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Board tenure: Don’t do it by the numbers

Wednesday, 22 August 2018   (0 Comments)
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By Parmi Natesan and Prieur du Plessis

How long should directors serve? It’s an increasingly hot topic but, like many governance debates, mindlessly following a formula isn’t the answer.

Experience shows that one of the biggest challenges in governance is to move from mindless, by-the-numbers compliance to a thoughtful engagement with how to apply a principle to achieve a desired goal. We can see this dynamic playing out in one of today’s current hot governance topics: board tenure.

To avoid the trap of coming up with a metric and simply ensuring they comply with it, organisations should take the opportunity to understand why board tenure is an issue. The reason behind interrogating how long board members should serve is the aim of ensuring that boards are both independent and effective, and that their expertise and experience are what the organisation requires at that particular time.

King IV, in line with its intent to guide organisations away from taking refuge in compliance by formula, is careful not to stray beyond principle: The governing body should establish arrangements for periodic, staggered rotation of its members so as to invigorate its capabilities by introducing members with new expertise and perspectives while retaining valuable knowledge, skills and experience and maintaining continuity (Principle 12).

Investors, particularly institutional investors, are beginning to use board tenure as a proxy for board independence and effectiveness for several reasons. One is that the median age of South African directors is 55, and the fear is that this cohort is not technology savvy enough to provide proper strategic guidance in a business environment at risk of disruption from technology innovation. Another is that boards appear to be too pale and male, and thus restricting tenure lengths is seen as a way to open up board seats for governing body members from different groups who might help organisations better navigate competing stakeholder concerns.

The risk of crude calculations

In theory that is quite true, but one needs to sound an immediate caveat. True diversity, of the type that is valuable to a board, is more a question of attitude, belief, experience and expertise than the simplistic tally of gender and race. We have surely already seen how the latter has fatally compromised black empowerment.

Nevertheless, it is probably inevitable that we will always rely to some extent on rules of thumb, such as the current one that an acceptable board term for a non-executive director is three years, renewable for a further two terms.

On the face of it, this does seem like a good starting point but one must remember that board members will naturally develop strong relationships over time, and that they are likely to fall imperceptibly into “groupthink”. Without knowing it, even the most dedicated director is likely to become less liable to ask awkward or challenging questions.

In such an environment, reappointing non-executive directors every three years can become automatic. It is hard to undertake a thorough and objective assessment of the value a particular director has added and is likely to add.

At the same time, somebody who is deeply familiar with an organisation is also in a strong position to add value.

Research seems to indicate that this balance between the need for new blood and the value of experience does shift. Companies where there is too rapid a turnover of directors tend to fare less well than those where there is board continuity, but there comes a point at which the respective values of freshness and experience swap over. A study by Sterling Huang (Board Tenure and Firm Performance, May 2013, p3) of the relationship between board tenure and firm performance makes the point strongly as illustrated by the accompanying graph.

Board Tenure and Firm Performance, May 2013.
Source: Sterling Huang, Board Tenure and Firm Performance, May 2013.

On average, directors add more value until their eighth year; longer tenure tends to be associated with reduced positive impact on the company’s value. Note, however, how the graph slopes up and down, so simply decreeing a certain length of board tenure is likely to be a blunt instrument, at best.

It’s obviously very important that boards should take steps to ensure they constantly refresh themselves both with new skills and new blood, willing to ask the outsider’s questions. At the same time, they must balance this imperative with the need to retain valuable institutional memory. However, they should resist the temptation to use somewhat arbitrary figures for “ideal” board terms as a proxy for this goal; rather, they should use the expiration of an agreed tenure term to trigger an objective review of the board member’s performance in the light of the organisation’s business strategy.

This will not be achieved immediately, to be sure. But smart chairs will begin changing board culture now to confirm a focus on an objective assessment of the value added by a director, and not the time he or she has put in on the board. 

Parmi Natesan and Dr Prieur du Plessis are Executive Director: Centre for Corporate Governance and Chairman of the Institute of Directors (IoDSA) respectively. 

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info@iodsa.co.za
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