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Oct 29, 2014

ISS’ proposed policy change targets board independence

Proposed new criteria take a harder look at board turnover and executive leadership changes

ISS appears poised to pay even closer scrutiny to who qualifies as an independent board director. The proxy advisory firm recently released draft versions of proposals to revise its voting recommendation policies in a number of governance areas for a handful of countries. One of its US proposals proposes revisions to its policy for recommending for or against shareholder proposals calling for an independent chairman of the board.

As ISS notes, requests for an independent chairman of the board were the most common kind of shareholder proposal submitted to US companies in the 2014 proxy season. The number of such proposals that actually went to a vote at annual shareholder meetings rose to 62 from 55 in 2013, and ISS recommended against 32 of those 62 proposals this year

Under the current policy, ISS typically will recommend in favor of independent chair proposals unless the company satisfies all of these criteria:

• The board designates a lead director, elected by and from the independent board members with clearly delineated and comprehensive duties

• The board is ay least two-thirds independent

• The key board members are fully independent

• The company has disclosed governance guidelines

• The company has not exhibited sustained poor TSR performance (defined as one- and three-year TSR is the bottom half of the company’s four-digit industry group, unless there has been a change in CEO with in time period)

• The company does not have any problematic governance issues 

Most of the additional criteria that ISS proposes to add to the list are designed to take a harder look at what constitutes independence in a board member. For example, ‘recent board and executive leadership transitions at the company’ appears to be an attempt to get a clearer view of board turnover or, in the absence of turnover, at least a better understanding of how long current directors have served under the same CEO or other top executives. Another new factor being proposed -- director/CEO tenure -- targets much the same thing. The possibility of raising the bar on qualifications for independence is relevant in light of recent research by Spencer Stuart showing a nearly 30 percent decline in board turnover between 2002 and 2012, as well growing concerns about board independence and extreme ‘clubbiness’ on boards.

For Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, it’s no surprise that shareholder demand for independent board chairs is rising. Combining the chair and CEO roles was based on boards having an advisory rather than monitoring function, so once boards resumed being monitors it doesn’t make sense for the person being monitored to chair the group doing the monitoring, he explains.

Determining the degree of independence of other board members is more complicated, however.

‘I don’t know if tenure necessarily reflects adequate independence. The idea is do you lose independence the longer you’ve been there?’ says Elson. ‘I don’t know if that’s the issue so much as you get stale the longer you’ve been there and you’re less effective because you’re staler,’ he says.

It’s also more difficult to ‘innovate against yourself’ and to question the way the company operates the longer you’ve been there, says Elson. ‘I believe in term limits. After 15 years, you’re out of there.’

He says he expects the percentage of S&P 500 companies whose boards specify term limits for directors in their governance policies to rise in the coming years from the 3 percent that Spencer Stuart reported recently. ‘The whole push on diversity is going to change that. I think the only way to diversify a board is to have seats coming up and the only way to have seats coming up is to have some sort of term limits,’ he says. 

ISS said it believes a more holistic review of each company’s board leadership structure, governance practices and financial performance will strengthen the application of its policy on proposal recommendations.

David Bogoslaw

Associate Editor and Online features producer for Corporate Secretary