With proxy season now upon us, we at Westlaw Business see it as our job to inform you of the top issues raised in recent proxies, SEC correspondence and other related documents.  With difficult economic conditions and increasing shareholder activism, this year’s proxy statements require a degree of re-thinking not seen for some time.  To help you with that, we’ve begun this series, covering must-haves in this season's proxies.

Are incredibly shrinking boards the latest casualties in our era of dividend cuts, salary caps and workforce reduction?  Though they have positive expense ramifications, these cuts are not to be made lightly.  In an evolving trend, they are joined by still other board cuts that companies are not driving.  Some board members are departing, seemingly intent on reducing their risks or simply the exhaustion ensuing from our risk-filled era.  Together, a range of governance concerns results, with critical implications to companies in this hazardous time.

Daunting new legal and economic circumstances are already challenging boards.  Some companies are now wrestling with their boards shrinking in size and how both to represent shareholders and to govern effectively.  All of this in an age where boards have become increasingly important as not only a provider of strategic guidance to management, but also as an inhibitor on management’s actions when they run counter to the interests of shareholders.  Further, the board’s committees form the “plumbing” for key functions overseen by the board. By law, companies must have three board committees, audit, compensation and nominating.  In addition, companies will sometimes tack on their own home-grown committees to this list including, executive, governance, and independent directors committees.

In the face of all of changing corporate needs, a new trend is emerging – boards are not growing, but rather shrinking. Voluntary board reductions have been announced at companies from retailers to energy. As one example, Eddie Bauer announced on January 27 the reduction of its board from ten members to seven. The reduction is being carried out in the context of an overall cost-cutting measure which includes a fifty percent reduction in the cash compensation and a reduction in the value of equity grants for the remaining board members.

Eddie Bauer’s governance issues are not insubstantial, leaving shareholders to wonder whether financial savings are worth the loss of business experience.  Two of the individuals served on the nomination and corporate governance committee and one served on the compensation committee. Edward Straw, one of the members voluntarily stepping down, served as interim chief executive officer from February to July 2007. Board independence is less of a concern: the remaining board is made up almost entirely of independent members except for the chief executive officer.

Board-related cost cuts are being implemented in other companies as well. Manas Petroleum, an oil and gas exploration company headquartered in Switzerland, is reducing its board from six to five members as well as reducing salaries on the remaining members. On February 23 Energy Partners Ltd., also an oil and gas exploration company, announced the restructuring of its board, reducing it from eleven to seven members. This is being done in conjunction with the retention of a financial advisor to assist in the exploration of strategic alternatives for the company.

Involuntary reductions are also a sign of our times.  The increased risk profile, scrutiny, and workload associated with board membership may be getting to some.  Along with age-driven resignation (whether driven by mandatory retirement policies of companies or exhaustion), companies are losing wisdom and experience.  Regardless of the reason, the departures will require finding qualified nominees, particularly for such important roles as the designated financial expert on audit committees. Companies such as Hershey and General Motors have announced director resignations within the past 90 days.

The risks of shrinking boards to governance are many. While always important, the board’s importance actually grew following the scandals involving Enron and Worldcom as its role as protector of shareholder interest was enhanced.  The implementation of Sarbanes-Oxley came with the requirement for an independent board.  This group, separate from management’s interests, is to oversee sound corporate governance practices. Limiting the number of board members may potentially impact both the independent status of the board and its ability to adequately exercise its business judgment around issues ranging from compensation to takeovers. This may be of particular concern where there is no separation of the board chairman and the chief executive officer.

As firms continue cut costs, they may consider board reductions as potential solution. This decision will need to balance the predicted cost savings with a corresponding loss in corporate governance experience. Boards may need to ultimately justify whether these economic decisions were strategically prudent.

Published: March 5, 2009