Improving the 'director value proposition.' (Governance Letter).

• Author: Daum, Julie

How candidates are now assessing the risk profile of the boards they are being asked to join, and why companies need to take a hard look at what they offer -- the value proposition -- to attract and retain directors.

AS THE DUST SETTLES from corporate scandals that rocked the capital markets, boards face an enormous credibility gap regarding their ability to protect shareholders' interests. As they adjust to the new and proposed regulations and recommendations created to calm investor jitters and to protect shareholders from future governance debacles, they face a new challenge: attracting and retaining the directors they need for effective governance.

With more stringent independence guidelines and CEOs under pressure from their own companies to sit on fewer boards, the pool of eligible director candidates has narrowed considerably. To make matters worse, the perceived risks of being a director of a public company have increased dramatically. Board turnover is expected to double, increasing to roughly 33% this year. These developments do not bode well for companies attempting to attract and retain the best director talent. And while director compensation is expected to increase, these increases will not be sufficient to overcome the increased risks of being a board director.

Given these factors, companies expecting to retain their current directors or recruit new ones will be forced to pay close attention to the "director value proposition" -- the rewards and benefits of serving on a company's board. Individuals increasingly are weighing the director value proposition when deciding whether to take on the commitment and responsibility of a particular directorship.

Changing risks and rewards

People join boards for an abundance of intrinsic and extrinsic rewards. Historically, the intrinsic rewards of board service have included the opportunity to contribute their skills and expertise, to enhance their knowledge, to develop business contacts, and to enjoy the prestige of being affiliated with a respected corporation. The extrinsic rewards, on the other hand, primarily are financial, including cash compensation, benefits, perquisites, and company stock. But, given the present, watchful governance climate and elevated accountability, both the rewards and the risks have shifted.

Many of the traditional intrinsic rewards are eroding. Business affiliations might create a conflict of interest, and many business connections could be interpreted as a breach of ethics. At the same time, demands on directors' time have multiplied. For example, one director indicated that the current workload is two and a half times greater than it was in the past. In 1992, one survey found that American directors typically spent 95 hours a year on the business of the board; last year's edition of the same survey found that figure had risen to an average of 173 hours, including preparatory work such as reading board papers and traveling for meetings.

Moreover, prospective directors are faced with the need to judge the level of risk they will be exposed to by joining a company's board. Like it or not, post-Enron, directors will be on the short list of targets of public scrutiny whenever questions are raised concerning corporate misconduct. In addition, the potential legal liabilities have increased under the Sarbanes-Oxley Act. Not only has the likelihood of shareholder suits increased, but also the likelihood of losing these suits has increased. This higher level of legal liability is directly reflected in the significant increases in D&O insurance premiums.

Public suspicion about corporate misconduct is not helping allay directors' fears. A CNN/USA Today/Gallup poll conducted in July 2002 found that 79% of respondents believed that the incidence of corporate executives taking improper actions to benefit themselves at the expense of their corporations was very or somewhat widespread." The debacles at Enron, Tyco, WorldCom and elsewhere revealed a degree of misconduct that had heretofore been considered extremely unlikely and left widespread lingering skepticism about corporate malfeasance and directors' abilities to prevent it.

The bottom line remains: Prospective directors face the increased risk that, despite their best efforts, the company they serve will engage in practices that push or go beyond the limits of the law to the extreme detriment of the shareholders, and the directors are likely to be held partially responsible.

The key to attracting talent

So, how are prospective directors to assess the boards they may or may not join? Generally, the candidate should judge the overall reputation of the company, its governance practices, and, in particular, the integrity of its leadership team.

Of primary importance is the reputation of the CEO. In our survey of directors on this topic, we asked: "Under what circumstances would you not accept a position on a company board?" Almost all of the respondents pointed directly or indirectly to the CEO, citing trust, openness, and willingness to listen as critical attributes. Beyond the individual assessment of the CEO, prospective directors are looking for broader indicators of corporate integrity.

At the core of corporate integrity is a proactive approach and clearly communicated commitment to effective governance, which directors are -- or should be -- looking for now more than ever. In sizing up the commitment to effective...