Among their myriad responsibilities, boards of directors are expected to review CEO performance as well as their own. Directors use various processes and models for conducting these evaluations, but they all have one common factor: Conducted away from public eyes, these reviews are something of a black box to investors and other audiences.
It is increasingly clear that board and CEO performance evaluations matter deeply. This process of performance evaluation can result in constructive feedback to the reviewee, helping him or her to identify and improve upon areas of weakness. When necessary, the review may result in an acceleration of the board refreshment or CEO succession process.
Either way, having a robust and functioning process is critical to mitigating the negative impact of sub-par performance. Given the importance of these processes and their confidential nature, how can investors and other stakeholders have confidence in a robust and effective process at their portfolio companies?
One way to provide this assurance is through clear discussion in the proxy statement, and also in year-round corporate governance and investor relations messaging. Here, we see great divergence in company disclosure practices.
To be clear, we are not saying that the results of performance reviews be made public. Rather, that the disclosure and description of the process should be sufficiently specific—and presented in clear language, not legalese or boilerplate—so that investors can have confidence in the process and that it will work as intended to mitigate downside risk. Unfortunately, in reviewing hundreds of proxy statements each year, we have found that such confidence-inducing disclosures are not prevalent. The good news, though, is that each year we are seeing more companies focusing on and improving the clarity of these disclosures.
We have seen greater evolution in board evaluation and refreshment disclosures than in disclosures around CEO performance and succession planning. Assuming both are equally important, the stronger showing in the board evaluation and refreshment disclosure is understandable.
Most boards have between eight and 12 directors. With an increased focus on board refreshment and using 10 years as a dividing line between short- versus long-tenured length of service, it is expected that companies will cultivate a pipeline of potential candidates that can bring added diversity and skill sets to the board. It is also common practice that one or more incumbent directors may be candidates for rolling off the board in any given year (whether or not this actually occurs).
Since companies typically have one CEO at a time (with a couple of notable exceptions), CEO turnover is not as regular an event as is the replacing of an individual director. According to Equilar data, in 2014, the average S&P 500 CEO had served an average of 7.4 years, and 6.0 at the median. Ten years prior, those figures were 6.6 and 5.2 years, respectively. What’s more, boards may feel that CEOs might be sensitive to significant public discussion of succession plans and are thus reluctant to say too much about these processes, other than to confirm that succession discussions are a regular and important topic of board consideration.
One caveat to this is that following a CEO succession event, we may see that the board indicates that the recent succession event was in part a result of the board’s robust annual evaluation and succession planning and a testament to its effectiveness.
The following companies, in their most recent (2017) proxy statements, use a combination of text and visual elements to explain their board evaluation processes in such a way that the discussion is easily located, digested and understood. These and other companies are raising the bar on the important topic of board evaluation. On the other hand, companies that stand still too long on this and other key disclosure issues risk becoming seen as relative laggards when viewed in the context of peer company disclosures.
Ron Schneider is the Director of Corporate Governance Services for Donnelley Financial Solutions. He can be reached at ronald.m.schneider@dfsco.com.