The role of the lead director

September 2014 | FEATURE | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

Until recently, many American firms appointed one individual to act as combined chief executive and chairman of the board. To be sure, there are advantages to this system. Combining the roles does provide the person at the top of the firm with different perspectives on how the firm is progressing.

However, the combined role also has many critics. The practice reduces transparency surrounding the chief executive’s actions, which creates the possibility of a scandal or corruption taking hold. Given the increased focus on bribery and corruption in the post financial crisis world, it is natural that firms want to mitigate these risks wherever possible. To that end, there is increasing discussion in US boardrooms about splitting the role of chairman and chief executive. While it is estimated that currently only 45 percent of S&P 500 companies separate those roles, that number is growing.

The benefits of splitting the role are clear. Chief among these is that shareholders are provided with an additional layer of protection against wrongdoing. It also enables the chairman to better monitor the company’s performance on behalf of the stockholders. Activist shareholders usually prefer a chief executive-chairman split, believing the combined role undermines a board’s obligation to lead the firm directly.

However, a third way has emerged in the US. Increasingly, firms are beginning to embrace the position of the lead director. In recent years a number of developments have led to the proliferation of lead directors, one of the most important of which was the passing of the Sarbanes-Oxley Act in 2002. Sarbanes-Oxley can be seen as a direct consequence of an escalating level of public distrust and suspicion of corporate management, perpetuated by a series of high profile, multibillion dollar incidents involving financial powerhouses. The scandals surrounding companies such as Enron and WorldCom had a serious impact on both the public and regulatory perception of corporations and their boards.

One feature of Sarbanes-Oxley, clarified by regulations issued by the SEC, and recently adopted by both the NASDAQ and the New York Stock Exchange, effectively requires listed companies with non-independent chairmen to elevate one of their independent directors to the position of lead director. Changes to each exchange’s listing regulations mean that non-management directors must now meet at regularly scheduled executive sessions without management. Those meetings must be overseen by a lead director. Furthermore, both exchanges have indicated that those firms must communicate the identity of this person to the company’s shareholders, thus creating a clear channel of communication between the firm’s board and its stakeholders. Outside of these directives the position of lead director has not yet been clearly defined in the US. However, new SEC guidelines set out in 2012 did attempt to clarify the oversight structure of boards. According to the SEC, wherever applicable, firms are now required to explain why the roles of chief executive and chairman are separate or unified. Where the roles are still combined, companies must disclose whether they have appointed an independent lead director. If they have appointed a lead director, firms are obliged to clearly define the scope of that director’s role. Furthermore, the new governance rules set forth in Sarbanes-Oxley require independent directors to form a majority of directors on every public company board, as well as ensuring that they have a significantly larger role in the management of board committees going forward.

In many respects, the role of lead director has become pivotal to a company’s operations. Primarily, the lead director must work in unison with the board’s chairman. Together they can ensure that the board is able to carry out its responsibilities effectively and independently of both management and the corporation’s controlling shareholders. As the role of lead director has proliferated over time, it has begun to exert a significantly greater degree of influence within the boardroom. Arguably the position has now grown to a level where it can be seen as a separate, independent chairman-type role. The lead director is often responsible for dealing with a wide gamut of tasks, from regulatory compliance through to performance evaluation of employees, directors and members of the C-suite. Given the fluid nature of the lead director’s position, there is still no clear universal agreement on the full responsibilities with which a lead director should be charged.

“In many respects, the role of lead director has become pivotal to a company’s operations.”

Many lead directors improve board performance by facilitating discussions around core issues. Furthermore they are also responsible for steering the board’s independent directors towards consensus, and ensuring that that resulting plan is recognised and implemented.

Outside of boardroom discussions, lead directors have begun to assume other duties and responsibilities which have previously fallen within the purview of the chairman or chief executive. One such task is taking the lead when dealing with any difficult or underperforming directors. It is important to remember that although the board is a regulated legal entity, it is still made up of individuals with their own styles, beliefs and personalities. Inevitably there will be clashes and disagreements within such a group, particularly when we consider that boards of directors are responsible for overseeing multimillion dollar companies and budgets. When a disagreement arises, or a director becomes difficult to deal with, the responsibility often lies with the lead director to smooth over the situation. Indeed, dealing with troublesome directors has long been a challenge for boards and the chairman or chief executive. As the lead director often assumes the role of a board facilitator, the onus is on her to mitigate the negative impact of a difficult director on boardroom harmony.

Clearly, lead directors play an important role in the modern boardroom, so it is vital that firms and their governance committees select the right candidate for the position. However, there is no hard and fast rule for appointing lead directors. In many respects the process is rather ill defined. Regardless, boards must have a clear direction and expectation about their particular choice for lead director. Equally they must also allow for a transparent selection process when nominating their candidate. Boards must lay out the core duties and responsibilities that the lead director will fulfil. In some respects the selection process will be very similar to the hiring procedure for other board members.

The selection process of the right candidate should also include other board members. The wider pool of directors can and should have a direct involvement in the selection of the lead director. Also, genuinely engaging with other board members involves them in the process and can help to invest them in the success of whoever is selected to fulfil the role.

When deciding upon a lead director it is important for companies to be mindful of the fact that an effective lead director acts as a go-between for the board and the chief executive. Accordingly the position requires an individual who can effectively and comfortably bridge the gap between the C-suite and the board of directors. Understandably this dual responsibility to both facets of a company’s management structure can be demanding, and will call for an individual with a unique and clearly defined skill set. It is imperative that a lead director helps to create and foster a degree of alignment between directors and the chief executive. In order to achieve this goal the lead director must be able to call on a number of different qualities. She must be able to demonstrate subtlety and nimble-footedness in negotiations with various members of the board, as well as acting as a sounding board for other directors.

However, the lead director must not focus purely on her relationship with other directors. The required three-way communications channels between the board, the chief executive and the lead director must be well maintained in all directions. The lead director must foster strong ties with the company’s chief executive so they are comfortable disclosing information to one another. There should be an air of trust between the two which will allow both parties to speak honestly and freely about the performance of the firm or other directors as well as other important issues.

In securing the most successful outcomes for the company, at times the lead director’s relationship with the board will undoubtedly become frayed. By acting as the go-between for a number of parties she will regularly place herself in a difficult position. To that end she must be willing to report and act upon any behaviour or performances she deems to be unacceptable. Accordingly, the lead director should be involved in the performance assessment of both directors and the C-suite from an early stage. This extends to the performance of the company’s chief executive. The lead director, in conjunction with the board’s chairman, should be in a position to provide a fair and unbiased analysis of the performance of the company’s top executives. Particularly as it pertains to the chief executive, the lead director can help to establish a comprehensive evaluation process and begin to gather detailed feedback from board members on the chief executive’s overall performance.

Lead directors perform a crucial and often sensitive function in today’s boardroom. However, given that many analysts suggest the ideal candidate for the position should lack the ambition for power or to succeed the chief executive, it is clear that firms should look to reward lead directors for their talents in other ways. Accordingly, compensation packages on offer to lead directors are often more lucrative than those given to other board members; it is believed that in the US around 80 percent of lead directors are likely to receive additional compensation. Although this is likely to vary across industries, lead directors often have a retainer around $20,000 to $25,000 more per annum than regular directors.

Born out of regulatory necessity, the lead director has become a vital component in the boardroom for many companies. Yet the role is still in its infancy. It is likely that the position of the lead director, much like prospective candidates for the position, will continue to grow and evolve over time. Selecting the right candidate can be almost as arduous as performing the role itself.

Richard Summerfield