Qualifications and Evaluations of Directors and Boards

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on Thursday June 16, 2011 at 9:09 am
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Editor’s Note: Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton firm memorandum.

As part of a continuing study, on April 5 the European Commission issued a consultation green paper on corporate governance. It is a very thoughtful study. It covers many of the same issues that have been the subject of the corporate governance debate in the United States. Of special interest, and relevance to us, is the discussion of the composition of the board and the qualifications of the directors:

  • 1. The composition of the board has to suit the company’s business. The non-executive members of the board should be selected on the basis of merit, professional qualifications, experience, personal qualities, independence, and diversity.
  • 2. The single most important factor in the selection of a director is an accurate assessment of the candidate’s skills and expertise.
  • 3. Gender diversity is important and should be an imperative.
  • 4. A director must devote sufficient time to his/her duties and should limit the number of boards he/she serves on to assure he/she can fully meet his/her commitment to each.
  • 5. The board should evaluate its performance annually. The evaluation should assess its membership, organization, and operation as a group, and the competence and effectiveness of each member and of the board committees. The evaluation is best conducted by an external consultant who would bring an objective perspective and be able to share best practices and experiences of other companies.

In addition, and also of special interest is the recognition by the European Commission that boards are subject to undue pressure from shareholders to achieve short-term performance. The green paper recognizes that the proper purpose of corporate governance is “to curb harmful short-termism and excessive risk taking” and that shareholders should “be encouraged to take an interest in sustainable returns and longer-term performance….”

  1. The idea that shareholders should be encouraged to take an interest in sustainable returns and longer-term performance is interesting but probably more idealistic than realistic.

    The vast majority of shareholders who are not involved in the management of a company buy shares in the hope that the price of the shares will increase and the shareholders will be able to sell them at a profit. This is a short term, not a long term, objective.

    Why would a shareholder who has a short term objective take an interest in sustainable returns and longer-term performance?

    The task for management and a Board is to cause the company to do things that generate short term gains for shareholders but are not inconsistent with the company’s long term performance objectives. That is not easy to do.

    Comment by David Bernstein — June 16, 2011 @ 9:59 am

  2. I completely agree with Mr. Lipton and the European Commission regarding these critical understandings of enlightened corporate governance. In supporting boards in finding skilled, experienced, independent current and diverse candidates, I can say that this list of 5 seemingly intuitive practices is very difficult for some boards to execute concurrently.

    In regard to #2, finding the right skills and experiences is generally poorly undertaken. Word-of-mouth nominations by the Nominating & Governance committee, if not paper, cursory type matrices are used. Moreover, skills and experiences tend to trump attributes and diversity when all of these factors should be considered critical. Unfortunately, most boards, in my opinion, do not have the tools nor the processes to implement the best practices suggested by the EC.

    In my experience, directors are interested in the long-term interests of the organization. I know my clients are all investing in improving their effectiveness in order to significantly contribute and be aligned with shareholder value for the long-term. This includes performance evaluations more than annually. Taking #5 one step further, products like ours which take effectiveness to the director level, provide benchmarks and relative measures means that each director has the opportunity to ensure that the vision and mission of the company is carried-out by the board.

    I believe boards want to find the right directors, and continue to push past compliance toward sustainable returns and long-term performance improvements for shareholders. I also believe, however, that many boards often take comfort in the fact that as a group they are doing all this well when that is simply not the case.

    Comment by Michelle Ronco — June 17, 2011 @ 1:52 pm

  3. Completely agree about Directors limiting the number of boards they are on. We come across many organisations (particularly charities) where people join the board but are unable to commit the time necessary for the role

    Comment by Leadership Development UK — June 23, 2011 @ 6:57 am

 

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