What’s the proper election rotation of board members, annual or classes?

by Jamie Flinchbaugh on 11-01-11

Bad boards have been in the news lately. The ongoing debacles at HP and Yahoo seem almost comical, to the point that you can literally imagine clowns running around in the board room.

Of course, the easy thing for many people to assume is that they are just made up of bad people. This is much less likely than bad, or broken, board dynamics. As a “team”, they no longer function.

There are two fundamental ways to elect directors, either annually or periodically (called classified boards). Periodic are often classes, or groups, of directors, that often get elected every 3 years. They of course rotate the terms, so there is at least the opportunity to turn over portions of the board every single year. Annual elections have shareholders voting on all of the board members every single year. Why is there a push to move towards annual elections? Because of the perceived increase of accountability. I say perceived because even electing boards out is based on very limited information on shareholders part. Second, there is a desire to take out a shareholder’s frustrations on someone, and often the board is the only thing available to do so.

There is some indication that things are moving in the direction that advocates of annual elections desire anyway. Board tenure is dropping, down from 7.6 years to 6.8 years, which is a significant drop. There are various reasons for this. Age limits are one element that has had an impact, with an average age of forced retirement at 72.1 years.

However, I see several downsides of simply increasing board turnover.

First, one of the ongoing criticisms of Wall Street and Corporate America is too much short term focus. If the entire board must worry each year about showing results or being replaced, is there any reason to believe that this chronic problem won’t get worse? Any pressure already existing on the company to just hit a target will likely increase, and there will be a strong incentive to sacrifice the long-term to benefit the short-term.

Second, also against the wishes of those advocating annual elections: increased turnover will increase management control of the situation. Where’s the stability if the board is always turning over? In management. They can become entrenched, and even with annual elections become more active in shaping the board the way that they want. Any new board or board member takes a little time before they assert themselves too aggressively, unless the situation is desperate.

Third, and although more general, but boards are like any other team. They need time to gel and start understanding each other so that they can work in a cohesive way. They are not full-time; they’ll meet 4-12 times in a year, so with less bandwidth it can naturally take longer to build team unity. Experienced board members are used to this fact, so it might take them a little less time than a typical team. But constant churn can cause a team to lose valuable time.

I’m very much in favor of accountability, and I understand the logic of annual elections. But boards of directors need some stability. Without it, they cannot effectively and consistently discharge their duties. I believe class elections are a more effective balance of needs.

What are your thoughts? How does your company balance accountability and stability, whether in the board of directors or elsewhere?

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