The AICD’s Amber O’Connell asks whether lengthy board tenure is a barrier to innovation.
At a recent director event for an industry sector with which I am familiar, I looked around the room at the directors present. Their older age, their lack of gender and cultural diversity, and their extended tenure (up to 30 years for some) struck me as impediments to the success of their boards and organisations. Despite these directors’ sound knowledge of their sector and years of dedicated service, it is fair to ask if the governance profile needs to change. Looking further afield at the state of other smaller sectors, the question arises as to the effect of director tenure on an organisation’s ability to innovate, and move with the times.
Much attention has been paid to the impact of extended director tenure on performance. There are conflicting results on the relationship between tenure and performance in several dimensions such as internal controls and financial returns. Regrettably, little attention has been paid in academic literature to the impact of extended director tenure on innovation.
Wertheim et al suggest there are two distinct strands of investigation that address director tenure and effectiveness – these are the ‘expertise hypothesis’ where directors are considered to become more effective as their understanding of a business improves, and the ‘entrenchment hypothesis’ where they become complacent and stagnant in their role after some time. The paper concludes that companies are benefited by increased board tenure only up to a certain point, and beyond that point, incremental increases in tenure no longer have a significant effect on corporate governance. While it does not support the theory that extended director tenure is detrimental in relation to internal controls, it cites the following:
Boards with many long-serving directors are now described as "entrenched" and deaf to shareholder concerns (Hymowitz and Green, 2013). Critics posit that older directors - who are typically the longer-tenured directors - can no longer keep current with respect to industrial or technological developments and are unable to offer new insights into corporate issues; they fear that these directors may hold fossilized positions that are no longer relevant in the changing economic and business environment (Canavan et al., 2004). Some argue that extended board service can create a culture of undue deference to management, particularly in cases where the chief executive also has held the position for many years. 2
In “Zombie Boards” a paper looking at the relationship between director tenure and firm value, Sterling Huang of INSEAD Business School demonstrates that having a higher proportion of directors with tenure greater than 15 years measurably decreased firms’ value, and Huang identifies “nine years as the empirically observed optimal tenure”.3
A paper that does solely focus on the link between director tenure and innovation from the journal European Accounting Review by Ning Jia states that:
…stagnant boards that are filled with directors with extended tenure fail to refresh themselves in a timely manner, can no longer keep current with technological developments and grow unable to offer new insights into corporate issues… long executive tenure is often associated with rigidity and a commitment to established policies and practices that potentially kill the entrepreneurial spirit and hinder innovation.4
Jia’s research concludes that long-serving directors are less effective in advising management on innovative activities, and (when looking at US listed company boards) that entrenched boards – those with a higher proportion of directors with board service exceeding 10 years “produce significantly fewer patents, and these patents receive significantly fewer subsequent citations… These firms also exhibit lower R&D productivity and exploratory innovation intensity”. 5
If this is the case in some of the largest companies, which are subject to significant public scrutiny, it follows that entrenched boards in smaller less visible sectors would lag even further behind when it comes to innovation and dynamic behaviours. If there is a low expectation for directors to move on, what motivation do they have to make a significant contribution during their directorship? If they are not moving through various roles in their careers how can they learn from other businesses or sectors? If this is the norm across their sector – where is the space for new voices and new ideas to refresh the sector?
Anecdotally, long average director tenures are more common in not-for-profit or member-based organisations, such as registered clubs, charities and customer owned banking institutions. For example, average director tenure in the customer owned banking sector is 10.42 years while the major banks sit at around 5 years. 7
Some of the reasons driving board entrenchment are explored by Beck and Tunny:
Convincing long- serving directors to retire from the board can be difficult where there is no policy or constitutional reason for doing so. There are two reasons for this. First, for some directors, their directorship has become the last source of any income outside of a superannuation or public pension. They do not want to leave because the money is important. Second, but not necessarily mutually exclusive, the directorship may have become the last link the director has with their previous professional or business life. At the same time they might have become emotionally bonded with the organisation – it has become such an important part of their life that it is a major ‘reason for being’ – giving purpose to their existence. In these circumstances, seeking to have the director step down from the board can be fraught with difficulty. 8
Managing this ‘difficulty’ is one of the arguments for constitutionally set term limits.
As with many matters in corporate governance we look to the ASX Corporate Governance Council (ASXCGC) for best practice. While the ASXCGC discusses tenure primarily in the context of independence (another discussion entirely), it has decided not to specify a recommended maximum length of tenure. “Instead of specifying that a tenure of over nine years may compromise director independence… listed entities now need to explain why the independence of directors with more than 10 years’ service has not been compromised by their length of service.”9
Director tenure is an important factor to consider in determining the mix of skills, experience and personal qualities for a board. To this point, the ASXCGC recognises the interests of a company and its members are “likely to be well served by having a mix of directors, some with a longer tenure with a deep understanding of the entity and its business and some with a shorter tenure with fresh ideas and perspective.” 10
So why are we so reluctant to impose term limits, perhaps at 12 years of service? Experience and corporate knowledge are important, but surely there are other board members who can provide this after three, four or five years? Some commentators have suggested term limits allow directors to retire with dignity. They avoid hard conversations and preserve relationships, while managing expectations.
Katz and McIntosh (2016) suggest many investors as well as proxy advisors are approaching at the issue of tenure in the wrong way. Rather than focussing on simply the longest serving directors they “believe that it is the average tenure of the entire board that is most relevant. This is a more meaningful metric for evaluating board refreshment and director succession.” This seems fair on balance. Should governance and industry leaders be braver in developing relevant benchmarks and assessment tools?
While the definition of board entrenchment differs across academic papers, it generally conceptualises boards with an average tenure of more than 10-12 years. One or two studies also consider director age, and so perhaps some diversity metrics would be useful in any benchmarking tool.
Katz and McIntosh also promote the more flexible approach to scrutinising boards used by BlackRock, which focuses on “board responsiveness to shareholders on board composition concerns, evidence of board entrenchment, insufficient attention to board diversity, and/or failure to promote adequate board succession planning.” 11
Overall it seems unbalanced to target all directors with long tenure, and it would be more appropriate to look to remedy ‘entrenched boards’, using average director tenure as an aid. Determining average director tenure is an easy exercise for any board and is a way to approach discussions on board entrenchment without targeting individual long serving directors. It is vital that organisations, and sectors more broadly, address this important leadership issue in a time of technological change – when innovation has never been more important to an organisation’s success. I anticipate that some boards (within the sectors mentioned earlier) would suggest it is hard to find the right candidates amongst their membership base – but the talent is there if boards are willing to look for it. Succession planning should be a key feature of any high performing board. Leaders, especially directors, should look across their sectors for evidence of board entrenchment and find the courage to speak up. Perhaps it is also the duty of sector-based industry bodies to be leaders in the governance space, just as they are advocates for good policy and public relations.
Leading organisations however, will recognise that managing board tenure, renewal, and diversity is a way to gain an advantage over their competitors.
- Wertheim, P., Neill, J., John, D., Curtis, E., 2016. “Director Tenure and Leadership effectiveness over internal controls”. Journal of Leadership, Accountability and Ethics, June.
- Huang, S., 2013. “Zombie Boards: Board Tenure and Firm Performance”. Published in Essays on Corporate Finance, 2014.
- Jia, N., 2016. “Should directors have term limits? Evidence from Corporate innovation”. European Accounting Review, June.
- Unda, L., 2016. “The impact of regulatory governance standards on board characteristics: evidence from Australian credit unions”. JASSA The Finsia Journal of Applied Finance, Issue 4.
- Considering remarks in the Unda (2016) research and tenure of directors of ASX 200 banking institutions (currently 4.5 years).
- Beck, J., & Tunny, J., 2014. Director Tenure. Published by Effective Governance.
- ASX Corporate Governance Council, 2014. Corporate Governance Principles and Recommendations. 3rd Edition.
- Katz, D. A., & McIntosh, L., A., 2016. “Director Tenure Remains a Focus of Investors and Activists”. New York Law Journal, July.
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