Board Search Firms Take Some Rare Fire

Board search firms have long been considered the best vehicles for finding high-quality new directors who meet the U.S. stock exchanges’ definitions of independence and are outside the CEO’s network of friends, neighbors and relatives. But corporate governance experts are beginning to challenge that assumption, suggesting that search firms tend to recommend individuals who won’t question the CEO too closely. Critics also claim that recruiters proffer the same candidates again and again.

Lauren Cohen, an associate professor at Harvard Business School who presented a research paper on director recruiters at the University of Delaware’s 2012 Corporate Governance Symposium, found that companies using board search firms to find directors are more likely to engage in practices that the governance community frowns upon than ones that don’t use search firms. For example, Cohen found that companies with at least one director identified by a search firm are significantly less likely to fire their CEOs after poor corporate performance. They are also significantly more likely to engage in mergers and acquisitions and to see abnormally low returns from M&A activity. Cohen’s research further indicated that boards that use search firms pay their CEOs higher salaries and total pay.

Cohen coauthored the paper (entitled “Who Chooses Board Members?”) with Ali Akyol of the University of Melbourne.

Theorizing about the findings in an interview after the symposium, Cohen says he thinks that self-interest might explain why search firms tend to recommend directors who are easy on the CEO. “Search firms might select such candidates, as they want to be rehired by a company, and their hiring must be approved by the CEO,” he says.

Charles Elson, who heads the University of Delaware’s Weinberg Center for Corporate Governance and serves onHealthSouth’s board, was one symposium attendee who said he has had some negative experience with search firms. “The search firm lists are always the same,” he complained, adding that once, while sitting on a board that used a search firm to find a new director, “I said, ‘If I see the same list one more time, I’m going to throw up.’ My concern would be that the usual suspects may be go-along, get-along kind of people.”

Dennis Carey, vice chairman of Korn/Ferry International, counters that his firm has recruiters from many backgrounds who offer a broad diversity of views. “Some of the ideas that [our recruiters] bring to the table when we are doing board work are things that have never surfaced at any of the other firms where I’ve worked,” Carey says. In the Wall Street Journal article Don’t Force Firms to Split CEO and Chair Dennis Carey writes about similar topics involving boards and the recruiting process.

More boards began using search firms to find directors about a decade ago, because of a regulation the SEC passed in 2003. The rule requires companies to disclose their director nomination process and the sources of all new directors. Before the regulation became effective in 2004, CEOs tended to have much more control over who got named to their boards. Afterward, boards logically figured that investors would be displeased to know that their CEO handpicked directors. Boards took more control over director recruiting, and many hired independent search firms to assist them with the process.