Spencer Stuart Board Index: How Boards Are Changing

The financial crisis of 2007-08 prompted a flurry of governance proposals, some of which are now coming to fruition in the form of declarations from the Securities & Exchange Commission that are meant to raise the bar on board disclosure about director recruitment and succession-planning practices. Meanwhile, board directors and corporate watchdogs alike await the outcome of other pending legislative and regulatory actions that are under review by the SEC or are wending their way through congressional committees. Proposals on the table include those that would make it easier and less expensive for shareholders to nominate board directors; give shareholders a say on executive compensation; and require boards to have a standing risk committee and a nonexecutive chairman.

What's too often lost in this latest round of corporate governance debates is the magnitude of change already seen in corporate boards. A growing number of boards already embrace corporate governance best practices and continue to try to improve their effectiveness—even in the absence of government regulation or specific shareholder pressure.

While the breadth of the changes in board behavior cannot be captured fully in data alone, the numbers do tell a striking story about how board governance has evolved. Many of the trends in the composition and governance practices of corporate boards are reflected in the data compiled for the Spencer Stuart Board Index (SSBI). Now in its 24th year, the index is the result of a careful study of the proxies of companies in the Standard & Poor's 500-stock index. It tracks trends in board service, the careers and backgrounds of new directors, and the policies and processes of these boards. It also includes a survey of corporate secretaries about the issues dominating the board agenda.

annual elections, majority required

What has changed in America's corporate boardrooms? Here's what the data reveal:

More than two-thirds (68%) of S&P 500 boards have adopted a declassified board structure and annual elections of directors. A high priority for advocates of corporate governance reform, annual director elections have become the norm for corporate boards in the span of a few years. Ten years ago, only 38% of S&P 500 boards elected directors annually.

Boards are rapidly adopting majority voting requirements. Another priority for institutional shareholders during the past several proxy seasons has been the adoption of majority voting rules. In general, these require directors who fail to secure a majority vote of shareholders in board elections to offer their resignation. In fact, boards have moved quickly to adopt this standard. The 2009 Spencer Stuart Board Index found that 65% of S&P 500 boards have majority voting requirements, compared to 56% in 2008.

Boards are limiting the number of corporate boards that directors may serve on. Ten years ago, directors commonly served on multiple boards. As the scope of the board's role has grown and the amount of time required for board service—both during and outside formal meetings—has increased, many boards have concluded that there should be limits on directors' board commitments. SSBI research revealed that 67% of S&P 500 companies restrict the number of corporate boards their directors may join.

As recently as 2006, the percentage of companies that had such restrictions for directors was only 27%. Some 40% of those companies that do not place a numerical restriction on board service ask directors to notify the chairman before accepting an invitation to join another board and/or they encourage directors to "reasonably limit" additional board service. For similar reasons, boards are limiting—and in some cases prohibiting—the number of board positions company executives may accept.

A wider range of experience and perspectives are represented in the boardroom. A decade ago, chief executives, chief operating officers, chairmen, presidents, and vice-chairmen represented 53% of the pool of new independent directors. In 2009, the proportion of new directors with these backgrounds fell for the third year in a row, to 26%. A primary driver of the evolution in the director profile is the drop in the number of active CEOs serving on outside boards.

division of labor: CEO vs. chairman

Boards now seek directors with experience in finance, risk management, and technology, for example, or they look for executives who have global experience. While this change has undeniably resulted in the loss of some of the leadership expertise and big-picture perspective that CEOs can bring, it also has infused many boards with energy, fresh ideas, and a broader diversity of perspectives.

Strategy, risk management, and succession planning are high on the board agenda. Some 67% of respondents in the SSBI study said the board's role in corporate strategy discussions was among the issues demanding the most focus from the board, compared with 31% in 2008. S&P 500 boards also are placing more focus than before on risk management (50% said this was a top concern) and CEO succession planning (45%), according to the survey.

More boards are considering whether to split the responsibilities of the chairman and CEO. Governance activists have long advocated that American public companies divide the chairman and CEO roles between two people, a practice that is already commonplace in the United Kingdom. The financial crisis reignited demands from a range of stakeholders that boards establish the nonexecutive chairman role. Many boards have made the decision in favor of this division of labor. Ten years ago, 80% of S&P 500 company CEOs were also the chairmen of their boards. Since then, the percentage of boards that combine the chairman and CEO roles has steadily declined, to 74% in 2004, and 63% in 2009.

The board of directors has taken ownership of director recruitment. No longer tapped through social or professional networks by CEOs, boards have assumed responsibility for director recruitment and put in place a thoughtful process to attract and evaluate director candidates. Boards approach the task of identifying and screening new director candidates in a more strategic and hands-on manner than in the past, and director candidates typically undergo rigorous vetting by the nominations committee before joining the board. As a result of this new recruiting mindset and process, the mix of directors around the board table is starting to look quite different.

Of new directors in 2009, 17% were retired senior executives, including retired CEOs, COOs, and presidents; 18% had financial backgrounds; 21% were corporate executives in general management roles; and 8% were academics and nonprofit leaders.

be proactive, anticipate, communicate

What's next for corporate boards? Whatever the specific requirements that ultimately emerge from the SEC or Congress, directors should understand that the rules of corporate governance have changed. The environment in which boards operate today is highly dynamic, influenced by the changing expectations of shareholders, regulators, employees, and even customers. Boards will face pressure to continually raise the bar on their governance practices as shareholders push for more transparency into board activities and more influence over certain board decisions—including executive compensation and director recruitment. All this suggests several implications for corporate boards:

Boards need to be sensitive to the fact that corporate governance is dynamic. Directors should stay abreast of developments in governance and be willing to question how they do things and what can be done better. Boards will want to have robust discussions about the range of issues and potential consequences of governance changes. Boards should continue to move along directions that are sound and not wait to adopt useful practices until they are mandated. By understanding the forces behind change, boards and CEOs can work closely together to define and implement the most effective governance practices for their organizations.

Boards should improve communication with shareholders. Ongoing communication between the board and the company's top shareholders can improve shareholders' understanding of the board's corporate governance practices and help the board stay ahead of investor concerns. In addition, communication with investors through vehicles such as the proxy should reflect a genuine interest in transparency.

Directors should ensure that the board has the right mix of skills. Directors should continuously review the board's skill sets relative to the company's strategy and direction to ensure that the board as a whole has the knowledge, experience, and skills to guide the management team as it addresses new challenges and market opportunities. The annual board self-evaluation is a natural platform for the full board to review its composition and discuss the expertise that it will need in the future.

Finally, boards should have in place a CEO succession-planning process that is robust, sustainable, credible, and based on the company's strategic direction. Increasingly, boards will be asked to disclose some dimensions of their succession-planning process, and should be prepared to do so. In addition to planning for long-term succession needs, boards also should be in a position to accelerate a CEO transition in response to performance problems or other emergency succession needs. In the most effective processes, the board gets to know potential internal candidates in both formal and informal settings, ensuring that they are benchmarked against the external talent marketplace.

Before it's here, it's on the Bloomberg Terminal.