Are Professional Board Directors the Answer?

As a result of the recent wave of corporate scandals and the ensuing regulatory changes, corporate boards in the United States have been facing an increasing number of demands. Companies now have bigger agendas for their board directors, requiring deeper reviews of policy topics, such as ethics codes, internal controls and director performance evaluations. Audit committees are meeting more frequently, and directors are being asked to devote more time to their duties, including the review of comprehensive board reports.

At the same time, the pool of available candidates to fill board positions has been shrinking. Increasing numbers of active senior managers have been avoiding — and will continue to avoid — outside director responsibilities, due primarily to personal choice or the mandates of their own boards. The business community clearly is moving away from what used to be the common practice of senior executives serving simultaneously on the boards of four or five companies. (For a detailed discussion of these and other issues, see “ The Changing Face of Corporate Boards” by Edward E. Lawler III and David L. Finegold.)

One obvious solution is to recruit retired senior managers to take more active roles as directors. But boards would have to be certain that the skills, knowledge and — perhaps most importantly — motivation of any such candidates are all present in sufficient quantity. Because many retired senior managers have accumulated considerable wealth during their working years, the monetary rewards of board positions might be insufficient to elicit the best efforts from those individuals. One concern is they might not remain on boards during rough times, especially if the difficulties could tarnish their professional reputations or possibly lead to personal liability.

Professional Directors

Given these realities, companies looking to fill board openings might do well to consider another class of potential candidates — professional directors. Here, the term “professional director” does not refer to academics, attorneys and other individual contributors who serve on several boards (apparently the traditional definition of the term). It instead refers to well-established professionals who devote all of their work, time and energies to corporate board activities. Such individuals might come from a variety of backgrounds, but they will likely be drawn from one of three categories.

The first is senior managers in midcareer. These executives have considerable experience but prefer employing their knowledge and experience in a less operational and more consultative manner. For example, a typical professional director in this class might be a person with 20-plus years of experience, including service at the senior executive level, who has worked for multinational companies and emerging businesses. Such an individual is not likely to have sufficient personal resources to be financially independent for the long term, so compensation would be an important issue. (A caveat here is that people could tend to favor supporting the status quo when they are highly motivated by compensation, especially if their selection was pushed through by the CEO and others with vested interests.) A professional director in this category might serve on five or six boards to fill a full-time work schedule, which would provide the financial resources necessary to maintain an executive lifestyle.

The second type of professional director could be developed from the ranks of executives 10 years senior to those in the first category. Thus, they would typically have 30-plus years of experience. Tired of senior management stresses yet having sufficient financial resources, individuals in this group might choose to serve on just three boards. The service could be viewed both as a career change and as a prelude to retirement.

The third category is former senior partners in national accounting firms with 30-plus years of experience in audit and internal-control functions. Although their career experiences will not be as broad as those of many other senior executives, individuals in this category would be ideal candidates to chair the corporate audit or compensation committees, probably on three or more boards. The number of board invitations likely to be accepted would depend on a person’s motivation for professional activity as well as the added time required to chair major board committees.

Candidates from these three categories, in addition to another group made up of retired senior managers, could greatly alleviate the growing shortage of qualified board directors. In fact, four professional directors, one from each category, could occupy the equivalent of some 13 to 15 board seats at several corporations. These would be positions that traditionally have been filled by active senior managers working as outside directors on a part-time schedule. The 13-to-15 estimate assumes the following: five or six board positions for the midcareer manager, three for the top manager ready to give up operational roles, three for the former senior partner from an accounting firm and two to three for the retired CEO.

When initially recruited, both the professional directors and the retired senior managers should have the necessary knowledge and experience to fulfill their duties. Boards should also take steps over time to ensure that all of those individuals build on their skills and knowledge base, perhaps through educational offerings and close involvement with current management issues. Fortunately, director education has become increasingly available.1 Columbia Executive Education at Columbia University’s Graduate School of Business, for example, now offers a course for directors on “improving financial integrity,”2 and several trade associations offer boot-camp courses for directors.3

Unfortunately, no data are readily available regarding the number of professional directors now serving on the boards of U.S. corporations. One reason might be that the business community lacks a universally accepted definition for such a position. But a Canadian search firm estimates there are 30 to 40 professional directors currently serving top companies in that country. The search firm defines professional directors as individuals who have left their professions “far earlier than the traditional retirement age in order to pursue board work as a vocation in itself.”4

The Changing Concept of “Director”

From both legal and operating perspectives, corporate directors have long been considered a rather homogenous group because they all have the same level of legal liability and the same responsibilities to stockholders. Today, however, the term “director” is no longer a one-size-fits-all descriptor because some companies are now appointing outsiders to be presiding directors (to run meetings without the CEO) or lead directors (to handle the evaluations of directors and to ensure that important organizational issues are discussed and relayed to the CEO).5 These new positions allow boards to allocate responsibilities with more variability. Consequently, some professional directors are assuming greater outside-director responsibilities than part-time board members who hold full-time managerial positions at their own companies.

For years some firms, including American Express Co. and Monsanto Co., have had outside directors with varying levels of responsibility. But companies should be wary when such arrangements take any director beyond normal board activities, particularly when they lead to consulting relationships. The danger is that any consulting arrangement could compromise a director’s ability to evaluate the organization’s performance.6 The Walt Disney Co., for example, recently banned the practice of paying consulting fees to its directors. The corporation had been criticized for rendering such fees to George Mitchell, its presiding director, and for using his law firm for legal work.7

Regardless of their makeup, all boards operate on the basis of information. With professional directors having a much greater wealth of information, it is possible that a board might divide into two distinct groups with respect to the amount of information they possess in making policy decisions. (This division assumes a board with the firm’s CEO as the only inside director. If additional inside directors were present, they would obviously add a third group to the mix.) Traditionally, the different groups have had the same legal liabilities, but that could soon be changing. A Delaware judge recently made the following ruling: “Officers and directors with a ‘specialized expertise or knowledge’ can be held to a higher (liability) standard … .” If other courts adopt a similar stance, some board directors could become much more influential on specific decisions, even more so than hired outside experts.8 On the other hand, this precedent could also obligate directors to question their expert colleagues more closely to ensure that they are applying their knowledge in a reasonable manner (a key issue in the Delaware case). This close questioning might then generate board conflict.

Compensation Practices

Corporations usually pay all outside directors an annual fee that is supplemented with compensation for special meetings and committee work. The use of professional directors would require companies to institute a new compensation system. In the past, lead and presiding directors have tended to be compensated far in excess of traditional part-time directors because of the additional workload. Likewise, professional directors should receive extra compensation (perhaps in line with that of lead and presiding directors), assuming they accept more responsibilities than the part-time board members. Some experts have suggested that professional directors be compensated at a level similar to that of other top professionals in their respective fields, so that stockholders and the public do not perceive them as being overly compensated.9

Other issues also need to be addressed. Specifically, directors on certain committees would need to be compensated for that extra work, which can be considerable. Some audit committees, for instance, now meet five times a year.10 Also, if the workload of a professional director would require that person to retain support personnel, companies would need to develop policies explicitly stating what they are willing to subsidize.11

The Benefits

If a company were to use professional directors, it could assemble an 11-person12 independent board with the following composition: one lead director (probably a professional director); one presiding director; three professional directors, accepting more than the traditional board responsibilities; two senior executives currently employed by other companies, accepting traditional board duties; three traditional outside directors, representing important external constituencies; and the firm’s CEO. (For a company in the health care field, the three external constituencies might be represented by a medical professor, a research scientist and the CFO of a health maintenance organization.)

This 11-person model provides three key benefits: (1) it limits the difficult recruitment of outside senior managers to two persons; (2) it expands the analytical responsibilities of five people (three professional directors, lead director and presiding director), which is nearly half the board, to help meet more rigorous board standards; and (3) most importantly, it relieves the overwhelming time crunch that nonprofessional directors face as board agendas continue to become broader and more complex.

With respect to board composition, a much-debated topic is whether companies should allow CEOs to fill positions on their own boards. (A related issue is whether the CEO should also be allowed to chair the board, as discussed in “Should the CEO Be the Chairman?” by Jay W. Lorsch and Andy Zelleke, p. 71.) CEOs can tend to dominate board proceedings because they have a much more detailed understanding of company operations than do most board members. CEOs may also be unduly influential because of strong social or professional relationships with some of the directors. On the other hand, a knowledgeable CEO can help expedite meeting agendas, for instance, when outside directors are struggling to understand a new policy issue related to the strategic plan. In terms of voting power, the CEO in the 11-person model has only one vote, and as any experienced director knows, important board decisions are rarely decided by a single vote.

FOR MOST CORPORATE BOARDS, appointing professional directors will be a compromise that they will be required to take, however reluctantly. Having professional directors is not likely to be viewed as the perfect solution because most boards will probably continue to prefer current senior managers as being the ideal type of outside director. But as the responsibilities and duties of board membership become increasingly demanding, professional directors may very well be the best option.