Changes at the top: What the new regulations mean for director recruiting

Boardrooms throughout America are adjusting to a new way of life. In the wake of corporate scandals that severely damaged investor confidence, new regulations and recommendations are forcing boards to reevaluate how they operate. Only time will tell whether these newly mandated board practices will improve the overall quality of corporate governance in the US, or whether the new standards simply represent an overreaction to the recent governance crisis. What is immediately apparent, however, is the impact of these regulations on director recruitment – specifically, how and who boards are recruiting.

The Sarbanes-Oxley Act, SEC regulations and the New York Stock Exchange (NYSE) recommendations, coupled with negative public opinion, have sent Corporate America scrambling to reevaluate board independence and the role of the audit, compensation and nominating committees.

The NYSE strongly recommends that the entire board be comprised of a majority of independent directors, as defined by new, specific, more restrictive criteria, with compliance required 18 months after SEC approval. The NYSE recommendations also dictate that the nominating and compensation committees must be composed entirely of independent directors. Sarbanes-Oxley requires the audit committees of all publicly listed companies to be completely independent and have at least one financial expert by 2004 – and if not done, explain the reasoning.

The regulations regarding committee independence and financial expertise – in conjunction with a rise in the amount of work required from each committee – are altering the makeup of the board. Due to scheduling challenges, it is increasingly difficult for an independent director to sit on more than one committee. To ensure that boards have the appropriate number of independent directors serving on the three most demanding committees, the overall size of some boards will have to increase.

As boards work to comply with the new mandates, they will need to find a balance of directors who not only fit the above criteria, but who also are capable of creating an effective board. Based on the more than 200 board assignments Spencer Stuart currently is working on in the US, we have observed two major changes in how boards are handling director recruitment.

Spotlight on the nominating committee

One of the biggest changes taking place within the boardroom is the manner in which the board identifies and recruits new directors. In the past, the CEO was the primary driver of the selection process. It was not unusual for a board to consider only one candidate and for the interview to take place over a business lunch – attended by only the CEO and the candidate. The expectation was that, if there was a nominating committee, it would approve the candidate, possibly even sight unseen. Today, however, the nominating committee is central to the entire process, with the CEO playing a more supportive role.

Boards are beginning to adopt a much more structured and disciplined process for selecting new directors. Boards are not just looking for someone they know. Working with an outside firm to identify potential candidates, the chairman of the nominating committee may now be the first person to meet with the candidate. And rather than making a decision based on one or two interviews, the committee will likely ask the candidate to meet other board members or key management executives. In addition, the nominating committee may see two to three candidates for one director spot. To facilitate this more strategic approach to director recruitment, we strongly recommend the following steps:

1. Assess current board versus strategy.
   This includes confirming board member independence, completing a skills analysis of the board and determining potential retirement dates for board members.
2. Identify the needed board skills.
   Once determined, compare these desired skill-sets against the existing skill-sets on the board and then craft a director profile as a “road map” for selecting future board members.
3. Develop a recruiting plan.
   Put in place a process for identifying the ideal board candidate and solicit input from the board. If needed, hire an independent director recruiter to aid in the process.
4. Vet candidates thoroughly.
   Carefully select the group who will interview the candidates – making sure it is comprised of board members, the CEO and possibly other key management executives. And finally, the nominating committee must complete stringent due diligence on the final candidate to ensure that there will be no unpleasant surprises or conflicts of interest.

Challenges to finding directors

The added due diligence in the nominating process is not a one-way street. Potential directors, for a variety of reasons, also are much more cautious in their approach to potential directorships.

For many years, boards sought out well-known CEOs to sit on their boards, with 41% of new directors falling into the active chairman/president/CEO category in 2002, according to the Spencer Stuart Board Index. Today, boards are aggressively searching for executives who meet the criteria for independence and have specific skills and expertise. They also need enough qualified directors who can – and are willing to – sit on the audit committee.

However, this talent pool for directors has shrunk. The perceived financial and personal risks of being a director of a public company have increased dramatically and, as a result, prospective board members are doing their own due diligence to a far greater degree. In addition, directors cite that board work is taking twice as much time as in the past. As a result, many who meet the criteria for independence or financial expertise are reluctant to serve. For most, the risk-reward equation is out of balance. And while CEOs and other senior-level executives are finding directorships less attractive, they also are under pressure from their own companies to sit on fewer boards. CEOs, on average, now sit on 1.1 outside boards in 2002, a decrease from two outside directorships in 1998.

These combined factors of a shrinking pool of qualified and willing director candidates – coupled with the board’s need to have additional outside directors serving on the three main committees – have required the nominating committee to look at a longer and alternative list of candidates. Depending on their strategic needs, nominating committees may spend more time looking at executives with very specific functional or industry expertise, while others may opt to target retired CEOs or younger executives who are seeking additional experience to round out their careers.

Conclusion

As a result of the new regulations, today’s boardrooms have to adjust to numerous changes. But they also are presented with an opportunity to reassess and enhance their independence. The new, disciplined approach to director recruitment will force boards to analyze each director opening and facilitate the nominating committee’s ability to be successful. In the end, if done correctly, the board should be able to recruit directors who have specific expertise that will contribute to the company’s overall success.

About the authors

Julie Hembrock Daum is the leader of Spencer Stuart’s North American Board Services Practice.

Tom Neff has been with Spencer Stuart since 1976, managing the worldwide firm from 1979 to 1987 and establishing the Board Services Practice in the US in the early 1980s. They are based in Spencer Stuart’s New York office.

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