“Board Composition, Refreshment and Tenure –

Hot Issues for Corporate Boards”

October 2015

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Introductions

• Glenn Booraem – a Principal at Vanguard Group, Inc. and Treasurer of each of the Vanguard Funds

• Rakhi Kumar – Managing Director and Head of Corporate Governance at State Street Global Advisors

• Charles Elson - Director of the John L. Weinberg Center for Corporate Governance, Edgar S. Woolard, Jr. Chair in Corporate Governance, and Professor of Finance, Alfred Lerner College of Business & Economics, University of Delaware

• Ann Mulé – Associate Director of the John L. Weinberg Center for Corporate Governance, Alfred Lerner College of Business & Economics, University of Delaware, and Moderator

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Introduction and Overview• Shareholders are increasingly focusing on the

importance of board composition – both activists and large institutional investors like Vanguard, State Street, BlackRock, to name a few

“Independent oversight…and more broadly, appropriate board composition…is the single most important factor in good governance.”**

– F. William McNabb III, Chairman and CEO, VanguardOctober 30, 2014

**See transcript of talk by William McNabb, Chairman and CEO of Vanguard, October 30, 2014 -http://www.lerner.udel.edu/centers/weinberg/2014-events

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Director-Centric Model Under State Law

• Current legal framework of corporate governance as created by state law is a director centric model where the Board has the responsibility “to manage and direct” the affairs of the corporation with its accompanying fiduciary duties

• The fiduciary duties of the board and its directors include:– Due Care– Loyalty– Good Faith

• Board composition is one of the most important keys to an effective board

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Independent Director Industry Expertise• Independence is critically important – but it is not enough

• Numerous boards are now comprised of independent directors, none of whom have industry expertise, and an inside CEO who is the only one with industry expertise - DANGER – a “management knowledge-captured board”– Knowledge is power – “you don’t know what you don’t know”– Issue is particularly acute with regard to company strategy and risk. Industry expertise is

critical to understanding competitive threats and strategic opportunities– Can lead to inadvertent/unknowing de facto deference to the CEO – Can be just as dangerous as a management-captured board (i.e., a board that is not

independent) because in both instances the board is not doing an adequate job of monitoring and advising management

• “The Management Knowledge-Captured Board,” published in 2014 in Directors & Boards magazine, is included in the course materials

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Importance of Independent Director Industry Expertise

• The 2014 NACD Blue Ribbon Commission on Strategy Development – recommends that boards become more involved in strategy

issues on an ongoing basis – that in order for this to be successful, the nominating and

governance committee SHOULD CONSIDER DIRECTOR EXPERTISE in relation to the strategic direction of the company

• ONE MORE IMPORTANT REASON TO HAVE INDEPENDENT DIRECTOR INDUSTRY EXPERTISE ON THE BOARD

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Activism• Activist investors generally seek to effect change in a

company’s strategy, operations, performance, board and/or management with the goal of increasing shareholder value

• In making the case for change, activists focus on a company’s vulnerabilities

• One tool in the activists’ “play book” in the last few years has been to focus on director skills and expertise or lack thereof

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Activism• The argument that the activist will make – the board is not

functioning properly because it does not have board members with the requisite industry knowledge and experience to effectively oversee management – is extremely compelling in its logic and simplicity – and – is very hard to defend against

• Boards that do not focus on this issue run a risk those shareholders will do it for them

• Examples: Hess, Bob Evans, Darden

• Example of a company fighting back: DuPont

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Impact of Activism• In the past, activists usually put their own people (from their hedge fund) on their director

slates

• Looking at the more recent activist interventions over the last 3 or so years - many activists have nominated extremely qualified directors who were not affiliated with their hedge fund and who had outstanding industry expertise and other extremely important functional skills (such as restructuring, capital markets, financial, governance, etc.)

• What is interesting is that years ago these highly qualified individuals would not have agreed to stand because of the perceived “reputation tarnishing” associated with running on a dissident slate. Now these people don’t view being on a dissident slate as a negative.

• Even large Wall Street law firms don’t view representing activists as “reputation tarnishing”. A recent Wall Street journal article reported that one of America's oldest corporate law firms is beginning to represent activist investors, betting that these investors are going main stream, while continuing to represent their corporate clients.

• It is becoming increasingly clear that associating with activists is becoming more acceptable

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Board Refreshment• The composition of the board as a whole should reflect the

most appropriate director skill sets and expertise to effectively oversee evolving company strategy and hold management accountable

• Mechanisms to refresh the board to bring in desired skill sets and avoid board “stickiness”:– Board evaluations– Mandatory retirement age– Director tenure– Term limits

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Board Refreshment• Evaluations

– The PwC 2014 Annual Corporate Director Survey found the following with regard to Board evaluations (note that directors were responding):• 70% of respondents noted they find it challenging to be frank in evaluating

the board• 63% of the respondents found it to be a check the box exercise• To have a good board evaluation process, boards need to address these issues

– Rigorous board evaluations, including assessing committees and individual board members, are considered a best practice and an optimal board refreshment tool

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Board Refreshment• Mandatory Retirement Age

– Many boards have relied on mandatory retirement age– According to the Spencer Stuart “Board Index 2014” - regarding mandatory

retirement age• 73% of all S&P 500 boards have established a mandatory retirement age for directors • Of the 361 boards with a mandatory retirement age, the ages run:

– 92% - 72 or older (versus 75% in 2009)– 30% - 75 or older (versus 15% in 2009)

• Term Limits– Deloitte and the Society of Corporate Secretaries & Governance Professionals

“2014 Board Practices Report: Perspectives from the Boardroom” found:• 82% of large cap companies have mandatory retirement age limits• 4% of large cap companies have term limits

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Board Refreshment• Director Tenure– State Street’s 2014 voting policy on director tenure• Concerned with long-tenured directors, which may

indicate a lack of refreshment skills and perspectives • Impact of voting policy in 2015

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Board Refreshment• Director Tenure– BlackRock• Effective February 2015, Blackrock adopted revised

Proxy Voting Guidelines for U.S. securities that included, among other things, key changes on board composition:– Expanded the scope of the guideline on board composition to

explain how they take into account director tenure, diversity, board evaluation, and the relevance of directors’ experience, among other factors, in forming a view on director elections

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Board Refreshment• Director Expectations – Length of Board Service– Consider telling Board members up front:

• that it is not a lifetime appointment (or until a mandatory retirement age)

• that he/she is being asked to join because his/her current skill sets are needed; however, if there comes a time that his/her skill sets are no longer needed or as relevant as other skill sets, he/she will be asked or should volunteer to not stand for re-election

– Make it clear to the entire board that this is the new “paradigm” and that a board member is not doing a “bad” job because he/she is not asked to stand

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Board Refreshment/Diversity• EY noted in its 2015 proxy season insights: spotlight on board composition

– That the continued lack of turnover on many boards and slow progress on increasing diversity, including gender, race and ethnicity, are bringing director tenure and board succession planning under scrutiny

• Historically nominating committees have asked search firms to find candidates who are current or former CEOs, which creates a much narrower pool of candidates with fewer diverse candidates – In the Spencer Stuart 2014 Board Index relating to the S&P 500, 60% of the

respondents said that recruiting an active CEO or COO is a priority, 40% said they were looking for a retired CEO/COO

– In Heidrick & Struggles recent Board Monitor “Four Boardroom Trends to Watch,” it is noted regarding the 339 new board seats filled in Fortune 500 companies in 2014:• 47% were current and former CEOs• 20% were current and former CFOs

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Board Refreshment/Diversity• As noted in the previous slide, while companies look for board candidates who are

current or former CEOs, COOs or CFOs, female directors are gaining some momentum

• The “2014 Catalyst Census: Women Board Members” found the total number of board seats held by women at U.S. stock index companies to be 19.2% - up from 15.2% in 2009

• In the recent Heidrick & Struggles Board Monitor “Four Boardroom Trends to Watch,” it is noted that of the 339 new Fortune 500 directors recruited in 2014, “99 were female, representing 29.2% of the total…” This was compared to 18% in 2009

• Heidrick & Struggles also notes that the percentage of Hispanics recruited to boards in 2014 was 5.0%, compared to 5.1% in 2009. The percentage of African-Americans appointed in 2014 was 8.3%, compared to 5.3% in 2009. The percentage of Asians appointed in 2014 was 5.3%, compared to 3.9% in 2009

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Board Refreshment/Diversity• Diversity should be an outcome of a well-considered

board composition succession plan based on skill sets and qualifications

• Diversity of thought – “cognitive diversity”• Diversity for diversity’s sake can yield unintended

consequences • Recruiting candidates with specific skills sets rather

than focusing on current or former CEOs broadens the pool of potential candidates

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Engagement• Engagement is increasingly occurring between companies/ directors and

their investors

• Expect to be prepared to discuss board composition, director skill sets and experience and how it relates to company strategy and risk in company engagements with investors

• Expect to be prepared to discuss the evaluation process utilized by the board to assess its performance

• State Street Engagement Protocol

• See also the SDX Protocol, which provides guidance on shareholder/director engagement – http://www.sdxprotocol.com/

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Engagement/Disclosures• Another way to engage with investors is through company

disclosures (e.g., filings and routine communications)– Use disclosures to illustrate and provide context for important

points/information regarding board composition, refreshment and diversity

• See The Conference Board’s “Recommendations of the Task Force on Corporate/Investor “ and “Guidelines for Engagement” (which includes a pyramid “Engagement: A Layered Approach” on page 8)

• Company disclosure examples

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Final Thoughts