Corporate Counsel Weekly – Broc Romanek

Article by Kerry D. Moynihan

In the interview below, he answers questions from BNA’s Broc Romanek concerning
searches for individuals to serve as a director on corporate boards.

1. Who normally retains you to find qualified director candidates (e.g., the Chairman of the Board, Chairman of the Nominating Committee, etc.)?

Historically, the Chairman of the Board, who is most frequently the CEO, initiates Director searches. More frequently now, with the changes in governance practice, the Chairmen of the Governance or Nominating Committees are leading the process.

2. Is it now standard practice for corporations to utilize the services of an organization such as yours in board searches (whereas, perhaps it wasn’t so common in years past)?

It is increasingly the practice for corporations to use an independent third party, most frequently a retained executive search firm, to recruit directors. For a long time, there has been a search market for directors, as Board Member magazine estimates that the stark turnover of Directors of U.S. public companies has been about 12,000 seats. Yet with the intensified demands for genuine independence from Sarbanes-Oxley, the big board regulations, and pressure from large institutional investors such as CALPERS, an ever greater percentage of Director searches are being filled by firms such as ours.

3. Executive recruiters have been quoted as saying that there may be as much as a 50 percent turnover in the boardrooms of Fortune 1000 companies over the next 12 months. What are the primary factors that you believe will cause this type of turnover?

Of course, there was always normal turnover as Directors reach mandatory retirement age and the like. However, the increase will, I believe, be largely driven by the increased time demands of serving on a Board. For example, if a prominent Director is serving on five Boards and on the Audit Committees of three of them, s/he is probably looking at a minimum of an additional two hundred hours of service each year. That adds up to a lot of time taken away from managing your own enterprise or playing golf, as the case may be! As a result, many Directors are in effect rebalancing their portfolio service, with the recognition that it is better to be actively involved in three Boards than not able to devote adequate time and energy to five. Another factor that is contributing to this is clearly the heightened awareness of potential liability. Financial liability is one thing (although virtually every company has good Directors and Officers Insurance), but I know of virtually no cases where the personal net work of Directors was significantly adversely impacted by their actions as a member of a Board. I think the greater risk factor leading people to leave the Boardroom is reputational risk. The $25,000 or $50,000 or even $150,000 that a Director earns for service on a large public company Board is simply not worth losing one’s reputation if involved in an Enron, Tyco, or WorldCom type of situation with earnings re: statements, misappropriation of funds, etc.

4. I have read that 60 percent of qualified candidates are turning down offers to serve on boards. What are the most common reasons that these individuals give for declining offers?

Certainly, a larger portion of prospective Board candidates are declining to consider serving on Boards. Again, the most common reasons are lack of time and over-commitment to other activities. Certainly, some people cite a fear of liability, although I believe that a much smaller portion actually admit that this is the reason than actually are factoring it into their decision. Given the increased time commitment and other issues, many prospective Director candidates with whom we speak also cite the need to be passionate about the business. If you have a limited number of Boards on which you can sit, you had better be genuinely excited about the business.

5. Is it true that most of the best board members have reached their limit on the number of boards they can sit on? How do you go about finding candidates who might become very good board members, but who haven’t yet served in such a role?

Certainly, this is a case of simple supply and demand. Experienced Directors are increasingly being tapped to sit on other Boards. Yet, the average number of Boards on which they can or will sit is also declining. As a result, search firms and their clients must broaden the pool of potential candidates that they consider when filling an open seat. With the rotation of many older Directors off Boards, we are seeing an increase in younger Directors and an overall change in demographics. Some of these individuals have served on one or perhaps no public company Boards yet. We look for executives with strong operating records, who have run whole businesses and have, therefore, encountered the kinds of gestalt issues that the CEO has. Increasingly, we’re also looking for people with very strong, specific functional expertise. The need for financial experts obviously has created an increase in the number of CFOs and retired audit partners who are being actively considered for Board roles. More heads of Human Resources will be drafted for Boards, particularly as there is an increase in demand for independent and qualified Compensation Committee chairs.

You can look at this issue of identifying the up-and-comers in two broad ways. Firstly, find people who have run significant business units, but may not be CEOs of free-standing public companies. There are people running multi-billion dollar business units of larger companies who are perfectly qualified to make a major contribution, but who to this point, have not had the public visibility that their CEOs have had. Enlightened companies will often encourage their division Presidents and senior functional executives to seek outside Board seats to season their business judgment and round them out.

The second point to consider here is that increasingly, Boards are looking at their own collective skill set, and this has driven a need for the kind of in-depth functional expertise I’ve mentioned.

Our advice to people seeking to join corporate Boards includes:

  • Start by being a highly successful executive
    Develop expertise in some of the cutting edge issues and governance that corporations face today
    Actively network with thought leaders and business leaders to broaden perspective
    Serve on the Boards of not-for-profits or on the Advisory Boards of emerging companies

6. One of the traits that is often mentioned as a desirable characteristic for a board member is not being reluctant to challenge management. How important is this in your view and how do you determine to what extent a prospective board member has this trait?

It is absolutely critical to have genuine independence of mind and the willingness to speak up and challenge management. I think this quality is right near the top. Any shareholder advocate would argue that, as well. Frankly, any senior management team worth its salt should welcome an atmosphere of free and frank exchange of ideas. Remember, you can disagree without being disagreeable. Sometimes that comes from the perspective of someone who is very intimate with the details of the business at hand. Other times it can come from a Board member who comes from a completely different industry, who can ask the “naïve” questions and challenge the conventional thinking and assumptions in a traditional business. Both of these work. That said, I strongly believe that it is vital that Directors remember that it is the role of the Board to ensure that there is a proper process for developing strategy; not to set the strategy or execute it themselves or manage its execution. You can challenge assumptions, but don’t try to run the company.

7. What type of due diligence, or background check, do you do on an individual before determining that he or she would be a qualified candidate for a particular director position?

Typically, the people that we consider for Boards have a pretty public record of achievement, and given the ubiquity of information on the Web, we can usually do targeted research and due diligence at a very high level, very early. When we engage people in discussions, we interview them in detail, both about their background as operating executives who are leaders in their fields and in an attempt to gauge their potential contributions as a Board member, often in several sessions over a number of hours. Beyond that, we also do in-depth reference checks, typically with a variety of constituents in order to get a “full 360-degree view” of the candidate. This usually includes people for whom they have worked; people who have worked for them; peers; customers; outside vendors or service providers such as auditors, attorneys, investment bankers, and the like; and, Directors from other Boards on which they sit. I typically also like to speak to at least one person with whom the candidate has had a less “structural” or a specific conflict. By “structural” I mean where their roles would by their very nature put them at odds, e.g.: speaking to a VP of Marketing who would stereotypically wish to spend money; or the CFO, who would stereotypically want to save money. Examples of specific conflict would be asking a candidate to speak to people they have had to fire from their positions. We think that this in-depth diligence is one of the most valuable things that we do. In addition, we always do education verifications and typically do some kind of criminal background check, as well.

8. Much has been written about the difficulty of finding “financial experts” to serve on audit committees? What has your experience been on this?

Clearly, the narrow definition of a “financial expert” has made it more difficult to find qualified directors. It has been noted that the oracle of Omaha, Warren Buffet, arguably the greatest investor of our time, would not be qualified to serve as the financial expert of an Audit Committee under the current rules. I think that the vast majority of shareholders would prefer to have Warren Buffet acting as the guardian of their interests, with his wonderful gestalt view on business issues than some narrowly focused expert on the latest FASB pronouncement. I believe that the pendulum will swing back to a more reasonable place on the issue.

That said, the number of meetings for Audit Committees and consequent demand on the time of Directors has increased by 50%-100% on average. Therefore, it is not merely a question of qualifications, but of the commitment necessary to serve on the Audit Committee that is a constraint for many people to consider taking on that role. Even as the demand for financial experts to serve on the Audit Committee has increased, and new pools of prospective candidates have been added to consideration, most notably CFOs and retired audit partners from the major accounting firms, this may be the most difficult executive search in America today. As a firm, we track Audit Committee membership, particularly on companies cited for good governance, and have increasingly isolated that experience as a key criterion in our selection process.

9. When corporations provide a profile of the type of individual they would like to add to their board, are there any particular aspects of the profile that are most common – either in terms of what they want, or what they don’t want?

The old standard profile was someone that the CEO liked and who liked the CEO, someone for whom the prime criterion was getting along with the social dynamics of the current Board. This has clearly changed. More frequently, Boards of Directors are looking at their collective skill sets and doing the kind of gap analysis to shore up the areas of weakness or lack of experience. Sensible Boards don’t expect individual Directors to be all things to all people, and indeed, given the time commitments necessary, this further renders this desire impossible. Therefore, rather than just collective good business judgment, members of Boards are increasingly looked to for their counsel and expertise on specific topics or domain expertise. The most obvious of these is the financial expert requirement. Also high on the list of many firms are executives with strong operating experience, who have faced the very issues that the CEO faces: e.g. an understanding of the application of technology to business, a broader understanding of an increasingly global business environment, and an understanding of dealing with increased government regulations.

10. Has the compensation level for directors changed much?

Clearly, the compensation for Directors is quite literally all over the map. The largest companies, the GEs, IBMs, and J&Js of the world, are paying Directors as much as $125,000 to $150,000 a year and more. Yet, I am also aware of companies with billions of dollars in sales who in the past have paid Directors little more than $10,000 or $15,000 a year. I think that there will be inevitably a trend of rising compensation, and our surveys of Directors and senior executives show that there is overwhelming agreement on this. Just how much it will rise remains to be seen. I think there is a simple law of supply and demand at work here, though. There will be bidding wars for the high profile Directors for the highest profile companies; not because the Directors fees are necessarily going to make a substantive difference in the lifestyles of Directors (and surveys also show that compensation is only about sixth on the list of why someone takes on a directorship), but rather as a realization and confirmation that these roles will take time and must be regarded as serious responsibilities.

I think you will also see a greater premium being placed on additional committee service. For example, one Director I know reports that his service on the Audit Committee earned him an additional $500 emolument last year. This year, it will be $10,000. Will he go buy a new house or a new boat with that money? Absolutely not. Yet a twenty-fold increase in the compensation, even if it is largely compensation for service, even if it is largely symbolic, should be enough to make anyone stand up and take notice. A corollary of this is that as directors’ fees do rise, I think that we will see more professional Directors. These will not be the sort who sit on ten or eleven Boards, but those who are fully engaged on three, four, or five, in order to keep their hands in the business and make a strong contribution.