Is an Independent Chair a Best Practice?

Independence is a foundational principal in corporate governance.

Many good governance proponents would argue that corporate boards should be comprised primarily of outside directors who meet the legal definition of independence. In laypersons’ terms, this means they are free of any conflicts of interest that would prevent them from discharging their fiduciary responsibilities to the company’s owners.

Likewise, many governance experts would say that splitting the chair and CEO roles between two individuals also is a best practice. In this instance, the chair would be an independent director who focused their attention on managing the board, while the CEO ran the company.

Having an independent chair can be especially helpful when the board has appointed a new CEO who has never held that position before; the chair can focus on board governance while the CEO transitions into their new role. Splitting the jobs can also provide a check on an overbearing CEO who might dominate the board if they were also the chair.

This approach would seem to enhance the board’s independence, but is it a best practice? And does splitting the chair and CEO roles necessarily improve the company’s profitability?

Results from Bank Director’s 2020 Governance Best Practices Survey suggest that most bank boards have a majority of independent directors. The survey included 159 independent directors, chairs and CEOs at banks under $50 billion in assets. It was sponsored by Bryan Cave Leighton Paisner.

Forty-four percent of the survey participants say they have just one inside director on their boards, while 27% have two, 12% have three and 18% have more than three. An inside director is normally a member of management. Survey banks with more than $10 billion in assets were more likely to have just one inside director, while banks under $500 million in assets were more likely to have multiple insiders on their boards.

A majority of survey participants — 58% — have an independent director as their board chair, while the CEO was also the board chair at 31% of the respondents. Interestingly, survey banks under $500 million in assets were more likely to have split the chair and CEO roles (73%), while banks over $10 billion were less likely to have dual roles (50%).

James McAlpin Jr., a Bryan Cave partner who leads the firm’s banking practice group, says that while a combined role can make a difference in a situation where the board has to replace the CEO because of a performance issue, he does not consider it to be a best practice.

“Maybe 10 years ago I would have said, ‘Yes, it is a best practice for the chair not to be the CEO,’ but I have changed my opinion,” McAlpin says. “I do think it absolutely matters who the individual is. And in an instance where you have a well performing and highly respected CEO, it may make the most sense for that person to be the chair because they often want to run the board. And it would be difficult to retain them if they are not the chair.”

McAlpin’s point speaks to a simple truth at most banks: It is the CEO who drives the company’s performance, not the board or an independent chairman. A strong governance culture can certainly have a positive impact on a bank’s financial performance by establishing an effective risk management culture, adopting compensation practices that reward high performance and making sure that a capable CEO is in place. And an independent chairman can provide a CEO with an important sounding board if the two have a good relationship. But the CEO runs the company, not the board or the independent chair.

“I’ve never seen a study of this, but I doubt you would see any statistical advantage in terms of performance for having an independent chair,” McAlpin says. “In fact, it might be the opposite where the banks perform better if the chair and CEO are the same person.”

Greg Carmichael was not given the chairman’s title when he became the CEO at Fifth Third Bancorp, a $203 billion regional bank in Cincinnati, in November 2015.

“When we made the transition to myself as the new incoming CEO, we elevated our lead director to become the chairman for a period of time,” Carmichael explains. “It was decided and voted on when I became CEO that at some point I would become the chairman. And that time frame was roughly two years. They didn’t want to put the burden of the chairman role on me initially, which was appropriate. They also wanted to make sure that I had a chairman in place to help me through that transition to CEO.”

Carmichael was later appointed chairman in January 2018, and he says it was helpful that initially he could just focus his attention on running the company. “When you become a new CEO, you’re drinking from a fire hose and you’re just inundated with a ton of information and there are things you have to demonstrate and manage that take a lot time,” he says. “You have to get your operating rhythm in place. You have to get your credibility with [Wall Street], with your own organization; you have got to chart your vision, what you’re about and where you’re taking the company, and that takes an inordinate amount of time your first couple of years. They didn’t want that to be encumbered by me worrying about the board dynamics and the board meetings and so forth.”

Marsha Williams, Fifth Third’s chair during Carmichael’s early years as CEO, had served on the bank’s board since 2008; prior to her elevation, she had been the board’s lead director for two years. “It was very helpful to me because I had a great relationship with Marsha and it was always just a reassuring conversation or good guidance if there was input on something she thought was important,” he says.

After Carmichael assumed the title of chairman, Williams returned to her previous role as the board’s lead director. Carmichael says they continue to work together well. “There’s probably not a week that goes by that we don’t talk,” he says. “She’s a great sounding board on ideas and thoughts that I have. She’s good at giving me independent feedback from the board [about] things they’d like to hear more about.”

Carmichael’s relationship with Williams highlights the importance of having a lead director when the CEO is also the board chair. Lead directors have less authority than board chairs, but they can help build an important bridge between the CEO and the independent directors.

Unfortunately, of the survey banks that have appointed an independent chair, only 55% have also appointed a lead director. “I think having a lead director is a best practice,” says McAlpin. “It’s important to have someone [the CEO] can talk to without having to talk to the entire board to bounce ideas off. I think it’s important for both the board and the CEO.”

A Director’s Viewpoint: What Makes a Good Bank Director?

bank-director-12-18-15.pngI’ve been on four bank boards, and currently serve on the board of Pacific Premier Bank, a $2.7 billion asset bank based in Irvine, California. On two boards, I was chairman and CEO, and I figure I’ve served with about 40 different individual board members over the past 30 years.

Unlike many people, I don’t believe that boards are the key to a bank’s success. I think it’s the CEO, with the board playing the key role of choosing and retaining the right person as CEO. I’ve even said, half jokingly, that a board could meet once a year and have only one agenda item, which is whether or not to renew the CEO’s contract for the coming year.

But what actually makes for an effective director? First, those directors who talk the most at board meetings are not necessarily the most effective. I’ve had directors who rarely said a thing at the meetings but who proved extraordinarily helpful during one-on-one sessions prior to or after formal board meetings. I had one director when I was CEO who was a very successful subdivision developer. He was shy and uncomfortable talking in group settings, but once a month he’d come to the bank and we’d spend about an hour going over things. He asked good questions and was very helpful with his thoughts on our longer-term strategy. His name almost never appeared in our board minutes, and if you didn’t know better, you might have thought he was a non-factor. The reality was that he was one of the best directors on that board. His effectiveness was simply behind the scenes and in private.

Second, there are directors who get involved in very special situations where they make a big difference. One was a private equity investor in a bank where I was chairman and CEO. It was a turnaround situation, and once we returned the bank to profitability, we decided to sell it. This director had been involved in the sale of countless companies his firm had invested in, and he offered to help me out. While I had spent a career in banking, I had no experience in negotiating the sale of a bank. This director really ran the show when we sat down with the chairman/CEO of the bank we chose to sell to. He got us a vastly better deal than I could have. His private equity firm had never invested in a bank before, but there is an art to selling a company, regardless of the sector, and this individual was an artist.

Another director on the board when I served as the CEO ran a large fixed income operation, and he, too, rarely spoke at our board meetings. However, he probably saved us from failing almost before we got started. Our bank was active in originating and securitizing mortgages. We did one of our very first trades with Drexel Burnham, and on the day it was supposed to settle, this director called me at home around 5:30 a.m. West coast time. He remembered that we had voted to approve Drexel as a counter-party, and he remembered from our board package that we had some trades that would be settling a few weeks after our board meeting. He told me that morning that there were rumors that Drexel might fail to open for business that day and to call him the moment I got to the office.

My blood turned cold as I realized what a Drexel failure would mean. Fannie Mae would deliver our mortgage-backed securities to Drexel, and if Drexel filed a bankruptcy, as they did later that morning, we’d be one of thousands of creditors standing in line asking the courts to release our securities. I was pretty certain what our regulators would do. They’d most likely want us to write off the security and take a recovery when we finally got our hands on it. This write down could have impaired our capital, and coming off the thrift crisis, the regulators were in no mood to be forgiving. Anyway, this director told me exactly what to do. He told me to call Fannie Mae and have the security sent to Goldman instead of Drexel, and while the trade would initially fail, at least it wouldn’t be tied up in a Drexel bankruptcy. We scrambled to get approved by Goldman, and it all worked out, but none of this could have happened without the help of this one director. These two directors seemed very disengaged at the board meetings, and it would have been easy to criticize them for almost never participating in any discussions. But in both cases, if only in those single situations, both were extraordinarily effective in helping the bank.

The only bad director I can think of in the past 31 years was one who constantly meddled and tried to run the bank. It’s an old cliché that directors direct and managers manage, and this one individual would write me extraordinarily long e-emails almost every day telling me exactly what I was to do. Dealing with him was a drain on my time, and he alienated other board members. He even got in fights with our regulators, further proving how counter-productive he was. I could handle the occasional spell check director. It’s not that helpful when a director reading board reports says, “I think you misspelled a word in the third line of the second paragraph on page 47,” but it’s only a minor irritant.

What I didn’t appreciate was one director who never looked at his package until he showed up. We used to FedEx them four to five days before board meetings, and he’d show up with his FedEx envelope sealed, and he’d open it when he showed up for the board meeting. Reading a board packet is pretty much a bare minimum for being a board member, and I resented his unwillingness to do this basic homework. Finally, I have found that board members who’ve served a long time can serve a valuable purpose. Having a director with institutional memory can be helpful in many ways, and especially so, I think, when there’s a new CEO or new directors.

Do I view and judge directors differently having served both as an independent director as well as an inside one? I think I do. When I was a CEO, I’d be sometimes frustrated by directors who might not seem to understand some aspect of banking that I assumed they should know. I tried not to let my frustration show, but I don’t think I was always successful. As an independent director now, I’m a lot more tolerant. I can appreciate how difficult it is to learn certain things when you’re only exposed to them at a monthly or quarterly board meeting.

If I were to re-do my tenure as a chairman/CEO, I’d try to make it easier for board members to feel free to ask things that they were afraid to ask. The 40 or so directors I’ve known were all highly intelligent, and my appreciation of the ways directors can bring their intelligence to bear has only grown over the years.

Is Your Board Suitably Engaged?

board-effectiveness-9-2-15.pngI was in a board meeting the other day for one of my community bank clients. The president of the bank, let’s call him Hank, had just finished giving a presentation to the directors about a new product that the bank was considering rolling out. When the president finished giving his presentation, the chairman leaned back in his chair, locked his hands behind his head and declared: “Well, that was a very nice presentation Hank. Frankly, if it is good enough for Hank, it is good enough for me.”

Suffice it to say that this vignette does not depict a highly functioning board of directors. Sadly, however, it is not uncommon to hear similar conversations in boardrooms across the country, particularly in smaller community banks. It is this type of deferential attitude that can result in regulatory fallout for directors and the institutions they serve. Most lawsuits brought by the Federal Deposit Insurance Corp. in the wake of a bank failure are brought on the basis of the board being “asleep at the switch.” This article will provide a couple of helpful tips that you should consider implementing to make sure that your board remains suitably engaged to oversee the bank’s management and create maximum value for the institution’s shareholders.

  • Your board should reflect the make-up of the bank’s customer base and the communities it serves. A diverse group of directors representing the predominant industry groups in your bank’s markets will ensure that your board has the appropriate expertise and understanding of the unique issues facing the bank and its customers. This will help you ask the right questions and accurately evaluate the risks presented by customers and other issues the bank faces.
  • Choose a strong, but thoughtful chairman. Oftentimes, a board can be dominated by the individual running the meetings and decisions of the board largely reflect the thinking of the chairman. While it is important to select a chairman who is not afraid to make decisions, that person should also be open and thoughtful to differing opinions and should not discourage robust discussion of the issues. To this end, it is often a good idea to bifurcate the role of chairman from the CEO of the institution. An independent chairman can maintain an objective perspective and not develop tunnel vision, which can often result from being “too close” to the issues.
  • Maintain board visibility during regulatory examinations. One thing that bank examiners like to see is that the board’s engagement extends beyond the boardroom itself.  It is a good idea to have representatives from the board of directors stop in to see the examiners once or twice during the examination process. It can be as casual as simply checking in to make sure everything is going alright, or to answer any questions that have arisen during the exam that have not yet been adequately addressed by bank personnel. Examiners are often impressed when board members take an active interest in the examination process and engage with the examiners other than during the meeting to present the results of the exam.
  • Don’t let your meetings get hijacked by one issue. It is very easy for one issue to dominate a board meeting, particularly an issue that a number of the directors are passionate about. It is critical to maintain a manageable agenda and to have appropriate leadership to be able to stay on task during meetings. Otherwise, one of two things can happen: (i) other equally important issues can be given short shrift and hasty decisions can be made, or (ii) meetings can drag on for hours and directors can become more interested in their other obligations than in the business at hand. If it appears that a more robust discussion on an issue is warranted than the allotted time would permit, the chairman should table the issue for the next meeting (or a special meeting if time is of the essence), in order to make sure that appropriate consideration is given to all agenda items.

The items covered in this article only scratch the surface of how to keep your board suitably engaged. The important take-away, however, is that a failure to adequately run the board could result in significant harm to the institution and personal liability for the directors. The board of directors of an insured financial institution is the gatekeeper of the institution and should actively and meaningfully participate in overseeing and directing the operations of the institution.