As Published in the 2016-2017 NACD/Pearl Meyer Director Compensation Report
One of the areas that we expect shareholder activists and institutional investors to continue emphasizing is board refreshment in an attempt to expand diversity, invigorate fresh ideas and perspectives, and bolster the expertise of the board.
Boards can consider several actions in an effort to promote director refreshment. The most obvious would be to implement mandatory turnover through term or age limits. As noted in our 2016-2017 NACD/Pearl Meyer Director Compensation Report analysis, age limits are already in place in the majority of larger organizations (81% of Top 200 companies), but only half of all companies in our analysis have age limits. It is noteworthy that, unlike some European companies (e.g., those in the United Kingdom), U.S. companies interested in mandatory turnover have gravitated toward age limits rather than term limits.
Another tool for boards is to have a robust director succession planning and evaluation process that outlines clear strategies, policies, and procedures that can refresh board skills and expertise. Boards can make tenure expectations clearer during director recruitment and onboarding. Each sitting board member should be evaluated annually to ensure that individual skills and expertise continue to be relevant to the company and that the combination of board member backgrounds addresses all the needs of the company.
One issue that is rarely mentioned when thinking about board refreshment is the design of the director compensation program and how certain design features can encourage directors to leave the board when the time is right. As we know, for the majority of boards, the largest portion of director compensation is delivered in the form of annual equity grants. The manner in which the equity vests can be a contributing factor as a director contemplates retiring from the board. Surprisingly, many companies require directors to forfeit unvested equity upon termination for any reason, including “retirement.” (Often this provision is a carry-over from the executive grant agreements, rather than a conscious decision regarding the appropriate treatment of director equity.) Although the predominant practice is for equity grants to vest immediately or within one year of grant (32% and 45% of all companies, respectively), many companies have vesting periods that are longer than one year. These longer vesting periods, combined with forfeiture provisions designed to address executive retention concerns, can potentially lead to situations in which a director would be walking away from significant value upon retirement. We encourage companies to review their director equity programs and ensure that vesting provisions do not inadvertently discourage appropriate board refreshment.
