What Lead Directors Do

According to public filings, about 96% of the boards of Standard & Poor’s 500 (S&P 500) companies had a lead or presiding director in 2008. That was not always the case; in fact, that percentage represents a four-fold increase since 2003. The greater prevalence of lead directors is a byproduct of the passage of landmark U.S. corporate governance reform legislation — the Sarbanes-Oxley Act — in 2002. The passage of Sarbanes-Oxley, and the subsequent increase in the number of lead directors, arose from a growing public distrust of management and board “insiders” in the wake of a series of multibillion-dollar financial debacles such as Enron Corp. and WorldCom Inc.

One mandate of Sarbanes-Oxley — which was subsequently clarified by regulations issued by the U.S. Securities and Exchange Commission (SEC) and the New York Stock Exchange (NYSE) — is a requirement that independent directors on the board of a U.S. public company meet not only as part of the full board but also separately and apart from management and non-independent directors. The lead or presiding director role was institutionalized by the need to have a director chair such meetings of the independent directors. (The terms presiding director and lead director have come to be used interchangeably; as a practical matter, the use of the term lead director predominates.)

The new governance rules also required that, generally, independent directors not only constitute a majority of directors on every public company board, but that they have a much greater role in the work of the board committees. For example, companies listed on the NYSE were now required to have audit, compensation and nominating/corporate governance committees that consist only of independent directors. This represented a substantial change. The traditional source of influence on directors had been the CEO and the chairman of the board; historically, their roles had included identifying issues that should be addressed by the board, appointing board committee members and creating the agenda for board meetings.

To understand the emerging role of the lead director in U.S. public companies, my research assistants and I examined SEC filings for S&P 500 companies, which represent a broad cross section of the largest U.S. enterprises. We performed two sets of analyses: our baseline study in 2005, which consisted of an analysis of the 2003 and 2004 annual filings of the of S&P 500 companies, and a more recent study, in 2008, which consisted of a similar analysis of the S&P 500 companies’ 2006 and 2007 filings. An average of 482 companies reported proxy statements for the four reporting years examined. Although there were changes in the membership of the S&P 500 between our first and second study, these changes were relatively few in number and not considered material. Surveys conducted by Chicago-based Spencer Stuart and Los Angeles-based Korn/Ferry International — both executive search firms that recruit board directors — helped shape the study methodology.

In order to provide a context for better understanding the information in the public filings, I also for five years collected anecdotal comments about the role of the lead director made at corporate governance conferences and courses. In this way, I gathered views from directors of various public companies, as well as views from officials of regulatory compliance agencies and exchanges and from shareholder advocates. I also researched the subject using various director education Web sites.

The Lead Director’s Expanding Role

In both of our studies, we found that lead directors’ duties fell into eight main functional categories. In both periods, the most common duties involved chairing meetings of the independent directors and planning board meetings. However, over the period between the studies, the scope of a typical lead director’s responsibilities tended to expand — particularly in the areas of director evaluations, CEO evaluations and relationships with external constituents. Although a majority of the companies studied still do not report that the lead director’s duties include a direct role in the retention of consultants or in interactions with external constituents such as investors, the growth in the percentage that do may indicate a building trend.

Anecdotal evidence suggests that these shifts in the lead director’s responsibilities are consistent with the stated desires of influential political, regulatory and external institutional forces. For example, not only members of the compliance staff of the SEC but also executives from Institutional Shareholder Services (ISS), an influential corporate governance watchdog organization that has been acquired by New York-based RiskMetrics Group Inc., have spoken in public presentations about the lead director’s responsibility to lead independent directors in challenging senior management on behalf of shareholder interests. To independent auditors and to the entity that evaluates their performance in the United States, the Public Company Accounting Oversight Board (PCAOB), a lead director is both leader of the independent directors and the de facto alternative to the CEO and CFO for obtaining certain guidance, assurances or even approvals.

Independent directors tend to be solidly behind the more activist definition of the lead director’s role. Because the independent directors’ role has been made so pre-eminent, both their duties and also their exposure to criticism and legal liability have increased. Board processes have become more formalized, with previously routine decisions now being subject to the advice of legal counsel. The workload of independent directors has increased, and the need for greater coordination of the committee work performed by independent directors translates into increased frequency in communications among independent directors and the lead director. Perhaps not surprisingly, our 2008 study found that 83% of lead directors spend more than five hours per month on their lead director role, and 48% spend more than 10 hours per month on their lead director duties.

Lead directors may help other directors in obtaining formal information, but their real value is in providing the informal insight that properly frames the issues. Many times, it is the decisions that management did not make or issues that were not brought to the attention of the board that worry board members. Although it is not possible for a lead director to know everything that is going on in a company and its relationships, a lead director who is inclined to get and stay involved provides a level of assurance to the other directors that the major issues are being examined.

The appointment of the lead director is made, typically, from the independent directors of the current board; rarely is a lead director specially recruited from the outside. It should be noted that SEC filings indicate that most boards do not routinely rotate the lead director’s appointment among board members. This suggests that independent directors choose the person whom they are comfortable with and who has demonstrated a willingness to make the time commitment.

How will the role of the lead director continue to evolve? There is anecdotal evidence that suggests that some lead directors have taken a more active role in the recent financial crisis — particularly in activities associated with bank loans, mergers, bankruptcies and liquidations. This emerging trend fits with our research data, which seem to suggest that the lead director’s role is beginning to evolve to include more direct engagement with credit partners, regulatory bodies and the media. This may be especially true in times of crisis, when the CEO is faced with a multitude of challenges.