10 years later: Sarbanes-Oxley Act Continues to Shape Board Governance

Landmark governance legislation set off broad changes in corporate governance, including board independence, board and audit committee composition and audit committee processes

Jul 30, 2012, 14:49 ET from Spencer Stuart

NEW YORK, July 30, 2012 /PRNewswire/ -- Ten years after the Sarbanes-Oxley Act and a slew of exchange listing requirements ushered in a new era of corporate governance, U.S. public company boards today are more independent from management, more financially savvy and more diverse. Signed into law on July 29, 2002, the Sarbanes-Oxley Act was intended to improve the audit process and internal controls, increase board independence from management, and improve disclosure and transparency. 

Data compiled as part of the 2012 Spencer Stuart Board Index demonstrates some of the ways boards have changed in the past 10 years and highlights trends in the composition and governance practices of corporate boards.

Board independence

Although Sarbanes-Oxley did not expressly address board composition, increasing the independence of public company boards was a primary objective of the legislation. Listing requirements established by the New York Stock Exchange and NASDAQ at the time established definitions for independent directors and required that independent directors make up a majority of a listed company's board of directors.

  • The percentage of independent directors on S&P 500 boards has increased from 79 percent in 2002 to 84 percent in 2012.
  • In 2002, the CEO was the only non-independent director on 31 percent of S&P 500 boards compared with 59 percent of boards today.  

Boards have gradually adopted models of board leadership intended to increase the independent oversight of the board, including the separation of board and CEO roles and the rise of lead and presiding directors.

  • In 2002, one-quarter of S&P 500 boards separated the chairman and CEO roles, compared with 43 percent in 2012. Meanwhile, 23 percent of S&P 500 boards in 2012 have a nonexecutive chairman who is truly independent, an increase from 13 percent in 2007.
  • Following the passage of Sarbanes-Oxley, many S&P 500 boards moved quickly to establish a lead or presiding director role. By 2004 (the first year Spencer Stuart tracked this data), 85 percent of S&P 500 boards had a lead or presiding director. Initially, more boards created a presiding director role, often rotating the responsibilities among committee chairs or independent directors. Over time, as boards clarified the role, more named lead directors and granted them more authority. Today, 92 percent of S&P 500 boards have a lead or presiding director.

Audit committee independence and expertise

A key focus of Sarbanes-Oxley was to improve companies' financial reporting and internal controls. It established financial reporting and disclosure requirements, set standards for audit committee activities and membership -- requiring, for example, at least one audit committee member who has previous accounting or financial management expertise -- placed oversight of the accounting firm with the audit committee and raised expectations for the financial literacy of the audit committee.

  • The percentage of chief financial officers, treasurers or other financial executives serving as the audit committee chair increased from 4 percent in 2002 to 33 percent today.
  • In 2003 21 percent of boards reported having a financial expert -- 146 financial experts in total -- versus 2012, when 100 percent of S&P 500 boards report having at least one financial expert for a total of 1,096.
  • As the job of audit chair has become larger and more demanding, fewer active CEOs and other top corporate leaders -- but more retired leaders -- are serving as audit committee chair. Active CEOs, chairs, presidents and chief operating officers made up 27 percent of audit committee chairs in 2002 versus 10 percent today, while retired executives have become more likely to serve in the role, 18 percent in 2002 versus 30 percent today.
  • Audit committees meet more often than in 2002. On average, S&P 500 audit committees had five meetings in 2002 versus 8.7 in 2012

Director recruiting and board composition

In response to new listing rules requiring that board nominating and governance committees be composed solely of independent directors, these committees assumed the primary responsibility for director recruitment, many adopting methodical and rigorous recruiting processes with an eye to bringing real value and a sense of purpose to the group with each new addition. Meanwhile, an increase in the demands on the board caused sitting CEOs to reduce their outside board commitments.  As a result of this new recruiting mindset and process, the mix of directors around the board table looks quite different today.

  • As boards recruited additional independent directors and "financial experts," we witnessed an increase in the number of new directors on the S&P 500, peaking in 2004 with a total of 443 new independent directors.
  • The percentage of S&P 500 boards with a nominating committee made up entirely with independent directors rose from 75 percent in 2002 to 99.6 percent in 2012.
  • The average S&P 500 CEO sits on .6 outside boards today, half the 1.2 average in 2002. Today, 54 percent of S&P 500 CEOs do not sit on any outside boards, compared with 48 percent in 2007.
  • Active CEOs, chairs, presidents and COOs represented 41 percent of new S&P 500 board directors in 2002, compared to 25 percent today. With fewer active CEOs serving on boards, many companies are turning to executives the next level down. Leaders of major business divisions and functions make up 22 percent of new directors today, compared with just 7 percent in 2002.

Ongoing change

The evolution of board governance did not end with the adoption of Sarbanes-Oxley and the implementation of new listing requirements. Boards have continued to evolve their practices on their own or at the behest of shareholders. Among the other significant changes in the past 10 years include the following:

  • Succession Planning. Sarbanes-Oxley brought about the unambiguous ownership of CEO succession by boards. The 2009 SEC position in support of shareholder proposals for enhanced disclosure on succession planning placed further emphasis on transparency. In 2012, 96 percent of S&P 500 boards discuss CEO succession planning in their corporate governance guidelines, reporting that they have both long-term and short-term/emergency plans in place. 63 percent report discussing succession plans annually.
  • Annual director elections. A high priority for advocates of corporate governance reform, annual director elections have become the norm for corporate boards in the span of a few years. The number of S&P 500 boards holding annual elections of directors has more than doubled since 2002. In 2002, 59 percent of S&P 500 boards had three-year terms and 40 percent had one-year terms; today 83 percent have one-year terms and 17 percent have three-year terms.
  • Annual board and director evaluations. Listing requirement made annual committee evaluation mandatory. Today 98 percent of S&P 500 boards report that they conduct some form of board evaluation annually versus 90 percent in 2008. 31 percent evaluate the full board, committees and directors versus 17 percent in 2008.
  • Mandatory retirement. More S&P 500 boards have mandatory retirement ages today, 55 percent in 2002 versus 73 percent in 2012. But among companies that have one, mandatory retirement ages tend to be higher today than in 2002. Eighty-five percent of S&P 500 boards today have a retirement age of 72 or older, compared with 36 percent in 2002. The average age of S&P 500 boards also has increased, from 60 in 2002 to 62 today.
  • Director compensation on the rise. The SEC executive compensation disclosure rules that took effect at the end of 2006 provided more transparency into total director compensation. The average total compensation among S&P 500 boards has increased by 11 percent in the past five years, from $217,586 in 2007 to $242,385, and the mix of director compensation has changed as well. Stock options and board meeting fees are a less common component of director compensation, falling from 42 percent to 25 percent and 52 percent to 33 percent, respectively since 2002.

About the Spencer Stuart Board Index: The Spencer Stuart Board Index tracks trends in board service, the careers and backgrounds of new directors, and the policies and processes of S&P 500 boards. The 2012 index draws on the latest proxy statements from 486 companies filed between May 15, 2011 and May 15, 2012. The SSBI will be published in its entirety and posted on Spencer Stuart's website (www.spencerstuart.com) in November 2012.

About Spencer Stuart

Spencer Stuart is one of the world's leading executive search consulting firms. Privately held since 1956, Spencer Stuart applies its extensive knowledge of industries, functions and talent to advise select clients -- ranging from major multinationals to emerging companies to nonprofit organizations -- and address their leadership requirements. Through 53 offices in 29 countries and a broad range of practice groups, Spencer Stuart consultants focus on senior-level executive search, board director appointments, succession planning and in-depth senior executive management assessments. For more information on Spencer Stuart, please visit www.spencerstuart.com.

SOURCE Spencer Stuart