SSBI: key trends drive board composition; The latest Spencer Stuart Board Index reveals some dramatic changes in board composition in the wake of regulatory reform and the adoption of new best practices in governance.
MORE THAN TWO YEARS since the corporate governance reform movement achieved a milestone with the passage of the Sarbanes-Oxley Act, governance regulations continue to be debated, celebrated, and cursed.Are boards more effective, independent overseers of management than in the past? Have regulations stifled innovation and created unnecessary expense, or do they reflect the legitimate costs of ensuring appropriate governance? The debate on these issues is likely to continue for years to come.
What we know for certain from our work on hundreds of director recruitment assignments each year is that one of the most profound changes affecting boards today--the movement of responsibility for recruiting directors away from management and to the nominating committee--is now firmly entrenched.
No longer is a director position easily filled by a friend of a director or the CEO. Nominating committees consisting of independent directors now have responsibility for selecting new board members. They have adopted methodical and transparent recruiting processes that signal to shareholders the board's commitment to effective governance. Meanwhile, prospective board candidates are weighing more carefully the time, risks, and rewards associated with each directorship. As a result, recruiting new directors has become a more complex, time-consuming and, often, more difficult process than it was in the past.
This new rigor has real benefits. With the goal of assembling a board of directors that will add the greatest value to the company, nominating committees are giving careful consideration to the skills and experience needed on the board in light of the unique character and strategic goals of the organization, and they are recruiting directors best suited to those needs. They also are engaging outside experts and HR professionals within the organization to help them make these decisions. In short, boards are establishing thoughtful search processes aimed at achieving a more targeted recruitment and a more effective board.
Competing forces
If recruiting directors today is a more thoughtful, methodical process than it was in the past, it also is more challenging. The competing forces of dwindling supply and increased demand have combined to make attracting new directors dramatically more difficult.
Why is this happening? First, demand has grown as a result of governance reform requirements. During the past several years, Spencer Stuart has seen a continual increase in the number of director searches. This past year alone we have conducted more than 300 director searches in North America. Boards now must recruit directors who meet the newly tightened definition of "independence" and have the qualifications to serve on key board committees--the audit, compensation, and nominating committees--which now must be wholly independent. It's also expected that board turnover will increase as directors continue to pare back the number of board commitments they make.
Meanwhile, the classic director candidate--a sitting CEO--has much less time to devote to what has become a much more demanding job. As a result, CEOs are accepting fewer board assignments, and it is becoming more common for a CEO's own board to set a limit of one outside directorship. Data from our 2004 Spencer Stuart Board Index (SSBI) study of corporate governance in S & P 500 companies show that CEOs of these firms now serve on an average of less than one board position, down from an average of two outside directorships in 1998. In addition to the time demands, the increased liability and reputational risks of being associated with a poorly governed company are causing qualified candidates to carefully consider each directorship.
Rethinking the ideal candidate
As a result, boards have had to rethink their vision of the ideal director candidate. Rather than focusing their search heavily on active CEOs, nominating committees are considering retired CEOs, who have the expertise and may have more time, as well as other senior executives. In particular, as boards recruit new audit committee chairmen, demand has grown significantly for individuals with financial expertise, including former professional auditors from the major accounting firms. Nominating committees also are recruiting directors with specific skills or expertise that will enhance the board's effectiveness. While directors from all of these backgrounds can bring valuable insights and experience and make important contributions to the board, nominating committees must evaluate whether particular candidates have the desired broad senior-level experience and control over their schedule.
The 2004 SSBI study revealed some dramatic changes in board composition. Among the highlights of the study:
* Women made considerable strides. More new female independent directors than ever were added to S & P 500 companies in the past year.
* Director compensation is up 14% from 2003 and the mix has changed, with more being paid via retainers rather than meeting fees and stock options.
* CEOs accepted fewer outside directorships. For the first time the average number of outside directorships for CEOs fell below 1 to 0.9.
* There was an upsurge in the number of boards that appointed a lead or presiding director to 84% of S & P 500 companies, a significant increase from 36% in 2003.
Here is a summary of the report's findings.
Board Composition
The average board size is unchanged.
* In 2004, the average S & P 500 board consisted of 11 directors, the same as in 2003, down slightly from 12 in 1999 and 13 in 1994.
* Fewer companies have very large boards. Only 9% of boards have 15 or more directors compared with 16% in 1999.
* Nearly one-quarter of S & P 500 boards have between eight and nine directors, while in 1999 only 16% did.
As expected, demand for new independent directors continues to grow.
* There are 443 new outside directors, a 13% increase over the 2003 figure.
* Active and retired CEOs and COOs are still preferred, with 44% of new directors coming from these backgrounds.
* The number of new independent directors who are active CEOs has stabilized at 33%, after dropping steadily from 2000 through 2002.
* Surprisingly, in light of the requirements for financial expertise, the number of new directors from CFO, financial management, and accounting backgrounds is essentially unchanged from the 2003 level, at 14%.
* New independent directors have an average age of 56, unchanged from 2003. The average age of independent board members is stable at 61.
Female directors have made significant strides.
* 24% of new independent directors are women. This was the largest increase in new female independent directors at S & P companies ever during one year.
* The average age of new female board members is 52, four years younger than the overall average for new directors.
* The proportion of women on boards has increased to 16% in 2004 from 13% in 2003 and 12% in 1999. Overall, 87% of boards have at least one female director.
* 17% of S & P 500 companies have three or more women on the board.
* Four boards have a female membership of 40% or higher: Pepsi Bottling with 40%, Albertson's with 50%, Avon with 55%, and Golden West Financial with 56%.
* However, the number of female CEOs has decreased to seven in 2004 from nine in 2003. In 1999, there were four female CEOs.
More companies separate the chairman and CEO roles.
* 74% of all S & P 500 company boards have a combined chairman and CEO position. This is a decrease from 77% in 2003 and 80% in 1999.
* Of boards that separate the chairman and CEO roles, 57% have a former CEO as chairman. Again, this represents a decline from 2003, when 70% of these boards had a former CEO as chairman.
More boards name a lead or presiding director.
* 84% of S & P 500 companies have appointed a lead or presiding director, a significant increase from 2003, when just 36% had.
* Among the 360 boards where the CEO is the chairman, 318 have identified a lead or presiding director.
* There are 37 boards with a leadership structure of a nonexecutive chairman who is independent and who is not the former CEO.
* On some boards, the lead or presiding director role is a rotating position: 16% of boards rotate the position among committee chairmen, while 6% of boards rotate the position among the independent directors.
* 14% of boards with lead or presiding directors pay additional compensation to the appointed director. Most additional cash retainers range from $25,000 to $50,000 per year.
The number of financial experts has increased significantly as the compliance deadline nears.
* 91% of boards have identified at least one financial expert. This has surged from 2003, when just 21% had one.
* S & P 500 companies identified 832 financial experts in 2004, compared with 146 in 2003.
* Slightly more than one-third of the financial experts on audit committees are directors who are new to the committee.
* Among the 154 financial experts new to the audit committee, 47% are new to the board, suggesting that boards are adding directors who satisfy the financial expert requirements.
Board Organization and Process
Significantly more boards report a mandatory retirement age.
* 79% of boards have a mandatory retirement age, compared with 66% of boards in 2003.
* Of those boards with a mandatory retirement age, 88% have set it at 70 or 72. Several boards retain the discretion to extend the service of a director who has reached retirement age.
Boards are settling at eight to 10 meetings a year.
* The average number of board meetings per year increased slightly to 8.0 in 2004 from 7.8 in 2003.
* 37 boards met more than 13 times, double the number that met that frequently in 2003.
Some boards streamline their committee structure.
* The average number of committees is unchanged at 4.3. The number of boards with six or more committees has been cut in half to 16% from 31%.
* More boards have settled on five committees--25% of boards in 2004, compared with 11% in 2003.
* Other than the three mandatory committees (compensation, audit, governance/nominating), the executive and finance committees are most common.
Almost all companies have the three mandatory committees.
* 100% of S & P 500 boards have an audit committee composed entirely of independent directors.
* All the boards have a compensation committee; 99% of these compensation committees consist only of independent directors.
* 98% of boards have a nominating/governance committee, and 98% of them are composed entirely of independent directors.
Audit committee membership fell for the second year.
* The average number of directors on the audit committee is 4.17, down from 4.23 in 2003 and 4.35 in 2002.
Most audit committee chairs are active executives.
* 26% of audit committee members are active chairmen, presidents, or CEOs.
* Retired chairmen, presidents, and CEOs make up the next-largest group at 21%.
* The number of audit committee members with CFO and accounting backgrounds rose to 9% in 2004 from 5% in 2003.
* Other corporate executives, including active and retired senior human resources, strategy, and operations professionals, represent 12% of audit committee members, compared with 7% in 2003.
Audit committees meet more often.
* Overall, the average number of audit committee meetings increased by 74% since 2002. On average, audit committees met 8.7 times, up from 7.3 in 2003 and 5.0 in 2002.
* Only three audit committees had three meetings or fewer in 2004, compared with 18 in 2003 and 91 in 2002.
* By comparison, 40 audit committees met 14 or more times in 2004, compared with 10 in 2003. No audit committees met that frequently in 2002.
* 54% of all audit committees met between eight and 13 times in 2004, an increase of 44% from 2003 and 336% from 2002.
Compensation
Director pay increases are fueled by higher annual retainers.
* More of directors' compensation is coming from annual retainers.
* The average annual retainer is now $50,000, up 14% from 2003 and 48% from 1999.
* 117 boards paid retainers of at least $60,000 in 2004, compared with 82 boards in 2003 and 32 in 1999.
* 35 boards paid a retainer of $100,000 or more, compared with 21 in 2003.
* Only 18 boards paid less than $20,000, down from 27 in 2003 and 39 boards in 1999. Four boards pay a retainer of $10,000.
Board meeting fees have increased moderately, but the number of boards that pay fees has continued to decrease.
* Two-thirds of boards pay meeting fees, down from nearly 80% in 1999.
* Of those that do, the average payment is $1,700 per meeting, up 6% from 2003 and 24% from 1999.
Stock option-based compensation declines.
* 68% of S & P 500 companies provide a stock option program for directors, compared with 74% in 2003 and 77% in 2002.
* Just five boards paid retainers entirely in options in 2004, down from 16 in 2003 and 28 in 2002.
Slightly fewer company boards pay committee meeting fees in 2004.
* 63% of the S & P 500 boards pay a committee meeting fee, compared with 67% in 2003.
* Among the 308 boards that pay a committee meeting fee, 34 boards (11%) pay more to audit committee members, twice as many as in 2003.
* The average meeting fee paid to audit committee members is 43% higher than meeting fees paid to members of other committees.
Committee chairmen receive higher meeting fees than other committee members.
* Among the 308 boards that pay a committee meeting fee, 50 boards (16%) pay more to committee chairmen.
* Of those 50 boards paying higher meeting fees to committee chairmen, 13 boards (26%) pay a higher fee to the audit committee chairman, while only seven boards did in 2003.
More boards pay retainers to committee members.
* 99 (20%) of the S & P 500 boards pay a retainer to committee members, a 32% increase from the 2003 figure. Of these, 62% pay more to audit committee members.
* The average retainer amount paid to audit committee members is 6% higher than the amount paid to members of other committees.
More boards pay a retainer to committee chairmen.
* 376 S & P 500 boards pay retainers to committee chairmen, a 19% increase from 2003. Of those, 55% pay the audit committee chairman a larger retainer. Twice as many boards are paying a premium to their audit committee chair as did so in 2003.
* The average retainer for audit committee chairmen is 85% higher than the average retainer paid to chairmen of other committees.
* The highest audit committee chairman retainer, paid by Monster Worldwide, was $8,000 monthly or $96,000 annually.
The fundamental need
Ironically, for all the changes to board composition and recruiting, the qualities of an outstanding board director have changed little in the 20 years since Spencer Stuart began doing board searches. As much as ever, companies need directors who can lead with integrity and independence; are able to focus on strategic issues; are knowledgeable about the external factors impacting the organization; can provide candid and constructive feedback to management; bring diverse perspectives but work to come to a consensus on major decisions; and hold management accountable for performance.
As they institute new recruiting processes and comply with regulatory requirements that promote board independence, nominating committees should keep these other qualities top of mind.
TABLE 1 CEOs Holding Chairman Position 2004 74% 2003 77% 1999 80% TABLE 2 Number of Board Meetings 2004 2003 3 and fewer 0% 0% 4 to 7 56% 57% 8 to 10 27% 30% 11 to 13 9% 9% 14 and more 8% 4% TABLE 3 Number of Standing Committees 2004 2003 2 2% 3% 3 26% 27% 4 31% 28% 5 25% 11% 6 10% 25% 7 or more 6% 6% TABLE 4 Audit Committee Member Background 2004* 2003 Active Chair/CEO/President 26% 29% Retired Chair/CEO/President 21% 19% Active/Retired Other Corp. Executives 12% 7% Academia/Nonprofit 10% 11% Investor 7% 12% Consultant 6% 6% Active/Retired CFO 5% 3% Investment Banker 4% 4% Active/Retired Accounting 4% 2% Lawyer 4% 5% N/A 2% 2% * Numbers add up to more than 100% with rounding. TABLE 5 Number of Audit Committee Meetings 2004 2003 3 and fewer 1% 4% 4 to 7 37% 56% 8 to 10 37% 27% 11 to 13 17% 11% 14 and more 8% 2% TABLE 6 Committee Member Retainers 2004 2003 Average committee member retainer $8,667 $5,231 Average audit committee member retainer $9,180 $8,077 TABLE 7 Use of Search Firms While boards are not required to disclose whether they hire an executive search firm to identify and evaluate potential director nominees, many include this information in their discussion of their director nomination process. For the 2004 S & P 500: Search firm used in the past year 68 Search firm currently engaged 39 Have in past/may in future 94 Have not used a search firm 15 No mention of search firm 174 Total 490
Julie H. Daum is North American Board Services Practice Leader for Spencer Stuart. Thomas J. Neff managed the worldwide firm from 1979 to 1987 and established the Board Services Practice in the U.S. in the early 1980s. They are based in the firm's New York office. The Spencer Stuart Board Index (SSBI) has been a preeminent statistical source on board composition, governance, and compensation since 1985. The SSBI annually tracks board changes based on proxy data analysis of the S & P 500 companies combined with direct surveys of these companies on key governance issues.
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The authors can be contacted at jdaum@spencerstuart.com and tneff@spencerstuart.com. The full SSBI report is available on the firm's Web site at www.spencerstuart.com.
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| Title Annotation: | SPENCER STUART GOVERNANCE LETTER; Spencer Stuart Board Index |
|---|---|
| Author: | Daum, Julie H.; Neff, Thomas J. |
| Publication: | Directors & Boards |
| Geographic Code: | 1USA |
| Date: | Jan 1, 2005 |
| Words: | 2891 |
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