Is there a case for limiting director length of service?

September 28, 2020

September 28, 2020

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Governance

Mainfreight is one of New Zealand’s most successful listed companies. At its recent AGM, its Managing Director made a spirited defence of how long some of his directors had been in office. His comments focused attention on a long-running debate about whether there should be limits to a director’s length of service. This is not a concern confined solely to the commercial sector. Recently, the longevity of the board of the Laura Fergusson Trust was also in the news.

There is an increasing trend Internationally for regulators to force boards to refresh their membership through some limit to how long directors can stay on boards. This intervention is often associated with a requirement for the number of ‘independent’ directors a board must have. It is common to associate a loss of independence with a length of service beyond something in the vicinity of 10 years.

The Mainfreight case is interesting. It has been one of the best performing of New Zealand’s publicly traded companies for a long time. Still, its four longest-serving directors have been on the board for an average of nearly 26 years. It is easy to see how institutional investors might be starting to make a case for board refreshment. Given the apparent struggles of the Laura Fergusson Trust, it is not surprising that its board, with its seven members having served for a combined total of 96 years, has come in for adverse comment.

So, what are the pros and cons of limiting director length of service?

The case against a limit
Arguments made against limiting director tenure typically include the following.

  • That length of director tenure is a poor measure of director independence.
  • Forced director rotation can cause the premature loss of valued expertise and industry connections, and the loss of organisational memory to current decision-making
  • Long-serving directors provide continuity – they are a bridge in the succession of both directors and management
  • Regular turnover can destabilise the dynamic of the board.
  • Forcing turnover in its membership makes more work for the board in the identification, recruitment, and orientation of new board members.
  • New board members take a long time to become fully integrated into the dynamics of the business, and conversant with the capabilities of those on whom the business depends.
  • Replacing long-serving board members weakens the board relative to management by diluting the board’s relative understanding of the business.
  • Tenure limits are inherently ageist and are therefore discriminatory.
  • Long-serving directors protect the culture of the business. Changing the board’s composition more regularly can destabilise both company and management.

The case for limiting the length of director service
There is also a wide range of strong counterarguments. Here are some examples.

  • Boards need a regular infusion of new capabilities, new ideas and fresh perspectives. Too little movement in membership risks institutionalisation and ossification.
  • A tenure limit should stimulate an active succession planning process and assist a board to fine-tune its composition to reflect the organisation’s changing operating environment.
  • Boards which lack membership refreshment become increasingly vulnerable to groupthink.
  • The longer directors serve on a board, the more entrenched they become and the more difficult to remove.
  • Entrenched board membership stands in the way of an adjustment to increasing demands (and regulation) for greater diversity.
  • Board members who serve long terms are likely to be increasingly comfortable with the status quo and committed to existing intra-board relationships.
  • Long-serving board members increasingly serve for the wrong reasons (e.g. for social status, for continuing ‘relevance’, and to maintain valued social relationships).
  • Longevity can overvalue past contributions at the expense of the future. Even if a long-serving director has been effective, their continued occupation of a board seat is keeping someone off the board who may have even greater value to add.
  • That board members who allow a colleague to hold onto a board seat for too long may be in breach of their fiduciary duty to act in the best interest of the company.
  • With a core of long-serving board members, there is potential for a concentration of power that deters possible replacements and intimidates new members.
  • Provided limited terms are staggered, there can be a better balance between continuity and refreshment.
  • Unlimited tenure risks loss of director independence given, for example, the likelihood of an overly close relationship developing between long-serving directors and managers.
  • A maximum length of service requirement offers a respectful and efficient mechanism to exit passive, ineffective, or troublesome board members.

Are there alternatives to a maximum length of service?

It is hard to argue that periodically refreshing a board with a well-chosen new director or two is not a good idea. Vacancies need to be created to achieve this. So, if directors themselves do not know when it is time to go, what are the alternatives to a strict limit to maximum tenure?

The most obvious is to have an effective individual performance review process. Most board appointments are for a specified term. Arguably a director’s term should not be extended without evaluating their current contribution and its relevance to the needs of the board. However, robust independently facilitated individual director performance reviews are relatively rare. The usual excuse for not undertaking such a process - that it may upset relationships on the board - is likely a strong pointer to a board that needs change!

In the absence of director performance reviews, another option is to apply an active and transparent succession planning process. Done well this is, in effect, a continuing gap analysis comparing a board’s present capabilities with those it needs to grapple successfully with the challenges it faces.

Another option to trigger the appointment of new members would be to set a maximum average tenure for the board. The result would not directly challenge the longest serving board member when this maximum average tenure is exceeded. Other changes could be made to the board’s composition to bring the average tenure back below the limit.

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