As US corporations seek to increase diversity of backgrounds, skills, and professional experience on their boards, they face a central hurdle: there is a limited number of seats that become open each year. To overcome that hurdle, boards can (temporarily) increase their size—which they are doing modestly. Additionally, they can adopt and implement board refreshment policies and practices that foster an appropriate level of turnover within the current ranks of the board.
Regardless of their approach to board refreshment, companies should expect continued investor scrutiny in this area. While institutional investors may defer to the board on whether to adopt mandatory retirement policies, many are keeping a close eye on average board tenure and the balance of tenures among directors and will generally vote against directors who serve on too many boards.
The aggregate rate at which new directors are elected at larger companies has remained virtually unchanged in recent years. Boards can increase diversity even with modest turnover.
This article provides insights about board refreshment policies and practices, as well as director evaluations at S&P 500 and Russell 3000 companies. Our findings are based on data pulled in July 2022 from our live, interactive online dashboard powered by ESGAUGE, as well as a Chatham House Rule discussion with leading in-house corporate governance professionals held in April 2022.
Election of new directors. The aggregate rate at which new directors are elected at larger companies has remained virtually unchanged in recent years. In the S&P 500, the share of newly elected directors has held steady at 9 percent since 2018. By comparison, in the Russell 3000, the share of new directors increased from 9 percent in 2018 to 11 percent as of July 2022. With Russell 3000 boards having a median size of nine directors, this level of turnover means that companies are electing on average slightly less than one new director per year.
There are benefits to having an average turnover of one to two directors per year because it provides boards with useful continuity and an ability to onboard and integrate new directors into the boardroom in a thoughtful manner. Further, boards have proven that they can increase diversity even with a modest level of turnover: the percentage of female directors in the Russell 3000 increased from 16.6 percent in 2018 to 26.8 percent in 2020.
Nonetheless, as a matter of mathematics, even if 50 percent of new directors are women, it will take decades to achieve gender parity on corporate boards. This means that boards need not only policies that promote refreshment but also that make the most of openings as they occur.
Mandatory retirement based on age. The share of companies with a mandatory director retirement policy based on age is in decline. In the S&P 500, the share of companies with such a policy decreased from 70 percent in 2018 to 67 percent as of July 2022. The absence of a retirement policy based on age is even more pronounced in the Russell 3000. There, only 36 percent of companies disclosed having such a policy as of July 2022 (compared to 40 percent in 2018).
Moreover, existing retirement policies based on age are becoming less strict. The percentage of S&P 500 companies whose policy permits no exception declined from 41 percent in 2018 to 34 percent as of July 2022 (and from 24 to 18 percent in the Russell 3000).
There is a direct relationship between company size and the adoption of the strictest type of retirement policy based on age. Larger companies are more likely to have a policy that permits no exceptions, and smaller ones are more likely to have no policy at all.
As of July 2022, a majority of companies (54 percent) with annual revenues of $50 billion and over disclosed a mandatory retirement policy based on age that permits no exception. This percentage decreases gradually to only 3 percent for the smallest firms with annual revenues under $100 million. Conversely, 95 percent of the smallest firms disclosed no policy, compared to 19 percent of the largest firms.
The vast majority of companies with a mandatory retirement policy set the retirement age at either 72 or 75. While the share of companies that expect directors to resign at 72 is declining, the percentage that set the age at 75 is rising. As of July 2022, 84 percent of S&P companies and 81 percent of Russell 3000 firms with a retirement policy set the retirement age at either 72 or 75.
However, the share of S&P 500 companies with a retirement age of 72 fell from 44 percent in 2018 to 35 percent as of July 2022. The share with a retirement age of 75 rose commensurately, from 39 to 49 percent in the same period. A similar pattern can be seen in the Russell 3000.
Despite companies moving away from mandatory retirement policies based on age and the trend toward increasing the mandatory retirement age at companies that have such a policy, the average director age has not changed much. It remained steady at 63 years in the S&P 500 and 62 years in the Russell 3000.
The largest firms are most likely to adopt director term limits, and the smallest firms are least likely.
Mandatory retirement based on tenure. Establishing term limits, or mandatory retirement policies based on tenure, remains an uncommon practice. Companies prefer to have the flexibility to retain valuable board members. Indeed, long-serving directors can be especially strong contributors to board discussions.
Directors whose service predates that of the CEO have particularly useful institutional memory, and may be even more willing to challenge management because the current CEO was not involved in their selection. In both the S&P 500 and Russell 3000, the percentage of companies with a retirement policy based on tenure remained virtually unchanged, from five percent in 2018 to 6 percent as of July 2022 in the S&P 500, and from 3 to 4 percent in the Russell 3000.
The largest firms are most likely to adopt director term limits, and the smallest firms least likely. As of July 2022, 12 percent of the largest companies, with annual revenues of $50 billion and over, disclosed a policy that sets a maximum tenure. Conversely, only 1 percent of the smallest companies, with annual revenues under $100 million, have such a policy.
The most prevalent term limit for companies that have a mandatory retirement policy based on tenure is 15 years, followed by 12 years; 57 percent of S&P 500 companies with such a policy require board members to step down after 15 years of service, and 25 percent set the term limit at 12 years.
By comparison, 47 percent of Russell 3000 companies set the term limit at 15 years and 20 percent at 12 years. Moreover, while the share of companies with a term limit of 10 years decreased considerably in the S&P 500 (from 12 percent in 2018 to 4 percent in 2022), it rose in the Russell 3000 (from 14 to 19 percent).
The average departing director tenure has increased slightly at larger companies and decreased at smaller companies. In the S&P 500, the average departing director tenure has fluctuated but overall rose from 11 years in 2018 to 12 years in 2022. It decreased from 10 to 9 years in the Russell 3000. This suggests that larger companies, especially, prefer to retain valuable board members, regardless of their tenure.
Director overboarding. Companies increasingly limit the number of other public company directorships their board members can hold, a result of growing investor concerns regarding director time commitments. In the S&P 500, the share of companies with an overboarding policy applicable to all directors grew from 64 percent in 2018 to 72 percent in 2022, and from 45 to 50 percent in the Russell 3000.
There is a direct relationship between company size and the adoption of director overboarding policies, with larger companies more likely to have a policy that applies to all directors, and smaller companies are more likely to have no policy at all. As of July 2022, 73 percent of companies with annual revenues of $50 billion and over disclosed a director overboarding policy that applies to all directors.
This share declines steadily to 20 percent for the smallest companies with annual revenues under $100 million. On the other hand, 68 percent of the smallest companies reported having no policy, versus 12 percent of the largest companies.
Although the number of directors who serve on more than one board has grown, most only sit on one additional board. It is rare for directors to hold four or more board seats.
When an overboarding policy for all directors exists, it most often sets a limit of three or four additional board seats. As of July 2022, 59 percent of S&P 500 companies and 46 percent of Russell 3000 firms with an overboarding policy restricted additional board services to three seats, and 34 percent of S&P 500 and 40 percent of Russell 3000 companies set the limit at four. The share of companies with a limit of three seats rose in both indexes in recent years (by 23 percentage points since 2018 in the S&P 500 and 13 percentage points in the Russell 3000). However, it declined for a limit of four board seats (by 17 percentage points since 2018 in the S&P 500 and 5 percentage points in the Russell 3000).
In this context, “all directors” refers to independent, nonexecutive directors. More stringent limits generally apply to directors who are also a public company CEO or executive officer.
Although the number of directors who serve on more than one board has grown, most only sit on one additional board. Larger-company directors are more likely to serve on additional boards than their smaller-company counterparts. In the S&P 500, the share of directors who serve on at least one other board grew from 58 percent in 2018 to 66 percent in 2022, and from 42 to 48 percent in the Russell 3000. In both indexes, directors are most likely to hold one other board seat: 34 percent of S&P 500 and 26 percent of Russell 3000 directors.
Additionally, 30 percent of S&P 500 and 21 percent of Russell 3000 directors sit on two or three additional boards. It is rare for directors to hold four or more board seats. Only 1 percent of S&P 500 and 2 percent of Russell 3000 directors do so.
Board evaluations. Almost all companies conduct some form of annual board evaluation (which, for NYSE companies, is mandated by listing standards), and the combination of full board, committee, and individual director evaluations is growing in popularity. As of July 2022, 99 percent of S&P 500 and 97 percent of Russell 3000 companies disclosed carrying out board evaluations. In the S&P 500, conducting full board, committee, and individual director evaluations has become the most common practice (52 percent of companies reported this combination as of 2022 compared to 37 percent in 2018).
The practice of conducting full board, committee, and individual director evaluations increases with company size, rising from 27 percent for the smallest companies with annual revenues under $100 million to 52 percent for the largest firms with annual revenues of $50 billion and over. Full board and committee (without individual) evaluations, on the other hand, are most common among the smallest companies (65 percent versus 46 percent at the largest companies).
Companies also increasingly disclose their use of an independent facilitator for board evaluations, and larger companies are more likely to disclose hiring an independent facilitator than their smaller counterparts. In July 2022, 29 percent of S&P 500 companies and 15 percent of Russell 3000 firms disclosed hiring an independent facilitator for board evaluations, versus 14 percent of S&P 500 and 6 percent of Russell 3000 companies in 2018. In 2022, 42 percent of the largest companies, with annual revenues of $50 billion and over, disclosed their use of an independent facilitator, but only 5 percent of the smallest companies with annual revenues of under $100 million did so.
Far more important than the mechanics of board evaluations, however, is their content. Even if boards do not do so every year, they should hold regular, in-depth, and candid discussions of whether the board has the appropriate composition to serve as an effective strategic partner with management in the coming years.
Moreover, as part of the annual board evaluation and renomination process, it’s also vital to have informal discussions to set an expectation that directors do not need to serve until they are required to leave, but rather should consider whether their contributions are still relevant to the needs of the company.
In conclusion, companies have a variety of board refreshment tools at their disposal to increase diversity of backgrounds, skills, and professional experience on their boards. The tools that focus on triggering discussions of turnover or reinforcing a culture of board refreshment may be particularly valuable. These include overboarding policies, policies requiring directors to submit their resignation upon a change in their primary professional occupation, guidelines on average board tenure, and individual director evaluations as part of the annual evaluation process. Unlike policies that mandate turnover, such as term limits and retirement policies, these more flexible tools can lead to a thoughtful process in aligning board composition with the company’s strategic needs.
Having policies that prompt or require board refreshment is not enough, however. Boards also need to embrace a culture of refreshment (in which there is no shame in rotating off a board before a director hits a mandatory retirement age), to exercise judgment about the level of turnover that is appropriate at any given time, and to view each opening on the board as an opportunity to enhance the board’s value as a strategic asset for the company.
This op-ed was first published in the March-April 2023 issue of The Corporate Board.
