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Take the high ground on director selection.

Take the High Ground On Director Selection

Not since the days when Harold Williams was Chairman of the Securities and Exchange Commission has there been as much discussion regarding the definition, as well as the performance, of an independent director. While the bonfire days of the massive takeover battles of the 1980s may have passed, fiduciary and governance responsibilities clearly continue to be the primary focus for those serving as directors.

These concerns are shared by the corporate chairman, primarily in terms of the independence of the outside directors and just how autonomous they can be. Institutional investors have become significantly more aggressive in voicing their views and demands regarding director performance, and will continue focusing on who are selected as directors, and how; how a board operates and functions; the composition and organization of committees; and, most importantly, the relationship between the board and the chairman/chief executive.

The views expressed here have been developed as a result of handling the recruitment of several hundred outside directors in the last decade. This experience has enabled us to meet, discuss, and develop strategies, not only with chairmen and nominating committees but also with prospective and current directors (of our clients), and it provides a rich reservoir of pragmatic experience.

First, what is an independent director? Our view is that an independent director has no current commercial or personal family relationship with the corporation served, is not a retired executive or employee of the corporation, and beneficially owns (votes) less than 5% of the voting shares of the company. While perhaps simplistic, this definition could provide a framework against which candidacies could be evaluated and "independence" determined.

It follows that a company would be well advised to establish visible criteria to be used in specific director selections. While nominating committees have been functioning for some 15 years, evidence would indicate that boards have been best constructed when the CEO has taken the lead in director screening and then used the nominating committee for advice regarding the proposed candidates.

Our experience indicates that the rate at which persons are declining board seats probably will stay at about seven or eight rejections for each acceptance.

This should help focus on the problems associated with identifying, but more importantly, attracting, and retaining qualified persons to serve. This means, also, that the definition of the independent director and the selection criteria used by corporations must be adhered to as closely as possible since there could be a natural tendency, with such a negative response, for less emphasis to be put on the qualifications of candidates. Frankly, we observe that those corporations that stick to their guns in terms of selection criteria do indeed end up with not only the best qualified directors but also directors who perform best.

Board composition undoubtedly will continue to show a rise in the ratio of outside to inside directors. During the 1980s, much of the sharp increase in the ratio resulted from reducing the number of inside directors, rather than increasing the size of the board. We believe that a 4:1 outside/inside ratio should be considered to be an appropriate guideline for the '90s. While 10 years ago 19 of 100 companies in the SpencerStuart Board Index (SSBI) had a majority of inside directors, all but four of these 100 companies changed their ratio during the past decade so that now a 3:1 outside/inside ratio is the norm.

More committees formed

The time demands placed on board members during the '80s resulted in an increase in the number of committees and their governance responsibilities. In 1987, for example, only 45 of the SSBI top 100 Boards had five or more committees, up only slightly from 42 in 1980. That number has risen significantly in the last three years, so that today, 63 of the top 100 boards have five committees.

We would suggest that the '90s will see a trend toward not only the audit committee being composed solely of the independent directors of a board but, most likely, also the compensation and nominating committees. This increased involvement by outside directors in active governance clearly will limit the number of boards on which a person can serve effectively. Indeed, these increased time demands could well result in a corporation requiring that their directors, both inside and outside, serve on no more than three or four boards.

Finally, not only from the pressures of the institutional investors, but also reflecting the fiduciary role of a director, compensation for directors in the '90s should see a move toward higher levels of stock ownership to either replace or augment board retainer and meeting attendance fees. The simple logic is that directors should have the same motivation as the shareholders they represent and board compensation should be geared directly to the value of the company as reflected by the market.

Focus on performance

This compensation approach could result in more candor and closer examination of the operating performance of the CEO and put more emphasis on the strategic growth plans of the corporation, as well as on the continuing quality of the operating performance.

Since the pressure from institutional investors will predictably increase in the '90s, there is the obvious need for constructive dialogue between the owners of stock and corporate management. However, in addition to the dialogue, it would be prudent for corporations to seize the initiative and anticipate the demands of their investors as to the identification and selection of qualified directors. Those chairmen who share with the public their criteria for selecting directors could make a significant contribution to corporate governance in the years ahead.

The entire area of governance in the '90s will be dynamic and demands for performance at all levels in the corporation will be intensified. This will include the performance of a board of directors. If Corporate America does not take the high ground on these issues, the regulators predictably will. Alternatively, shareholders should have recourse to appropriate sanctions.

Jack Lohnes is Chairman - Board Services of SpencerStuart Executive Search Consultants.
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Title Annotation:Chairman's Agenda: Balancing Shareholder Interests
Author:Lohnes, Jack
Publication:Directors & Boards
Date:Mar 22, 1991
Previous Article:The shareholder advisory committee.
Next Article:A vision of value-based governance.

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