Inside: AICD Board selection

Jennifer Stafford provides some tips on how boards can improve their selection processes.

Choosing the best team

Australian businesses are the best in the world at selecting board members. So says a recent survey examining 17 countries between 2004 and 2007, including Australia, China, the UK, the US, Ireland and Russia.

Such endorsement is welcome, particularly as boards face increasing scrutiny of their membership and selection practices. The latest AGM season provided well-publicised examples of increasing activism by some institutional investors and their advisers who targeted the election of directors to pressure boards whose performance they questioned.

Directors are the shareholders’ link to a company. Shareholders are very interested in who sits on their boards. They want to know about the skills and experience of their directors, their effectiveness in the boardroom, their capacity for independent thinking and the extent of director alignment with their views. The constant challenge is to build trust through effective communication between companies and their stakeholders.

The election of directors is a key opportunity for shareholders to shape the company they own. It is one of the powers reserved for shareholders that keeps boards accountable and mindful that they might be removed by shareholder vote if shareholders are not happy with their company’s performance. However, most often the debate is focused on the appointment of individual directors when the major task before the board is in choosing the best team. But how well do many shareholders understand the team dynamics in the boardroom? How well do boards inform their shareholders in advance of the election process to support the directors that are nominated?

The evolution of nomination committees in listed companies has been an important development in establishing a formal process for succession planning and renewal of the board and management. The nomination committee focuses on an appropriate mix of skills and a balance between members who are independent and those with experience. It is challenging to get the depth of experience, skills and personal qualities required for board appointments.

Well-managed boards are mindful of the need for refreshment and renewal of board skill sets, while balancing the need to retain adequate knowledge of their company. The board does not mirror the skills of management, nor second-guess its recommendations. The selection processes reflect a planned and considered approach to identifying the skills and qualities needed for effective board leadership as a team, in combination with management.

What do boards look for?

There is a long and complex list for boards to consider when appointing directors:

• Enhancing experience and skills in the boardroom. Where are the gaps? What skills will guide plans for the business?
• What is the business environment and global context?
• Risk management and regulatory expectations.
• Relevant business and industry experience.
• Independence from perceived conflicts.
• Diversity and refreshment.
• Temperament and character: intellectual ability, judgment, integrity.
• Teamwork and compatibility: interpersonal skills, interest in the business, commitment.
• Who is available and how to rank priorities in choosing an appropriate candidate.

An effective board needs a well-balanced combination of capable board members who are well suited to the circumstances and needs of the company. This should always be the rationale for boards proposing new directors for election by shareholders. Boards look for people who will add to their collective skills set and will be able to contribute in the board environment. To get this right, the selection process must be careful and rigorous.

Teamwork and compatibility are at the heart of an effective board. It should be understood that boards are not composed of shareholder representatives from different constituencies. Directors may not represent special interests or advocate the preferences of external parties. Boards are not parliamentary in style where partisan views are advocated and decisions made by a majority.

Well-managed boards make decisions by consensus and voting is rare. This collegial model is central to a board’s effectiveness and company reputations suffer when board deliberations are debated in public.

Company needs are dynamic and board composition must reflect changing needs. The board’s task is broader than in the past. The pressures on companies are more complex due to globalisation. The market for directors of large listed companies is competitive and favours proven performers with a sound track record in directorships. This reflects increasing risk and regulatory exposure for company directors.

Skills for board selection

People with executive and director experience are well regarded by boards faced with increasing obligations for risk management. It is essential to have directors with knowledge of the industry in which the company operates. Strategic skills are also important in driving the business direction and adding to shareholder wealth. Commercial savvy and financial literacy are essential qualities for all directors of listed companies.

Boards often seek specialist skills, such as legal and accounting skills, in response to regulation and technology advancements. It is also important to consider the diversity of skills in the boardroom. For example, a board might seek a new member, with appropriate experience, who shares a youthful perspective with the major customers of the business. Another might seek language skills and local knowledge to assist in guiding a business expansion into China. Experience in human resources is a valued skill on today’s board, reflecting the complexity of a multi-generational workforce and the recognition that human capital is a critical and increasingly scarce asset.

The size of the board is another consideration. Large boards can be unworkable, with too many directors wanting to speak and influence the outcomes. Different companies have different needs and current practice for listed companies in Australia tends toward a maximum of around 10 to 12 board members.

Independent thought and behaviour

Directors are required to act on behalf of all shareholders and to exercise discretion and independent judgment in the best interests of the company. This legal obligation on directors to act in the best interest of the company is often overlooked when the focus is on shareholders.

Directors’ independence is safeguarded because they can’t be removed except by the shareholders at a general meeting. Attempts to define independence have been controversial. If taken to extreme, the “independence from association” approach, which is used in the ASX Corporate Governance Council Principles, could result in the board comprising people with no experience in the industry in which the company operates.

Questions about independence are generally concerned with independence of mind and a willingness to act and make a difference in the boardroom. Such questions are not addressed by governance rules about prior business associations. However, company reporting of a regular and rigorous board evaluation process with clear outcomes can be effective in addressing investor concerns about director independence, tenure and whether directors are able to commit the time required. A board would not generally endorse a director for re-election if there were concerns about performance or suitability. Conversely, few directors would seek re-election without the support of the board and may choose to resign sooner if the support of board colleagues is lost. An Australian study identified board evaluation as a significant positive trend in corporate governance, noting that the outcomes were applied to succession planning and identifying the skills needed on a board.

When done in advance of re-election, a robust performance appraisal offers firm ground for a chairman’s endorsement that the directors continue to make a valuable contribution. Board policies can be used to support this practice. For example, BHP Billiton’s policy requires directors, including the chairman, who have served for nine years or more, to stand for annual election. That board’s statement in support of re-election attests that extended tenure has not compromised effectiveness, nor impaired independence of character or judgment.

Keeping shareholders informed and engaged

It is reasonable to expect companies to provide detailed information on proposed candidates for election. This could demonstrate the candidates’ experience and background, and how their involvement will complement the skills of existing directors. A statement in the annual report covering the directors’ business experience and expertise would also assist shareholders in understanding the skills of board members. Prior consultations between nomination committee chairmen and institutional investors and shareholder associations could identify where more information is required to support the election process for directors.

At the AGM, some chairmen are encouraging directors standing for election to speak to their nominations. For some, this development is introducing political overtones to the election process, while for others it is a communications tool that assists the investor community to assess their directors first hand. Webcasts of AGMs are making approaches such as speeches more relevant and accessible to a wider audience of institutional and retail shareholders. Developments in technology facilitate shareholder engagement and offer improved opportunities for companies to communicate directly and effectively with their investors.

How can boards improve their selection process?

• Design the process to respect the rights of shareholders to nominate, elect and remove directors.
• Help shareholders to understand their rights and the process followed by a board in nominating directors for election. Let shareholders know what skills and experience they bring to the team and how the team will benefit.
• Publish the methodologies of nomination committees for selecting and appointing directors on company websites for the benefit of shareholders.
• Always look to broaden the pool of potential candidates. AICD maintains a Directors’ Register and so do many state governments. The AICD Register states the candidates’ directorship qualifications. Large companies use executive search firms as one way to ensure the selection process is professional and to expand the field.
• Let your shareholders know how your board has been evaluated. Conduct an evaluation of each director standing for re-election and act on the results. Boards should not endorse directors for re-election if their performance is unsatisfactory.

Jennifer Stafford GAICD, is AICD’s senior policy adviser for corporate governance

FAQ of the month

Question

What is the age limit for being a director? Is it still 72?

Answer

There are no maximum age limits for directors prescribed under Australian legislation.

Until its repeal in April 2003, section 201C of the Corporations Act imposed a maximum age limit on directors. Section 201C provided that a person of 72 or older could not be appointed as a director except by a special majority of members.

Any appointment of an over-age person could only be until the conclusion of the next annual general meeting. Directors who reached 72 between AGMs could continue to act until the end of the next one.

This did not preclude people over 72 from acting as a company director, but imposed hurdles (annual re-appointment by special resolution) that do not apply to others and made it more difficult for a person over 72 to be appointed to a board.

However, a company’s constitution may have its own age restrictions, taking into account the anti-discrimination laws.

In a submission to Treasury in 1997, AICD’s position on age limits supported the removal of section 201C by noting:

• The key criteria for determining the appropriateness of the appointment of directors must be their competence and contribution. Age does not necessarily relate to competence and contribution.
• Companies, via their shareholders, should have the right to make their own rules regarding the make up of their boards, without legislative restrictions. Sound corporate governance requires boards to make appointments on the basis of appropriate contribution and competence.
• Matters relating to corporate governance are the province of shareholders and the company, not legislation or the Government.
• Limiting the age of directors is contrary to current equal opportunity and practice.

Several state and Federal laws cover anti-discrimination and equal opportunity, including the Age Discrimination Act 2004.

AICD Company Directors Conference 2009

Cairns 10-13 June 2009

Following the deferment of the Tokyo Conference, the AICD annual conference will now be held at the Cairns Convention Centre from 10-13 June 2009 with accommodation at the Sebel Cairns Hotel and the Hilton Cairns Hotel.

The program will feature presentations by Australian international speakers addressing the current global economic environment, the imminent Carbon Pollution Reduction Scheme, Tales from the Corporate Battlefield and The Director of the Future.