Board composition: The road to strategic refreshment and succession

Having the right individuals in the boardroom is critical. Directors need to have the right skills and experience that align with the company’s long-term strategy. Diverse and fresh perspectives are also important. So how should boards be thinking strategically about their board succession plan to ensure optimal board composition now and into the future?

Shareholders and other stakeholders are paying increased attention to board composition. Institutional investors are putting pressure on boards to have a more rigorous process around board composition and refreshment. They are asking whether there is enough diversity in the boardroom, if the board has the right skills, how they think about director tenure and whether there is a succession plan. Many shareholders also want enhanced disclosure to better understand the board’s activities in this area. And, hedge fund activists have focused on board composition as part of their campaigns.

In our experience, approaches to board refreshment and succession planning fall along a spectrum. Some boards are strategic and forward-thinking, while others are reactive — with multiple options in between. Our view is that boards benefit from a more strategic approach.

In practice: the board succession planning maturity continuum

Example: John Smith is on the board of ManufactCo. and will reach the board’s mandatory retirement age of 75 in approximately one year. He has a strong traditional manufacturing background and qualifies as a financial expert on the audit committee. Cheryl Jones will reach the mandatory retirement age two years after John. She has deep expertise in financial management and investment banking and also qualifies as a financial expert on the audit committee.

Reactive

The nominating/governance committee plans to begin searching for a director candidate in the next few months to find a replacement for John. The committee will seek a candidate with skills similar to John’s. The annual performance assessment survey did not reveal any substantive changes needed to overall board composition. Although several directors suggested skills that may be needed in the future, the committee chose not to memorialize this in a skills matrix.

Progressing

John’s departure was identified a year in advance during annual board succession planning, and the nominating/governance committee has spent that time discussing his replacement. The committee maintains and refreshes the board’s skills matrix each year. It concluded that the company’s digital strategy is becoming increasingly important and that a director with digital skills will be critical to board composition. The committee also noted the need for greater gender diversity, and the fact that several other board members qualify as audit committee financial experts. The nominating/governance committee created a candidate profile based on this information and has been soliciting ideas for director candidates to replace John next year.

Strategic

The nominating/governance committee has been preparing for John’s departure for more than a year. It is also planning for the vacancy that will be created when Cheryl reaches the mandatory retirement age two years after John. The committee reviewed the results of the board and individual director assessments to consider whether the skill sets of current directors are still relevant. It also regularly updates the board’s skills matrix as part of the succession planning process. This process identified digital skills in the manufacturing industry, gender diversity and operating experience as elements important to prioritize for overall board composition. The nominating/governance committee created candidate profiles with prioritized skills and attributes for both John’s and Cheryl’s successors. They discussed the succession plan and candidate profiles with the full board. The committee has been actively searching and interviewing director candidates to replace both John and Cheryl. The board’s skills matrix is disclosed in the proxy statement to provide greater transparency to investors.

Make board refreshment and succession planning priorities on the agenda

Implementing a strategic approach to board refreshment and succession planning requires effective board and committee leadership. For most boards, the nominating/governance committee oversees the process. This includes developing and recommending criteria for board composition, addressing director tenure, creating a succession plan and leading the search for new candidates. In addition to the committee, the full board should also understand, review and have input into the process.

Boards are unlikely to tackle these topics in a rigorous way unless it is explicitly part of their agenda. So it is critical to regularly carve out time on the nominating/governance committee and board agendas.

Board culture also has a role to play. The culture has to allow for frank and candid dialogue about board composition, director tenure, retirements and the need for different director skill sets. These are sensitive, difficult discussions, which make strong board leadership all the more essential.

Shareholders have heightened expectations about understanding the board’s approach to refreshment. They want to know whether a robust succession plan exists, whether it addresses skills needed in the future and how frequently the topic is discussed, among other items. Some boards are evaluating whether greater transparency on their approach would be valuable considering shareholders’ interest.

Assess skills and attributes, and incorporate results from performance assessments

Nominating/governance committees further along the strategic board refreshment and succession maturity continuum compare the skills and attributes of current directors with those that are critical to the company’s long-term strategy to identify and address any gaps. If there are gaps, the board can add expertise or consider bringing in outside experts to fill the gap.

As companies are innovating, implementing new technologies and entering into new markets, their business models may call for directors with new or different skill sets. But boards shouldn’t focus on adding a director with just a singular new skill set (e.g., cyber or human resources). Directors need to be able to contribute in all areas of board oversight.

The committee should use board composition matrices or a similar tool to help them evaluate their skills and attributes, and include these items as part of their multi-year board succession plan. Boards further along the refreshment maturity continuum share the matrix with their full board for input and agreement. They may even voluntarily disclose these tables, or something similar, in their proxy statements.

Feedback from the annual board, committee and individual director assessments should also be incorporated into the board refreshment process. When assessments are done in a meaningful way, they can help identify whether new or different skills or greater diversity is needed.

Sample board composition matrix

Source: PwC, Board composition - Key trends and developments, July 2018.

As part of the board refreshment process, boards should understand institutional investors’ views about increasing diversity, particularly gender and minority representation, in the boardroom. Boards can also think about whether it would be beneficial to add younger directors (e.g., age 50 or under) to the board. There is a growing recognition that boards with a good mix of age, experience and backgrounds tend to foster better debate and decision making and less groupthink.

Many investors view the pace of change for board diversity as too slow. Some investors have raised their board accountability efforts by voting against the entire board of directors or the nominating/governance committee in director elections when board diversity is lacking. Various state lawmakers have also weighed in by enacting legislation requiring a certain number of board seats be held by women or diverse directors. But boards shouldn’t wait for investors or others to push for increased diversity. Instead, they should ensure that diversity is a board priority and address any factors preventing the board from making progress.

Board Action on Assessments

Set directors’ expectations around tenure

Boards further along the maturity continuum openly discuss and forge agreement on appropriate director turnover, and how it will be achieved. Board leadership sets the tone about the length of director service at the outset. They ensure directors understand that re-nominations are not simply assumed — they are based on the evolution of the company and board, and sustained high-performance at the individual director level.

In addition to setting clear expectations around director tenure, boards should periodically assess whether tenure-limiting policies are appropriate. Most boards rely on mandatory retirement policies to promote turnover. In some cases, boards make exceptions to mandatory retirement ages to keep a particular director on the board. This can become problematic as it can set a precedent for all future directors nearing retirement age. Term limits are much less common.

Another area that boards can focus on is the optimal mix of board tenure levels or aggregate board tenure. Some boards seek to balance their composition of new directors, those with medium tenures and those with long tenures.

But boards shouldn’t rely solely on tenure-limiting policies to drive turnover. The annual performance assessment can be an effective tool to evaluate board and individual director performance on a regular basis.

Some institutional investors and proxy advisory firms have also been vocal about director tenure. They are concerned about how tenure affects director independence, objectivity and the ability to challenge management. Boards should consider these views as part of their succession planning.

Take a multi-year view toward departures and address upcoming leadership changes

A key part of strategic board refreshment and succession planning is anticipating and proactively addressing planned and unplanned vacancies in the boardroom. Without a plan, the board may feel pressure to waive or change board policies, including mandatory retirement ages, or simply recruit a director with the same profile as the one retiring. This ad hoc approach doesn’t allow the board to think more broadly about alternatives that may result in a better fit or better board performance.

Boards further along the maturity continuum take a longer-term view — focusing three to five years out — to effectively address anticipated departures. They create a waterfall chart that identifies all directors, their skill sets and expertise, their board roles (including leadership and committee membership), board tenure, the year they would likely be leaving the board based on expected retirement and other factors.

This broader view gives the nominating/governance committee ample time to effectively plan and recruit the right candidate and have a smooth transition.

It is equally important to address the prospect of unexpected turnover, particularly for those directors serving in leadership positions. A plan that considers the potential for such an event to occur positions the board to fill vacancies more quickly.

For leadership changes due to retirement, committee chair rotation or other reasons, an existing board or committee member is often chosen as successor. This is because the individual already has institutional knowledge of the company, familiarity with the key issues and relationships with the other board or committee members and management. While the successor has this information, leading practice when there is an expected leadership change is for this individual to have a six-month to one-year time period to “shadow” the current leader and obtain deeper insights into the role.

Board leadership roles can’t be filled by just anybody on the board. Effective succession planning by the nominating/governance committee should ensure new board leaders have the right skills, time and commitment to perform the role. Board and committee leaders set the tone in the boardroom. They have to be able to promote effective working relationships, handle conflict and be strong facilitators. Specialized knowledge and experience are also critical for audit and compensation committee chairs in order to address the technical issues handled by these committees. Boards also need to take into account regulatory requirements for certain skills — such as financial expertise on audit committees — that will need to be considered when addressing leadership succession.

Agree on a succession plan that prioritizes needs and build a talent pipeline

Strategic board refreshment will bring in discussions around director departures, tenure evaluation, skill set assessment and performance assessment results to agree on a multi-year succession plan.

Nominating/governance committees will want to collectively debate, prioritize and settle on the board’s future composition needs and a timeline for changes. The key is to be agile and allow the board to make changes as situations or needs arise. For example, some boards have expanded their size to make composition changes faster or to provide an opportunity for a director candidate to shadow another director during a transition period.

Ultimately, the board succession plan and priorities should be reviewed and agreed to by the full board. This action helps the board understand the full complement of directors and how each individual director’s skill set and attributes are relevant to the company. It can help directors understand new skills needed in the boardroom, identify potential future directors, and may be an impetus for further education and skills development for existing directors.

When identifying the board’s needs for future director candidates, it is important to be realistic. Boards can fall into the trap of creating a “laundry list” of attributes, desired skill sets and expertise that is unlikely to be filled by one director candidate. Instead, ranking what is most important can make it easier to find appropriate candidates and choose among multiple candidates.

Boards further along the maturity continuum look not only for a candidate they need now, but also proactively build relationships with potential candidates to develop a talent pipeline. Some boards keep a running list of potential director candidates for future reference. Directors should utilize approaches that look beyond asking other sitting directors for recommendations to find their next board candidate.

The Changing Profile of New S&P 500 Directors

Conclusion

Boards should strive to move up the board refreshment and succession maturity continuum toward a strategic approach. A strategic approach delivers benefits to board performance and increases long-term shareholder value. At its best, board refreshment and succession planning is an iterative process that takes into account the company’s evolving business model and the changing governance landscape. This is increasingly important as investors continue to seek greater transparency around the board’s activities in this area.