The anomalous functioning of demand and supply in the “market for independent corporate directors” of public companies especially, but not exclusively, in the U.S. is an issue many in the business and investment communities recognize but is insufficiently discussed openly, explicitly and frankly in public fora. It is a labor market whose structure is far from being the paragon of robust competition, where poorly performing directors are readily replaced by more effective ones.
As a long-time board director, business executive, university faculty member, author and testifying expert witness in commercial disputes around the world who has focused on how performance of enterprises is degraded by weak corporate governance practices and antitrust enforcement, the absence of full-throated debates and discussions of potential remedies for these challenges at the apex of public companies is a bit of mystery to me.
The phenomenon is analogous to that when companies selling inferior products or services are edged out of markets by rivals with superior offerings. The dearth of competition in the market for independent corporate directors of public companies results in the toleration and in some cases the propagation of weak governance practices.
But the problem is even more complex than that. It is a double-edged sword.
The absence of sound corporate governance behaviors in public companies’ boardrooms, including refraining from posing what might be seen by some as “rock the boat” questions, can stifle the free play of competitive forces in the market for independent corporate directors. If such a market were allowed to fully function, incumbent public company independent board members—unprompted by outside stakeholders and investors exerting pressure for more effective governance—would take steps to ensure low performer directors exit and new directors judged to be high (or potentially high) performers would enter.
This is hardly just a conceptual or an academic issue. It is a core economic policy challenge for the world’s most advanced economies. Especially the United States.
For decades, the U.S. has been the global champion for the pursuit of rapid, sustained economic growth attained by both expanding markets and reducing barriers that inhibit them from operating flexibly. Much of our effort on this score has focused on pushing for greater competition in the U.S. economy and in others around the world through pursuit of regulatory reforms, enactment of new statutes, and more effective enforcement of existing laws that maintain and foster open, competitive markets for firms’ products, services, and workers.
Indeed, in the area of U.S. labor markets, at the start of this year, the U.S. Federal Trade Commission proposed a much welcomed (at least by us with expertise in antitrust) ban on companies utilizing non-compete clauses in employee contracts—long considered to be an excessively heavy-handed constraint on the efficient functioning of the U.S. labor market for professional workers.
Fostering strong competition in the market for independent corporate directors to ensure U.S. boardrooms are occupied by the best people to oversee our largest, fastest growing, and most innovative public companies, is a glaring exception. Against the backdrop of the intensified economic challenges posed by China, among other countries, few Americans would take issue with this objective—although many in our country are insufficiently familiar with how boardrooms function, and the critical role played by independent directors.
More generally, we all presumably believe in the goal of ensuring the goods and services our firms sell both domestically and abroad are world-class; that our job market for employees and management—from the factory floor to the C-suite—results in our public companies hiring people that are hard-working, possess cutting-edge talent, and offer state-of-the art ideas; and that firms utilize the most modern, sustainable technologies available.
There is also the presumption—although too rarely voiced by society—that the stewards of the country’s public corporations are the best suited people to be sitting in the boardroom, and when they are not, they are replaced. No part of such companies should be off-limits in meeting that test—even at the very top.
Perceptions of the Competitive Structure and Governance Performance of Public Company Boards
If one thinks of appraising the competitiveness of the U.S. labor market for independent corporate directors on public country boards in similar terms as is done for products markets, it is an “industry” characterized by both “high barriers to entry” and “high barriers to exit.”
It is common knowledge that very highly qualified people—whether based on experience, skillsets, gender, diversity and other dimensions—face difficulty being selected to join public company boards (“barriers to entry”), especially the boards of the largest and most well-known companies.
At the same time, the low turnover rate of incumbent directors on public company boards (again, especially the boards of the largest and most well-known companies) is widely acknowledged—by the companies that hire them, the directors themselves, and the search firms that often facilitate matching demand and supply (“barriers to exit”).
Keeping with the analogy of the competitive structure of product markets, the labor market for independent directors for public company boards might also be characterized as having a low level of “seller concentration”—numerous candidates seeking board seats (i.e., a very competitively structured market for people offering their services)—combined with appreciable “buyer concentration,” a relatively small number of public companies (especially the larger well-known firms) seeking to fill board seats.
With such asymmetry in the structure of the buyer and seller sides of a market, the hiring boards (buyers) can exercise market power over the director applicants (sellers), leaving little room for maneuvering by the latter. (Such buyer market power is called “monopsony,” the opposite of “monopoly,” when sellers can exercise undue influence in the terms of a transaction.)
While assessing systemically the strength of competitive forces impacting the performance of the market for public company directors is relatively straightforward, since there are data from surveys of companies published annually (see below), systemic appraisals of the quality of the governance decision-making process undertaken by directors of public company boards is, of course, far more difficult.
For three reasons. First, while outcomes of certain governance decisions may be made public, the deliberations undergirding such decisions (as well as others) generally are not. Second, appraising governance discussions and decisions necessarily involves qualitative judgments, which, by definition, makes systemic comparisons very challenging. But most important of all—and this speaks to the very dilemma at hand—board peers are unlikely to be critical of one another, especially on the record.
Needless to say, there are very well-known—and highly publicized—cases of poor governance performance by public company boards. One only need recall the case of Enron’s financial implosion; Blockbuster’s failure to comprehend and respond to innovation in its market; and Volkswagen’s weak oversight of the integrity of the company’s auto pollution test outcomes.
In light of the reticence and constraints on directors carrying out peer evaluation of their governance behaviors, how then can such assessments be carried out? The most competent public company boards engage third-party, independent evaluators to conduct confidential/blind peer assessments, the results of which can be shared on a bilateral basis between the evaluator and each director privately.
When governance behavior deficits are found, remedial steps and coaching by the evaluators for each director may be offered. Unfortunately, systematic data on the incidence of such occurrences are not readily available. Of course, whether such remedies are embraced by directors and improvements in deficient board governance practices are rectified is a separate matter.
Data on Competition in the Market for Board Directors: Entry and Exit
Most of the data publicly available on the extent of competition in the market for corporate directors come from surveys conducted by search firms, management consultancies, and public relations companies, summaries of which are generally made public. Indeed, the release of such reports by these entities has become an annual ritual.
While there is necessarily some overlap among these surveys, because most of them do not embody the same survey methodologies; there is significant variation in the way the survey questions are posed; the sample frames differ, for example, regarding sectoral coverage, size of firms surveyed, geographic scope, and specific themes explored year to year; the results are not necessarily strictly comparable across surveys. However, because some of the surveys themselves have been deployed for several years—utilizing the same questions year after year—longitudinal comparisons can be made within each survey.
For convenience, we focus here on the survey results released in August 2022 by the The Conference Board, the data for which pertain to those collected in early July 2022 from their live dashboard, as well as historical data for 2018, 2019, and 2021.
Entry of New Directors
The Conference Board’s data indicate the average level of annual rates of bringing on new board directors in the U.S. across firms of different sizes in a variety of industry sectors among the S&P 500 and Russell 3000 over the 2018-2022 period is quite low—centering in the 9% to 10% range.
More telling is these levels have barely increased since 2018, with the relatively smaller firms (those comprising the Russell 3000) doing so marginally more progressively. And most of that movement has taken place only in the last 2-3 years. It is a sure bet such timing is a direct response to external stakeholders becoming more vocal about boards become more diverse.
Critically, what is rarely understood from these data is that the magnitude of the absolute number of directors being elected as new board members is very small: overwhelmingly on average it is the election of just one new person to a board, with election of two new members being a distant second.
Not surprisingly, since board size tends to be larger for bigger firms, the incidence of electing one (or two) new director(s) is greater for the S&P 500 than for the Russell 3000.
Still, the overall conclusion is clear: as a percentage of the total number of directors on a given board, all other things being equal, the entry of a single director does not equate to significantly altering the composition of the board. Such a marginal change cannot fundamentally constitute board “renewal.”
Exit of Existing Directors
Apart from voluntary exit from boards, for which systematic data are not widely available but its incidence is largely believed to be infrequent, involuntary exit by board directors generally comes in three forms: (i) mandatory retirement age; (ii) term limits; and (iii) caps on the number of boards on which a director can sit simultaneously.
The Conference Board data from 2022 indicate for the largest firms captured by the survey (that is, a sample from the S&P 500), about one-third of them did not have a mandatory retirement age for directors, and that percentage rose relative to the preceding three years.
Among the surveyed smaller Russell 3000 firms, in 2022, 60% did not have a mandatory retirement age, a share that had not changed significantly over the previous 3 years. Importantly, whereas about a third of the larger firms allowed for exceptions to their mandatory policy over 2018-2022, less than a fifth of the smaller firms permitted such exceptions during the corresponding period.
Of course, a key issue is the actual age at which directors face mandatory retirement. The mandatory retirement age for the S&P 500 has steadily risen: whereas 72 years old was the cut off for most of the surveyed S&P 500 in 2018 and 2019, by 2021 and 2022 more of them increased their ceiling to 75 years old. All other things equal, this indicates barriers to exit actually have been rising.
Among the surveyed Russell 3000, throughout 2018-2022 a larger proportion stipulated 75 years old rather than 72 years old as the mandatory retirement age. But whereas the share of firms abiding by the younger age ceiling has decreased, the proportion of firms that have raised the limit to 75 years old has markedly increased.
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