In praise of holding on to your board members

The global trend to limit the tenure of directors is misguided

According to common wisdom, independent directors who have been on a company board for a long time are less effective than their colleagues who have joined more recently.

Such is the concern about long-term directors that several jurisdictions around the world have introduced laws to limit their terms. They are perceived to lack independence, to be entrenched in the company and to be captive to management.

However, recent research by academics at UNSW Business School suggests otherwise. The study finds that companies with long-term directors on their board pay their chief executives less and are more likely to sack underperforming CEOs. They are also less likely to make acquisitions and those acquisitions which they do make are of higher quality.

Co-researcher Ying Dou says he and his colleagues had noted the negative views about directors with long tenure, but thought there may be more to the story. 

“We were aware that there could be several advantages for having a long-tenure director because these directors have accumulated a lot of experience and expertise on the board which is obviously important,” says Dou, an associate lecturer and PhD candidate in the school of banking and finance at UNSW Business School.

With colleagues Sidharth Sahgal and Emma Jincheng Zhang, Dou looked at the performance of US firms listed on the S&P 1500 and compared it with the proportion of long-term directors on each company’s board. Long-term directors were defined as those who had been on a board for 15 years or more.

Continued commitment

In their paper, Should independent directors have term limits? The role of experience in corporate governance, the researchers outline several surprising findings.

Contrary to perceptions that they may have grown tired or complacent, long-tenure directors work harder than their colleagues. They are less likely to miss board meetings and are significantly more likely to be a member of one of the major board monitoring committees.

“This membership could be attributed to experienced directors having deeper knowledge of the firm and its operations relative to newer directors, but it nevertheless signals a continued commitment to their role,” the researchers write.

Instead of being captured by management as is the common perception, long-term directors appear better able to stand up to management.

An increase of one experienced director on the compensation committee decreases the average pay of the CEO by about 3.2%. CEO turnover is more sensitive to stock performance when there is a higher proportion of experienced directors.

Long-term directors can also limit the empire building aspirations of the CEO, but when an acquisition is made it is more likely to deliver better returns for the company.

Finally, the presence of one additional experienced director on the audit committee can reduce the probability of intentional misreporting by approximately 25% relative to firms where there are no experienced directors on the audit committee, the researchers say.

‘One of the reasons long-term directors might be harder working and make better decisions is to protect their reputations’

YING DOU

Reputation and innovation

One of the reasons long-term directors might be harder working and make better decisions is to protect their reputations, says Dou. The reputation of a director who has been on a company board for, say, 15 years is much more closely intertwined with the success of the company than the reputation of a director who has just joined.Having a preponderance of long-term directors on a board may raise questions about how innovative that company could be if its board isn’t being refreshed as often as other company boards. But Dou says that long-term directors may actually give management the courage to be more innovative.

Being innovative involves taking a risk and the CEO could be concerned that if the project failed they would lose their job. But the deep knowledge long-term directors have about the company puts them in a stronger position to judge the CEO’s performance. 

“The CEO knows that even if something goes wrong, the directors might not just blindly fire the CEO because these directors have sufficient expertise to judge whether the failure is because of the CEO or because of some other reason,” Dou says, but adds that this is not an area the researchers looked into.

The independence question

Various jurisdictions around the world have recently limited the tenure of directors because of concerns about their independence.

In the UK, directors must be terminated after nine years of service or explain why their long tenure has not compromised their independence. In France, directors are not considered independent if they have served on a company’s board for more than 12 years.

In Australia, the ASX Corporate Governance Council dropped its plan to recommend companies cap the terms of their independent directors at nine years. Under the proposal, companies that did not adhere to the guideline would have had to explain to investors why they didn’t.

In a submission to the stock exchange, the Australian Institute of Company Directors (AICD) argued against limits on tenure, saying the mere fact that a director has served an arbitrary number of years does not indicate a lack of independence.

“It also fails to acknowledge the benefits that can be derived for boards by having directors with longer lengths of tenure, for example continuity of organisation-specific knowledge (which will be of particular importance for companies that operate in more complex environments), greater board stability and improved board dynamics and collegiality,” the AICD wrote.

It’s a point picked up by Tim Boyle, managing partner at board advisory firm Blackhall & Pearl. Boyle says that having long-tenure directors is important in capital intensive industries where investments have very long lead times, such as mining, infrastructure or life insurance, but less important in young businesses such as start-ups.

‘Overall, the results show that experienced directors make a valuable contribution to corporate governance within firms’

– YING DOU, SIDHARTH SAHGAL & EMMA JINCHENG ZHANG

An investigation by The Wall Street Journal found that 76 of the 357 non-executive directors presently employed at Australia's top-50 listed companies – or 21% – had served on their respective boards for at least nine years.

Businessman and UNSW chancellor David Gonski was on the board of Westfield for 26 years and has so far served 18 years on the Coca-Cola Amatil board. 

“If you were to say to me he did not make a contribution after the ninth year, I think it would be hard to justify that,” Boyle says.

He adds that directors’ tenure usually only becomes an issue when directors are underperforming and it’s used as an excuse to move those directors on.

Accumulated information

In companies there is often an asymmetry of information between the management, who spend all of their working hours at the company, and directors, who might be on the boards of several companies and often have to rely on management for information. Long-term directors can help redress the balance. 

“The CEO knows much more than the board. But for those key strategic decisions, if you have people on the board who have been around awhile, that imbalance of information is broken down a bit,” Boyle says.

Outside the scope of their paper, the researchers formed the view that the optimal tenure for directors is 21 years.

“The reason is that once they reach 21 years, the marginal benefits of having a longer tenure is probably exceeded by the marginal cost in terms of being captured by the management,” says Dou.

Another reason is that long-tenure directors tend to be getting old, so their energy might be flagging, Dou suggests.

But this is only after two decades in a role. “Overall, the results show that experienced directors make a valuable contribution to corporate governance within firms,” the researchers conclude.