Musical Chairs: How Big A Board Should Be

On Oct. 23, Bally Total Fitness made a number of board-related announcements, including that the board would be reduced from nine members to five by the time of the company’s annual meeting, scheduled for Dec. 19.

Bally’s move to a smaller group of board members, however, is somewhat surprising to governance experts, and underscores the question of how large the “ideal board” should be. (The company, however, did not elaborate and did not return several phone calls seeking comment.)

These questions are especially critical in this post-Sarbanes-Oxley, post-Enron world when directors are being called on to spend more time at meetings and scale back the number of boards on which they sit. And, of course, directors are more prone to being sued these days.

For its part, the Council of Institutional Investors maintains on its Web site that absent “compelling, unusual circumstances,” a board should have anywhere from five to 15 members. That range is “not too small to maintain the needed expertise and independence, and not too large to be efficiently functional,” it adds.

Others, however, fret that five members could be too small for a board these days. Shirley Westcott, a managing director at proxy-advisory firm Proxy Governance, says that while Proxy Governance recommends no specific size, five members “sounds rather small.”

McGurn

Patrick McGurn of Institutional Shareholder Services goes even further: “In this day and age, it is too small. It is anorexic. Really small boards are insufficient to deal with SOX and most post-Enron requirements.”

“It’s like the Goldilocks effect … No one wants to prescribe a specific level [for the ideal board size].”

— Kenneth Bertsch, Managing Director Of Corporate Governance Analysis, Moody’s Investors Services

He and other critics of small Boards say that companies today must maintain three critical committees staffed by outside directors: audit, compensation, and nominating. While boards are not required to have different people serving on those committees—and can even let the board chairman serve as committee members—governance experts insiste that one director serving on all of those committees is an untenable workload.

Kenneth Bertsch, managing director of corporate governance analysis at Moody’s Investors Service, also says small boards—which he defines as fewer than eight—create staffing challenges for committees, leaving a shortage of diverse perspectives. “A lot of boards that are small have two insiders and one or two with similar industry background,” he insists. That overlap limits the opportunity to appoint individuals with differing backgrounds.

Size Matters

According to the National Association of Corporate Directors’ 2006 survey of boards of directors, the average board has nine members—and the average number of outside directors serving on those boards is 7.1. And overall, 80 percent of companies indicated that their board size is sufficient for their own company’s needs. “We are advocating staying in that range so companies have enough people on key committees,” says Doreen Kelly Puyak, an NACD spokeswoman.

Likewise, ISS conducted a similar study and found that nearly half (47.8 percent) of the companies it rates have six to eight board members; another 30 percent have nine to 12.

Also according to ISS, the size of the board also hinges on size of the company in question. Sixty-eight percent of companies that comprise the S&P 500 have nine to 12 members, although only 16 percent have 13 or more. Only three companies in the S&P 500 have six members or fewer.

On the other hand, among the Russell 3000 (excluding the three S&P indices), 56 percent have six to eight directors, but only 32 percent have nine to 12. “Even at smaller companies, you don’t see fewer than seven,” McGurn stresses.

Some companies have taken the size question a step further, and included specific language about board size in their governance guidelines. Time Warner, for example, states on its Web site that its Board should generally have no fewer than 12 nor more than 16 directors. ExxonMobil’s bylaws provide that the board may have no fewer than 10 and no more than 19 members. “Normally, the board intends to have approximately 11 to 13 members with 2 to 3 employee directors and 9 to 10 non-employee directors,” the company says in its guidelines.

Negotiating A Solution

While many governance experts are concerned that boards don’t get too small, they are equally troubled by exceptionally large boards. In the past, it was not uncommon for large banks to have more than 20 directors, which amounted to an old-boys club comprising, in part, local businessmen.

RECOMMENDATIONS

Below is an excerpt from the Council of Institutional Investors' policies on board size, composition, and independence.

Director Elections. When permissible under state law, companies' charters and by-laws should provide that directors are to be elected by a majority of the votes cast. If state law requires plurality voting (or prohibits majority voting) for directors, boards should adopt policies asking that directors tender their resignations if the number of votes withheld from the candidate exceeds the votes for the candidate, and providing that such directors will not be re-nominated after expiration of their current term in the event they fail to tender such resignation.

Independent board. At least two-thirds of the directors should be independent (i.e., their only non-trivial professional, familial or financial connection to the corporation, its chairman, CEO or any other executive officer is their directorship). The company should disclose information necessary for shareholders to determine whether directors qualify as independent, whether or not the disclosure is required by state or federal law. This information should include all financial or business relationships with and payments to directors and their families and all significant payments to companies, non-profits, foundations and other organizations where company directors serve as employees, officers or directors. (See Council definition of independent director.)

All-independent board committees. Companies should have audit, nominating and compensation committees, and all members of these committees should be independent.

The board (not the CEO) should appoint the committee chairs and members. Committees should be able to select their own service providers. Some regularly scheduled committee meetings should be held with only the committee members (and, if appropriate, the committee's independent consultants) present. The process by which committee members and chairs are selected should be disclosed to shareholders.

Board size and service. Absent compelling, unusual circumstances, a board should have no fewer than 5 and no more than 15 members (not too small to maintain the needed expertise and independence, and not too large to be efficiently functional). Shareholders should be allowed to vote on any major change in board size.

Companies should establish and publish guidelines specifying on how many other boards their directors may serve. Absent unusual, specified circumstances, directors with full-time jobs should not serve on more than two other boards. Currently serving CEOs should only serve as a director of one other company, and then only if the CEO's own company is in the top half of its peer group. No person should serve on more than five for-profit company boards.

Source

Council Of Institutional Investors

Governance experts say these large boards tend to become non-collegial bodies. “It’s more like a lecture hall and not a discussion group,” McGurn quips. “It does not lend itself to working in a collaborative fashion.”

Bertsch agrees. He insists excessively large boards—he defines them as having more than 15 members—tend to be more passive, less collegial, and less likely to take on important responsibilities. “It’s hard to have a discussion that is open and free-flowing,” he adds.

In fact, these days, boards of this size are more likely to result from mergers shortly after companies are combined. Eventually, however, the boards tend to shrink.

Even so, some experts don’t believe excessively large boards pose a particular problem. “I haven’t seen it become an issue in terms of performance of a company, or a board is so unwieldy it seems unmanageable,” Westcott insists.

In the future, boards could slowly start to shrink in size due to a number of trends. For one thing, governance advocates now want directors to serve on fewer boards than they have in the past, as the demands of the job have increased and left them overworked. And as the pool of viable candidates dwindles, more companies simply may not fill an open spot.

Also, the rash of majority-vote bylaws and policies adopted in the last two years could lead to a wave of resignations of directors who don’t receive enough “yes” votes (or get too many “withhold” votes) to stay on the board. Companies may take their time to replace those departed directors or choose not to name a replacement at all.

On the other hand, a number of boards are increasing in size, in large part as a result of activist investors who are seeking representation. For example, earlier this year Acxiom Corp. agreed to increase the size of its board from 9 to 11 as part of a settlement with hedge fund ValueAct Capital.

Ashworth Inc. agreed to increase its Board from seven to nine under a settlement with Ramius Capital Group, which had launched a proxy fight. Ramius also got Sharper Image Corp. to increase its board size from seven to nine earlier this year under a proxy-fight settlement.

Meanwhile, activist investors are pushing Gateway to expand its board and add three new members, and to change other governance practices.

Ultimately, though, Moody’s Bertsch concedes no one really knows the ideal size. “It’s like the Goldilocks effect,” he says. “No one wants to prescribe a specific level.”