Tenure of the Board: Balancing Experience Against Fresh Enthusiasm
By: Scott Bellows
Grace runs a fast-pace information technology business. The firm experienced explosive growth during the past five years and now dominates the market it its niche space. Founded in Nairobi in 2008, it now operates major offices in Kisumu, Mombasa, Dar es Salaam, Lusaka, Kampala, Harare, Addis Ababa, and Johannesburg.
Further, Grace’s team now offers multiple product lines instead of the sole IT solution from 2008. Sitting back in her office in Westlands, she recalls with fondness the early days of the company when she relied on family and friends to serve on her board of directors. The initial board invested 2 million Kenyan Shillings to boost the business. Now valued at 255 million Kenyan Shillings, the original family and friend investors still own 60% of the company and represent 6 seats on the 9 member board of directors.
Grace ponders whether to expand the board in order to keep the original 6 or reduce the number of original members to 3. Should she value experience versus new ideas? Then which should she find more important between enthusiasm and institutional memory? How would new members get along with original members?
In the end, the board’s decisions do not lie with her. The shareholders must vote. What should she recommend?
A debate rages in corporate governance circles pertaining to length of tenure on boards of directors. Precisely as Grace must decide her company’s future, academics, CEOs, directors, and shareholders all ponder, research, and share experiences on the most desired methods to achieve board performance through restrictions or lack of limits on board tenure.
Unfortunately for Grace, the Kenyan information technology industry standard in Kenya for the average length of service for board chairpersons stands at 8 years. Meanwhile, IT boards in Kenya remain the youngest boards with an average board of director age of 50.5 years according to Brain Trust Strategies.
Why Care about Board Tenure?
Why should we as Kenyan businesses care to step into the foray over length of service on a board? The simple answer boils down to performance. Boards of directors that advocate stronger interests of shareholders actually provide governance that leads to better firm operations and strategy. Inasmuch, boards need strong shareholder representation. Research by Professors Gomper, Ishii, and Metrick in 2003 covered 1,500 firms and found that board of directors structures that included pro-shareholder provisions performed remarkably better through higher profits.
So, our decision on board tenure must revolve around whether tenure helps or hinders shareholder representation.
Pros
There exist 3 main ways to alter the time commitments or time overlap for boards of directors. First, a company may introduce term limits. Term limits force boards to infuse new members that hold new ideas and energy. Term limits further enable new skill sets onto boards through targeting new members based on skills, not organisational history with the firm.
Term limits also bring the possibility of focusing on gender and minority diversity on the board. Women comprise only 11.6% of board members of firms on the Nairobi Securities Exchange (NSE). Separate research out of Harvard University in 2010 by Professor Siegel and colleagues shows that hiring women and minorities as employees and in governance positions in countries where such groups struggle for workplace equality, such as Kenya, actually increases firm performance. The previously discriminated against women and minorities become grateful for the work or governance opportunity and labour harder and integrate more new ideas into the organisation. Other research by Credit Suisse showed that large global companies with female outperformed firms with all male boards by 26%. Term limits could enable swifter integration of women and minorities onto boards.
Second, staggering board terms enables the forced voting at varying years for new board members. Therefore, the board does not risk losing all board members in a single vote and lose institutional memory or consistency while requiring new voting. As a matter of preference, large multinational NGO Kiva.org has invested 2 billion shillings into Kenya. The organisation’s Africa Representative, David Kitusa, states that “Kiva.org values boards of directors that stagger member terms and introduce term limits. We feel this increases board diversity. We assign higher investment grade ratings to such firms.”
Lastly, companies may introduce a mandatory retirement age for its board members. The Kenyan Capital Markets Authority requires retirement at age 70. The average age of Kenyan board members, according to Brain Trust Strategies’ survey, yields an aging 57 year average. Meanwhile, the average age for chairpersons of companies listed on the NSE comes in at 65 years.
Many other nations do not require mandatory retirement, but companies often include age limit policies. Deloitte surveyed North American publicly listed firms in 2012 and found that most publicly traded firms there require retirement between the ages of 72 and 74. Then board members over the age of 40 years comprise 90% of members of North American boards. Younger board members may serve the interests of shareholders more than their aged counterparts who hold decades of service with ingrained loyalties.
Cons
Those who dislike term limits stress that such policies deny boards of institutional memory and experience with the company. CEOs also fear the loss of engagement by the board member once his or her term expires whereby the CEO may hope for future investment from them. Additionally, constant recruitment of new members may prove tiresome or new members may threaten the CEO’s leadership and desired strategy in favour of shareholders.
While Kenyan NGOs often utilise term limits for board members, corporations typically do not institutionalise such policies. Similarly, Deloitte found that only 5% of North American traded companies kept term limit policies for board members.
Meanwhile, staggering the beginning of board terms actually reduces the power of shareholders. It denies shareholders the right to hire and fire board members each year. Inasmuch, in the event that the board acts against the wishes of shareholders, the shareholders cannot retaliate in a short time span. Inasmuch, staggering board terms enhances CEO power and reduces shareholder power. Remember, shareholder power enhances firm profits more than CEO power.
The current trend among boards endeavouring to champion shareholder rights involves “declassifying” boards. Board declassification involves requiring all board members to stand for election by shareholders each year. Dr. Daines and Dr. Klausner in 2001 fed into Professor Gomper and colleagues’ findings that declassification alone may enable substantially stronger board advocates for shareholder rights and lead to increased company profits over time.
Lastly, forced retirement may cause otherwise competent board members to leave board positions and deprive the firm of good governance skills due to an arbitrary condition, age, that may not correlate to performance in all situations.
Conclusion
Now that you know the facts, how would you advise Grace and her firm? Should she remove some existing board members who served since inception and replace them with new members? If so, how should she replace them: age limits, term limits, or staggered vs. annual voting? As most issues in business, the answer often lies with the specific modalities of the respective firm and industry. Grace should likely integrate a combination of tactics balancing the pros and cons.
How would you approach Grace’s situation? Share your ideas on Twitter at #KenyaEconomics.