interim—rather than first becoming embroiled in the emotional and political machinations of how to push someone off the board. Citigroup (C) appears to be taking this approach: Their new directors have increased the size of Citi's board to 17, a fairly large size when U.S. boards on average tends to be in the range of 8 to 12 directors. Yet, hardly anyone could question the value their new recruits will bring into their boardroom.

Inevitably, the issue will arise that some very valuable directors have backgrounds inconsistent with what might seem to be optimal board composition. If these are truly some of the stars of your boardroom in terms of performance, I'd be inclined to keep them—and defend them to the death in a proxy contest. If there are only one or two and the rest of the board composition can withstand the scrutiny to make the overall slate credible to stockholders, this should not be a major problem. If, however, the directors with questionable backgrounds are not strong performers, this exercise may actually provide the impetus the nominating committee could have been looking for as a means of saying good-bye to these folks prior to retirement age.

third-party evaluations Another consideration for any nominating committee is the implementation of a robust individual director evaluation process—one conducted by a third party. While results of this type of exercise should never be publicized, merely having this process—still quite leading edge in the U.S.—can be useful to mention in a proxy contest or any other situation in which you have to underscore your board's commitment to director effectiveness. Having conducted individual director evaluations since 1997, I have seen this process result in a number of important changes in the way that boards work.

Effective directors can better understand their own strengths and contributions while less effective directors are forced to confront their shortcomings. In three instances I know of, the process resulted in a director either choosing to leave the board or failing to be renominated. In other cases, it yielded some important changes in boardroom behavior and level of engagement.

The well-publicized board failures of the last few years might lead you to think that it's tough to get good people to sit on boards. And it is challenging. With boards under greater scrutiny than ever before, picking the right people has taken on greater import. Active CEOs today are sitting on only one outside board instead of three or four, while retired executives now limit themselves to three or four boards. And prospective directors are doing more due diligence on the boards they join.

But in spite of these changes, there is a great deal of superb board talent out there. Look at some of the new directors who just joined the boards of Citigroup and General Motors.

Every week I get e-mails from people who want to sit on boards—well-qualified people, who have been CEOs and auditors of public companies—nd want to know how to be considered. I gave a speech to over 1000 CFOs in Las Vegas and the top question I was asked was "I'm retiring. How do I get on another company's board?" In the Sarbanes-Oxley era, retiring CFOs should be the most highly prized boardroom animal in corporate America—yet their phones were clearly not ringing.

Be proactive in searching out the boardroom talent you need to improve your board composition. Shareholder activists are going to start finding their own board talent to put together credible slates for proxy contests. Your nominating committee needs to make sure that your board's credentials can stand up to whatever they assemble.

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