Director tenure: longer is better, to a point
11/07/2016
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Director tenure has increasingly become a matter of relevance when investors and proxy advisors have been considering the independence of directors. Earlier this year the proxy advisor, ISS, said that its approach was to more closely scrutinise the directors if there were tenure or independence issues for around one-third or more of the board. Under its former Head of Research, ISS had previously indicated in 2014 that tenure of 12 years would raise a flag for its review.

This article looks at a study recently released on the linkages between director tenure and corporate performance, or company value. While it can be argued that independence wanes with increased tenure, the implications for corporate performance also need to be considered.

It is worth noting some recent commentary out of the US in this space:

In February, 2016, the California Public Employees’ Retirement System (CalPERS) Board of Administration released a revised version of its Global Governance Principles (see HERE) that included a new principle cautioning that board directors with more than 12 years on the same company board are at risk of compromising their independence.

CalPERS’ Principles require a company to carry out rigorous evaluations to either classify the director as non-independent or provide a detailed explanation as to why the director continues to be independent (somewhat like our ASX CGC’s ‘if not, why not’ approach).

At the same time, in February 2016, Yaron Nili, Fellow of the Program on Corporate Governance at Harvard Law School, published his detailed paper titled “The ‘New Insiders’: Rethinking Independent Directors Tenure”. His paper highlighted the potential effect tenure has on director independence. Nili maintains that in the US director tenure is one important variable that has not been addressed in the current US regulatory standards.

He provided arguments on the importance of tenure as a factor that may impact director independence and sought to direct the regulators to focus their attention on tenure by providing empirical data that showed a rise in director tenure over the last decade. Nili’s paper suggests the trend in rising tenure is a market reaction to push back on the regulatory focus on board independence being for the removal of senior executives from the board table.

Nili maintained this new long serving director became the “new insider,” being someone who met the regulatory requirements of independence but has much of the ‘inside’ knowledge of the former executives in the boardroom as a result of their lengthened tenure.

Nili suggested that because this ‘new insider’ can bring benefits to the company, an appropriate regulatory response may be to just limit the tenure of the directors on the audit and compensation committees, thus providing constant room for renewal but maintaining that inside knowledge in the broader boardroom context.

And, as we move in to this year’s Australian AGM season, it is worth recognising there will be more local commentary on the issue of director tenure. It is, therefore, equally appropriate to look at the other side of the argument and see what evidence is there on the impact of director tenure on the company’s performance.

Also in February this year, Joshua Livnat, an academic from the NYU Stern School of Business along with Quantitative Management Associates, released the results of their study of the relationship between average board tenure and company value.

Their study and analysis can be found in the paper, “Do Directors Have a Use-By Date? Examining the Impact of Board Governance on Firm Performance,” (see HERE) which concluded there was “considerable support for the notion that longer board tenure is positively related to stock returns, as well as contemporaneous and future firm value. The market rewards firms with stable boards with a ‘stability’ premium”.

The study analysed a sample of more than 3,000 companies over an 18 year period and was more detailed than any previous and similar analysis. Some other critical findings of the study include:

  • board tenure is positively related to forward-looking measures of market value;
  • that positive relationship, however, tended to reverse after about 9 years on average;
  • the detrimental effect of longer board tenure on market value (after the initial period of positive effects) is stronger for high growth companies. The authors maintained this finding to be consistent with the deterioration of the directors’ ability to advise on the technical matters of the business;
  • the effectiveness of two primary board functions – monitoring management and technological advice – deteriorates over time. The deterioration in monitoring is because long-tenured directors become less vigilant, and the deterioration in technological advice is because directors do not necessarily keep up with the technical changes in the business.

Given that the study is considered the largest and most comprehensive of any other similar study, it can be expected that investors, regulators and investor representative groups will have significant regard for its findings.

The study, of course, has the equal benefit of providing directors with the explicit knowledge of those skills attributes they bring to the board table that can be subject to deterioration. Forewarned is often forearmed, thus enabling them to focus on areas for development.

© Guerdon Associates 2021
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