Today, the search for a new director is more challenging, time-consuming, and complex. But the results are generally worth the added effort. Corporate boards have become far more strategic, inclusive, and transparent in their selection process. They recognize the consequences of choosing poorly and the substantial rewards of casting a wider net. In the process, they have converted a looming crisis into a significant opportunity to improve corporate boards — an opportunity that promises more substantive and enduring benefits than any corporate governance reforms introduced thus far.
From Compliance to Guardianship
The tidal wave of corporate governance reforms unleashed by the scandals of the early 2000s struck many in corporate America as unnecessarily sweeping and onerous, an overreaction to the sins of omission committed by a few inattentive corporate leaders (and their advisors and boards). These critics argued that complying with the new requirements imposed starting in 2002 by Sarbanes-Oxley, the SEC, and the New York Stock Exchange would inevitably distract board directors from their primary oversight responsibilities and longer-term strategic considerations. And, indeed, board agendas over the ensuing three years were preoccupied with ensuring compliance with the new requirements. Moreover, as we’ve just argued, the atmosphere of stricter scrutiny and heightened accountability has had a perverse impact on board recruiting. Many of the most qualified but circumspect candidates cited these requirements as their reason for declining director positions, and other sitting directors vacated board positions they perceived to be a newly time-consuming liability.
But in 2006, corporate governance turned the corner. Having “checked all the boxes,” boards emerged from under the cloud of compelled compliance and began to reap the benefits of a more independent, rigorous, and engaged membership. Only two directors on the average 11-person board today are insiders; in fact, in nearly 40 percent of the S&P 500 companies, the CEO is the only insider.
Audit, compensation, and nominating committees are made up of only independent directors, and the trend is now extending to other committees as well, including the finance, investment, and legal/compliance committees. The lead director role has become institutionalized, with 96 percent of boards reporting that they have named a lead director, as compared with 36 percent three years ago.
Perhaps even more compelling than the data are the impressions we glean from our day-to-day interactions with boards and senior executives in the process of conducting director searches. The newly imposed requirements of board independence have set in motion a more thoughtful, deliberative, and rigorous search process, one that is led by the head of the nominating committee rather than the CEO. Our recent experience convinces us that boards are not only more independent, but also more engaged, accountable, and diverse than they were five years ago.
And it is these new boards, empowered by the recent round of corporate governance reforms, that will launch the next, even more penetrating and constructive round, as members eventually replace themselves and usher in the next generation of governance guardians.
Of the 391 directors added to S&P 500 boards in 2006, nearly a third (31 percent) are first-time public company directors. Facing a shortage of qualified prospective members, boards have extended their searches in productive new directions to include recently retired CEOs, chief operating officers, financial experts, and business heads situated one or even two levels down in large, global enterprises.
As part of the 2006 SSBI, we sent a supplemental survey to companies, asking them to list any first-time independent directors they had recruited during the past year. The responses included the chief financial officer of a $50 billion public company, a division president of a $30 billion corporation, and the head of marketing and strategy for a $20 billion enterprise. Despite being first-time directors, these individuals are hardly novices and will, no doubt, contribute substantial value to their boards. Moreover, they will enhance their own companies in the process as they develop experience on the directors’ side of the table and gain insight on key governance and business issues.