This article is part of Board Games 2013, Report on Business's annual report on corporate governance. View the full rankings table: The best and worst governed Canadian companies in 2013.
They're called "zombies" – corporate directors who have served on a board for so many years they have lost energy for the job and are shuffling through the motions.
Regulators and investors around the world are taking aim at long-serving boards, calling for more fresh blood around the table and even term limits to ensure there is regular turnover of directors. Critics say long-time directors become too stale or too close to management, losing their ability to become strong advocates for investors, or to bring in new ideas.
"We think it's healthy for a board and a company to have fresh ideas," said Doug Pearce, chief executive officer of the $100-billion B.C. Investment Management Corp., who supports having term limits for directors.
In Canada, boards are aging as directors begin serving later in life. In 1997, 47 per cent of directors were 61 or older, and 8 per cent of those were over 70, according to data on 300 large public companies from consulting firms Korn/Ferry and Patrick O'Callaghan & Associates. By 2010, 60 per cent of directors in Canada were 61 or older – including 15 per cent of them over age 70.
The trend, combined with a gradual reduction in the size of many boards, has meant a slowdown in board turnover. A U.S. study by consulting firm Spencer Stuart found that S&P 500 companies appointed fewer new directors last year than in the previous 10 years.
The average tenure of directors in Canada is now 8.6 years, according to data compiled this year by the Clarkson Centre for Board Effectiveness at the University of Toronto. But there is a wide variation, with many large boards having at least one director with more than 20 years service.
Concerns about long-serving directors have led an array of countries to adopt rules to limit the terms that directors can serve, although no such rules are in place in Canada.
In France, public companies cannot call directors "independent" after 12 years, while Australia has proposed a similar rule with a nine-year term limit. Many other countries, such as Britain, do not prohibit directors from serving long tenures but require companies to spell out in public filings why they still consider directors independent after they have served for more than nine years, in essence creating a term limit for many boards.
Much of the pressure for change has come from shareholder groups, who say academic research shows directors are less effective as their terms stretch for decades.
A study published in July about U.S. boards concluded that the optimal term for directors on typical boards is nine years, after which they add less value for the company. The report, "Zombie Boards: Board Tenure and Firm Performance," by Sterling Huang of INSEAD Business School, also concluded that the ideal term for directors varies by up to two years in either direction, depending on a company's complexity and other characteristics, so the same term limit for all companies "may not lead to the intended outcomes."
Richard Leblanc, a law professor and governance specialist at Toronto's York University, said many directors grow attached to the work, the prestige and the pay, and are reluctant to leave voluntarily. He is concerned that long service makes some directors less independent from management as time passes.
"Boards can ossify and can become entrenched and stale," he said. Since the global financial crisis, he added, "there's less tolerance from shareholders. … There's less tolerance for entrenched boards and there's more acceptability of term limits, diversification and renewal."
Two weeks ago, the corporate governance director for the largest U.S. pension plan – the $275-billion (U.S.) California Public Employees Retirement System – issued a call to investors to vote against reappointing long-serving directors on "stagnant boards" to keep directors from becoming too clubby, stale or cozy with management.
The call to action came after the Washington, D.C.-based Council of Institutional Investors, which represents large institutional investors, amended its governance policies in August to urge boards to consider directors' years of service when deciding on their independence. "Extended periods of service may adversely impact a director's ability to bring an objective perspective to the boardroom," the council said.
The Toronto-based Canadian Coalition for Good Governance, which represents most of Canada's largest institutional investors, has not called for limits to directors' terms, executive director Stephen Erlichman said, but acknowledges that they can be an effective way to encourage more board turnover and make room for more women on boards.
But Mr. Erlichman said he worries that the ability of a director to be independent-minded is often unrelated to tenure: "You could have a director here for 20 years [who] will not be 'captured,' and you could have a director there for one year and the director is captured before they even came on."
Critics also argue term limits may arbitrarily force directors off boards at the peak of their knowledge and usefulness.
Director Peter Dey, who heads the governance committees of Goldcorp Inc. and Granite Real Estate Investment Trust, said directors don't necessarily lose their independence after a certain number of years. He said it's up to board chairs to move directors off the board who are not performing, rather than relying on term limits to avoid "a difficult conversation."
"Applying term limits can cause boards to lose valuable contributors from the board and give underperformers some sense of being tenured," Mr. Dey warned. "Every director should recognize that his or her term expires not later than the next shareholders' meeting."
But Robert Prichard, chairman of Bank of Montreal, does not see the bank's 15-year term limit for directors as an alternative to doing performance reviews.
"Term limits should not be about underperforming directors; they should be about board renewal," he said. "Even when all the directors are performing well, some renewal is desirable. A new director often brings fresh insights to the business and its governance."
Bank of Montreal introduced a term limit in 2009 so that its board could "find the right balance between continuity and institutional memory on the one hand, and fresh eyes and ideas on the other," Mr. Prichard said.
He said the board previously had a retirement age of 70 for directors, but found it was "an imperfect mechanism" because younger directors could end up staying for decades and older ones had only a few years of service. The new term limit allows directors to serve 15 years or until age 70, whichever comes first, but directors can serve at least 10 years regardless of the retirement age.
Bank of Nova Scotia introduced a similar term limit in 2011, allowing new directors to serve for 15 years or for at least 10 years, even if they reach the retirement age of 70. Average director tenure on its board is now nine years, down from almost 12 years in 2008.
"I think that's not a bad zone to be in," said Scotiabank director Thomas O'Neill, who helped to develop the new standard.
He said the goal is to have a balance of experience and "continued renewal" on the board, but said a relatively long term limit is needed because Scotiabank's wide array of international holdings create a steep learning curve for new directors. "To get your sea legs at the bank takes longer than it would in a non-financial institution," Mr. O'Neill said.
In Canada, term limits remain rare. Only 8 per cent of the country's 300 largest public boards reported having them in 2012, up from 6 per cent a year earlier and 4 per cent in 2010, according to Korn/Ferry.
Although the proportion of boards with term limits is small, almost all of them are among the largest companies in Canada, including all of the six largest banks, as well as companies such as BCE Inc., Talisman Energy Inc., Fortis Inc., Shoppers Drug Mart Corp. and TransAlta Corp. The most common term limit is 15 years, the research shows, although they range from nine years to 20 years.
Vancouver-based governance consultant Patrick O'Callaghan said many companies with term limits are those most willing to hire comparatively younger directors in their 40s and 50s, but are concerned they could be on the board for two or three decades before hitting the retirement age.
Companies also find term limits make board planning easy, he said. "It provides more certainty around planning turnover and the skills and experiences that will be needed on the board."
Mr. Pearce says BCIMC is encouraging companies it invests in to introduce term limits, saying business is changing so rapidly that he believes boards need a mix of newer directors who know about current trends.
"We're not dogmatic about the limit, but after 10 or 12 years on a board, you ought to be thinking of moving on, and a board ought to be looking for a replacement. … When we look at companies and products and how things are running, I don't think the old mindset is necessarily the one we ought to follow."
Editor's Note: An earlier version of this story said Bank of Montreal allows directors to serve on its board until age 70, but allows directors to stay longer if they reach age 70 without having served at least seven years on the board. In fact, the bank has extended the minimum term for those directors to 10 years.