Does Length of Director Tenure Impact Investment Performance?

By Robert Lewenson – ESG Engagement Manager

With the current spotlight shining on corporate governance practices, boards of directors are under much scrutiny with regards to myriad factors such as credentials, remuneration, independence, demographics and tenure.

With respect to tenure, an oft held view is that entrenched board composition compromises board independence; diminishes a board’s effectiveness in representing the interests of shareholders; discourages diversity and fresh ideas; and stifles robust debate. On the other hand, it has been argued that entrenched directors contribute an invaluable degree of knowledge and deep business experience to the business.[1] 

What are entrenched boards?

There are various ways to understand what an entrenched board means. MSCI defines an entrenched board as one where any of the following conditions are true:

• More than 35% of the board has a tenure greater than 15 years
• There are more than four directors whose tenure is greater than 15 years
• There are more than four directors who are over 70 years old
• More than 22% of the board has a tenure greater than 15 years AND more than 15% of the directors are over 70 years old.

This article refers to entrenchment from a tenure and, thus, experience point of view only. To be clear, I am not discussing boards on which the directors are strongly protected from removal by shareholders, nor am I discussing boards where family-controlled companies prevent the appointment of new directors from outside of the family. . In fact, both instances are associated with, and indeed even partly responsible for, an economically significant reduction in a firm's value[2]. 

So, in considering performance from a purely investment return perspective in an emerging market context, does tenure-based entrenchment add to or detract from company performance?

Entrenched boards and the link to investment returns

In a recent report[3], MSCI presented evidence from both developed and emerging markets that long-term results suggest that investors should indeed consider the involvement of entrenched boards, as a potentially positive, rather than a negative, attribute.

Let’s take a look at the effect of entrenched boards on long-term performance of companies in emerging markets. The following chart[4] shows a significant gap in the percentage of total shareholder return which accrued to entrenched board companies over a five-year period versus companies with non-entrenched boards during the same period. 

The gap is significantly higher for family companies and even more so for founder companies (the founder is the only family member involved with the company and does not have negative control of the company).  While we may look at other indicators for performance, we do see an important measure in what companies return in share price and dividends to shareholders/investors in the long-term, in relation to the nature of their board composition as determined by age and tenure.

¹ Chintrakarn, Pandej and Jiraporn, Pornsit and Tong, Shenghui and Kitsabunnarat-Chatjuthamard, Pattanaporn, Estimating the Effect of Entrenched Boards on Firm Value Using Geographic Identification (November 14, 2014)

[2] In The Costs of Entrenched Boards, Bebchuk, L. A., and A. Cohen, 2005, Journal of Financial Economics, the authors ask if the market value of public companies in the United States is related to whether a firm's board of directors is strongly protected from removal by shareholders. In South Africa, Pick n Pay has been criticised for allowing family members to manage the company for too long “When family outstays its welcome at its own firm” A. Crotty Sunday Times 9 August 2015

[3] Ric Marshall, MSCI, Entrenched Boards: Director Tenure and Performance (April 2015)

[4] Ric Marshall, MSCI, Entrenched Boards: Director Tenure and Performance (April 2015) Figure 3

FirstRand Limited – entrenchment and performance 

Let’s take a look at a local example of the link between tenure-based entrenchment and performance in a well-known South African (SA) company. Figure 2 is a summary of the Board of Directors of FirstRand Limited * [1]:

[1]We choose FirstRand Limited as it fell into the Top 25 MSCI ACWI ex-US companies with entrenched boards as of 30 April 2015

*At time of writing CEO Sizwe Nxasana has stepped down from his post effective 1 October 2015 and Johan Burger will assume the role.

As you can see, with five directors with tenures exceeding 15 years, according to point two in the definition of entrenched boards set out above, this Board is entrenched. So what does this mean in terms of performance? Well, FirstRand Limited is the best performing bank in the SA banking sector over five-years on annualised total shareholder return basis (Source: Bloomberg). 

According to Tracy Brodziak, Head of Research for Old Mutual Equities, which is part of South African-based asset manager Old Mutual Investment Group, entrenched boards based on tenure may well contribute to performance, “In our view, an entrenched board is not necessarily a negative. We prefer to evaluate a board of directors in terms of how they have actually managed a company and the results of their capital allocation decisions. A company like FirstRand may have an entrenched board – but that board has years of experience. Also, a number of directors have a significant portion of their personal wealth invested in FirstRand and have acted like “owners” of the business.  They have made excellent capital allocation decisions and we have been very happy shareholders.”

Conclusion

As we have seen from the above analysis, SA companies with entrenched boards may well drive greater investment performance than their competitors, owing to the length of company specific experience.

As responsible investment managers, among many other considerations, we consider the quality and experience of the members of the boards that govern our investee companies, and have a view that long tenure may be a positive indication towards the investment case.  However, this may not be applicable where they are entrenched by virtue of enjoying strong protection from removal by shareholders in the company’s constitutional documents or otherwise.