Director Rotation

What Is Director Rotation?

Director rotation is a process of limiting corporate board members service lengths and having them vacate their positions. A policy regarding director rotation, or rotation of directors, may be included in a corporation's corporate governance policy or articles of incorporation. The corporation's policies might specify the term that each member can serve as well as the number of board positions that will be up for re-election each year.

Director rotation can also be a process to rotate board members between various committees or the rotation of board chair roles.

There is no universal or blanket policy for corporate governance and director rotation. Corporate boards must weight the pros and cons of rotating their members.

Understanding Director Rotation

Every public company is required to have a board of directors, which is a group of elected individuals that have the responsibility to represent the shareholders of the company. A board's role is to create policies for oversight and corporate management as well as help the company's executives make sound decisions regarding any issues the company might face.

A typical director rotation policy might stipulate that one-third of the directors will "retire by rotation" — vacate their positions — leaving them open for new directorship each specified period. The directors that have served the longest will be included in the one-third to retire by rotation. Directors are typically elected at the corporation's annual meeting.

Reasons for Director Rotation

There are various reasons that companies rotate their directors, and the process has its advantages and disadvantages.

Director rotation helps develop strong corporate governance practices. Governance involves establishing corporate policies, rules, and resolutions that cover corporate behavior. One of the goals for good corporate governance is to have a transparent process in place that includes a set of rules and controls.

Companies today must not only produce consistent earnings, but also exhibit positive behavior in the community through environmental responsibility, ethical behavior, and corporate citizenship. If companies fail to live up to their corporate governance and citizenship responsibilities, the executive management and the board of directors may feel the ire of their shareholders.

The Securities and Exchange Commission (SEC) is a federal agency responsible for maintaining a fair and orderly functioning of the markets while being charged with protecting investors. In 2015, then-Commissioner Luis A. Aguilar of the SEC touted in a speech the importance of corporate directors.

"Ultimately, the quality of a company’s corporate governance infrastructure can provide a window into the effectiveness of the board of directors’ oversight of the company for the benefit of shareholders and the long-term health of a company." — Sec.gov

Director rotation also helps to reduce entrenchment, conflicts of interest, and encourage new leadership.

Disadvantages to Director Rotation

However, a disadvantage to director rotation is that it can weaken the knowledge and experience levels of the corporate directors. Board members with lengthy tenures often know the business well, meaning they've led the company through the good times and the bad.

Another disadvantage of rotation is that it might encourage short-term outlooks and overly risky behaviors. However, companies that limit the rotation to one third or less help alleviate these disadvantages since the majority of the board members would remain to help maintain balance and provide experience.

Corporate board performance is continuously under experimentation. However, there is no standard policy for corporate governance or director rotation. Corporate boards must weight the pros and cons of rotating their members and the impact on the company and its shareholders.