Why Age Limits Don’t Work

Much has happened to the banking world in the past eight years. Mobile check deposits have become commonplace and fintech companies have upended what consumers expect from their financial institutions. Even the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act took place within that time frame.

Eight years also is the average tenure of a director at S&P 500 financial institutions and banks. And it’s within the director group where the bank searches for the acumen to guide management as it adjusts to those trends. Yet, bank boards, by-and-large, don’t have the proper tools in the arsenal to ensure their directors have the strengths to accomplish that level of oversight or to upgrade the board when strategies change.

Many boards use age limits-and to a much less extent term limits-to filter in new talent, and remove underperforming directors. While most studies will only look at the largest public banks, it’s an issue that permeates throughout all financial firms, including small ones-where boards often consist of family members or large stakeholders-says Eric Fischer, a former senior fellow at Boston University’s Center for Finance, Law, & Policy and former general counsel at the Boston-based bank holding company, UST Corp., which was purchased by Citizens Financial Group in 2000. And the limits are holding banks back.

“Retirement age policies and term limits are very blunt, imprecise instruments,” says Fischer. “[They] mask the real issue of how to improve the compilation of your board. The leadership of the board doesn’t have the courage to address the hard social issues to get rid of under-skilled or underperforming directors.”

This creates problems internally, breeding hostility. PwC, in its annual study on board composition, found that 46 percent of directors believe at least one peer should be replaced, either due to performance or changing strategies within the company. The rate ticks even higher when asking a director who has tenure of less than two years. But PwC has also found that a board in which the CEO fills the chair role is less likely to do anything about an underperforming director. Large banks and capital market companies have the highest rate-86 percent-of chairs who also serve as CEO.

“CEOs like directors they can count on to back their directions,” says Fischer, adding it’s a reason why you may not want to link the two roles. There is some evidence that boards may be struggling with the usefulness of age limits, by raising the age limits over time.

According to new data from the executive search firm Spencer Stuart, the age in which mandatory retirement kicks in for directors has jumped at the largest financial firms. In 2007, only 8 percent of firms had a retirement age of 75. That has moved to 28 percent. While 72 remains the most popular mandatory retirement age, it has fallen from 44 percent in 2007 to 36 percent today. What these age limits do is create a “mechanical way” to update the board leadership, says Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute, but “some function well at 75 and some don’t function well at 55.”

Instead of using age limits, companies should develop strong evaluation processes for individual directors, and use the findings to make changes. “What’s the downside?” says Paula Loop, head of PwC’s Governance Insights Center. “There’s a lot of positives with feedback. If you have directors that are not performing well, [they] have the opportunity to improve.” It also helps young directors to understand the skills that they need to hone, in order to better handle the responsibilities.

Many banks, for years, have had some form of evaluation, in part to ease regulator concerns. But these typically look like annual questionnaires and evaluate the overall board’s performance. It’s usually on the chair to determine whether to treat those evaluations as check-in-the-box exercises for compliance purposes or tools to make changes when necessary.

Lukomnik argues that the evaluation questions shouldn’t focus on simple stuff, like punctuality, but instead consist of reviews where each board member explains the strengths and weaknesses of his or her peers. “Trust and confidentiality matter” in this type of evaluation, says Lukomnik.

“Boards will tell you it ruins the camaraderie of the board if they’re evaluating each other,” says Julie Hembrock Daum, Spencer Stuart’s head of its North American board practice. But banks might not have the chance to decide for themselves, anymore. The Federal Reserve is currently considering rules that update expectations related to risk management for large financial institutions. Of the changes, a stronger board self-assessment may become a requirement, even as other areas of oversight are loosened. “An effective board assesses its strengths and weaknesses, including the performance of the board committees, particularly the risk, audit, and other key committees,” the proposal states.

While these rules would become binding for banks with over $50 billion in assets, regulators will use them to assess management ratings at smaller banks, according to Fischer. It will have a “spillover effect in what is good governance,” says Fischer.

In the end, it likely comes down to the bank’s chair whether the board’s current process provides the board with enough flexibility to adapt to changes, by utilizing the assessments to fix weaknesses at the board level.

“The truth is, most every board knows whether or not a director or multiple directors are either not doing the job, or more likely doing it adequately,” says Lukomnik. It’s up to the board to decide if “adequate is good enough,” he adds.