The trend towards board term limits is based on faulty logic

In the business world, experience is generally considered to be positive. When it comes to corporate directors, however, tenure is increasingly viewed with suspicion. Yet the trend towards board term limits is based on faulty logic and threatens performance.

The movement towards director term limits is global. In France, directors are not considered independent if they have served on the company’s board for more than 12 years. In the UK, publicly traded companies must either comply or explain: terminate a director after nine years of service, or explain why long tenure has not compromised director independence.

In the US, the Council of Institutional Investors, which represents many public pension funds, urges its members to consider length of tenure when voting on directors at corporate elections. The council is concerned that directors become too friendly with management if they serve for extended periods.

Institutional Shareholder Services, the proxy voting advisory firm that is a powerful force in corporate governance, penalises companies with long-serving directors by reducing their “quick score” governance rating. Under the current methodology, a company loses points if a substantial proportion of its directors has served for more than nine years. Although ISS recognises that there are divergent views on this, it concluded that “directors who have sat on one board in conjunction with the same management team may reasonably be expected to support that management team’s decisions more willingly”.

But the assumption that lengthy director service means cozy relationships with management simply is not supported by the facts.

First, there is a lot of turnover in executive ranks. According to Spencer Stuart, the recruitment firm, in 2013 chief executive officers of S&P 500 companies held their jobs for just seven years on average. This figure has been falling over the past few decades.

Second, new research has found that experienced directors add value. In a study, economists at the University of New South Wales defined an experienced director as one with more than 15 years of service on the same board. This is superior to the typical definition in other studies, which look at average or median tenure for the entire board. They then looked at the performance of 1,500 companies from 1998 to 2013, including those with and without experienced directors.

The study found that experienced directors were more likely to attend board meetings and become members of board committees. Companies with a higher proportion of experienced directors paid their chief executives less, were more likely to change chief executives when performance faltered and were less likely to misreport earnings intentionally. These companies were also less likely to make acquisitions, which often expand a chief executive’s power while diminishing shareholder value. When they did, the acquisitions were of higher quality.

So, term limits do not increase director independence. Just the opposite: long tenure appears to help directors counterbalance chief executive authority. While term limits help companies refresh the board with new faces and talents, which can be desirable, they can lead to the loss of considerable experience and knowledge. This expertise is especially important in a complex company with global operations.

The assumption that lengthy director service means cozy relationships with management is not supported by the facts.

Of course, some directors may lose interest in a company, stop contributing to board discussions or start missing board meetings. They should be replaced regardless of their tenure.

Each year the nominating committee should make an inventory of the skills, experiences and characteristics the company needs. This analysis should take into account changes in the relevant industry and board norms, including director diversity. Then the nominating committee should evaluate whether these needs are being met by current board members or whether board composition should be adjusted.

In addition, the committee should conduct a rigorous annual review of the performance of each director. Unfortunately, some performance reviews of directors are superficial; others suppress criticisms of individual directors. If it does an effective review, it will be prepared to ask an underperforming director to step down, regardless of length of board service.

Careful assessments of board composition and director behaviour are more likely to contribute to corporate performance than mechanistic term limits.