SSBI: key trends drive board composition; The latest Spencer Stuart Board Index reveals some dramatic changes in board composition in the wake of regulatory reform and the adoption of new best practices in governance.

• Author: Daum, Julie H.
• Position: SPENCER STUART GOVERNANCE LETTER - Spencer Stuart Board Index

MORE THAN TWO YEARS since the corporate governance reform movement achieved a milestone with the passage of the Sarbanes-Oxley Act, governance regulations continue to be debated, celebrated, and cursed.

Are boards more effective, independent overseers of management than in the past? Have regulations stifled innovation and created unnecessary expense, or do they reflect the legitimate costs of ensuring appropriate governance? The debate on these issues is likely to continue for years to come.

What we know for certain from our work on hundreds of director recruitment assignments each year is that one of the most profound changes affecting boards today--the movement of responsibility for recruiting directors away from management and to the nominating committee--is now firmly entrenched.

No longer is a director position easily filled by a friend of a director or the CEO. Nominating committees consisting of independent directors now have responsibility for selecting new board members. They have adopted methodical and transparent recruiting processes that signal to shareholders the board's commitment to effective governance. Meanwhile, prospective board candidates are weighing more carefully the time, risks, and rewards associated with each directorship. As a result, recruiting new directors has become a more complex, time-consuming and, often, more difficult process than it was in the past.

This new rigor has real benefits. With the goal of assembling a board of directors that will add the greatest value to the company, nominating committees are giving careful consideration to the skills and experience needed on the board in light of the unique character and strategic goals of the organization, and they are recruiting directors best suited to those needs. They also are engaging outside experts and HR professionals within the organization to help them make these decisions. In short, boards are establishing thoughtful search processes aimed at achieving a more targeted recruitment and a more effective board.

Competing forces

If recruiting directors today is a more thoughtful, methodical process than it was in the past, it also is more challenging. The competing forces of dwindling supply and increased demand have combined to make attracting new directors dramatically more difficult.

Why is this happening? First, demand has grown as a result of governance reform requirements. During the past several years, Spencer Stuart has seen a continual increase in the number of director searches. This past year alone we have conducted more than 300 director searches in North America. Boards now must recruit directors who meet the newly tightened definition of "independence" and have the qualifications to serve on key board committees--the audit, compensation, and nominating committees--which now must be wholly independent. It's also expected that board turnover will increase as directors continue to pare back the number of board commitments they make.

Meanwhile, the classic director candidate--a sitting CEO--has much less time to devote to what has become a much more demanding job. As a result, CEOs are accepting fewer board assignments, and it is becoming more common for a CEO's own board to set a limit of one outside directorship. Data from our 2004 Spencer Stuart Board Index (SSBI) study of corporate governance in S & P 500 companies show that CEOs of these firms now serve on an average of less than one board position, down from an average of two outside directorships in 1998. In addition to the time demands, the increased liability and reputational risks of being associated with a poorly governed company are causing qualified candidates to carefully consider each directorship.

Rethinking the ideal candidate

As a result, boards have had to rethink their vision of the ideal director candidate. Rather than focusing their search heavily on active CEOs, nominating committees are considering retired CEOs, who have the expertise...