Gender Diversity on Public Company Boards

Posted on April 7, 2013 by Steve Odland

September 27, 2012

By David A. Katz and Laura A. McIntosh

The issue of gender diversity in the corporate boardroom has risen to new prominence in the wake of recent efforts to impose quotas for women directors for companies in the European Union. The EU’s recent initiative has provoked controversy not only as to the optimal gender balance of boardrooms but also as to whether a quota system is a fair or effective way to achieve the underlying objective of women’s full and equal participation in corporate affairs. In the United States, the relative dearth of women directors on public company boards, and the potential effect on company performance of increased gender diversity, has been a topic of interest in the corporate governance sphere for many years.Unknown

The meaningful participation of women at all levels of the corporate hierarchy is an important goal. From a practical perspective, however, we believe that aspects of the European experience demonstrate the downsides of using a quota system to obligate this result. Individual public companies, and the U.S. corporate culture generally, would, in our view, be best served by corporate boards’ taking a dedicated, thoughtful and individualized approach to the nomination, election and full integration of women directors. This approach seems likely to yield the most successful substantive result in the short and long term, producing benefits both for corporate performance and the common wealth.

EU Quota Initiative

The most recent effort to increase the number of women directors in Europe has been spearheaded by Viviane Reding, the European Union Justice Commissioner and Vice-President of the European Commission. Reding strongly supported a law imposing sanctions on companies that do not have boards composed of at least 40 percent women. The proposed law reportedly would have required Europe’s listed companies to meet the quota by 2020; companies with more than 250 employees or 50 million euros in revenue that did not comply would have faced administrative fines or be barred from state aid and contracts.

However, the proposal appears to have generated fatal resistance from EU member states. On September 14, officials of nine countries including the United Kingdom, which led the effort signed a letter addressed to Reding and Jose Manuel Barroso, President of the European Commission, indicating their strong opposition to any European-level adoption of binding provisions regarding the number of women on company boards.

The signatories have sufficient power to block the proposal under the voting process of the European Union, and other countries, including Sweden and Germany, have also indicated their opposition to such a law.

The opposition letter affirmed the signatories’ support for women in executive positions and as public company directors, stating that “[t]he myriad barriers women encounter throughout their career are unacceptable from a gender equality point of view [and]…are among the factors preventing the optimal use of the skilled workforce potential.”

The signatories noted that “[m]any of us are considering or have implemented various and differing national measures…to facilitate raising the proportion of women in boardrooms” but contended that “[t]hese efforts must be granted more time in order to establish whether they can achieve fair female participation in economic decision-making on Europe’s company boards.”

Therefore, the signatories concluded: “[A]ny targeted measures in this area should be devised and implemented at [the] national level. Therefore, we do not support the adoption of legally binding provisions for women on company boards at the European level.”

The proposed law is due to be published in draft form next month. A European diplomat reportedly said that many of the countries opposing the proposed law do not necessarily want to scuttle it completely but do want to ensure that national governments retain influence or control over enforcement of quotas.

In any event, the proposed legislation has a long road before it would be approved and have the effect of law: All 27 EU commissioners must agree on the proposed law before a draft is published, and the law then must be approved by national governments as well as the European Parliament.

Impact of Quota Legislation

Several European countries have implemented quotas at the national level for women directors on public company boards, including Norway, France, Italy, Spain, and the Netherlands.9 In 2003, Norway passed a law requiring that at least 40 percent of public company board seats be allocated to women. Covered companies were given five years to comply with the law, and the proportion of women directors rose from 9 percent at the time of implementation to the current average of just over 40 percent.

It is important to separate the effect of quota legislation from the effect of gender diversity on company boards. While the latter has been shown to be beneficial to corporate performance, there are indications that the former is a suboptimal way to achieve those benefits. A study of the aftermath of the Norwegian law showed that not only did the quota requirement cause a significant drop in stock price at the announcement of the law, but the quota then “led to younger and less experienced boards, increases in leverage and acquisitions, and deterioration in operating performance.”

This may be due in part to the fact that the quota requirement contained a relatively short timeframe in which Norwegian companies had to find and elect female directors, resulting in a drop in the average quality of board members.

By contrast to the results of the Norway study, a 2012 worldwide study of the nearly 2,400 companies in the MSCI ACWI by the Credit Suisse Research Institute showed that from December 2005 to December 2011, large-cap companies with women directors outperformed peers with no women directors by 26 percent and small- to mid-cap companies with women on the board outperformed their peers with all-male boards by 17 percent in that period.

The study also found that companies with one or more female board members experienced higher returns on equity, lower leverage, better growth, and higher price/book value multiples.

Some directors have opined that the significant increase in participation by women “professionalized” boards by contributing to a more pleasant, formal atmosphere at meetings, and some commentators view the policy as having “paved the way for women to influence corporate decision making.”

While other studies have reached mixed conclusions regarding the role of women in the boardroom, there are many possible reasons why the full participation of women on company boards could contribute to stronger performance. The Credit Suisse report identifies seven of these, described in detail in the report itself.

First, the appointment of women directors may be an indication that a company is already fundamentally sound and looking to improve from a position of strength. Second, there is evidence that greater diversity on a team can enhance the performance of both the majority and minority groups, improving average outcomes overall. Third, gender diversity can improve the overall level of leadership skills, as studies have shown that women excel in defining responsibilities clearly and mentoring and coaching employees.

Fourth, deliberately expanding director candidate searches to include women provides access to a significantly wider pool of available talent. Fifth, a gender-mixed board may have a better understanding of the consumer preferences of households, particularly in sectors where women make many of the spending decisions. Sixth, academic research has demonstrated that having women on a corporate board improves performance on corporate and social governance metrics for companies with weak governance. Seventh, women have been shown to be generally more risk-averse than men, which may explain in part why companies with women directors in the Credit Suisse study were less leveraged on average than their peers; the study notes further that “lower relative debt levels have been a useful determinant of equity market outperformance over the last four years.” Strikingly, the Credit Suisse study showed that almost all of the share price outperformance of companies with women directors came after 2008, during the financial crisis period and its aftermath.

These companies exhibited less volatility in a falling market and delivered higher returns during this period, suggesting that women directors contribute to a stronger defensive profile, including better risk management and downside control.

One recent study of Israeli companies concluded that boards with three or more women directors were roughly twice as likely to request further information and to take an initiative, leading to higher return on equity and net profit margins compared to peer companies.

Moreover, both men and women directors were more active when at least three women directors were in board meetings, and women were more likely than their male counterparts to take actions on supervisory issues.

In addition to enhanced corporate performance, there are other reasons to favor the full participation of women in boardrooms: the values of societal fairness, gender equality, and corporate meritocracy, for example, or the desire to create a positive culture of valuing the contributions of each individual. While quotas provide a relatively quick fix to the problem of gender imbalance in the boardroom—and some politicians and commentators have expressed frustration with the rate of voluntary action absent legal requirements-they do so in an artificial manner that could create resentment and board dysfunction. Moreover, forcing quotas of women directors prioritizes gender diversity over all else, potentially at the expense not only of director quality but also of other types of diversity that may be valuable to corporate performance.

Business Community View

The European business community, while expressing support for increasing the number of women directors, generally opposes European-level quotas as means of doing so. BusinessEurope, the largest organization of employers in the European Union, issued a position paper this past May outlining views similar to those expressed in the UK-led opposition letter described above.

The paper supports a voluntary approach to increasing diversity, both in terms of gender and in terms of talent, skills and experience. BusinessEurope opposes mandatory European-level initiatives and, in particular, one-size-fits-all quotas “which disregard the highly diverse conditions in different sectors/companies and do not take into account the way corporate boards function and are renewed.”

It appears that companies are willing to take voluntary measures to increase the number of women directors on their boards. They are aided in their efforts by organizations such as the Professional Boards Forum, which helps chairmen in Norway and the United Kingdom find qualified women to fill independent director positions,26 and the 30 Percent Club, a group of chairmen of U.K. companies who are working toward a goal of 30 percent female representation on U.K. boards.27 The 30 Percent Club’s mission statement highlights the view that meaningful participation by women cannot be mandated by top-down quotas but instead must be the result of concerted, long-term efforts to encourage women to succeed in corporate careers. The organization issued the following statement last month, as controversy over the potential EU quota legislation was brewing:

“[T]he only way to achieve better gender balance at all levels in the UK’s leading companies is to ensure the pipeline of female talent is developed from an early stage. In light of recent commentary on the lack of progress at the Executive Board level, the group argues that a concerted effort to develop the pipeline of female talent…will help achieve better gender diversity in senior roles at UK companies.”

The 30 Percent Club is no doubt correct that improvement in the number and quality of corporate positions held by women will “trickle up” into the boardroom; the full integration of women into the boardroom and executive suites of major public companies is a goal with both long- and short-term components.

U.S. Boards’ Gender Diversity

According to GMI Ratings’ 2012 Women on Boards Survey, the United States currently ranks 11th out of 45 countries in terms of gender diversity on public company boards, with an average of 12.6 percent women on S&P 1500 boards.29 Because there are fewer women on the boards of smaller companies, only 11.6 percent of Russell 3000 directors are women.30 In addition to these data points, a GMI study from July 2012 also found significant differences among states and regions, largely driven by the concentration of specific industries in certain areas.31 The percentage of women on U.S. boards increased by only 0.5 percent in the period 2009 to 2011.

The United States has not yet seen a strong movement toward quotas or other legal requirements in terms of gender diversity on boards. U.S. Securities and Exchange Commissioner Elisse B. Walter, speaking last week at the Third SAIS Global Conference on Women in the Boardroom, argued in favor of action at the shareholder level. She pointed out that strong disclosure standards help provide investors the information they need in order to exercise their “voice” to encourage companies to increase the diversity of their boards. Commissioner Walter cited evidence that the SEC’s rule on disclosure of director qualifications that first applied in 2010 is leading to more detailed discussions regarding the composition of boards, and as a result, investors are more engaged in the issue.

As in Europe, the United States has organizations that are committed to increasing the number of women on corporate boards. DirectWomen, for example, is a program designed specifically “to identify, develop, and support…accomplished women attorneys to provide qualified directors needed by the boards of U.S. companies, while promoting the independence and diversity required for good corporate governance.”33 Through strategies designed to help women advance in their careers and come to the attention of executive search firms and other corporate leaders, DirectWomen and groups like it are effecting meaningful change at the individual company level.

Many positions on U.S. public company boards are filled by search firms and companies can provide these firms with specific requests as they seek additional diversity on their boards.34 These firms are working hard to develop a larger group of qualified women candidates who are actively seeking board positions. In our experience, these search firms are very successful at helping public companies increase gender diversity on public company boards. The Credit Suisse Research Institute report indicates that increasing the number of women board members can result in an improvement in the quality of directors and many other positive effects for companies. Doing so through voluntary action, which takes into account the individual circumstances of each company, should be the best way to achieve these benefits without the downsides of mandated quotas and artificial timeframes. As the issue of gender diversity in the boardroom gains prominence, as the benefits to having women directors become better understood, and as resources such as director databases increase in utility, it seems likely that U.S.  companies will pursue the goal of greater gender diversity with increasingly successful results in the boardroom and for investors.

 

[David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.]

 

Footnotes

1 See Aoife White, “EU Said to Seek 40 Percent Quota for Women on Supervisory Boards,”Bloomberg, September 4, 2012.

2 Letter to President Jose Manuel Barroso and Vice President Viviane Reding, European Commission, from Totyu Mladenov, Bulgarian Minister of Labour and Social Policy, et al., September 14, 2012. The letter was also signed by officials from the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, the Netherlands, and the United Kingdom (“Opposition Letter”). Germany indicated its support for the views contained therein in a subsequent letter to U.K. officials. See “Germany joins EU group against women’s quota,” The Local, Sept 15, 2012.

3 See James Fontanella-Khan, “UK musters support to block EU women quota,” Financial Times, September 16, 2012.

4 Opposition Letter, supra note 2.

5 Id.

6 Id.

7 See Stephen Castle, “European Plan to Put More Women on Boards Runs into Opposition,” The New York Times, September 17, 2012, available at www.nytimes.com/2012/09/18/business/global/18ihtboards18.html.

8 Id.

9 See Brian Groom and Ines Burckhardt, “Business opposes quota of women directors,” Financial Times, September 4, 2012.

10 Kenneth R. Ahearn and Amy K. Dittmar, “The Changing of the Boards: The Impact on Firm Valuation of Mandated Female Board Representation,” Quarterly J. of Economics, 2012, vol. 127(1): 137-197, May 20, 2011 (First Draft March 18, 2009, Current Version August 18, 2011), available at papers.ssrn.com/sol3/papers.cfm?abstract_id=1364470.

11 The MSCI ACWI Index is defined as follows: “The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 45 country indices comprising 24 developed and 21 emerging market country indices. The developed market country indices included are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The emerging market country indices included are: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey (as of May 30, 2011).” MSCI, http://www.msci.com.

12 Credit Suisse Research Institute, “Gender Diversity and Corporate Performance,” August 2012, at 12, available at infocus.creditsuisse.com/data/_product_documents/_shop/360145/csri_gender_diversity_and_corporate_performance.pdf.

13 Id. at 3.

14 Agnes Bolso, “Ignore the doubters. Norway’s quota on women in the boardroom is working,” The Guardian, July18, 2011; see also Global Corporate Governance Forum Focus 9, “Women on Boards: A Conversation with Male Directors” (“Women on Boards”), 2011 available at www1.ifc.org/wps/wcm/connect/b51198804b07d3b2acabad77fcc2938e/Focus9_Women_on_Boards.pdf? MOD=AJPERES.

15 See Steven M. Davidoff, “Seeking Critical Mass of Gender Equality in the Boardroom,” The New York Times Dealbook, September 11, 2012 ( “Critical Mass”), available at

dealbook.nytimes.com/2012/09/11/seeking-critical-mass-of-gender-equality-in-the-boardroom/.

16 “Gender Diversity and Corporate Performance,” supra note 12, at 17-19.

17 Id. at 19.

18 Id. at 6.

19 Id.

20 See Miriam Schwartz-Ziv, “Does the Gender of Directors Matter?” Working Paper, June 23, 2011 (last revised September 7, 2012), available at

papers.ssrn.com/sol3/papers.cfm?abstract_id=1868033.

21 Id.

22 See, e.g., Stanley Pignal, “Commission to push quota for women directors,” Financial Times, March 4, 2012 (quoting Viviane Reding as saying, “I am not a fanatic about quotas…but I like the results quotas bring about.”); Christine Murray, “Quotas for women directors are the way forward,” BreakingViews, September 5, 2012 (opining that without mandatory quotas and tough sanctions, companies are too slow to add female directors to boards).

23 BusinessEurope claims to represent, through its 41 member federations, more than 20 million companies from 35 countries. The organization describes its mission as “to ensure that companies’ interests are represented and defended vis-à-vis the European institutions with theprincipal aim of preserving and strengthening corporate competitiveness.” See BusinessEurope, http://www.BusinessEurope.eu.

24 BusinessEurope Position Paper, “Gender Balance in Boards of Directors,” May 25, 2012, available at ec.europa.eu/justice/newsroom/gender-equality/opinion/files/120528/all/63_en.pdf.

25 Id. at 1.

26 See Professional Boards Forum, http://www.boardsforum.co.uk.

27 See 30 Percent Club, http://www.30percentclub.org.uk.

28 30 Percent Club, “Development of senior female talent is a key longer term goal and a growing priority for companies,” August 29, 2012, available at www.30percentclub.org.uk/press/30-club-recognises-strongprogress-on-non-executive-directorships-%e2%80%93-inevitably-not-yet-matched-by-executive-pipeline/.

29 GMI Ratings 2012 Women on Boards Survey, March 2012, at 11, available at http://www.gmiratings.com. Citing Catalyst (a nonprofit organization devoted to furthering women in business), Steven Davidoff notes that American companies have the fourth-highest average of women directors in the world, noting that women make up 16 percent of the average board of a Fortune 500 company in the United States. “Critical Mass”, supra 15; see Catalyst, “Women on Boards,” August 2012, available at www.catalyst.org/publication/433/women-on-boards.

30 GMI Ratings, “Variation in Female Board Representation Within the United States,” July 2012, at 2, available at www3.gmiratings.com/home/2012/07/variation-in-female-board-representation-within-theunited-states-lamb-and-gladman/.

31 Id.

32 U.S. Securities and Exchange Commissioner Elisse B. Walter, “Remarks at Third SAIS Global

Conference on Women in the Boardroom,” September 20, 2012, available at

www.sec.gov/news/speech/2012/spch092012ebw.htm. See also Securities and Exchange Commissioner Luis. A. Aguilar, “Diversity in the Boardroom is Important and, Unfortunately, Still Rare,” September 16, 2010 (speech at SAIS Center for Transatlantic Relations: Closing the Gender Gap: Global Perspectives on Women in the Boardroom) available at www.sec.gov/news/speech/2010/spch091610laa.htm (“While the SEC’s new rule focuses only on disclosure, an indirect effect of putting a focus on a board’s diversity is that boards may decide to add, or add more, minorities and women as directors. It is reasonable to expect that the process of focusing on their diversity policy and its effectiveness could likely result in greater diversity. I personally believe that companies that expand their search for new directors to include more women and minorities will find a breadth and depth of talent that will serve to improve their performance and increase the wealth of their investors.”).

33 See DirectWomen, http://directwomen.org.

34 See “Women on Boards”, supra note 14, at 35 (comments by Peter Browning); see also Aguilar, “Diversity in the Boardroom is Important and, Unfortunately, Still Rare,” supra note.

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Important Questions About Activist Hedge Funds

Posted on March 9, 2013 by Steve Odland

The following was written by WLRK and  is re-posted here with permission.

March 8, 2013

Important Questions About Activist Hedge Funds

          In what can only be considered a form of extortion, activist hedge funds are preying on American corporations to create short-term increases in the market price of their stock at the expense of long-term value.  Prominent academics are serving the narrow interests of activist hedge funds by arguing that the activists perform an important service by uncovering “under-valued” or “under-managed” corporations and marshaling the voting power of institutional investors to force sale, liquidation or restructuring transactions to gain a pop in the price of their stock.  The activist hedge fund leads the attack, and most institutional investors make little or no effort to determine long-term value (and how much of it is being destroyed).  Nor do the activist hedge funds and institutional investors (much less, their academic cheerleaders) make any effort to take into account the consequences to employees and communities of the corporations that are attacked.  Nor do they pay any attention to the impact of the short-termism that their raids impose and enforce on all corporations, and the concomitant adverse impact on capital investment, research and development, innovation and the economy and society as a whole.

The consequences of radical stockholder-centric governance and short-termism prompt a series of questions that cry out for re-examination of basic premises by the academics who exalt simplistic principal/agent theories and neo-classical economic models on only select principal/agent relationships while ignoring not only all social cost and all of behavioral economics but even the application of these same agency theories to other key actors in the current financial landscape.  So too do they cry out for re-examination of the regulations that facilitate corporate raiding and short-termism and the failure to put in place a system that would allow managements to achieve the optimal long-term value of public corporations, for the benefit of long-term investors and the whole American economy.  The boot-strap, bust-up, junk-bond takeovers of the 70’s and early 80’s proceeded unchecked and laid waste to the future of many great companies, all cheered on by the academics and aided by do-nothing regulators.  The new incarnation of sacrificing the future for a quick buck is at least as dangerous.  It requires new thinking to address the new threat.

Among the questions that must be addressed are:

  1. Purpose of the American Business Corporation.  Is the fundamental purpose of the American business corporation, and the proper goal of sound corporate governance, optimal long-term value creation?  Or is the purpose to maximize short-term stockholder value at any time any particular stockholder—with its own goals and agenda, which are unlikely to be congruent with the interests of other stockholders—happens to demand it?
  2. How Are “Excess” Returns Actually Obtained?  Activist hedge funds are reportedly outperforming many other asset classes as their raids seem to “unlock” value through pressured transactions.  Is this value actually created, or merely appropriated from fellow stockholders with longer-term investment horizons, and from other stakeholders such as employees, including by sacrificing capital spending and investment in long-term research and development?
  3. Are There Really Best Practices?  Is there sufficient (or any genuine) evidence that “best practices” corporate governance of the type promoted by the academics and advisory services results in enhanced long-term performance of the corporation — especially given the fact that American corporations have historically enjoyed the best long-run performance in the world?  Is “best practices” corporate governance a major factor in short-termism?
  4. Structural Conflict.  Is there a structural conflict in a system in which stockholders exercising power over a corporation owe no legal duty to anyone and are an ever-changing group that is free to enter a stock in size without advance disclosure and exit at any time of their choosing, act in concert, or even mask their interests using derivatives and engage in empty voting?  And in which the decision-makers at these stockholder bodies are themselves agents, compensated, in many cases, on the basis of the short-term performance of the investment portfolios they supervise on behalf of savers and investors?
  5. The “Principal/Agent” Premise.  Is the essential premise of the stockholder-centric proponents – the principal-owner/agent view of the corporate firm – accurate or reasonable, given that the legal system gives legal immunity to the “owners” (stockholders) and imposes fiduciary duties and liabilities on the “agents” (directors)?
  6. The Missing Principal.  Is the principal/agent structure of institutional investors imposing an unacceptable cost on corporations when the underlying beneficial holders of the managed portfolios– retirees, long-term investors and savers – play little if any role in checking the power of those running the investment intermediaries?  Regulation, litigation, and public scrutiny perform powerful roles in addressing agency costs that may exist at the corporate board and management level.  But given the massive intermediated ownership of public corporations today by a variety of different types of institutional investors with varied compensation and governance arrangements of their own, do we fully understand the agency costs of these investment intermediaries, who is bearing those costs and whether they are being sufficiently monitored and mitigated? And why has the academy not fixed its gaze on these powerful actors, including advisors such as ISS and Glass Lewis?
  7. Trust the Directors.  Is the assumption by academics that directors on corporate boards cannot be trusted based on any actual evidence, on observed anecdotal information, or just the skepticism of a group that has never (or rarely) been in the boardroom or been charged with overseeing a for-profit enterprise?  And does the constant assumption and allegation of untrustworthiness in fact create both a disincentive to serve and a disinclination to act, all to the detriment of the corporate enterprise and its beneficiaries?
  8. Directors’ and CEOs’ Time.  Is it desirable that directors and CEOs spend a third of their time on governance?  Has the governance-rather-than-performance-centric debate resulted in a new breed of lawyer-type-CEOs and box-checking “monitoring” boards rather than sophisticated and experienced “advising” boards?
  9. Escaping Governance.  What part of the private equity activity wave is fairly attributable to increased costs imposed by corporate governance in the public markets that makes management for long-term value appreciation difficult or impossible in those public markets?  Is that good or bad?
  10. Why Do Venture Capitalists and Entrepreneurs NOT Choose the Academics’ Governance Model? Why do highly successful technology corporations go public with capital structures that preserve management control? To avoid the pressure for short-term performance? To avoid shareholder pressure on management? Do these companies underperform or are they our most innovative companies?
  11. Economic and Business Theory. Is there any evidence that the ideas and suggestions of short-term money managers, who oversee diverse portfolios, promote long-term (or even medium-term) value creation? What happens to investment, strategic thinking and risk management in a world in which the ideas have time horizons measured in months or quarters? How do the advocates of stockholder-centric governance take account of the fact that stockholders do not have information and expertise about the corporation on a par with its directors and officers? Similarly are long-term stockholder interests and wealth creation served by intermediaries in the proxy advisory services, operating without regulation or fiduciary duty, either to the corporation or its stockholders or to investors and beneficiaries? And what to make of the elephant-in-the-room fact that activist hedge funds don’t have to eat what they cook?
  12. Political Theory. At bottom, doesn’t the stockholder-centric theory hark back to the crudest 19th century aspects of laissez-faire capitalism—pressing for the legal system to recognize a single social good (maximizing rentiers’ portfolio returns) while ignoring or slighting the interests of employees, communities and societal welfare? Is stockholder-centric governance as currently promoted and practiced by the academic and governance communities, and the short-termism it imposes, responsible for a very significant part of American unemployment and a failure to achieve a GDP growth rate sufficient to pay for reasonable entitlements without a significant increase in taxes?

Martin Lipton
Theodore N. Mirvis
Adam O. Emmerich
David C. Karp
Mark Gordon
Sabastian V. Niles

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Board Challenge: Preparing for Crisis

Posted on March 3, 2013 by Steve Odland

By Weil, Gotshal and Manges, LLP

An integrity lapse by a key executive, an environmental disaster, a compromise of confidential information, a product taint: companies expend significant resources on risk management and internal procedures to avoid such failures. But as important as crisis prevention is, companies must also be prepared to contain and manage crisis situations when they do occur. The board plays an essential role in this preparation. The board needs not only to assure that senior executives are well positioned for crisis management, but must also consider the board’s own preparedness and capacity for addressing crisis. A board should develop a plan that ensures both (1) the strength of its own culture to withstand the stresses that crisis brings, and (2) its ability to effectively manage both the corporation’s business interests and possible litigation consequences when making decisions in crisis-mode.

UnknownCrisis Readiness

By its very nature, crisis involves the unexpected, but a board can and must anticipate the occurrence of crisis. Times of crisis frequently create the risk of significant impairment of a company’s operational, financial, or reputational integrity, as well as the risk of related litigation. By the time a particular risk materializes, the board should already have adopted general procedures and policies that prepare it to coordinate with management to address the problem and minimize negative effects. The board should identify a crisis-management team and assign defined roles and create processes for problem analysis, decision-making and communication. In formulating this team and these procedures, the board should keep in mind the effect its action may have in future litigation, which is often brewing in the background during times of crisis. The board must be particularly tuned into issues related to attorney-client privilege. Adopting a comprehensive crisis-readiness plan will enable the board to decide issues with dispatch and in a manner that conveys appropriate concern resolve and credibility, while minimizing future-litigation risks.

Recognizing Crisis

The board and management need to be attuned to the most common and likely causes of corporate crisis. While crisis comes in many forms and the likelihood varies based on industry and other company specific factors, common causes of crisis include:

• Concerns regarding management credibility or integrity

• Loss of a key executive

• SEC or other government investigation or regulatory action

• Significant litigation

• Financial reporting issues, financial restatement

• Allegations of fraud

• Poor operating results (over multiple periods)

• Product failure

• Information security or confidentiality breach

• Environmental disaster

• Liquidity issues

• Default on covenants

• Failing labor relations

• Failing shareholder relations

• Systemic ethical issues

• Contest for corporate control

Boards should consider coordination with management to conduct crisis response simulations from time to time. This can be in the form of a discussion of several hypothetical scenarios involving issues that the board and management believe could arise and create significant problems for the company. Where appropriate, the board should consider involving legal counsel, either internal or external, in this exercise, to help the board to identify litigation-control measures that should be adopted in particular types of crises.

Internal Controls, Risk Management & Corporate Governance

The foundation of effective crisis management is a well-developed system of internal controls, risk management processes and corporate governance practices. Periodically, the board and management team should assess the strength of that foundation by, for example:

• Reviewing corporate policies and controls such as specific prohibitions on unethical and illegal conduct, confidentiality requirements and communication policies to ensure that they:

a. address appropriately and thereby decrease the likelihood of the types of behaviors that could raise significant risks, and

b. are aligned with ethical (and regulatory) expectations so as to foster the support and understanding of the public and regulators should a crisis occur;

• Identifying and periodically reviewing significant risks to business operations, financial condition and reputation and considering how crisis might materialize and be addressed in relation to such risks;

• Evaluating the governance culture and considering ways to continuously improve upon it; and

• Monitoring ongoing litigation and considering patterns of litigation risk.

Crisis Team

Effective crisis management also requires that the board identify a crisis-response team in advance. This is the team that will activate as soon as the potential crisis has been identified. The function of this team is to provide early assessment, response and litigation-risk management. One misstep companies frequently make during times of crisis is underestimating the seriousness of the problem, including the potential impact for negative public reaction and regulatory action or litigation. A frequent and related mistake is overestimating the company’s capacity to address the problem at the departmental level and without outside expertise. The crisis team should be designed to include a variety of expertise to help quickly determine what else may be needed. The company should identify:

• An internal crisis team: This should include senior executive officers (the CEO, CFO, COO, General Counsel), representatives of key operational departments and the heads of compliance, internal audit, human resources, corporate communications/PR, and sales/marketing. It should also include the appropriate board-level contact point, which may vary depending on the situation but likely will include the independent board leader and/or the audit committee chair. When a specific situation arises, the identity of the crisis team may need to be adjusted based on needs and on recusal of anyone whose integrity or behavior may be at issue. At times the full board may need to become involved.

• A team of external advisors: This should include external legal advisors and communications experts. Having established relations with professionals who get to know the company and the key members of the board and management before crisis occurs can pay dividends when the company must react quickly. The board should also understand under what circumstances the board may need to rely on independent advisors—primarily when the integrity or performance of the CEO or other executive officer is at issue or when management is otherwise conflicted. When coordinating with legal advisors, the board should be particularly aware of issues related to attorney-client privilege and develop procedures to avoid waving it.

Unknown-1Communications Plan

Well before any bad news materializes, the board needs to communicate its expectation to the CEO and key members of the management team (at minimum, the CFO, the general counsel, and the internal auditor) that bad news should be delivered promptly and directly. Everyone should understand that the board wants early warning and does not want to be “surprised” by hearing bad news from another source—especially a public source—because management thought it could manage its way out of a problem and failed to inform the board early.

The board and management should develop an agreed, workable and well understood crisis communications plan. A crisis communications plan should be thought of as a protocol for both internal and external communications in a crisis situation. Since actual communications must relate to the particular circumstances, the crisis communications plan should focus primarily on ensuring that the right people can be called together quickly to determine how to move forward and communicate, together with guidance for ensuring that the company speaks with one voice and confidentiality is maintained until the company has decided to speak. Key elements include the following:

• The plan should call for early communication of the known facts to the identified crisis team and the board for early analysis and response planning.

• Once the right people and expertise are involved, they can decide the time frame and message for communications with regulators, employees, shareholders, customers, suppliers, creditors, insurers, and the media.

• In most situations, the CEO or other members of the management team will be tasked as the spokesperson for both internal and external communications. However, any issues that involve concerns about the actions or integrity of the CEO will require board involvement in communications. In certain circumstances this may extend to situations involving other executive officers.

• Special attention should be given to monitoring social media given the speed with which information and misinformation can be transmitted and to having capacity to come up with strategies for using social media effectively in a crisis.

Note that sensitivity to how information flows in crisis response efforts is important in determining who to get involved and at what point. Even when at first blush an emerging crisis may not appear to have a legal issue at its heart, consideration should be given to whether and at what point there is benefit to having an attorney involved in coordinating the efforts of other advisors to help preserve the ability to assert the attorney-client privilege of certain communications.

Companies with operations and markets in non-U.S. jurisdictions should make sure that there crisis management efforts are sensitive to how different cultures react, so that they can manage accordingly, including by involving relevant experts who can assist not only with tailoring communications to different cultures but who also understand the political, regulatory, and legal environment.

Special Considerations Regarding Social Media and Preparedness for Crisis

Given the speed with which news, rumor, and innuendo can be disseminated through social media and the tendency for social media to be treated as an informal means of communication, it is particularly important that the company has in place and has educated its employees about policies related to the use of social media. When formulating social media policies and thinking about the risks of social media, it is important to differentiate between its uses since the type and degree of risks are distinct depending on how social media is being used:

• Social media can be a significant tool for listening to what customers, shareholders and others have to say about the company and in this respect can serve as an early indicator of issues that may be arising. Much of the risk related to observation or “listening” may be controlled through clear policies about mining public information in legitimate and transparent ways. Companies also need to prepare in advance for a negative message that is broadly repeated. Since the context will drive the appropriate response, and the response will need to be determined in real time, the company should have an understanding about who the crisis communication team is

• Social media can also be a powerful means of spreading a message—but it is in the effort to influence viewpoints where much of the risk lies. Corporations need to have very clear policies about who can speak on behalf of the corporation through social media (and any other media). These policies need to be accompanied by education for those who are restricted from speaking on the company’s behalf as well as for those who are empowered to speak.

In addition, policies should address expectations about how employees refer to the company in their personal use of social media. Clearly, there needs to be a system for vetting official company messages as well, just as for other media. However, since much of the value in social media is its real time and targeted nature, consideration needs to be given to the balance between these benefits and the degree of prudent internal control. Directors should use the same rules for social media that they use for contacts with shareholders and potential investors.

Directors should avoid at all costs any ad hoc communication about the company. Only official and coordinated communication is appropriate.

Because of the complicated and constantly developing legal issues surrounding online communications, a company’s social media policy should be carefully reviewed by legal counsel and updated as necessary.

Crisis Assessment, Investigation, and Mitigation

When a crisis hits, the crisis team—internal and external as appropriate—will have to quickly assess the situation to define the scope of the further investigation and analysis that will need to be undertaken and to fine-tune the team:

  1. How serious might the problem be and how widespread?
  2. How much is known and what is known now and what needs to be determined?
  3. What is the likely impact on liquidity, on customers, key employees, suppliers, and relations with regulators?
  4. What is the risk of related litigation or other potential for interrelated problems?

The crisis team and the board and management generally should assume that things are worse (or may get worse) than they appear, and bring a healthy skepticism to bear without overreacting. Based on its initial assessment of the situation, the crisis team will need to determine who the appropriate team is to lead the investigation and the response. This should include conferring with both inside and outside counsel about the plan, paying particular attention to attorney-client privilege issues at this stage.

The level of board involvement will depend on the nature and scope of the problem, including the extent to which members of the senior executive team are implicated. In most crises, the current CEO and key members of her team will be best positioned to provide the crisis management required. In such circumstances, the board should be fully and regularly advised and should provide guidance with sensitivity to the need for management to focus on the issue at hand. However, if the issue relates to, or could potentially implicate, senior management’s credibility or integrity, the outside and independent directors may need to oversee the crisis response including potential investigation with assistance from independent counsel. Is a special board committee needed to look to investigate allegations of wrongful conduct? Is independent outside counsel required? Is forensic expertise required? The board will also need to assess whether there are specific additional resources and expertise needed to help guide the company through the problem.

When company management has lost credibility with external constituents, the board may need to assess who is best positioned to give regulators, investors, creditors, customers, employees, and the public comfort that the board and management are engaged and focused on protecting the corporation’s assets.

The board also must be mindful its own public perception. In some instances, for example, where the issues raise concerns about whether the board was appropriately engaged, governance reforms or even changes in board composition may be helpful or necessary to send the right message to key constituents and investors.

Effective Board Culture

An effective board culture is essential to effective crisis management. A strong board culture will prevent the board from wasting time getting its own house in order when it should instead be taking decisive action.

The board culture to strive for is one in which confidentiality is protected and independent viewpoints are respected and valued, but consensus can be readily achieved after opportunity for full and informed discussion. Well-functioning boards usually are able to achieve a consensus that all directors can support, with only rare resort to a majority position that a minority of directors oppose. A corporation should embrace governance structures that support this type of culture.

A board’s ability to achieve consensus in an efficient manner is a function of its success in developing trust and mutual respect among members, creating shared expectations of how individual members should behave and contribute, and adopting a common understanding of the what is in the company’s best interest. A healthy board culture is one in which directors understand one another’s styles and strengths. Effective boards agree on the rules of engagement and accepted behaviors while valuing distinct opinions. Directors trust and rely on one another and at times defer to one another’s judgment. Well-performing boards reach consensus without significant conflict or tension. Dissent and disagreement are expressed and resolved.

A particular challenge for the board as a team is that it is charged with overseeing management but must at the same time rely on management for information and to otherwise support the work of the board. The board must be mindful of its relationship with management and should seek a “constructive tension” that balances attentive oversight and a critical review of management’s strategy and performance with support and guidance for management.

• Discuss and agree on the role of the board and management, clarifying as necessary the extent of delegated authority and expectations about board information needs and board involvement in decision- making.

• Emphasize the value and the limits of “constructive tension” in board/management relationship.

• Discuss and agree on valued behaviors—behaviors that are consistent with an environment in which “constructive tension” can thrive:

–      Respect for fellow directors’ and managements’ expertise and viewpoints – Constructive skepticism in questions directed to management

–      Opportunity for, and ease of, open discussion and debate

–       Commitment to achieving consensus after engaging in an informed and deliberative process

–       Commitment by all participants to listen and to self-control (not everyone needs to be heard on every issue)

–        Trust among directors and between directors and management

–        Protection of confidences

–        Attention to schedule, but in a manner that ensures time for important discussions

• Periodically evaluate board culture along the lines outlined immediately above

• Remind directors of confidentiality requirements and privilege issues.

Board Strategies for Avoiding/Addressing Potential Problem Behaviors

Note that boardroom confidentiality is critical if a board is to create and maintain an atmosphere in which full and frank discussion can thrive, and consensus can ultimately be reached. A failure of board confidentiality can undermine the ability of a board to make timely and deliberated decisions. It also may signal more significant difficulties within a board. And it may exacerbate or even lead to crisis situations.

A director must keep confidential all matters involving the corporation that have not been disclosed to the public. Directors must be aware of the corporation’s confidentiality, insider trading, and disclosure policies and comply with them.

Although a public company director may receive inquiries from major shareholders, media, analysts, or friends to comment on sensitive issues, individual directors should avoid responding to such inquiries, particularly when confidential or market-sensitive information is involved. Instead, they should refer requests for information to the CEO or other designated spokesperson.A director who improperly discloses non-public information to persons outside the corporation can, for example, harm the corporation’s competitive position or damage investor relations and, if the information is material, incur personal liability as a tipper of inside information or cause the corporation to violate federal securities laws. Equally important, unauthorized director disclosure of non-public information can damage the bond of trust between and among directors and management, discourage candid discussions, and jeopardize boardroom effectiveness and director collaboration.

Confidentiality: Excerpts From ABA Directors Guidebook, 6th Edition (2011)

Every company is susceptible to a crisis—whether from a single event or from a confluence of circumstances. The board plays a key role in positioning the company to weather crisis by acting to prevent the crisis from spiraling out of control and by establishing credibility with key constituents. The board also plays a critical role in positioning the company to deal with any litigation that may arise out of a crisis situation. To do so effectively requires both crisis preparedness and the development of a board culture of cohesion, respect and confidentiality.

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Compensation: Back to Basics

Posted on February 17, 2013 by Steve Odland

By Pearl Meyer & Partners

Compensation committees continue to find themselves at the center of the executive compensation firestorm, subject to intense public scrutiny and skepticism. Despite a fledgling economic recovery, unemployment remains stubbornly high, fueling resentment over the compensation levels of the 1 percent. Added to that, the regulatory environment grows ever more complex, threatening to overwhelm committees in a sea of expanding compliance requirements.

UnknownNotwithstanding the crowded agenda facing members in the months ahead, we think compensation committees are best served by taking a step back and asking three fundamental questions around executive pay programs.

How does your company define pay for performance? 

The focus on pay for performance by investors and boards alike is not new. There is virtually no public company that does not espouse the concept of aligning executive pay with sustained shareholder value in the CompensationDiscussion & Analysis (CD&A) section of their proxy. However, Institutional Shareholder Services (ISS) upped the pay-for-performance ante late in 2011 by rolling out a new methodology for evaluating CEO pay as disclosed in 2012 proxy statements. While we believe there are methodological flaws to the new review20, it is nevertheless critical that companies understand how their programs will hold up under the analyses and how their investors are likely to react to ISS’s ratings.

Beyond simply reacting to ISS’s analyses, companies should proactively communicate their pay-for-performance structure and alignment to their internal and external stakeholders. Communication begins with providing a clear and detailed rationale for choosing performance metrics other than total shareholder return (TSR), given that ISS has deemed TSR to be the best measure of performance from the perspective of shareholders.

In practice, however, TSR often fails to capture the motivational objectives of incentive plan design. To be sure, ultimately pay outcomes should create a reasonable alignment between the financial well-being of executives and shareholders. But incentive plans are not designed to serve as a “reward” for good results. Rather, they are intended as a tool for prioritizing executives’ attention and driving good decision-making that will promote the organization’s most important strategic needs. Put another way, TSR is an outcome—i.e., the market’s referendum on the company’s performance. The job of management is to generate performance levels (i.e., the input) that warrant a favorable TSR outcome. As such, management should be held accountable and be paid on the basis of performance that leads to positive TSR outcomes, as well as for the positive TSR outcome itself. The committee’s task is therefore to ensure programs are based on incentive metrics that are right for its needs and, over the long term, will be demonstrably tied to shareholder value creation.

Historically, incentive measure selection/calibration affected only short-term incentive design for most companies, since long-term performance plans were fairly rare. And, for most senior executives, the annual bonus target award value was dwarfed by the opportunities represented by long-term time-vested equity awards. However, a recent PM&P study21 indicates that long-term performance plans have quickly increased in both prevalence and target value. Committees therefore need to ensure they are devoting adequate time and attention to considering the selection and validation of plan metrics.

Ideally, incentive performance measures should be:

• Central to the company’s business strategy and market differentiation;

• Strongly and demonstrably correlated to shareholder value creation;

• Influenced by management actions in an appropriate timeframe (i.e., short-cycle metrics for annual incentive plans, longer-developing metrics for long-term incentives);

• Complementary to one another; and

• Able to be accurately measured and monitored.

Selecting the appropriate short- and long-term incentive metrics is only the first step—equally important is the process of goal-setting. The determination of target performance should incorporate multiple factors, including the company’s annual budget, historical performance, peer performance, and analyst expectations. The range of performance between threshold and maximum should be wide enough to justify the pay differential. At the same time, the threshold level of performance should not be so low that it will be perceived as a “give away” by shareholders, nor should the maximum be so high so as to be viewed as unachievable by participants without taking undue risks.

Finally, the committee should review actual pay relative to actual performance as part of its annual executive compensation analysis. The analysis should be more robust than the standards relied upon by ISS, using other performance measures in addition to TSR and including other named executive officers. Further, the calculation of actual pay should use the period-ending market value of equity grants, rather than the grant date value—this is particularly critical for option valuation. Importantly, the committee should then use the results of the actual pay-for-performance review to help refine the goal-setting process in the coming year.

Unknown-1How are you rewarding and retaining your stars? 

The lackluster economy took retention concerns off the radar screen for many companies in recent years. That said, many committees22 continue to see succession planning as one of their most important tasks and biggest concerns.

Corporate reality suggests that the retention of key next-generation talent cannot be left to chance—merit budget increases are firmly stuck at 2 percent – 4 percent for the foreseeable future and a slow economic recovery will limit the promotional opportunities for high performers at many companies. Furthermore, widespread attention to lists of defined governance “best practices” has pushed some companies too far in the direction of formulaic, “numbers driven” incentive structures.

Committees can play an important role by making sure their senior management has the tools and retains the flexibility to adequately differentiate high performers. They can ask the following questions:

• Does the annual incentive plan include individual objectives and/or the ability to exercise both positive and negative discretion?

• Do annual equity grant guidelines have ranges or flexibility to differentiate grants among individuals at the same level?

• Does the company have other long-term retention-oriented compensation and benefits programs (e.g., non-qualified deferred compensation plans)?

• Are there sufficient non-compensatory rewards for high performers (e.g., a positive culture, mentor programs, career development/training, etc.)?

With all the focus on pay for performance it is important that Committees not lose sight of the importance and the value of a stable executive team. Unwanted turnover can cause disruption on a number of fronts; and the organizational costs associated with external hiring of key executives can be substantial. Notwithstanding the importance of having a strongly performance-based compensation structure, companies must also make sure there are adequate retention elements to the compensation and benefits programs to ensure that key next-generation leaders are motivated to stay and perform.

When was the last time you really looked at your compensation philosophy and structure? 

While this “to do” may not seem very interesting or “new,” the timing here is important. Many companies reacted to the economic volatility of the past two years by making temporary changes to their compensation programs such as adjusting bonus payout curves and modifying equity grant levels. As companies and the economy settle into a “new normal,” committees should take the opportunity to step back and reassess their compensation philosophy and structure, rather than simply reverting to their old ways.

Start with a review of how changes to the company’s business expectations might drive changes to pay structure. For example, more modest future growth expectations might suggest a need to revisit the mix of options and full-value shares. Likewise, a change to the company’s cash position or debt structure may highlight the need to rethink incentive measures and weightings.

Next, consider changes to competitive practices. Have peers made changes to their pay programs that affect your company’s competitive positioning? Most notably, changes in pay mix (fixed vs. variable pay/cash vs. equity) or changes in incentive leverage (increase or decrease in thresholds and maximums) can change the competitive pay-for-performance landscape and may require changes to company programs to keep pace.

Finally, consider your approach to accepted “best practices” in compensation and benefits design. Public scrutiny and the influence of shareholder activists and governance watchdogs have made certain historical practices “unacceptable” by current standards (e.g., tax gross-ups), while other practices have become majority practice (e.g., stock ownership guidelines).

We do not advocate taking a purely “prevalence-based” approach to compensation philosophy and structure, nor do we believe companies should blindly adopt so-called “best practices” simply to satisfy ISS. Rather, we think companies should conduct a comprehensive, holistic review of their own current philosophy and structure. The objectives are to make sure, first and foremost, that they continue to support the company’s current business goals and objectives; that they provide competitive opportunity for competitive performance; and they are consistent with a culture of good governance and shareholder value creation.

In summary, we recognize that compensation committees need to spend a certain amount of time and attention on “current” compensation issues (regulatory compliance, responding to rating agency findings, etc.) But the urgent should not displace the important on committee agendas. Effective compensation committees should be making time in their annual calendar for strategic review and discussion of the design and structure of their executive compensation programs. Specifically, the three areas of review we’ve outlined above are focused on creating programs that stand the test of time, and deliver on the objectives of creating a strong, stable management team to deliver long-term value to shareholders.

 

 

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Governance Challenges Today and Tomorrow

Posted on January 27, 2013 by Steve Odland

By NASDAQ OMX

This report highlights several pressing issues that NASDAQ OMX views as urgent for consideration during 2012 and beyond.

Job Creation and Access to Capital images

• Capital formation and job creation are in NASDAQ OMX’s DNA. Forty years ago NASDAQ introduced the world to electronic markets, which are now the standard for markets worldwide. The creation of NASDAQ grew an ecosystem of analysts, brokers, investors, and entrepreneurs, allowing growth companies to raise capital that was not previously available to them. Companies like Apple, Microsoft, Oracle, Google, and Intel, all of which are listed on the NASDAQ Stock Market, use the capital they raised to make the cutting edge products that are now integral to our daily lives. As they’ve grown, these companies have created millions of jobs along the way.

• The business community, U.S. government, and individuals around the country are still struggling to understand how to make job creation a reality. At NASDAQ OMX, we believe certain regulatory reforms will significantly facilitate permanent jobs and benefit the U.S. economy, like re-evaluating Sarbanes-Oxley. Additionally, we need to do more to fix structural problems that hamper the development of small- and medium-sized companies, which have historically done the most to create jobs. Increasing the number of H-1B visas and creating venues for small companies to receive resources and capital, like NASDAQ OMX proposed BX Venture Market, are a start to encouraging job growth.

• NASDAQ OMX has blazed a trail for entrepreneurs to achieve the pinnacle of business when they take their companies public. Venture-backed and other growth phase companies face numerous challenges as they attempt to access capital. Sarbanes-Oxley, other regulations, and the U.S. litigation system represent palpable costs. But with meaningful regulatory and structural changes, as well as innovative platforms like the BX Market, we will make our companies and economy stronger and spur job creation.

Sarbanes-Oxley 404

• NASDAQ OMX fully recognizes and supports increased financial transparency. Section 404 of Sarbanes-Oxley requires costly external audits in addition to the traditional audits of a company’s financial statements. At NASDAQ OMX, we believe it is the most visible sign of overregulation in this country, and the primary excuse for foreign companies and smaller domestic companies to forgo a U.S. public listing.

• Working with the Biotechnology Industry Association (BIO), the technology industry and others that were members of a broad coalition of businesses, NASDAQ OMX supported provisions to provide a complete exemption from SOX 404(b) for smaller companies. NASDAQ OMX was the first exchange to support an amendment authored by Reps. Scott Garrett (R-NJ) and John Adler (D-NJ) during House Financial Services Committee consideration of the bill. The final version of the legislation provides the exemption for companies under $75 million in market capitalization from SOX 404(b).

• At NASDAQ OMX, we believe that expanding this exemption to include companies with a $700 million market cap will significantly reduce the cost of going public for many firms. We also believe that companies who receive a clean bill of health should only receive a biennial 404 audit.

Legal Immigration Reform

• To be the best, companies need the ability to recruit the best workers. Global competition means global access to human capital. NASDAQ OMX supports comprehensive highly skilled immigration reform. We must increase the number of H-1B visas available and reform the employment-based green card process. These issues should not be tied, in policy or debate, to the illegal immigration issue.

• One-quarter of America’s technology startups led by foreign born individuals generate $52 billion and employ 450,000 workers. As of February 2012, university-level foreign-born students were receiving the highest number of engineering degrees in the United States and lead one-quarter of America’s science and technology start-ups: think Google, Intel, eBay, and Yahoo.

• It’s clear we can no longer ignore the immigration issue. Without increases in H-1B visas and reform of the employment-based green-card process we will continue to educate the world’s brightest individuals and then watch them spur job growth, gross domestic production and innovation abroad.

Venture Capital Markets

• In our markets, the number one source of job creation is entrepreneurship. Just as business incubators nurture small companies until they are ready to leave the security of that environment and operate independently, there should be a space for incubating small companies until they are ready to graduate to a national listing. The United States must create a space for these companies just as our foreign competitors have successfully done.

• Many innovative businesses around the world possess the innovation and fortitude needed to thrive in the public markets but lack the capital and resources to do so. NASDAQ OMX is addressing this need with its recently approved proposal to create the BX Venture Market.

• The BX Venture Market is an investment in the global economy. There are a lot of great ideas and well-thought out business models that simply lack the funding and resources necessary to get off the ground. Some of the most successful and game-changing start-ups of our time arose through venture capital backing—Microsoft, Google, Apple, Cisco.

• In addition to our proposal for the BX Venture Market, we remain proactive in our commitment to supporting programs that propel developing companies. Recently, we contributed a $730,000 grant to the Edward Lowe Foundation to fund the Institute for Exceptional Growth Companies, a new research and education institute focusing on job growth and capital access for developing companies in the United States

Executive Compensation Unknown

• In 2011, the expanded availability of say-on-pay proposals provided investors an alternative avenue to express their views on corporate pay programs, and we anticipate this to continue.

• NASDAQ OMX worked with a broad coalition to ensure that corporate governance provisions of the Dodd-Frank Act were workable and did not tip the balance between shareholder, management, and directors’ influence. A requirement that directors be elected by majority vote was eliminated from the final bill. The bill grants shareholders the right to a non-binding vote on executive pay and benefits. The bill does not mandate a proxy access regime but gives the SEC authority to engage in a rule-making, open to public comment, to determine any changes in this area. Because of U.S. Chamber and Business Roundtable legal threats, the SEC has postponed action on proxy access.

Corporate Political Spending

• For the protection of investors, NASDAQ OMX believes in setting stringent standards for a company’s employees, officers and directors. Implicit in this philosophy is the importance of sound corporate governance.

• As a listing venue for public companies, NASDAQ OMX is committed to helping board members of our listed companies understand their governance responsibilities. We are partnering with experts to provide opportunities for directors to receive relevant continuing education. One such initiative is an alliance with the National Association of Corporate Directors to provide corporate governance educational services to NASDAQ OMX companies.

• NASDAQ OMX actively works with policy makers and business associations to support corporate governance policies that encourage exceptional standards without hindering the legitimate management of a company, the process of capital formation and does not unduly open companies to frivolous lawsuits or special interests. The needs of both short-term and long-term shareholders should be balanced by all policy decisions in this area.

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A Board-Building View

Posted on January 7, 2013 by Steve Odland

By Marsh & McLennan Companies

Corporate boards are dynamic social systems. While each board is unique, there are similar challenges that boards face as a natural consequence of being teams, composed of individuals charged with doing important work in a very specific legal, economic, and social context. Effective boards, similar to effective teams, need to be built and maintained over time. In our work with boards, we have found that board effectiveness is shaped by a number of key factors including:images

• Clarity of the role of the board—the work it needs to perform and how it adds value.

• Backgrounds of the individual directors (their knowledge, experience, skills, and diverse perspectives), and their ability to work effectively with others.

• Content of the board’s agenda, driven by the potential value added of the board.

• Quality of the information the board receives about the company.

• Dynamics that develop among directors as they work together as a whole, with other directors separately, and with members of management.

• Leadership that enables and supports all of the above.

None of these elements is static. Effective boards are always assessing themselves and engaged in what we call “board building”—working on the factors that drive board effectiveness.

Board Challenges

With that perspective, some of the most critical issues that many boards will need to address in 2012 and beyond include the following:1293442437rs4fjc

1. The board’s role in strategy. Surveys continue to indicate that directors consider engagement with management around corporate strategy as one of the most valuable elements of their role. Yet directors repeatedly report that they are not satisfied with how that process occurs today. Boards and management need to design ways to effectively engage directors in the development of strategic direction and key strategic decision-making in a way that adds to, but does not interfere with, the role of management. This is critical to the core questions: What is the role of the board, what is the role of management, and how does the board add value? In our view, strategic work at the board level needs to move beyond the “concurrence” model, where management proposes a strategy and the board is simply left with a choice of concurring with or rejecting the proposal.

2. Understanding the drivers of the business. In our observations, boards frequently do not understand the drivers of the business—the core causal factors that drive profitable growth, create competitive advantage and can result in unexpected volatility in earnings. Without that understanding, it becomes difficult (if not impossible) for a board to engage on strategy and to understand key risks that must be managed for the business to succeed. Critical to the understanding and knowledge of the business is a steady stream of useful information. Ultimately, it requires  forward-looking (vs. backward-looking) information that helps the board to understand performance patterns and trends. Too often, boards are inundated with data about what the performance of the company has been. Not often enough are boards given information that can provide insight into the trajectory of the enterprise.

3. Enterprise risk management. More than a decade after the concept of risk-return management became popular with the rise of enterprise risk management, or ERM, few companies include risk management in their financial and strategic decision-making. Yet, most of the critical variables that companies consider in their strategic planning process have become more unpredictable. As outlined in the yearly report of the World Economic

Forum—the Global Risks Report—in which Marsh & McLennan Companies participates, the pace and scale of events introducing uncertainty into corporate earnings is increasing. Far too often, however, a firm’s underlying risk management process has little connection to the firm’s strategic or financial management. Risk management needs to be integrated into the strategic thinking of the company supported by a top-down, strategic examination addressing the drivers and core material risks of the organization. This approach enables management to examine the impact of different scenarios involving multiple risks on financial statements easily, quickly and accurately, and to keep the board informed of how critical emerging events, such as the recent Greece crisis  and associated effects on the European economy could affect the company’s financials. The NACD Blue Ribbon Commission Report on Risk Governance, published several years ago, provides a useful blueprint for effective engagement of the board in understanding risk and ensuring the effective management of risk.

4. Board succession. While management succession continues to be an evergreen challenge, there is another succession issue that many boards face. With the extension of age limits, many boards are aging. In the short term, this is mostly positive—boards have been able to benefit from the wisdom and perspective of experienced people. However, we see a bit of a demographic time bomb ahead as boards will need to replace and replenish their ranks with talent over the coming years. Given the evolving role of boards and the complexity of the problems that companies face today, thought needs to be given to the type of director that is needed. Clearly, diversity is critical— gender, racial ethnic, and geographic. But there is also a need for a diversity of skill sets and experiences. Planning for director succession needs to become more strategic.

5. Board leadership succession. A related but separate issue is how boards plan for the succession of their own leadership. The age of independent board leadership has arrived, whether in the form of independent non- executive chairmen or lead directors. These roles are very real and very critical. How the independent leader of the board fulfills his/her role, relates to fellow directors, and shapes the relationship with management can all have a tremendous impact on the functioning and effectiveness of a board. Given how critical the role is, boards can no longer just hope that an effective leader will emerge once the current leader retires or leaves the role. Boards will  need to understand the requirements for independent board leadership. Based on those requirements, recruitment and succession planning will be needed to ensure that the right candidates are available and being developed.

6. Surfacing and managing conflict. As social systems and teams, the dynamics of boards are as important as the mechanics, and perhaps more so. A recurring problem for boards is related to raising and resolving conflicts. Many boards have not created a culture, an environment, and a process for surfacing disagreements. When disagreements do arise (whether they be around strategic issues, quality of management, or how directors work together) boards do not have the processes in place to constructively work through and resolve conflicts. Issues frequently simmer beneath the surface and either never get raised or boil up to the point of a painful and destructive conflict. Board leaders, senior management, and individual directors need to become more comfortable with raising issues and working them through in a constructive manner.

Building Boards That Are Prepared for the Future

The underlying theme of our list of issues is board preparedness. The future is, by definition, uncertain, and increasingly more so. Boards need to prepare to face that future by having the right agenda, the right people, the right processes, and the right leadership to deal with what may come down the road. Good leadership underlies the obligation that boards have to their long-term shareholders and other stakeholders of the corporation.

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Comply and Explain: Should Directors Have a Duty to Inform?

Posted on January 1, 2013 by Steve Odland

Posted below is an article by John C. Wilcox, Chairman of Sodali Ltd. and posted here with permission.

“Can we end the long tradition of the boardroom as a sealed chamber from which we issue only unanimous endorsements of management’s actions and results? Can we move toward more transparency about the boardroom process, without undermining the ability of management teams to produce the results that shareholders want?”1

Unknown-1I INTRODUCTION

A new “Directors’ Duty to Inform” could be derived from the “Standards of Conduct for Directors” in section 8.30 of the Model Business Corporation Act (MBCA).2 To fulfill their duty to inform, directors of publicly held companies would be obligated to explain to shareholders how they are discharging their duties in a manner they “reasonably believe to be in the best interests of the corporation.”3

A duty to inform would have five main objectives:

1. Explain the relationship between the board’s governance decisions and the company’s business goals;

2. Enable shareholders to make an informed evaluation of A. the company’s governance, B. the directors’ competence and independence, and C. the board’s exercise of business judgment;

3. Enhance directors’ credibility through the articulation of  the processes by which board decisions are made, and B. the strategic rationale for their decisions;

4. Encourage customization, flexibility, and strategic focus in boards’ corporate governance practices comparable to the “comply or explain” approach used in principles-based governance systems; and

5. Promote dialogue and reduce confrontation between boards and shareholders.

The substantive information provided by directors pursuant to a duty to inform would be company-specific, qualitative, contextual, and forward- looking, thereby bringing it within the protection of the business judgment rule. The intent of the duty would not be to increase directors’ liability, but to increase their accountability to shareholders.4

The duty could be discharged by means of a written annual “Directors’ Discussion and Analysis” or by periodic communications from board committees or the board chair to the shareholders.

The expected long-term impact of a duty to inform would be to “operationalize” corporate governance policies and accustom boards to provide greater transparency about their deliberations and decisions on matters relating to governance, business oversight, and strategy.

Regardless of whether a directors’ duty to inform can be inferred from the MBCA or other provisions of state law, it could be implemented through the adoption of a charter or bylaw amendment initiated by the board or by shareholders.

II THE PROBLEM: SHAREHOLDERS NEED TO OBSERVE AND UNDERSTAND BOARD CONDUCT

Nell Minow, editor and co-founder of The Corporate Library, has famously said: “[B]oards [of directors] are like subatomic particles—they behave differently when they are being observed . . . .”5

The key words in Minow’s statement are “observed” and “behave.” From the perspective of long-term investors, corporate governance is primarily a means to observe and monitor the behavior of directors, who are the shareholders’ elected representatives, and to influence their behavior when necessary. The simple presumption behind most governance reforms is that directors will act with greater care and diligence when they are effectively monitored and accountable for their decisions. This presumption is a matter of human nature rather than law.

Given the goal of improved observation, a major governance dilemma arises because the boards of U.S. companies conduct their deliberations and make their decisions behind closed doors. Even though two decades of governance reforms have expanded companies’ disclosure requirements and amplified the duties and responsibilities of directors, boardroom windows at U.S. companies remain closed, with shades down and curtains drawn.

Corporate advocates in the United States vigorously defend boardroom privacy on grounds of collegiality, competitiveness, independence, and respect for directors’ expertise and business judgment. However, boardroom secrecy and constraints on communication create problems: they can polarize relations between directors and shareholders, forestall dialogue, undermine trust, reinforce adversarial forms of engagement, and impose substantial costs on both companies and shareholders. For companies, the primary costs of board secrecy involve the time and resources boards must devote to formal compliance with governance rules, disclosure requirements, and shareholder engagements—not to mention the legal, lobbying, and public-relations dimensions of these activities. Shareholders, particularly institutional investors, incur comparable costs in their governance advocacy, monitoring of portfolio companies, engagement campaigns, activism, and promotion of shareholder rights—not to mention the losses incurred when poor governance practices cause the value of portfolio companies to decline.

In addition to imposing these systemic costs, board secrecy and adversarial relations between companies and shareholders have contributed to the rise of a proliferating industry of corporate-governance experts, proxy-advisory firms, governance-rating entities, proxy solicitors, consultants, and intermediary service providers. The demand for the services of these firms has grown rapidly during the past two decades in parallel with increases in governance regulation and shareholder activism. At this point, there is every reason to think that the costs and resource demands associated with these activities will continue to grow in the aftermath of the financial crisis and the new Dodd-Frank regulatory regime.6

Even though shareholders have achieved a largely unbroken record of success in promoting governance reforms, it is becoming increasingly clear that there is a limit to the effectiveness of prescriptive rules and external metrics. The financial crisis demonstrated all too clearly that compliance with rules and best practices does not ensure good governance. In some high-profile cases, companies’ full compliance with governance norms did little more than provide cover for weak board oversight, incompetence, and fraud. In this skeptical post-crisis environment, new strategies are needed to ensure that boards are not just compliant, but are implementing governance effectively. These strategies must come from within the boardroom. Although   shareholders will continue to demand greater transparency and accountability, a window into the boardroom can be opened only by the directors. Boards must act on their own initiative, not just in response to more disclosure requirements and governance rules.

imagesIII POTENTIAL SOURCES OF THE DUTY TO INFORM

A. The Model Business Corporation Act

The MBCA is a logical place to focus the search for the fundamentals of a directors’ duty to inform. Section 8.30 of the MBCA sets forth the “Standards of Conduct for Directors.”7 The operative language in section 8.30(a) states: “Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation.”8

The comment to section 8.30(a) explains: “The phrase ‘best interests of the corporation’ is key to an explication of a director’s duties. The term ‘corporation’ is a surrogate for the business enterprise as well as a frame of reference encompassing the shareholder body.”9

In essence, the MBCA confirms the common understanding that directors have a duty to act in the best interests of the company and its shareholders. From both corporate and shareholder perspectives, the purpose of corporate governance should be to support this principle that aligns the interests of shareholders with the economic success of the business enterprise.

The generic MBCA Standards of Conduct for Directors are supplemented by the language in section 8.30(c), which requires a director to “disclose . . . to the other board or committee members information not already known by them but known by the director to be material to the discharge of their decision- making or oversight functions.”10 The comment describes this standard as “a duty of disclosure among directors.”11

Although section 8.30(c) defines a limited reciprocal duty among board members, it could be recast to serve as a template for a directors’ duty to inform. Substitution of the word “shareholders” for the words “other board members” in section 8.30(c) would transform and broaden the duty to “encompass the shareholder body.” With this textual revision, the new version of section 8.30(c) would read as follows: “In discharging board or committee duties a director shall disclose, or cause to be disclosed, to the shareholders information not already known by them but known by the director to be  material to the discharge of their decision-making or oversight functions . . . .” Under the revised language, the phrases “not already known by them” and “their decision-making or oversight functions” would refer to the shareholders rather than the directors. If Nell Minow’s observation is correct, this simple change of wording would effect a radical transformation in boardroom behavior by exposing directors’ decision-making to closer observation by shareholders.

Corporate directors have not traditionally been responsible for determining what information is material to their shareholders’ “decision-making or oversight functions.” Disclosure requirements under federal and state law have led companies to focus on materiality with respect to shareholders’ investment decisions, not their administrative functions. Nevertheless, from the perspective of corporate governance, there are compelling reasons for expanding the board’s standards of conduct under section 8.30 to address the duties and responsibilities of shareholders that are analogous to those of corporate directors.

Like corporate directors, many institutional investors, financial intermediaries, and other trustees are fiduciaries. Under the Employee Retirement Income Security Act of 1974, the Department of Labor has long regarded the exercise of proxy votes as a fiduciary duty of pension trustees and their designated investment managers.12 As fiduciaries acting on behalf of beneficial owners, the “decision-making and oversight functions” of investors include voting proxies and electing the directors of portfolio companies. A persuasive argument can be made that in order to discharge their fiduciary duty to vote shares and elect directors in an informed manner, investors should have access to “material . . . information not already known to them” about the conduct of portfolio companies’ directors and their discharge of the duties set forth in section 8.30.13 A directors’ duty to inform would provide this information to shareholders.

B. The Corporate Director’s Guidebook The Corporate Director’s Guidebook, developed by the American Bar Association Committee on Corporate Laws, is another logical source for understanding and interpreting board duties.14 Section 3 of the Corporate Director’s Guidebook sets forth the “Responsibilities, Rights and Duties of a  Corporate Director.”

Section 3.C.4 describes as one of the “legal obligations” of a corporate director a “duty of disclosure” that comes close to the concept of a duty to inform, but falls short in several ways.15

Section 3.C.4 states: “As fiduciaries, directors have an obligation to take reasonable steps to ensure that shareholders are furnished with all relevant material information known to the directors when they present shareholders with a voting or investment decision.”16 The emphasized language limits the duty by aligning it with disclosure requirements that exist under federal securities laws and narrowing the context to situations that involve specific action by shareholders. It does not establish a general continuing duty to inform shareholders about board processes and conduct. Section 3.C.4 also mentions that some courts have expanded the board’s duty of disclosure beyond circumstances involving shareholder action: “[E]ven where the directors are not recommending shareholder action, they have a duty (independent of disclosure obligations generally under the federal securities laws) not to mislead or misinform shareholders.”17

This interpretation is helpful in its acknowledgement that the state law duty of disclosure is independent and separate from federal disclosure requirements. However, it describes the duty in negative terms as an obligation “not to mislead or misinform shareholders,” rather than asserting an affirmative duty to provide shareholders with information that is material to their evaluation of directors’ conduct and business judgment.

Directors’ “disclosure” and “transparency” duties should be distinguished from the duty to inform in order to reinforce the qualitative differences in information communicated by a board at will rather than pursuant to a legal mandate. The duty to inform should not set limits, or dictate information that is deemed to be material, or mandate specific disclosures. Instead, the duty should encourage open communication in the form of a narrative that tells the story of a board’s decision-making processes and the strategic rationale for its choices in the context of the individual business enterprise. The substance of the narrative should be based on the judgment of the directors, not dictated by compliance requirements.

C. The U.K. Governance System: Comply-or-Explain

By definition, a duty to inform would confer broad discretion on directors to explain how they discharge their duties in a manner they “reasonably believe to be in the best interests of the corporation.” The duty would introduce a do-ityourself dimension to boards’ corporate governance programs that would be largely voluntary and self-administered. The duty would not be administered by a regulator (as the Securities and Exchange Commission (SEC) regulates shareholder proposals under Rule 14a-8).18 It would not be enforced by a self- regulatory organization (SRO) (as the New York Stock Exchange enforces listed company standards with the threat of delisting).19

It would generally involve decisions protected by the business judgment rule and would therefore not be subject to the “Standards of Liability” defined in section 8.31 of the MBCA (although it would certainly be subject to federal and state antifraud provisions). In lieu of these traditional methods of oversight and enforcement, the duty to inform would be based on directors’ accountability to shareholders.

The best-known model for accountability-based governance is the comply- or-explain program that has been in operation in the United Kingdom for nearly two decades.20 Although not without its critics, the United Kingdom’s voluntary comply-or-explain governance regime offers a number of advantages for companies. Comply-or-explain is specifically designed to promote flexible and customized governance practices rather than prescriptive rules and check- the-box compliance. It gives deference to the knowledge, expertise, and judgment of corporate directors. It assumes that boards are best positioned to determine what specific information is relevant to an explanation of noncompliance. It assumes that directors will be candid and avoid boilerplate. Most importantly (and perhaps aspirationally), it assumes that institutional investors will be diligent in committing time and resources to evaluate the quality of a company’s governance decisions in the context of business strategy and financial performance.

The U.K. Corporate Governance Code does not explicitly define a directors’ duty to inform, but it mandates an open relationship and constructive dialogue between directors and shareholders. Section E of the U.K. Code states the following “Main Principle”: “There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.”21

The important principle at the heart of the U.K. Code is that the board itself must assume responsibility for dialogue with shareholders, rather than vice versa. This approach is in contrast with U.S. practice, which discourages communication from boards to shareholders and encourages shareholders to initiate dialogue, usually through adversarial forms of engagement.

The U.K. Code’s provision E.1.2 further requires: “The board should state in the annual report the steps they have taken to ensure that the members of the board, and, in particular, the non-executive directors, develop an understanding of the views of major shareholders about the company . . . .”23

Again, the point is that with U.K. companies, the board has a direct role in outreach and dialogue with major shareholders in order to understand their views.

Unknown-2IV COMPLY-AND-EXPLAIN: A HYBRID GOVERNANCE PROPOSAL

A directors’ duty to inform modeled on the United Kingdom’s principles- based, comply-or-explain system would pose challenges for U.S. companies. It is unclear whether state law could accommodate a board duty defined with such broad discretion and enforced primarily by means of shareholder accountability. Such a duty would occupy uncharted middle ground between the Standards of Conduct for Directors under section 8.30 of the MBCA and the Standards of Liability under section 8.31 of the MBCA. It is equally unclear whether the U.S. rules-based system of corporate governance could tolerate a principles-based, discretionary approach to directors’ duties and standards of conduct.

The success of a hybrid comply-and-explain governance system—grafting a new duty to inform onto the existing state and federal regulatory structure— would depend on two developments that are highly uncertain: (1) directors of U.S. companies would have to overcome their habitual antipathy to shareholders, assume a less-defensive posture, and accept primary responsibility for dealing with shareholder concerns related to governance and board conduct; and (2) institutional investors would have to give priority to their responsibilities as long-term owners, commit resources to the oversight of portfolio companies, and reduce their dependence on standardized third party governance analyses and proxy-voting recommendations.

In addition to these legal, structural, and cultural problems, the directors’ duty to inform would be likely to encounter resistance from U.S. companies and directors already overwhelmed by compliance requirements and facing additional controversial governance pressures including: the majority-vote standard in director elections, shareholder access, say-on-pay, risk oversight, takeover threats, conflicts of interest, short-termism, empty voting, proxy mechanics, environmental and social policies, and financial-system reform.

Ironically, the imposition of a directors’ duty to inform could actually help companies anticipate and avoid many of these contentious issues. A board-level narrative describing the decision-making process and explaining the context and business rationale for board decisions would help defuse shareholder concerns, reduce confrontation, and ultimately strengthen shareholder support even when there is a perception of non-compliance.

Executive compensation is a useful example that reveals the limits of disclosure rules and the need for better communication about board processes and policies. The say-on-pay movement grew out of shareholder frustration not only with perceived compensation excesses, but also with standardized disclosures that failed to address important strategic questions.24

The goal of an advisory vote is not to micromanage compensation but to increase board accountability and thereby compel directors to align pay with performance and explain how their compensation policies support business strategy and value creation. Through the exercise of a duty inform, directors would have greater discretion to provide a comprehensive Board Compensation Committee Report explaining their compensation philosophy, their decisions with respect to bonus and variable pay, and the economic goals that the incentives are designed to achieve.

This approach would be more effective than attempting to shoehorn the board’s views into the disclosure matrix of the management Compensation Disclosure and Analysis, or waiting to be targeted by shareholders and producing an explanation of directors’ policies and decisions after-the-fact.

V TOWARDS RECIPROCITY: AN INVESTORS’ DUTY TO INFORM?

Imposition of a directors’ duty to inform would not by itself result in “a dialogue with shareholders based on the mutual understanding of objectives.”25 Opening boardroom windows would help, but for interests to be fully aligned, institutional investors must also agree to comparable standards of candor and openness. Constructive dialogue between boards and shareholders must be a two-way street.

Debate over the Dodd-Frank bill launched a discussion of investor responsibility and fiduciary duty in the context of the abuses, conflicts of interest, and governance failures within the financial community that led to the crisis. As financial-system reform unfolds in the United States under the new law, many experts believe that institutional investors will replace companies and directors at the center of the governance-reform spotlight.26 Indeed, on October 21, 2010, the United States Department of Labor announced a proposed rule that would substantially strengthen the Employee Retirement Income Security Act (ERISA) definition of a “fiduciary.”27

More reforms are sure to follow. Discussion of investor responsibility is already well under way in the United Kingdom, where the Financial Reporting Council adopted a Stewardship Code for institutional investors in July 2010.28 It was preceded by an earlier Code on the Responsibilities of Institutional Investors, drafted in November 2009 by the Institutional Shareholders Committee, a forum representing major U.K. institutional investors.29

These efforts may prove useful as a precedent for a U.S. private-sector initiative bringing together both corporate and investor representatives to deal with the conjoined issues of board and investor conduct.

UnknownVI CONCLUSION

Well before the financial crisis, Leon Panetta suggested that companies should open the “sealed chamber” of the boardroom and provide greater transparency about board processes. Instead, boardroom windows remained closed and U.S. governance continued to pursue its traditional course of confrontation, legislation, and rule-making.30 Now, as companies stagger under the burden of compliance and face additional governance challenges in the Dodd-Frank Act, directors should seriously consider whether their sealed chamber is a privilege or a constraint and whether its growing costs outweigh its diminishing benefits.

The recent turmoil in the economy and financial markets underscores the importance of corporate governance and directors’ accountability to shareholders. However, in the United States, there is currently no basis for establishing a directors’ duty to inform shareholders about boardroom deliberations and governance decisions.

Section 8.30 of the MBCA requires directors to act in the best interest of the company and establishes a duty to inform other board members of information material to their decision-making function, yet it stops short of applying that standard to shareholders and investors. The Corporate Director’s Guidebook limits directors’ affirmative duty to inform shareholders in situations involving specific actions. The U.K. Code presents a more open model of communication under the voluntary comply-or-explain system, fostering flexibility and deference to business judgment. However, by requiring explanation primarily  when the board chooses not to comply, the U.K. Code still presents a level of communication short of the ideal.

A new duty to inform based on the principles of comply-and-explain would encourage directors of U.S. companies to articulate how decisions made in the boardroom advance strategic goals and align with shareholder interests. It would preserve directors’ discretion in the exercise of business judgment while providing shareholders with greater understanding of board conduct. In Panetta’s words, a directors’ duty to inform would “move toward more transparency about the boardroom process without undermining the ability of management teams to produce the results that shareholders want.”31

Under a comply-and-explain system, directors would have to overcome the inertia of a traditionally opaque and defensive posture, while investors would be under an obligation to embrace their oversight function and use their voice and votes to hold directors accountable. If directors and shareholders would both commit to such reciprocal duties, improvements in transparency, accountability, and corporate stability would surely result.

Copyright © 2011 by John C. Wilcox.This article is also available at http://www.law.duke.edu/journals/lcp. * Chairman, Sodali Ltd. 1. Leon Panetta, It’s Not Just What You Do, It’s the Way You Do It, DIRECTORS & BOARDS, Winter 2003, at 17, 21.

FOOTNOTES

For a general discussion of the problems of board–shareholder communication at U.S. companies, see generally Symposium, Who Speaks for the Board?, DIRECTORS & BOARDS, Second Quarter 2010, at 18; COMM. ON CORPORATE LAWS OF THE ABA SECTION OF BUS. LAW, REPORT ON THE ROLES OF BOARDS OF DIRECTORS AND SHAREHOLDERS OF PUBLICLY OWNED CORPORATIONS, available at http://www.abanet.org/media/nosearch/task_force_report.pdf; see also Stefan Stern, Investors Want You to Tell a Better Story, FINANCIAL TIMES.COM (May 31, 2010), http://www.ft.com/cms/s/0/c3bcd18e-6cdb-11df-91c8-00144feab49a.html. 2. MODEL BUS. CORP. ACT § 8.30 (2008). 3. See id. § 8.30(c) (This section obliges directors to act in accordance with their reasonable beliefs about the best interests of the corporation, but it does not require that they communicate these beliefs to the shareholders). 4. The liability for selective disclosure prohibited by Regulation FD under the Securities Exchange Act could be avoided by limiting the topics covered by a duty to inform. See the discussion in COMM. ON CORPORATE LAWS, supra note 1, at 11 n. 24. 5. The Prime of Ms. Nell Minow (A CFO Interview), CFO MAGAZINE, Mar. 2003, at 56, 626. See generally Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111203, 124 Stat. 1376 (2010).8.307. MODEL BUS. CORP. ACT § 8.30 (2008). 8. Id. § 8.30(a) (emphasis added). 9. Id. §  cmt. 1 (emphasis added). 10. Id. § 8.30(c). 11. Id. § 8.30 cmt. 3. 12. Letter from Alan D. Lebowitz, Deputy Assistant Sec’y, Dep’t of Labor, to Helmut Fandl, Chairman of the Ret. Bd. of Avon Prods., Inc. (Feb. 23, 1988), reprinted in COUNCIL OF INSTITUTIONAL INVESTORS, EVERYTHING YOU ALWAYS WANTED TO KNOW ABOUT PROXY VOTING BUT WERE AFRAID TO ASK 14–16 (2007), available at http://www.cii.org/UserFiles/file/ resource%20center/publications/Proxy%20Voting%20Primer.pdf; see also Interpretive Bulletins Relating to the Employment Retirement Income Security Act of 1974, 29 C.F.R. § 2509.94-2 (1994); Interpretive Bulletin Relating to the Exercise of Shareholder Rights and Written Statements of Investment Policy, Including Proxy Voting Policies or Guidelines, 29 C.F.R. § 2509.08-2 (2008). 13. MODEL BUS. CORP. ACT § 8.30 (2008). 14. COMM. ON CORPORATE LAWS OF THE ABA SECTION OF BUS. LAW, CORPORATE DIRECTOR’S GUIDEBOOK (5th ed. 2007).  15. See id. at 26. 16. Id. (emphasis added). 17. Id.  18. Shareholder Proposals, 17 C.F.R. § 240.14a-8 (2010). 19. N.Y. STOCK EXCH., LISTED COMPANY MANUAL § 802.1D (2009), available at http:// nysemanual.nyse.com/LCM/. 20. See FIN. REPORTING COUNCIL, THE U.K. CORPORATE GOVERNANCE CODE (2010), available at www.frc.org.uk/documents/pagemanager/Corporate_Governance/UK%20Corp%20Gov%20Code %20June%202010.pdf [hereinafter U.K. CODE]; see also James Hamilton, UK Reaffirms Comply or Explain Model for Corporate Governance as Financial Crisis Roils, CCH FINANCIAL REFORM NEWS CENTER (Aug. 28, 2009), http://financialreform.wolterskluwerlb.com/2009/08/uk-reaffirms-comply-orexplain- model-for-corporate-governance-as-financial-crisis-roils.html (“The comply or explain approach has been in operation since the Code’s beginnings in 1992 . . . and the flexibility it offers is valued by company boards and by investors in pursuing better corporate governance.”). 21. U.K. CODE, supra note 20, § E.1, at 25. 22. See Symposium, Who Speaks for the Board?, supra note 1.  23. U.K. CODE, supra note 20, § E.1.2, at 25. 24. See, e.g., TIAA-CREF, 10 QUESTIONS FOR EVALUATING CD&A’S (July 2007), available at http://www.shareholderforum.com/op/Library/20070822_TIAA-CREF.pdf. 25. U.K. CODE, supra note 20, § E.1, at 25. 26. For further discussion on the evolving role of investors, see generally the recent publications of BOGLE FIN. MKTS. RESEARCH CTR., www.vanguard.com/bogle_site/bogle_home.html; see also John C. Bogle, Founder & Former Chairman, Vanguard Grp., Building a Fiduciary Society Remarks at the IA Compliance Summit (Mar. 13, 2009), available at http://www.vanguard.com/bogle_site/ sp20090313.html.  27. Definition of the Term “Fiduciary”, 75 Fed. Reg. 65,263 (proposed Oct. 21, 2010) (to be codified at 29 C.F.R. pt. 2510). 28. FIN. REPORTING COUNCIL, THE U.K. STEWARDSHIP CODE (2010), available at www.frc.org.uk/images/uploaded/documents/UK Stewardship Code July 20103.pdf. 29. INSTITUTIONAL S’HOLDERS COMM., CODE ON THE RESPONSIBILITIES OF INSTITUTIONAL INVESTORS (2009), available at http://institutionalshareholderscommittee.org.uk/sitebuildercontent/ sitebuilderfiles/ISCCode161109.pdf. 30. Panetta, supra note 1, at 21. 31. Id.

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Key Issues for Directors in 2013

Posted on November 24, 2012 by Steve Odland

[The following summary was written by Wachtell Lipton Rosen & Katz and is posted here by permission.]

November 16, 2012

The Spotlight on Boards

The ever evolving challenges facing corporate boards prompts an updated snapshot of what is expected from the board of directors of a major public company – not just the legal rules, but also the aspirational “best practices” that have come to have almost as much influence on board and company behavior – for consideration in conjunction with Key Issues for Directors in 2013.

Boards are expected to:

• Establish the appropriate “Tone at the Top” to actively cultivate a corporate culture that gives high priority to ethical standards, principles of fair dealing, professional- ism, integrity, full compliance with legal requirements and ethically sound strategic goals.

• Choose the CEO, monitor his or her performance and have a detailed succession plan in case the CEO becomes unavailable or fails to meet performance expectations.

• Work with management to navigate the dramatic changes in economic, social and po- litical conditions in order to remain competitive and successful.

• Plan for and deal with crises, especially crises where the tenure of the CEO is in ques- tion, where there has been a major disaster or a risk management crisis, or where hard-earned reputation is threatened by a product failure or a socio-political issue.

• Determine executive compensation to achieve the delicate balance of enabling the company to recruit, retain and incentivize the most talented executives, while also avoiding media and populist criticism of “excessive” compensation and taking into account the implications of the “say-on-pay” vote.

• Interview and nominate director candidates, maintain appropriate expertise, inde- pendence and diversity balance, monitor and evaluate the board’s performance and seek continuous improvement in board performance.

• Approve the company’s annual operating plan and long-term strategy, monitor per- formance and provide advice to management as a strategic partner.

• Determine the company’s reasonable risk appetite (financial, safety, reputation, etc.), set state-of-the-art standards for managing risk and monitor the management of those risks within the parameters of the company’s risk appetite.

• Set state-of-the-art standards for compliance with legal and regulatory requirements, monitor compliance and respond appropriately to “red flags.”

• Take center stage whenever there is a proposed transaction that creates a seeming conflict between the best interests of stockholders and those of management, including takeovers and attacks by activist hedge funds.

• Set high standards of social responsibility for the company, including human rights, and monitor performance and compliance with those standards.

• Oversee relations with government, community and other constituents.

• Pay close attention to investor relations to develop an understanding of shareholder perspectives on the company, interface with shareholders in appropriate situations and support the fostering of long-term relationships with shareholders.

• Work with management to encourage entrepreneurship, appropriate risk-taking and investment to promote the company’s long-term success, despite constant market pressures for short-term performance.

• Review corporate governance guidelines and committee charters and tailor them to promote effective board functioning.

To meet these expectations, it will be necessary for major public companies

(1) to have a sufficient number of directors to staff the requisite standing and special committees and to meet expectations for diversity;

(2) to have directors who have knowledge of, and ex- perience with, the company’s businesses, even though meeting this requirement may result in boards with a greater percentage of directors who are not “independent”;

(3) to have directors who are able to devote sufficient time to preparing for and attending board and committee meetings;

(4) to provide the directors with regular tutorials by internal and external experts as part of expanded director education; and

(5) to maintain a truly collegial relationship among and between the company’s senior executives and the members of the board.

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ISS Moderates Proposed Voting Policy Updates for the 2013 Proxy Season

Posted on November 20, 2012 by Steve Odland

[The following summary was written by David A. Katz, Trevor S. Norwitz, Jeremy L. Goldstein, and S. Iliana Ongun of Wachtell Lipton Rosen & Katz and is posted here by permission.]

Institutional Shareholder Services has released its 2013 Corporate Governance Policy Updates, which represent a more moderate approach than the proposals it released for comment in October. These changes, which will generally apply for the 2013 proxy season, continue the trend of narrowing director discretion in matters traditionally considered to be within directors’ authority. In addition, ISS’ expansion into social policy matters appears often to be at odds with shareholder and corporate interests and is far more likely to benefit special interest groups. It should be noted, though, that ISS took into account many of the comments it received and in some cases moved from a one-size-fits-all approach to a more appropriate case-by-case analysis. Although it is important that boards of directors be cognizant of ISS voting policies, it is essential that, in their decision-making, directors carefully consider the best interests of the corporations they serve and not merely defer to shareholder advocacy groups.

Board Responsiveness to Majority Supported Shareholder Proposals.

Although ISS will tighten its policy and recommend that shareholders vote “against” or “withhold” their votes for incumbent directors who fail to act on a shareholder proposal that received the support of a majority of votes cast in the previous year, it has – as we and others urged – implemented a transition rule, so that the tighter standard will only commence with shareholder proposals appearing in companies’ proxy statements in 2013, and will not apply retroactively. For shareholder proposals that won a majority of votes cast during the 2012 proxy season, board responsiveness will be assessed under the existing standard, which requires approval by a majority of outstanding shares the previous year or the support of a majority of votes cast in both the last year and one of the two prior years. While we continue to believe that the change to the current policy may impede board effectiveness by discouraging boards from considering long-term strategy when evaluating shareholder proposals, ISS has appropriately determined not to impose the harsher standard retroactively.

ISS has stated that it considers a board to have responded to a shareholder proposal if the board either fully implements the proposal or, if a shareholder vote is required, includes it as a management proposal on the next annual ballot. ISS will consider responses involving less than full implementation on a case-by-case basis, taking into account several factors, including the subject matter of the proposal and level of shareholder support shown, outreach efforts by the board to shareholders in the wake of the vote and actions taken by the board in response to its engagement with shareholders.

Voting on Director Nominees in Uncontested Elections.

ISS currently recommends that shareholders vote “against” or “withhold” their votes for incumbent directors, even in uncontested elections, when the company has experienced certain extraordinary circumstances including, among others, material failures of governance stewardship, risk oversight, or fiduciary responsibilities at the company. ISS has specified that, starting next year, failures of risk oversight will include bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, hedging of company stock or “significant” pledging of company stock. This policy update is a shift from ISS’ original proposal, which sought to categorize any pledging of company stock as a problematic pay practice that could lead to a negative say-on-pay recommendation, rather than a failure of risk oversight. In our view, categorizing only “significant” pledging of company stock as a failure of risk oversight provides for a more nuanced case-by-case consideration of pledging practices, rather than a one-size-fits-all approach.

Realizable Pay.

For large capitalization companies only, ISS will not only look to the value of compensation granted to executives generally as reported in the summary compensation table, but will add the concept of “realizable pay” to its analysis. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for awards actually earned and target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be re-valued based upon the remaining term and updated assumptions, using the Black-Scholes option pricing model.

Golden Parachute “Say-on-Pay” Vote.

ISS has modified its analysis of the golden parachute “say-on-pay” vote to include consideration of existing change of control arrangements and not merely newly-adopted agreements, as was the case under the current policy. While recent amendments that incorporate so-called problematic features (e.g., golden parachute excise tax gross-ups and single trigger payments) will carry more weight in the overall analysis, it appears that the presence of multiple legacy “problematic” features will also be closely scrutinized.

Pay for Performance Peer Group Selection Methodology.

In performing its pay for performance analysis, ISS previously focused on the subject company’s GICS industry peers, which frequently omitted competitors of the target company and/or included firms that were not competitors of the subject company for business or talent. ISS’ new methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the subject company’s self-selected peer group. The methodology additionally focuses initially at an 8-digit GICS code (a broad group) to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and have chosen the subject company as a peer. In addition, ISS has slightly relaxed its size requirements, especially at very small and very large companies, and will use revenue instead of assets for certain financial companies.

Director Attendance; Overboarded Directors.

Starting next year, ISS will recommend that shareholders vote “against” or “withhold” their votes for: (1) individual directors who attend less than 75% of their board and committee meetings for the period for which they served, unless an acceptable reason is disclosed in an SEC filing; and (2) individual directors for whom proxy disclosure is insufficient to determine whether such directors met the 75% attendance threshold. In addition, ISS will no longer count publicly-traded subsidiaries owned 20% or more by the parent as one board with the parent company when determining the number of boards on which a director sits, and will continue to consider serving on more than six public company boards to be excessive. All subsidiaries with publicly-traded stock will be counted as boards in their own right, except such subsidiaries that only issue public debt. Mutual funds will continue to be rolled up to the mutual fund families, with one family counting as one board. Directors who sit on the boards of publicly-traded subsidiaries should re-evaluate their commitments to avoid inadvertently facing a negative recommendation from ISS.

Other Changes.

As ISS previously proposed, it has changed its recommendation for shareholder proposals to link executive compensation to environmental and social criteria from an automatic recommendation “against” to a “case-by-case” analysis. In adopting the change, ISS noted that incorporating sustainability-related non-financial performance metrics into executive compensation is becoming increasingly common in certain sectors, including the extractive industry sectors. ISS has also revised its policy position on proposals requesting information on a company’s lobbying activities to clarify that “lobbying activities” includes direct, indirect and grassroots lobbying, and not just direct lobbying. ISS’ expansion further into areas of social policy, however laudable it may appear to be, is in our view inappropriate and more likely to benefit special interest groups than businesses and the investors ISS purports to represent.

* * * * *

ISS’ 2013 policy updates generally continue the incremental shift towards a shareholder-centric model of corporate governance that may be at odds with the best interests of the companies that boards serve. As companies begin to prepare for the 2013 proxy season, they must be mindful of anticipated or actual negative recommendations and consider whether to proactively engage with shareholders to counteract any such recommendations. However, we continue to believe that in evaluating and responding to shareholder proposals, as in every decision they make, directors must carefully consider the best interests of the corporations they serve and not merely defer to shareholder advocacy groups.

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KPMG’s Ten To-Do’s for Audit Committees

Posted on November 11, 2012 by Steve Odland

By KPMG’s Audit Committee Institute

[This piece was written by KPMG, published by NACD, and is reposted here.]

Recognizing the sizeable challenges that audit committees and boards face, KPMG’s Audit Committee Institute (ACI) has issued its annual message to directors. “Ten To-Do’s for Audit Committees” highlights key issues that should be top of mind as audit committees think through their agendas for the future.

1. Stay focused on the audit committee’s top priority: financial reporting and related internal control risk. Ensuring that the audit committee’s agenda focuses on the issues that require its attention will be a significant undertaking. The challenges of ongoing economic uncertainty and volatility coupled with the impact of cost- reductions, major public policy initiatives, and an uncertain—yet clearly more-complex—regulatory environment will require the attention of every audit committee. Meeting this workload challenge will require focused (yet flexible) agendas, with an eye on the company’s key financial reporting and related internal control risks. As-needed updates from management between regular audit committee meetings can be invaluable.

2. Continue to monitor accounting judgments and estimates, and prepare for accounting changes. Monitor fair value estimates, impairments, and management’s assumptions underlying critical accounting estimates. Recognize that the company’s greatest financial reporting risks are often in areas where there is a range of possible outcomes, and management is called upon to make difficult judgments and estimates. Understand management’s framework for making accounting judgments and estimates (was the framework in the “Pozen report” considered?19), make sure management has appropriate controls in place, and ask for the external auditor’s views. Also, understand how major accounting changes on the horizon may impact the company, including implementation/resources and IT systems requirements. The SEC continues to explore what role IFRS will play in U.S. financial reporting, with a decision expected in 2012; and key FASB/IASB joint projects on revenue recognition, leases, financial instruments, and insurance are moving forward. Stay close to where these projects are headed and the timeline.

3. Consider whether the financial statements and disclosures tell the company’s story. Given the importance of transparency to the investor community, as well as the SEC’s ongoing focus on disclosures, consider how disclosures can be improved—perhaps going beyond what’s “required”— to better address expectations. Enlist management’s disclosure committee in this effort, and consider the findings of the recent FEI/KPMG study on disclosures, Disclosure Overload and Complexity: Hidden in Plain Sight. Understand the process management uses to calculate any non-GAAP measures that are used in SEC filings to ensure their relevance and reasonableness. At the end of the day, do the financial statements and disclosures tell the company’s story?

4. Focus on the company’s plans to grow and innovate. Growth, strategy, and innovation will be front-and-center as companies search for top-line growth and look forward, beyond the recessionary environment. A key challenge will be monitoring and calibrating growth plans to appropriately balance risk and reward. (Remember: good risk management enables innovation and growth.) Does lack of innovation pose a threat to the company? Make sure risk and strategy are discussed together—each hinges on the other. Given historically low valuations and high levels of corporate cash on hand, understand the company’s position in the M&A “ecosystem” (as a potential acquirer or target). Is there a robust M&A process in place in the event an offer or opportunity arises? What is the role of the audit committee versus the full board?

5. Reassess the company’s vulnerability to business interruption and its crisis readiness. As illustrated by the earthquake in Japan, the European debt crisis, and other systemic disruptions over the past 24 months, the global interconnectedness of businesses, markets, and risk poses challenges for virtually every company. Ensure that management is weighing a broad spectrum of “what-if” scenarios—from supply chain links and the financial health of vendors to geopolitical issues, natural disasters, and cyber threats. Is the company’s crisis response plan robust and ready to go? Is the plan actively tested or war-gamedz—and updated as needed?

6. Understand how technology change and innovation are transforming the business landscape—and impacting the company. IT risk discussions should be moving (rapidly) beyond “defensive” issues (compliance, data privacy, system implementations) to address the critical challenge today: understanding the transformational implications of IT and emerging technologies—cloud computing, social media, mobile technologies, and data—and the strategic issues they present. The audit committee can help the organization get its arms around IT by insisting on more frequent and robust communications with the CIO; elevating IT discussions to a senior management/full- board level (beyond the “IT shop”); helping to frame the big picture view of the company’s IT governance efforts (on data and social media); clarifying the oversight role(s) of the board, audit committee, and other committees; and strengthening the board’s understanding of IT (by bringing IT expertise onto the board and/or through education). A comprehensive IT risk assessment is essential, and support from internal audit can be invaluable. Review the SEC’s October 2011 guidance on cyber security disclosures, which may highlight IT issues requiring greater attention by the company and the board.

7. Focus on asymmetric information risk and seek out dissenting views. Is the audit committee hearing views from those below and beyond senior management—e.g., from middle management and business unit leaders, sell-side analysts and critics, and other third parties—about the risks and challenges facing the company? Does the information provided by management, internal audit, and external auditors tell a consistent story? What is being said about the company by customers, employees, and others on social media networks? Make time to visit company facilities and attend employee functions. Key goals here are to recognize when asymmetric information risk—the over-reliance on senior management’s information and perspective—is too high, and to promote a culture of candor and constructive skepticism, where raising red flags and challenging information are welcomed.

 8. Consider the impact of the regulatory environment on compliance programs and business plans. The increasing complexity of the global regulatory environment—including compliance challenges posed by the Foreign Corrupt Practices Act and the UK Bribery Act, the SEC’s whistleblower bounty program, and Dodd-Frank provisions on conflict minerals and compensation clawbacks—will require continued attention. The right tone at the top and throughout the organization is critical. From a broader business perspective, consider the potential impact of regulatory compliance developments on the business planning process, particularly when growth strategies include international expansion. Do the company’s regulatory compliance and monitoring programs align with its business plans?

9. Understand the company’s significant tax risks and how they are being managed and modeled. Prospects for business tax reform; ongoing assessment of uncertain tax positions; increased state, federal, and global enforcement activities; and the continued complexity of operating globally in different tax regimes all pose significant compliance and financial risks. To stay abreast of critical tax risks—including internal control, compliance, and disclosure issues—establish a clear communications protocol for management to update the audit committee on the status of its tax risk management activities. Ensure the tax function is monitoring the federal tax reform debate and “testing” the impact of various tax legislative scenarios (e.g., on R&D, capital investments, cash flow, hiring, etc.) and possible remedial steps as the proposals become more specific. Are leading risk management practices (such as scenario planning) being leveraged to manage significant tax risks?

10. Monitor the PCAOB’s initiatives on auditor independence and transparency, and consider the implications for the audit committee. PCAOB initiatives designed to promote auditor independence, objectivity, and professional skepticism have potentially significant implications for the audit process and the role of the audit committee. Set clear expectations with management and auditors for staying apprised of these projects and communicating their potential impact on the audit and the audit committee’s oversight (the PCAOB is seeking input from all stakeholders, including audit committee members). Consider how the audit committee currently reinforces auditor independence and skepticism. Would a more robust audit committee report be beneficial to investors?

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Corporate Governance: Five Mandates for a Complicated Era

Posted on October 28, 2012 by Steve Odland

By Heidrick & Struggles

[This piece was written by Heidrick & Struggles and published by NACD.  It is reprinted here.]

Directors can be forgiven for feeling bruised, even though the global economy shows slight signs of recovery. Consumer confidence appears to be picking up as jobless numbers ease, according to the latest figures from The Conference Board. And, chief executive officers seem less anxious about their organizations’ future prospects.

But directors themselves are far more guarded. NACD’s latest Board Confidence Index shows that directors’ confidence in continued growth in the U.S. economy has dropped. In fact, directors who last year characterized their outlook for general economic conditions as moderately positive now see little or no change for the future.

There is no way for directors to magically boost global demand or pull macroeconomic levers. But there are factors they certainly can control that will, over time, substantially improve the operations of the companies on whose boards they sit—not least because those factors will free the board and management team to focus on performance. Heidrick & Struggles identifies five issues that merit immediate and consistent attention.

1. Improving communications with shareholders. Do a quick Google search for “shareholder communication with directors” and up come all sorts of boilerplate assurances touting open lines of communication between boards and investors. But in many cases, the fine print betrays just how difficult it can be for shareholders to make themselves heard by directors.

Here’s one example that clearly demonstrates just how out of touch boards can often be in our Facebook and Twitter age: “Any shareholder who wishes to send communications to the Board of Directors should mail them addressed to the intended recipient by name or position in care of: Corporate Secretary [company name and address follows]. Upon receipt of any such communications, the Corporate Secretary will determine the identity of the intended recipient and whether the communication is an appropriate shareholder communication.” Translation: Please don’t bother—we are not open to input.

Increasingly, shareholders want—indeed, demand—more immediate access to the board. It’s not to circumvent proxy voting mechanisms or to subvert established whistleblower channels; it is simply to have more of a voice in issues that shareholders care about—and to know that directors are listening.

Given the well-publicized CEO succession snafus we have seen in recent years—and given the rise of shareholder activism in general—it is easy to see why shareholders are anxious for a real dialogue with the head of the nominating committee, for example. In an era in which corporate reputations can rise and fall with the ebb and flow of social media messages, it is necessary for directors to think anew about how their roles are perceived by investors.

We’re not saying every boardroom debate is up for public consumption or that every director should have a mandate to speak freely and candidly to anyone who asks—media, analyst, or shareholder. It is crucial that when directors speak, they speak with a unified voice.

But there are smart ways to be open. We believe that board openness starts with meetings with select institutional investors—and will soon become a hallmark of best-performing boards. As such, it will set the bar of expectation for shareholders everywhere. The Pfizer board is taking a more proactive approach to fostering open board and shareholder communications. It is sending out a press release announcing a board-shareholder meeting and later sending some of the materials distributed at the meeting between the board and 16 of its major shareholders. The reactions to this move are proving positive.

NACD has included “shareholder communications” as one of its 10 “Key Agreed Principles” to strengthen governance for public U.S. companies and made available a raft of materials for detailed discussion—from webinars to books to reports. Others eloquently support the case for improved communication with investors.

2. Mastering CEO succession planning. The old story about corner-office succession planning is that the CEO would keep an envelope tucked away in his or her desk drawer naming the future successor.

The story isn’t so far from the truth. The shock of it is that here, in 2012, CEO succession planning is still done so poorly—when it’s done at all. In recent years—naming no names—there have been some staggeringly awful succession gaffes by companies quite established enough to have known better.

The statistics are not encouraging. NACD’s 2009 research shows that 44 percent of corporations did not have a formal CEO succession plan in place. Although most had some basic process for replacing the CEO in an emergency, many had not planned for succession over a three-to-five year period. A 2010 study by Heidrick & Struggles and The Rock Center for Corporate Governance at Stanford University found that on average, boards spend only two hours a year on CEO succession planning, and only 50 percent have a written document detailing the skills required for the next CEO.9 Furthermore, in our 2011 Board of Directors survey, we found that only two-thirds of U.S. directors said their boards had vetted at least one viable candidate who could immediately step in as CEO if necessary.

The SEC is on the case. In October 2009, its Division of Corporate Finance issued new guidelines that support shareholders who want boards to provide more transparency about the process.11 The document pulls no punches: “We now recognize that CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce.”

Yet the benefits of thorough succession planning are not hard to find. Heidrick & Struggles’ research shows that merely announcing who your next CEO is can move the market value of your company by 5 percent or more.12 McDonald’s is the high-water mark for how to do succession planning right. When CEO Jim Cantalupo died unexpectedly in 2004, the board was quick to name veteran Charlie Bell—then president and chief operating officer—as Cantalupo’s successor. But shortly thereafter, Bell learned that he had cancer. The directors had a plan: Their continual preparation and development of a years-long leadership pipeline meant they did not have to go outside the company to replace Bell.

We have worked with a company that has pursued an exemplary board practice: It has run mock board meetings to identify a CEO successor in case of a sudden event like that which befell McDonald’s. The mock meeting was tasked to a specific committee, and individual directors had clear responsibilities for roles such as communicating to the executive team, to investment analysts, and others. That is the kind of initiative we have to see more often.

3. Aligning executive compensation with performance. This has long been a heated issue for boards, and it never seems to be resolved to the satisfaction of shareholders. Now, more than ever, it is the board’s responsibility to cool down the debate over executive pay.

The Occupy Wall Street movement is the least of directors’ concerns. Much more pressing are the increasingly shrill calls for fair play when CEOs are awarded epic sums for negative performance (and there were some jaw-dropping examples in 2011)13—or in quite a few cases, for no performance, in the form of “golden hello” handouts when a new CEO signs on. In some instances, the “hello” envelopes have been downright incendiary for some shareholders—and for the media—whether or not the sums have been inducements or “make whole” compensation for monies the executive may have left on the table at the previous employer.

Dodd-Frank, enacted in mid-2010, now gives shareholders some say on pay via non-binding votes on executive compensation and golden parachutes. But we contend that all too many directors—especially the members of compensation committees—are tone-deaf to the hard connection between performance and pay. We fully expect that institutional heavyweights such as CalPERS will, with Dodd-Frank behind them, wade more forcefully into compensation affairs. And we expect to hear a lot more from longtime activist investors such as Carl Icahn, Relational Investors, and others.

That said, we know plenty of directors who are frustrated by the compensation excesses they see all around them. They are more than happy to reward CEOs handsomely when those executives knock corporate performance out of the park, but they find themselves competing with decisions from directors at other companies who listen far too closely to what the compensation consultants have to say.

In their hearts, directors know that not all executives are somehow “above average.” Now they must confront this realization head-on.

4. Ensuring more diverse boards. Over the last three or four years, it is fair to say that diversity in boardrooms took something of a backseat. There is an excuse, of course: the economic downturn focused everyone’s attention on performance. But now it’s time to return to the admittedly hard job of building boards that represent the rich diversity found on any city street in the United States or in most offices and factory floors.

The pressure is on: There’s a striking example in the letter that CalSTRS earlier this year wrote to Facebook, urging that the company strengthen its corporate governance and increase the diversity of its board.14 The European Union is forging ahead with plans for quotas (always a controversial topic) to increase the percentage of women on boards.15 And we fully expect that organizations such as Catalyst—and increasingly influential efforts like Stanford University Graduate School of Business’s Stanford Women on Boards Initiative—will increase the drumbeat to appoint more female directors.

The calls for ethnic diversity may be less strident right now, but they are not likely to be mute for long. The rise of sovereign wealth funds, surging middle classes in emerging markets, and the growth of global markets are just some of the factors that are converging to pressure boards into mirroring the make-up of their shareholders worldwide.

Of course, it is one thing to be willing to build a more diverse board and quite another to do so. Heidrick & Struggles’ surveys show that nearly two-thirds of directors find it tough to hire well-qualified ethnic minorities, and more than half say it’s hard to hire qualified women directors. Nor is there widespread trust in the mechanisms for fostering diversity: Among men on boards, only 13 percent support quotas compared with 41 percent of women directors.

But those diverse hires have to happen. For a start, nominating committees have got to expand their director searches beyond their usual Rolodexes (86 percent of directors rely on their own contacts when looking for new directors, according to our research). Directors also have to proactively seek out and use the cornucopia of tools available to help accelerate diversity efforts—from the Diverse Director DataSource set up in April 2011 by CalPERS and CalSTRS to the wealth of board-succession planning tools offered by NACD.

Put simply: boards ignore the diversity issue at their peril.

5. Getting ahead of proxy access. Directors must begin taking this issue seriously. Even though a federal appeals court last year overturned the SEC’s interpretation of shareholders’ rights to nominate their own directors, most boards still have to get their arms around what the final rulings entail.

We agree with the experts that the SEC’s market-wide proxy access rule won’t much affect the 2012 proxy season. However, a wild card is now in play. Following the court’s ruling, what we are left with is the very real prospect of “private ordering” whereby irate shareholders can bring forward all manner of their own proposals to push proxy access in forms that they can determine, and whatever their intentions.

There is no telling how widespread such responses might be. But it is our bet that there will be a flurry of alarming though disparate assaults on individual companies. So it is incumbent on boards to get ahead of the proxy-access issue, possibly by developing their own rules and gauging the limits of those rules against likely shareholder advocacy.

As the Boy Scouts say, “It’s always better to be prepared.”

We don’t pretend that the five points made here represent the entirety of what should be on the board’s future agenda. But in our experience, the boards that adhere to the tenets we have outlined stand a far better chance of ensuring that their companies outrun and outlast their competitors.

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Government Role In Corporations

Posted on October 4, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Corporations, like all citizens, must act within the law. The penalties for serious violations of law can be extremely severe, even life-threatening, for corporations. Compliance is not only appropriate—it is essential. Management should take reasonable steps to develop, implement and maintain an effective legal compliance program, and the board should be knowledgeable about and oversee the program, including periodically reviewing the program to gain reasonable assurance that it is effective in deterring and preventing misconduct.

Corporations have an important perspective to contribute to the public policy dialogue and should be actively involved in discussions about the development, enactment and revision of the laws and regulations that affect their businesses and the communities in which they operate and their employees reside.

– Steve Odland

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Communities

Posted on August 29, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Corporations have obligations to be good citizens of the local, national and international communities in which they do business. Failure to meet these obligations can result in damage to the corporation, both in immediate economic terms and in longer-term reputational value.

A corporation should be a good citizen and contribute to the communities in which it operates by making charitable contributions and encouraging its directors, managers and employees to form relationships with those communities.

A corporation also should be active in promoting awareness of health, safety and environmental issues, including any issues that relate to the specific types of business in which the corporation is engaged.

– Steve Odland

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Employees

Posted on August 19, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

It is in a corporation’s best interest to treat employees fairly and equitably.

Corporations should have in place policies and practices that provide employees with compensation, including benefits that are appropriate given the nature of the corporation’s business, the employees’ job responsibilities and geographic locations.

When corporations offer retirement, health care, insurance and other benefit plans, employees should be fully informed of the terms of those plans.

Corporations should have in place and publicize mechanisms for employees to seek guidance and to alert management and the board about potential or actual misconduct without fear of retribution.

Corporations should communicate honestly with their employees about corporate operations and financial performance.

– Steve Odland

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Shareholders & Investors

Posted on July 27, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Over the past several years, some shareholders have expressed interest in having more input on matters affecting the corporations in which they invest. Corporations should productively engage with their long-term shareholders in a manner consistent with the respective roles of the board, management and shareholders. Corporations should be responsive to issues and concerns that are of widespread interest to their long-term shareholders.

Corporations also should take steps to educate shareholders and other stakeholders about the board’s role and its oversight responsibilities. Corporations should encourage shareholders to make voting decisions based on consideration of what is in the best interests of the individual corporation and its shareholders. Meaningful involvement of shareholders requires that shareholders make company-specific judgments and consider the interests of the specific corporation. In this regard, a corporation should consider additional outreach efforts as appropriate to explain the bases for the corporation’s recommendations on the matters it is asking shareholders to vote on.

Communication with shareholders is an important component of effective engagement. Corporations communicate with investors and other constituencies in proxy statements, annual and other reports, and shareholder meetings. Corporations also communicate through informal avenues of communication, such as earnings releases, conference calls and investor meetings.

» Corporations should consider whether, from time to time, it may be appropriate to use other mechanisms in order to solicit shareholder views. These may include periodic meetings with the corporation’s largest shareholders or surveys to obtain feedback from long-term shareholders about particular issues, such as executive compensation.

Corporations should take advantage of technology to enhance the dissemination of information. A corporation’s website should include copies of the corporation’s governance principles, the charters of its board committees and codes of conduct. Corporations also should consider posting biographies of directors and members of senior management, information about current committee memberships, copies of their articles of incorporation and bylaws, information about communicating with the board and information about the corporation’s annual meeting.

Corporations should have effective procedures for long-term shareholders to communicate with members of the board and for directors to respond in a timely manner to the concerns of long-term shareholders. Technology can facilitate these procedures. The board, or the corporate governance committee, should oversee and update these procedures as appropriate. Corporations should use the annual shareholder meeting as an opportunity to engage with shareholders.

Directors should attend the corporation’s annual meeting of shareholders, and the corporation should have a policy that directors attend the annual meeting each year, absent unusual circumstances. Time at the annual meeting should be set aside for shareholders to submit questions and for senior management or directors to respond to those questions. The board or its corporate governance committee should oversee the corporation’s response to shareholder proposals. The board should seriously consider issues raised by shareholder proposals that receive substantial support and should communicate its response to proposals to the shareholder-proponents and to all shareholders.

– Steve Odland

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Board and Committee Evaluation

Posted on July 8, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

The board should have an effective mechanism for evaluating performance on a continuing basis. Meaningful board evaluation requires an assessment of the effectiveness of the full board, the operations of board committees and the contributions of individual directors. There are a variety of ways to conduct board and committee evaluations. These include written questionnaires, group discussions led by a designated director, employee or outside facilitator (often with the aid of written questions) and individual interviews. Each board, with the assistance of the corporate governance committee, should determine what method or combination of methods will result in a meaningful assessment of the functioning of the board and its committees. Boards and committees should consider periodically varying the methods they use to keep the evaluation process fresh.

 

» For some companies, securities market listing standards require that the board and its audit, compensation and corporate governance committees conduct annual evaluations. Regardless of whether an evaluation is required, the performance of the full board should be evaluated annually, as should the performance of its committees. The board should use the annual evaluation to assess whether it is following the procedures necessary to function effectively. Each committee should conduct an annual evaluation to assess its effectiveness, and to review the committee’s charter to determine whether any changes are appropriate. The results of this evaluation should be reported to the full board.

» Boards take a variety of approaches to assessing the contributions of individual directors. In this regard, board positions should not be regarded as permanent, and directors should serve only so long as they add value to the board. The corporate governance committee should examine a director’s ability to continue to contribute to the board each time it considers the director for renomination. In addition, the corporate governance committee also should consider the continued value that directors will bring to the corporation as part of the committee’s regular assessment of the skills and experience represented on the board as a whole and the board’s current and future needs. Some boards also conduct individual director evaluations through a more formalized process that involves self or peer evaluations.

– Steve Odland

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Senior Management Development and Succession

Posted on June 22, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the ninth in a series of articles that summarizes their principles.

Long-term planning for CEO and senior management development and succession is one of the board’s most important functions. The board, its corporate governance committee or another committee of independent directors should identify and regularly update the qualities and characteristics necessary for an effective CEO. With these principles in mind, the board or committee should periodically monitor and review the development and progression of potential internal candidates against these standards, and see that internal candidates receive the necessary preparation.

The board should review the corporation’s succession plan at least annually and periodically review the effectiveness of the succession planning process. Emergency succession planning also is critical. Working with the CEO, the board or committee should see that plans are in place for contingencies such as the departure, death or disability of the CEO or other members of senior management to facilitate the transition to both interim and longer-term leadership in the event of an untimely vacancy.

The corporation should disclose information about the board’s succession planning process, either in the corporate governance principles or proxy statement or both. This disclosure can help facilitate shareholder understanding of the process that the board follows in planning for succession to the position of CEO. Under the oversight of an independent committee or the lead director, the board should annually review the performance of the CEO and participate with the CEO in the evaluation of members of senior management.

All non-management members of the board should participate with the CEO in senior management evaluations. The results of the CEO’s evaluation should be promptly communicated to the CEO in executive session by representatives of the independent directors and used by the compensation committee or independent directors in determining the CEO’s compensation.

– Steve Odland

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Board Operations

Posted on May 31, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the eighth in a series of articles that summarizes their principles.

Serving on a board requires significant time and attention on the part of directors. Directors must participate in board meetings, review relevant materials, serve on board committees, and prepare for meetings and discussions with senior management. Certain roles, such as committee chair, chairman of the board and lead director, carry an additional time commitment beyond that attendant to board and committee service.

Directors must spend the time needed and meet as frequently as necessary to discharge their responsibilities properly. The board of directors, with the assistance of the corporate governance committee, should consider the appropriate frequency and length of board meetings. Longer meetings may permit directors to explore key issues in depth, whereas shorter but more frequent meetings may help directors stay up-to-date on emerging corporate trends, and business and regulatory developments. When arranging a meeting schedule for the board, each corporation should consider the nature and complexity of its operations and transactions, as well as its business and regulatory environment.

The board of directors, with the assistance of the committee responsible for overseeing director compensation, should periodically review the compensation of the board in light of developments in the marketplace and the board’s needs. This review should include consideration of differential compensation for specific roles that carry more responsibility, such as chairing committees, acting as lead director or acting as independent chairman. The board should approve changes in compensation based on the recommendation of the committee. In determining director compensation, the board should focus on creating total director compensation that is reasonable relative to directors’ responsibilities and compensation at comparable companies. The board also should be comfortable that compensation adequately rewards directors for the risks associated with board service, as well as their time and efforts. Director compensation should consist of a mix of cash and equity. The board should consider paying the cash portion of director compensation in the form of an annual retainer, rather than through meeting fees, to encourage directors to view board service as an ongoing commitment and to foster a long-term focus.

Equity helps align the interests of directors with those of the corporation’s shareholders, but equity compensation should be carefully designed to avoid unintended incentives such as an emphasis on short-term market value changes. Corporations increasingly are providing the long-term equity component of director compensation in the form of restricted stock, rather than stock options, to better align directors’ interests with those of shareholders. The board should establish a requirement that directors hold a meaningful amount of the corporation’s stock for as long as they remain on the board.

Service on too many boards can interfere with an individual’s ability to satisfy his or her responsibilities, either as a member of senior management or as a director. Before accepting an additional board position, a director should consider whether the acceptance of a new directorship will compromise the ability to devote adequate time and focus to present responsibilities. Directors should notify the chair of the corporate governance committee before accepting a seat on the board of another corporation or assuming a significant new role on an existing board (such as a committee chair or lead director position). Some boards require the prior approval of the corporate governance committee before a director accepts a seat on the board of another corporation. Similarly, the corporation should establish a process to review senior management service on other boards prior to acceptance in order to consider the time commitment and review any potential conflicts of interest and interlocks.

The board’s independent or non-management directors should have the opportunity to meet regularly in executive session, outside the presence of the CEO and any other management directors.

» Time for an executive session should be placed on the agenda for every regularly scheduled board meeting. The independent chairman or lead director, as applicable, should see that adequate time is reserved for these sessions, and should set the agenda for and chair these sessions.

» To maximize the effectiveness of executive sessions, the independent chairman or lead director, as applicable, should follow up with the CEO and other appropriate members of senior management on matters addressed in the executive sessions.

Many board responsibilities may be delegated to committees to permit directors to address key areas in more depth as discussed above. Regardless of whether the board grants plenary power to its committees with respect to particular issues or prefers to take recommendations from its committees, committees should keep the full board informed of their activities. Corporations benefit greatly from the collective wisdom of the entire board acting as a deliberative body, and the interaction between committees and the full board should reflect this principle.

The board’s agenda must be carefully planned yet flexible enough to accommodate emergencies and unexpected developments. The chairman of the board should work with the lead director (when the corporation has one) in setting the agenda, and should be responsive to individual directors’ requests to add items to the agenda and open to suggestions for improving the agenda. It is important that the agenda and meeting schedule permit adequate time for discussion and a healthy give-and-take between board members and management. The board should work to foster open, ongoing dialogue between management and members of the board. Board members should have full access to senior management outside of board meetings.

Board agendas should be structured to maximize the use of meeting time for open discussion and deliberation. Highlighting changes relevant to recurring agenda items and distributing copies of presentations sufficiently in advance of meetings can facilitate review of materials prior to meetings and increase the time that is available for discussion and constructive dialogue.

The board must have accurate, complete information to do its job; the quality of information that the board receives directly affects its ability to perform its oversight function effectively. Directors should receive and review information from a variety of sources, including senior management, board committees, outside experts and the outside auditor, as well as industry journals, and analyst and media reports. The board should receive information before board and committee meetings with sufficient time to review and reflect on key issues and to request supplemental information as necessary.

Corporations should consider ways in which they can use technology, such as board portals, to provide directors access to relevant information on a timely basis. Technology can provide a mechanism for providing meeting materials, delivering real-time information about developments that occur between meetings and creating resources with background information and educational tools for directors to access at their convenience.

Corporations should have a robust orientation process for new directors that is designed to familiarize them with the various aspects of the corporation, including its business, strategy, industry, management, compliance programs and corporate governance practices. Common components of board orientation programs include briefings from senior management, on-site visits to the corporation’s facilities, informal meetings with other directors and written materials.

Corporations should encourage directors to take advantage of educational opportunities on an ongoing basis. Continuing education can assist directors in keeping abreast of issues and developments relevant to the corporation and enable them to address specific subjects in greater depth. Continuing education can take the form of participation in outside programs or “in board” educational sessions, led by members of senior management or outside experts and customized for the corporation. Many boards rely on a combination of the two methods by informing their directors of outside programs and holding educational sessions for the full board or particular committees on a regular basis.

Where appropriate, boards and board committees should seek advice from outside advisers independent of management with respect to matters within their responsibility. For example, there may be technical aspects of the corporation’s business—such as risk assessment and risk management—for which the board or a committee determines that additional expert advice would be useful. Similarly, many compensation committees engage their own compensation consultants. Situations where the board or a committee may decide it is appropriate to seek independent legal advice include circumstances involving conflicts of interest, external or internal investigations, and mergers and acquisition activity. The board and its committees should have the authority to select and retain advisers and approve the terms of their retention and fees.

– Steve Odland

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Role of the Compensation Committee

Posted on May 18, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the seventh in a series of articles that summarizes their principles.

Every publicly owned corporation should have a committee composed solely of independent directors that addresses compensation issues. The compensation committee should have at least three members and should be composed solely of independent directors. All committee members should have and maintain sufficient knowledge of executive compensation and related issues to perform their duties effectively.

The compensation committee’s responsibilities include overseeing the corporation’s overall compensation structure, policies and programs, establishing or recommending to the board performance goals and objectives for the CEO and other members of senior management (or, in some companies, in conjunction with the corporate governance committee), and establishing or recommending to the independent directors compensation for the CEO and senior management.

The compensation committee should see that the corporation’s compensation policies reflect the core principle of pay for performance and should establish meaningful goals for performance-based compensation paid to senior management. The committee should see that the corporation’s compensation policies and performance goals are closely linked to its strategic plan and that they create incentives to produce long-term value for shareholders without encouraging excessive risk-taking.

The compensation committee should have the authority to retain compensation consultants, counsel and other advisers to provide the committee with independent advice. The compensation committee should understand all aspects of an executive’s compensation package, and should review and understand the maximum payout due under multiple scenarios (such as retirement, termination with or without cause, and severance in connection with business combinations or the sale of a business).

The compensation committee should require senior management to build and maintain significant continuing equity investment in the corporation. To align senior management interests with the interests of shareholders, the committee should establish requirements that senior management acquire and hold a meaningful amount of the corporation’s stock for at least the duration of their tenure with the corporation.

In addition to reviewing and setting compensation for senior management, the compensation committee should look more broadly at the overall compensation structure of the enterprise to determine that it establishes appropriate incentives for management and employees at all levels and that these incentives do not encourage inappropriate risk-taking. The committee should consider carefully and understand the incentives created by different forms of compensation. Incentives should further the corporation’s long-term strategic plans by looking beyond short-term market value changes to the overall goal of creating and enhancing enduring shareholder value, and they should be consistent with the corporation’s culture.

The committee should see that the corporation has in place appropriate practices to mitigate risks created by compensation programs. Executive compensation should directly link the interests of senior management, both individually and as a team, to the long-term interests of shareholders. It should include significant performance-based criteria related to long-term shareholder value and should reflect upside potential and downside risk.

The compensation committee should carefully examine the benefits and perquisites provided to senior management and determine whether they appropriately balance the interests of long-term shareholders and the ability of the corporation to recruit and retain top talent. The corporation should generally bear the cost of these items only if they are directly related to management’s job performance; the corporation should not bear the cost of personal expenses.

The compensation committee should oversee the corporation’s disclosures with respect to executive compensation. Disclosure about executive compensation should be transparent and written in plain English so that it is understandable to shareholders. In particular, the committee should use the compensation discussion & analysis (CD&A) disclosure to provide shareholders with meaningful and understandable information about the corporation’s executive compensation philosophy, policies and practices, the factors that the committee and the board consider in making compensation decisions, and the relationship between executive compensation and corporate performance.

– Steve Odland

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Role of the Corporate Governance Committee

Posted on May 5, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the sixth in a series of articles that summarizes their principles.

Every publicly owned corporation should have a committee composed solely of independent directors that addresses director nominations and corporate governance matters. The corporate governance committee (often combined with or referred to as a nominating committee) should have at least three members and should be composed solely of independent directors. The corporate governance committee recommends director nominees to the full board and the corporation’s shareholders, oversees the composition, structure, operation and evaluation of the board and its committees, and plays a leadership role in shaping the corporate governance of the corporation.

Depending on how the board has allocated responsibilities among its committees, the corporate governance committee also may oversee the compensation of the board if the compensation committee does not do so, or the two committees may share oversight responsibility for this area. The committee should remain informed about legal and regulatory developments in the area of corporate governance. As part of its responsibility to oversee the composition of the board, the corporate governance committee should engage in succession planning for the board. This process should include looking at the skills and experience currently represented on the board, identifying qualifications and attributes that the board may find valuable in the near-term and the future based on the corporation’s strategic direction, and planning ahead for the departure of directors and the designation of new board members.

The corporate governance committee should regularly conduct an assessment of the mix of skills represented on the board to evaluate whether the board, as a whole, contains the right balance of professional and personal backgrounds, and includes individuals that bring industry and other relevant knowledge, financial expertise, diversity and other desired characteristics to the board.

In performing the core function of identifying and recommending director candidates to the board, the corporate governance committee should establish criteria for board membership and recommend these criteria to the board for approval. There are certain criteria that every director should have, such as sound judgment, integrity and an objective mind.

The committee should periodically review the board’s membership criteria and recommend changes to the board as appropriate. Based on the board’s membership criteria and the qualifications and attributes identified through the assessment of the board’s composition, the committee should identify director candidates, review their qualifications and any potential conflicts with the corporation’s interests, and recommend new director candidates to the board.

In identifying director candidates, the corporate governance committee should take a proactive approach by soliciting ideas for potential candidates from a variety of sources. The committee should have the authority to retain search firms as appropriate to assist it in identifying candidates and should provide search firms with the criteria articulated by the committee. The committee also should develop a process for considering shareholder recommendations for board nominees. Although it is appropriate for the CEO to meet with board candidates, the final responsibility for selecting director nominees should rest with the corporate governance committee and the board.

In connection with the renomination of current directors, the corporate governance committee should review their skills and experience, assess their contributions to the board, and consider their continued value to the corporation in light of current and future needs. Some boards may undertake these steps, in part, through individual director evaluations, which may occur through a more formalized process or in connection with renominating directors.

The corporate governance committee should monitor and safeguard the independence of the board. An important function of a corporate governance committee, related to its core function of recommending nominees to the board, is to see that a substantial majority of the directors on the board meet appropriate standards of independence that are consistent with securities market listing standards and to see that these directors are independent both in fact and in appearance. It is also important that directors have the ability to question management, exercise constructive skepticism and express their views even when those views may differ from those of management or other directors.

The corporate governance committee should consider all relevant facts and circumstances in assessing independence and make recommendations to the board regarding determinations of director independence. If the board has developed a set of standards for assessing independence, the committee should evaluate directors’ relationships in light of these standards. In addition, the committee should receive prompt notification from directors of any change in a director’s circumstances that may affect the director’s independence (such as a family member’s job change).

The corporate governance committee should conduct a periodic evaluation of the board’s leadership structure to assess whether the current leadership structure remains appropriate. In addition, the committee should oversee the process of planning for succession to the position of chairman of the board, which should involve consideration of whether to combine or separate the positions of CEO and chairman of the board when the current chairman’s tenure ends and consideration of whether a new CEO might necessitate a change to the board leadership structure.

The corporate governance committee also recommends directors for appointment to committees of the board. The committee should periodically review the board’s committee structure and annually recommend candidates for membership on the board’s committees. The committee should see that the key board committees, including the audit, compensation and corporate governance committees, are composed of directors who meet applicable independence and qualification standards. In addition, the committee should consider whether periodic rotation of committee memberships and chairs would provide fresh perspectives and enhance directors’ understanding of various aspects of the corporation’s business.

The corporate governance committee should oversee the effective functioning of the board. The committee should review the board’s policies relating to meeting agendas and schedules and the corporation’s processes for providing information to the board, with input from the lead director or independent chairman.

The corporate governance committee should assess the reporting channels through which the board receives information and see that the board obtains appropriately detailed information in a timely fashion. This includes receiving information from a variety of sources, from inside and outside of the corporation, including both positive and negative materials such as analyst reports, industry publications and press articles. It also includes seeing that relevant information that the corporation receives from key stakeholders, such as long-term shareholders, is appropriately shared with the board.

The corporate governance committee should develop and recommend to the board a set of corporate governance principles, review them annually and recommend changes to the board as appropriate. The corporation’s corporate governance principles should be available on the corporation’s website and should address, at a minimum, board leadership, qualifications for directors, director independence, director responsibilities, the structure and functioning of board committees, board access to management and advisers, director compensation, director orientation and continuing education, board evaluations and management succession.

The corporate governance committee should oversee the corporation’s efforts in the area of shareholder engagement and coordinate with management any appropriate board-level involvement in that process. The corporate governance committee should oversee the evaluation of the board and its committees. Specifics concerning the evaluation process are discussed under “Board and Committee Evaluation.”

– Steve Odland

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Role Of The Audit Committee

Posted on April 9, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fifth in a series of articles that summarizes their principles.

Every publicly owned corporation should have an audit committee of at least three members, who should all be independent directors. Audit committees typically consist of three to five members. The listing standards of the major securities markets require that all members of the audit committee qualify as independent directors under applicable listing standards, subject to limited exceptions, and that they meet additional, heightened independence criteria.

Audit committee members should meet minimum financial literacy standards, as required by the listing standards of the major securities markets, and at least one member of the audit committee should be an audit committee financial expert, as determined by the board in accordance with regulations of the Securities and Exchange Commission. Audit committee members, as with all directors, should understand the corporation’s business and risk profile and apply their business experience and judgment with an independent and critical eye to the issues for which the committee is responsible.

With the significant responsibilities imposed on audit committees under applicable law, regulations and listing standards, consideration should be given to whether it is appropriate to limit the number of public company audit committees on which a corporation’s audit committee members may serve.

Some boards have adopted policies that audit committee members may not serve on the audit committees of more than three public corporations, in accordance with applicable securities market listing standards. Policies may permit exceptions to this limit when the corporation’s board determines that the simultaneous service would not affect an individual’s ability to serve effectively on the corporation’s audit committee. The audit committee is responsible for supervising the corporation’s relationship with its outside auditor. In performing this responsibility, the primary functions of the audit committee include:

» Selecting and retaining the auditor and approving in advance the terms of the annual audit engagement. The selection of the outside auditor should involve an annual due diligence process in which the audit committee reviews the qualifications, work product, independence and reputation of the outside auditor, and the performance of key members of the audit team.

» Overseeing the independence of the outside auditor. The audit committee should maintain an ongoing, open dialogue with the outside auditor about independence issues. The committee should consider its overall approach to using the outside auditor as a service provider and identify those services, beyond the annual audit engagement, that the outside auditor can provide to the corporation consistent with applicable law and regulations and with maintaining independence. 

The audit committee also is responsible for overseeing the corporation’s financial reporting process. The audit committee should review and discuss the corporation’s annual financial statements with management and the outside auditor, and should review the corporation’s quarterly financial statements and related earnings press releases prior to issuance. As part of its reviews, the audit committee should review and discuss with management and the outside auditor the corporation’s critical accounting policies, the quality of accounting judgments and estimates made by management, any comments received from Securities and Exchange Commission staff, and any material written communications between the outside auditor and management.

The audit committee should oversee the corporation’s system of internal controls over financial reporting and its disclosure controls and procedures, including the processes for producing the certifications required of the CEO and principal financial officer. On a periodic basis, the committee should review with both the internal and outside auditors, as well as with management, the corporation’s procedures for maintaining and evaluating the effectiveness of these systems. The committee should be promptly notified of any significant deficiencies or material weaknesses in internal controls and should be kept informed about the steps and timetable for correcting them.

Unless the full board or one or more other committees does so, the audit committee should oversee the corporation’s program that addresses compliance with ethical and legal standards and important corporate policies, including the corporation’s code of conduct and the mechanisms it has in place for employees to report compliance issues. In accordance with applicable legal requirements, the audit committee should establish procedures for receiving and handling complaints and concerns related to accounting, internal accounting controls and auditing issues, and the committee should evaluate these procedures periodically and revise them as appropriate.

The audit committee should be briefed regularly by senior management on the status of outstanding compliance issues, including concerns submitted through the committee’s procedures for handling accounting and related concerns, and it should receive prompt notification of any significant compliance issues. The audit committee should report at least annually to the full board on its oversight of the compliance program.

Unless the full board or another committee does so, the audit committee should oversee the corporation’s risk assessment and risk management. Many corporations address risk through the audit committee, in part because securities market listing standards applicable to many corporations require audit committees to discuss policies with respect to risk assessment and risk management. However, the audit committee should not be the sole body responsible for risk oversight, and the board may decide that it is appropriate to allocate responsibility for some types of risk to other committees (for example, compensation risk to the compensation committee) or to the board as a whole.

No one risk oversight structure is right for every board, and different structures may be appropriate depending on a corporation’s industry and other factors. Committees with risk-related responsibilities should report regularly to the full board on the risks that they oversee and brief the audit committee as appropriate in cases where securities marked listing standards require the audit committee to retain some oversight responsibility for risk.

The audit committee should oversee the corporation’s internal audit function, including reviewing the scope of the internal audit plan, reports submitted by the internal audit staff and management’s response, and the appointment and replacement of the senior internal auditing executive. The senior internal auditing executive should have a direct communication line to the audit committee, so that the executive has the authority to report any issues or concerns directly to the committee.

Final decisions relating to the hiring and termination of the senior internal audit executive should be made following consultation with the audit committee. The audit committee should implement a policy covering the hiring of personnel who previously worked for the corporation’s outside auditor. At a minimum, this policy should incorporate the “cooling off” period and other auditor independence hiring requirements mandated by applicable law and regulations.

Audit committee meetings should be held at least quarterly, with additional meetings held frequently enough to allow the committee to monitor the corporation’s financial reporting appropriately. Meetings should be scheduled with enough time to permit and encourage active discussions with management and the internal and outside auditors. The audit committee should meet privately with each of the internal and outside auditors and management on a regular basis, and in any event at least quarterly, and communicate with them between meetings as necessary.

The audit committee also should hold private sessions on a regular basis with senior management responsible for the corporation’s legal function to facilitate the communication of concerns regarding legal compliance matters and significant legal contingencies. In addition, the audit committee should consider whether to hold private sessions from time to time with other parties, including senior management responsible for risk assessment and risk management, and those responsible for compliance.

– Steve Odland

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The Alternative to Shareholder Class Actions

Posted on April 3, 2012 by Steve Odland

http://online.wsj.com/article/SB10001424052702303816504577312373860495762.html?mod=ITP_opinion_0

Getty Images

In this article by Hal Scott and Leslie Silverman of the Committee on Capital Markets Regulation (of which I was a member from 2006-2010), they argue that “despite arbitration’s endorsement by Congress and the Supreme Court, the SEC has rebuffed efforts to substitute arbitration for securities class actions.”  In the past months, the SEC has blocked attempts by the Carlyle Group and proposals by stockholders of Pfizer and Gannett, to mandate arbitration rather than litigation in disputes between investors and management.  The SEC gave no explanation for its actions.  Scott and Silverman argue that securities class actions undercut the competitiveness of the U.S. capital markets and are contributing to companies issuing IPO’s to go elsewhere versus the U.S.  The Committee has focused for years on how to make the U.S. capital markets more globally competitive by reducing regulation.  Here is one more example of how regulation is harming the markets.

– Steve Odland

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Board Organization

Posted on March 24, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fourth in a series of articles that summarizes their principles.

Virtually all boards of directors of large, publicly owned corporations operate using committees to assist them. A committee structure permits the board to address key areas in more depth than may be possible in a full board meeting. Decisions about committee membership and chairs should be made by the full board based on recommendations from the corporate governance committee. Consideration should be given to whether periodic rotation of committee memberships and chairs would provide fresh perspectives and enhance directors’ understanding of different aspects of the corporation’s business, consistent with applicable listing standards.

In connection with joining a committee, directors should participate in orientation to familiarize themselves in greater depth with the subject matter areas that the committee is responsible for overseeing. In addition, all committee members should be encouraged to participate in continuing education relating to the committee’s areas of responsibility. For example, committees may benefit from periodic educational sessions, led by management or outside experts, which address recent developments and best practices relevant to the committees’ duties. In this regard, committee members should be cognizant of how recent developments impact the corporation’s own practices.

Committees should apprise the full board of their activities on a regular basis. Processes should be developed and monitored for keeping the board informed through oral or written reports. For example, some corporations provide minutes of committee meetings to all members of the board. Business Roundtable believes that the functions generally performed by the audit, compensation and corporate governance committees are central to effective corporate governance.

The listing standards of the major securities markets require corporations to have an audit committee that performs specific functions, and many corporations also are required to have committees that oversee executive compensation, director nominations and corporate governance matters. Business Roundtable does not believe that a particular committee structure is essential for all corporations. What is important is that the independent members of the board address key issues effectively. These issues include compliance, executive compensation, financial reporting, governance, risk oversight, director nominations and succession planning. Thus, the references below to the functions performed by particular committees are not intended to preclude corporations from allocating these functions differently, consistent with applicable listing standards.

Additional committees, such as finance, public responsibility or risk management, also may be used. Some corporations find it useful to establish committees to examine special problems or opportunities in greater depth than would otherwise be feasible. The responsibilities of each committee and the qualifications required for committee membership should be clearly defined and set out in a written charter that is approved by the board and publicly available. Each committee should review its charter annually and recommend changes to the board as appropriate.

– Steve Odland

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Harvard Law School Supports Declassified Board Challenges

Posted on March 19, 2012 by Steve Odland

The following statement was released today by the Harvard Law School Shareholder Rights Project:

“Below are links to joint press releases issued today by the Harvard Law School Shareholder Rights Project(SRP) and each of five institutional investors – the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation, the North Carolina State Treasurer, and the Ohio Public Employees Retirement System.

During this proxy season, the SRP has been representing and advising these institutional investors in connection with the submission of shareholder proposals to a significant number of S&P 500 companies that have staggered boards. The proposals urge a move to annual elections, which are widely viewed as corporate governance best practice. As the press releases below indicate:

  • Proposals to declassify boards have been submitted to more than eighty S&P 500 companies, and
  • Forty-two S&P 500 companies receiving proposals – about one-third of the S&P 500 companies that had a staggered board at the beginning of this proxy season – have already entered into agreements committing them to bring management proposals to declassify their boards.

The companies that have entered into agreements to bring management proposals to declassify their boards should be commended for their responsiveness to shareholder concerns and for their willingness to move to annual elections. A list of twenty-one companies that have entered into such agreements, including only companies that have already made public filings that disclose the planned management proposal, is available here.

Joint press release by the Illinois State Board of Investments and the SRP

Joint press release by the Los Angeles County Employees Retirement Association and the SRP

Joint press release by the Nathan Cummings Foundation and the SRP

Joint press release by the North Carolina Department of State Treasurer and the SRP

Joint press release by the Ohio Public Employees Retirement System and the SRP

The Harvard Law School Shareholder Rights Project is a clinical program through which Harvard Law School faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners. More information regarding the SRP can be found at http://srp.law.harvard.edu.”

 

– Steve Odland

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Board Leadership

Posted on March 16, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fourth in a series of articles that summarizes their principles.

Boards of American corporations have taken a variety of approaches to board leadership, with some boards combining the positions of CEO and chairman and others appointing a separate chairman or designating a “lead” director. No one leadership structure is right for every corporation at all times, and boards of different corporations may reach different conclusions about the leadership structures that are most appropriate for their corporations at any particular point in time.

The board should decide whether to combine or separate the positions of CEO and chairman of the board based on its assessment of what is in the best interests of the corporation and its shareholders based on the corporation’s particular circumstances, and the board should evaluate its leadership structure periodically. In addition, in connection with the CEO succession planning process, the board should consider the appropriate board leadership structure.

Whatever leadership structure a board chooses, independent board leadership is critical to effective corporate governance. To provide independent leadership for the board, the board should consider appointing a lead director (or presiding director with comparable responsibilities) if it combines the positions of CEO and chairman or has a chairman who is not independent. The lead director should be appointed by the independent members of the board and should serve for a period of at least one year. At some corporations the lead director is appointed annually, while at others the lead director serves for a longer term or an indefinite period of time.

Lead directors perform a range of functions, depending on the needs of the board. One of the primary functions of the lead director is chairing executive sessions of a board’s independent or non-management directors. The lead director should have the authority to call executive sessions, and should coordinate and oversee appropriate follow-up on matters discussed in executive sessions to maximize the effectiveness of these sessions.

Other key functions of the lead director may include chairing board meetings in the absence of the chairman of the board, reviewing and/or approving agendas and schedules for board meetings and information sent to the board, and being available for engagement with long-term shareholders as appropriate. The lead director also may play a key role in overseeing performance evaluations of the CEO and the board, and leading the board in crisis situations. Depending on the responsibilities associated with the position of the lead director or independent chairman, the position may involve substantial responsibility and require a significant time commitment on the part of a director.

– Steve Odland

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Board Composition

Posted on March 5, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the third in a series of articles that summarizes their principles.

Boards of directors of large publicly owned corporations vary in size from industry to industry and from corporation to corporation. In determining board size, directors should consider the nature, size and complexity of the corporation as well as its stage of development. The experiences of many Business Roundtable members suggest that smaller boards often are more cohesive and work more effectively than larger boards. Directors should be elected by a majority vote.

In addition, boards should adopt a resignation policy that requires a director who does not receive a majority vote to tender his or her resignation to the board for its consideration. Although the ultimate decision whether to accept or reject the resignation will rest with the board, the board should think critically about the reasons why the director did not receive a majority vote and whether or not the director should continue to serve. Among other things, the board should consider whether the vote resulted from concerns about a policy issue affecting the board as a whole or concerns specific to the individual director. If the board decides not to accept a resignation, the corporation should disclose the reasons for this decision promptly.

In addition, when a director is elected but receives significant “withhold” or “against” votes, the board should consider the reasons for the vote. Having a variety of backgrounds and experience, consistent with the corporation’s needs, is important to the overall composition of the board. Because the corporation’s need for particular backgrounds and experience may change over time, the board should monitor the mix of skills and experience that directors bring to the board and assess whether the board, as a group, has the necessary tools to work together in a productive and collegial fashion and perform its oversight function effectively. The board should consider implementing a structured framework for this ongoing process, such as using a skills matrix detailing specific qualifications and identifying the skills that current directors, and director candidates, bring to the board.

Directors with relevant business and leadership experience are beneficial to the board as a whole and to the corporation. These directors can provide a useful perspective on business strategy and significant risks and an understanding of the challenges facing the business. Corporations should assist directors who do not have significant background in a corporation’s business or industry through orientation programs and otherwise. All directors should remain informed about issues and developments relevant to the corporation’s business and industry by reviewing pertinent information provided by management and the corporation, subscribing to industry journals, reviewing analyst and press reports, and participating in educational programs. As part of the ongoing assessment of board composition, the board should plan ahead for the nomination of new directors by engaging in succession planning. The board should conduct a forward-looking assessment to identify qualifications and attributes that the board may find valuable in the future based on the corporation’s strategic plans, anticipated director retirements and evolving best practices in the corporation’s industry. The board also should plan ahead for director departures, considering whether it is appropriate to establish or maintain procedures for the retirement or replacement of board members, such as a mandatory retirement age or term limits.

The board should assess whether other practices, such as the assessment of director candidates in connection with the renomination process, annual board evaluations and individual director evaluations, may make a retirement age or term limit unnecessary. Many boards also establish a requirement that directors who change their primary employment tender a board resignation, providing an opportunity for the board to consider the desirability of their continued service in light of their changed circumstances. Board independence is critical to effective corporate governance. Providing objective independent judgment is at the core of the board’s oversight function, and the board’s composition should reflect this principle. Accordingly, a substantial majority of the board’s directors should be independent, both in fact and appearance, as determined by the board.

Board independence depends not only on directors’ individual relationships and outlook but also on their ability to question management, exercise constructive skepticism and express their views even when those views may differ from those of management or other directors. The board should make an affirmative determination as to the independence of each director annually and should have a process in place for making these determinations.

» Definition of “independence.” An independent director should not have any relationships with the corporation or its management—whether business, employment, charitable or personal—that may impair, or appear to impair, the director’s ability to exercise independent judgment. The listing standards of the major securities markets define “independence” and enumerate specific relationships involving directors and their family members (such as employment with the corporation or its outside auditor) that preclude a director from being considered independent.

» Assessing independence. The board should consider all relevant facts and circumstances when assessing directors’ independence, taking into account the requirements of the federal securities laws, securities market listing standards, and the views of institutional investors and other relevant groups. When evaluating whether a director is independent, the board should consider whether the director has any relationships, either directly or indirectly, with the corporation, senior management or other board members that could affect the director’s actual or perceived independence. Corporations must disclose in their proxy statements relationships that the board considered in assessing independence in accordance with the requirements of the federal securities laws. Many boards have adopted standards to assist them in assessing independence. These standards should be included in a corporation’s corporate governance principles.

» Relationships with not-for-profit organizations. The board’s director independence assessment should include a review of relationships that directors, and their spouses, have with not-for-profit organizations that receive support from the corporation. In conducting this assessment, the board should take into account the size of the corporation’s contributions and the nature of the relevant director’s relationships to the recipient organizations. Independence issues are most likely to arise when a director, or the director’s spouse, is an employee of the not-for-profit organization and when a substantial portion of the organization’s funding comes from the corporation. It also may be appropriate to consider contributions from a corporation’s foundation to organizations with which a director or a director’s spouse is affiliated.

– Steve Odland

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WomenCorporateDirectors Takes Action during Women’s History Month to Move Women into Board Seats Globally

Posted on February 29, 2012 by Steve Odland

http://www.prnewswire.com/news-releases/womencorporatedirectors-takes-action-during-womens-history-month-to-move-women-into-board-seats-globally-140867243.html

The Americas – Directors from throughout the Americas will convene in Palm Beach, FL on March 9 at WCD’s first-everAmericas Institute, with this year’s program focusing on Latin America and its growing priority for corporate boards. KPMG is lead sponsor of the event. Lars Thunell, CEO of the World Bank’s IFC, will deliver the keynote address at the event’s luncheon, and the slate of speakers and panelists includes: Sherry Barrat, Vice Chairman of Northern Trustand director of NextEra Energy, Inc.; Toti Graham, director of Interbank, Quimica Suiza, Grupo Salud del Peru, ENFOCA SAFI, Corferias del Pacifico, and Red i3; Janet Clarke, director of Cox Communications, eFunds Corporation, ExpressJet Airlines Inc., and Asbury Automotive Group Inc.; P. Michael McKinley, U.S. Ambassador to Bogota, Colombia, and former U.S. Ambassador to Peru; Lillian Garcia, EVP & AVP Argentina, Colombia, Venezuela & Ecuador, and Uruguay for Tupperware Brands Corporation; Madeleine L. Champion, director of Fresh Del Monte Produce, Inc., and Citizens Republic Bancorp Inc.; Julie Roberts, director of Calgon Carbon Corporation; Maria Sastre, director ofPublix Super Markets, Inc., and Darden Restaurants; and Steve Odland, director of General Mills.

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Role of the CEO and Management

Posted on February 28, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the second in a series of articles that summarizes their principles.

» It is the responsibility of the CEO and management, under the CEO’s direction, to operate the corporation in an effective and ethical manner. As part of its operational responsibility, management is charged with:

§ Operating the corporation. The CEO and management run the corporation’s day-to-day business operations. With a thorough understanding of how the corporation operates and earns its income, they carry out the corporation’s strategic objectives within the annual operating plans and budgets, which the board reviews. In making decisions about the corporation’s business operations, the CEO considers the long-term interests of the corporation and its shareholders and necessarily relies on the input and advice of others, including the board, senior management and outside advisers. The CEO keeps the board apprised of significant developments regarding the corporation’s business operations.

§ Strategic planning. The CEO and senior management generally take the lead in strategic planning. They identify and develop strategic plans designed to create long-term value for the corporation, present those plans to the board, implement the plans once board review is completed, and recommend and carry out changes to the plans as necessary. As part of the strategic planning process, the CEO and senior management identify, evaluate and manage risks associated with the plans.

§ Identifying, evaluating and managing risks. Management identifies, evaluates and manages the risks that the corporation undertakes in implementing its strategic plans and in the course of carrying out its business. It also manages the corporation’s overall risk profile, and senior management keeps the board informed on an ongoing basis about the corporation’s significant risks and its risk management processes.

 

§ Annual operating plans and budgets. With the corporation’s overall strategic plans in mind, senior management develops annual operating plans and budgets for the corporation and presents the plans and budgets to the board. Once the board has reviewed the annual operating plans and budgets, the management team implements them and monitors them, making changes as appropriate in light of changing conditions, assumptions or expectations. The management team also keeps the board apprised of significant developments and changes relating to the annual operating plans and budgets.

§ Selecting qualified management and establishing an effective organizational structure. Senior management is responsible for selecting qualified management and implementing an organizational structure that is efficient and appropriate for the corporation’s particular circumstances.

§ Accurate and transparent financial reporting and disclosures. Management is responsible for the integrity of the corporation’s financial reporting system, and the accurate and timely preparation of the corporation’s financial statements and related disclosures in accordance with Generally Accepted Accounting Principles and in compliance with applicable laws and regulations. It is management’s responsibility—under the direction of the CEO and the corporation’s principal financial officer—to establish, maintain and periodically evaluate the corporation’s internal controls over financial reporting and the corporation’s disclosure controls and procedures. In accordance with applicable law and regulations, the CEO and the corporation’s principal financial officer also are responsible for certifying the accuracy and completeness of the corporation’s financial statements and the effectiveness of the corporation’s internal and disclosure controls.

» The CEO and management are responsible for operating the corporation in an ethical manner. They should never put individual, personal interests before those of the corporation or its shareholders. Business Roundtable believes that when carrying out this function, corporations should have:

§ A CEO of integrity. The CEO should be a person of integrity who takes responsibility for the corporation adhering to the highest ethical standards.

§ A strong, ethical “tone at the top.” The CEO and senior management should set a “tone at the top” that establishes a culture of legal compliance and integrity communicated to personnel at all levels of the corporation.

§ An effective compliance program. Management should take responsibility for implementing and managing an effective compliance program and should report regularly to the board on compliance matters. As part of its compliance program, a corporation should have a code of conduct with effective reporting and enforcement mechanisms. Employees should have a means of seeking guidance and alerting management and the board about potential or actual misconduct without fear of retribution, and violations of the code should be addressed promptly and effectively.

– Steve Odland

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Role of the Board of Directors

Posted on February 22, 2012 by Steve Odland

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the first in a series of articles that summarizes their principles.

» The business of a corporation is managed under the oversight of the corporation’s board. The board delegates to the CEO—and through the CEO to other senior management—the authority and responsibility for managing the everyday affairs of the corporation. Directors monitor management on behalf of the corporation’s shareholders.

» Making decisions regarding the selection, compensation and evaluation of a well-qualified and ethical CEO is the single most important function of the board. The board also appoints or approves other members of the senior management team.

» Directors bring to the corporation a range of experience and knowledge, but there are certain characteristics that all directors should possess. Every director should have integrity, character and sound judgment. In addition, a director should represent the interests of all shareholders; directors should not represent the interests of particular constituencies.

» Effective directors maintain an attitude of constructive skepticism; they ask incisive, probing questions and require accurate, honest answers; they act with integrity and diligence; and they demonstrate a commitment to the corporation, its business plans and long-term shareholder value.

» The composition of the board, as a whole, should reflect a mix of skills and expertise that are appropriate for the corporation given its circumstances and that, collectively, enables the board to perform its oversight function effectively.

» Directors need to have a thorough understanding of the corporation, its business and the industry in which it operates. Directors should keep abreast of any relevant developments. Directors can gain and maintain this understanding through briefings from management, reviewing industry journals and press and analyst reports, participating in educational programs, etc.

» In performing its oversight function, the board is entitled to rely on the advice, reports and opinions of management, counsel, auditors and expert advisers. The board should use care in choosing advisers, be comfortable with the qualifications of those it relies on, and hold managers and advisers accountable. The board should ask questions and obtain answers about the processes used by managers and the corporation’s advisers to reach their decisions and recommendations, as well as about the substance of the advice and reports received by the board. When appropriate, the board and its committees should seek independent advice.

» Shareholders and other constituencies should reasonably expect that directors will exercise vigorous and diligent oversight of a corporation’s affairs. However, they should not expect the board to micromanage the corporation’s business by performing or duplicating the tasks of the CEO and senior management team. Directors should be informed about the operation of the corporation’s business, but they should not become involved with operational matters, which are the province of management.

» The board’s oversight function carries with it a number of specific responsibilities in addition to that of selecting and overseeing the CEO. These responsibilities include:

§ Planning for senior management development and succession. The board should oversee the corporation’s plans for developing senior management personnel and plan for CEO and senior management succession. When appropriate, the board should replace the CEO or other members of senior management. The board should review the corporation’s succession plans at least annually and periodically review the effectiveness of the senior management development and succession planning process.

§ Reviewing, understanding and monitoring the implementation of the corporation’s strategic plans. The board has responsibility for overseeing and understanding the corporation’s strategic plans from their inception through their development and execution by management. Once the board reviews a strategic plan, it should regularly monitor implementation of the plan to determine whether it is being implemented effectively and whether changes are needed. The board should understand the relationship between strategy and risk and review the risks inherent in the corporation’s strategic plans. The board also should be comfortable that the corporation’s incentive compensation program is appropriately aligned with the corporation’s strategic plan.

§ Reviewing and understanding the corporation’s risk assessment and overseeing the corporation’s risk management processes. The board has responsibility for overseeing the significant risks facing the corporation and the processes that management has implemented to identify and manage risk. The board, together with senior management, should agree on the appropriate risk profile for the corporation, and the board should be comfortable that the corporation’s strategic plans are consistent with that profile. The board should establish an appropriate structure for overseeing risk, involving assistance from committees as appropriate and the designation of senior management responsible for risk management. Whatever risk oversight structure the board adopts, that structure should enable the board to remain fully informed about, and understand, all of the corporation’s major risks and the steps that the corporation is taking to manage them.

§ Reviewing, understanding and overseeing annual operating plans and budgets. The board is responsible for reviewing, understanding and overseeing the corporation’s annual operating plans and for reviewing annual budgets presented by management. The board should monitor implementation of the annual plans to assess whether they are being implemented effectively and within the limits of approved budgets and whether the annual plans are appropriately responsive to changing conditions.

§ Focusing on the integrity and clarity of the corporation’s financial statements and financial reporting. The board, assisted by its audit committee, should be satisfied that the financial statements and other disclosures prepared by management accurately present the corporation’s financial condition and results of operations to shareholders and that they do so in an understandable manner. To achieve accuracy and clarity, the board, through its audit committee, should have an understanding of the corporation’s financial statements, including why the accounting principles critical to the corporation’s business were chosen, what key judgments and estimates management made, and how the choice of principles and the making of these judgments and estimates affect the reported financial results of the corporation.

§  Advising management on significant issues facing the corporation. Directors can offer management a wealth of experience and a wide range of perspectives. They provide advice and counsel to management in formal board and committee meetings, and they are available for informal consultation with the CEO and senior management

§ Reviewing and approving significant corporate actions. As required by state corporate law, the board reviews and approves specific corporate actions, such as the election of executive officers, the declaration of dividends and (as appropriate) the implementation of major transactions. The board and senior management should have a clear understanding of what level and types of decisions require specific board approval.

§ Reviewing management’s plans for business resiliency. As part of its risk oversight function, the board should oversee the designation of senior management who will be responsible for business resiliency. The board should periodically review management’s plans to address this issue. Business resiliency can include such items as business continuity, physical and cyber security, and emergency communications.

§ Nominating directors and committee members, and overseeing effective corporate governance. It is the responsibility of the board, through its corporate governance committee, to nominate directors and committee members, and to oversee the composition, independence, structure, practices and evaluation of the board and its committees. The committee should regularly evaluate the skills and experience represented on the board and oversee succession planning for the board.

§ Overseeing legal and ethical compliance. The board should set a “tone at the top” that establishes the corporation’s commitment to integrity and legal compliance. The board, acting through its committees as appropriate, should oversee the corporation’s compliance program and be comfortable that the corporation has implemented systems that enable the board to remain informed about the program and any significant compliance issues that may arise. In this regard, the board should be knowledgeable about the corporation’s compliance program and should be satisfied that the program is effective in preventing and deterring violations. The board, or an appropriate committee, should receive regular briefings about developments and significant changes relating to the program and about the corporation’s compliance trends. In addition, significant investigations of possible misconduct, investigations of misconduct involving senior management, the conclusions from any such investigations, and the investigative and remedial actions being taken should be presented to the board or appropriate committee. The board should pay particular attention to conflicts of interest, including related-person transactions.

 

– Steve Odland

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FTI Consulting Corporate Governance Survey

Posted on February 13, 2012 by Steve Odland

Capital Markets -Corp Gov Survey Feb 2012 FINAL

Here is the latest survey on Corporate Governance by FTI Consulting.  There were several interesting key findings:

  • Executive compensation is still a critical topic for investors and may be even more so than it was in 2011
  • Director independence and separation of chairman and CEO role are vital; investors are also focused on director qualifications and access to the Chairman
  • The trend toward greater shareholder involvement in corporate affairs continues
  • Proxy access is back
  • Other emerging issues in corporate governance have reasonably strong support
  • Ability to call a special meeting
  • Political contributions
  • Act by written consent
  • Decision-making on proxy matters is mostly independent and fairly balanced between PMs and Legal/Compliance

Of course, none of these issues is new but they continue to be top of mind.

– Steve Odland

 

Published with permission of FTI Consulting.

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CalSTRS To Vote Proxies Independently

Posted on February 6, 2012 by Steve Odland

CalSTRS introduced their report on executive pay last week.  It was notable for a couple reasons.  First, the large retirement fund acknowledges that questionable pay practices are on the decline although there still is room for improvement in their opinion.  From their press release:

“The California State Teachers’ Retirement System (CalSTRS) released, “Lessons Learned: The Inaugural Year of Say-on-Pay,” its analysis of shareholders’ ability to vote on executive compensation, known as say-on-pay, during the 2011 proxy season.  The analysis provides key findings from the first year with mandatory say-on-pay. The document notes that some questionable practices are on the decline, such as companies paying taxes on executives’ use of perquisites, and excessive perquisites themselves. However, the analysis also discusses CalSTRS’ primary reasons for voting against say-on-pay proposals and identifies areas where many companies can improve. Among these findings, are:

  • Persistent disconnect between executive pay and company performance was CalSTRS’ overwhelming reason for “against” votes.
  • Continued board use of broad discretion in developing compensation policies remains problematic.
  • Appropriate peer group selection continues to be a challenge.”

A second notable comment comes from the report itself:  “Given the unique nature of compensation, CalSTRS tried to evaluate pay holistically at every company.”  This is good news.  It is another example of a large investor looking at governance matters at public companies on an individual basis rather than relying on the black box models used at proxy advisory firms.  This judgment is welcome as no two situations are the same.  Good corporate governance demands that institutional investors make judgments about their investments’ corporate governance in context.  Hopefully more investors will follow this route in the future.

– Steve Odland

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Short-termism Creates Long Term Problems

Posted on February 5, 2012 by Steve Odland

If you asked most people what the goal of corporations should be they would rightly say the creation of long term shareholder value.  Unfortunately, today, most behaviors of public companies are focused on short term results, often quarter to quarter, resulting in long term issues.

The accounting requirements of quarterly earnings reporting has created a cadence for the planning and execution of business.  Each quarter companies are required to predict, execute, announce, and defend the variance of the results.  Each quarter’s results are expected to be higher than the previous quarter and the same quarter in the prior year.  Of course, like gravy, business is lumpy.  No business, even so-called non-cyclical businesses, operates on a straight line.  And yet that is what the analysts typically forecast and what investors expect.  Deviation from the line on the upside creates even higher expectations for the future and ultimately a let down, while deviation from the line on the downside often creates a call for management change.  In fact, “good management” is often defined as consistency in results.  Anyone who has ever worked inside a company knows that consistency is the rarest form of result and is more serendipitous than a symptom of good management.

The focus on short-termism can have negative consequences inside a company.  Once expectations for the coming quarters are shared internally, employees feel bound and determined to deliver.  But there are only so many buttons and levers that can be pushed in the short term to legitimately drive results.  As a result, short-term decision-making creeps in.  When results are not coming in as expected, costs must be cut and in the short-term this usually means marketing expenditures needed to grow the business are reduced or eliminated.  These cuts make more money in the short term but damage long-term results, sometimes irreparably.  Worst case, some employees may take things into their own hands and act or report financial results improperly.  Of course this is a terrible result that always ends up damaging the company for years to come.

Even the practice of issuing quarterly earnings guidance, once believed to be good management practice, creates short-termism.  In addition to defining the future focus as three months rather than three years or three decades, it creates the pressured referred to above.  Heaven help the management team that misses guidance as the analysts pummel them personally, shareholders are critical, and boards lose faith that their teams can deliver.  Hence the tendency to under forecast.  But even this practice can end poorly as it may diminish the goals and results

Boards and management teams must work together to resist short-term practices and focus on the long term.  They cannot allow pressure from short-term investors to take their eye off the ultimate goal of long-term shareholder value creation.

– Steve Odland

Posted in Board, Board of Directors, Corporate ethics, Corporate Governance, Ethics, Short-term, Short-termism | Tagged , , , , , | Leave a comment

WomenCorporateDirectors Announces Launch of First Annual “Americas Institute” for Boards

Posted on February 2, 2012 by Steve Odland

http://www.prnewswire.com/news-releases/womencorporatedirectors-announces-launch-of-first-annual-americas-institute-for-boards-138566604.html

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BlackRock To Vote Proxies Directly

Posted on January 20, 2012 by Steve Odland

In a letter to 600 of its largest holdings, BlackRock chairman Laurence Fink urged companies to consult with BlackRock directly to address their proxy issues before they consult with proxy advisory firms.  This is a huge development.  BlackRock holds at least 5% of the stock of more than 2400 companies worldwide through actively managed funds as well as their iShares index funds.  They hold about $3.5 trillion in (yes, with a T) in client assets.  This move to weigh in on proxy matters with their own considerations is uniquely different than most institutional holders who rely on outside proxy advisory services to determine how to vote on proxy issues.

This development may be negative for a company if BlackRock decides to create their own “rules” of corporate governance.  But, alternatively, this could be a positive development since BlackRock says they will consider each company’s issues uniquely.

BlackRock reportedly has voted with the board’s recommendation 91% of the time historically.  Time will tell if this support continues or whether BlackRock decides to take a different course.

– Steve Odland

 

http://www.bloomberg.com/news/2012-01-19/fink-leverages-blackrock-s-3-3-trillion-in-shareholder-push.html

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Don’t Force Split CEO, Chairman Roles

Posted on January 17, 2012 by Steve Odland

Today’s Wall Street Journal article entitled “Drive to Split CEO, Chairman Roles Gains Steam” talks about a group of mostly past chairmen & CEOs called the “Chairmen’s Forum” that are proposing a policy endorsing an independent director as chairman after an incumbent CEO-chairman leaves.  Their view is that boards function more effectively with independent chairmen. 

Once again, this view endorses a “one-size-fits-all” approach to corporate governance.  Their point of view may be valid in some cases but it may also not be the best approach in other cases.  This is why boards are made up of mostly independent directors with usually the CEO as the only non-independent director.  Independent directors need to have the latitude to implement the best structure for the firm based on their judgment and knowledge about the needs of the firm.

It’s disappointing that a group of people almost all of whom had the ability to lead their company with combined chairmen and CEOs roles now have decided that it would be best to dictate to all companies to do the opposite.  It’s almost as if they are seeking to create roles for themselves as non-executive chairmen so they have something to do in retirement.  I’m sure that couldn’t be the reason but why push this for all firms?  Instead they should outline a principles-based approach that states when it makes sense to combine the roles, and when it doesn’t.  They should acknowledge that the huge shift in governance of the past decade has led to mostly independent boards and that these boards are best capable of defining the structure that is best for their companies.

Prescriptive, one-size-fits-all approaches to corporate governance are not the answer.

–Steve Odland

 

http://online.wsj.com/article/SB10001424052970203735304577165041967514410.html?mod=WSJ_business_whatsNews

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Customize Corporate Governance

Posted on January 15, 2012 by Steve Odland

The “rules” seemingly have been written about corporate governance.  Risk Metrics, Glass-Lewis, Proxy Governance, etc. all have written their version of rules that public companies are supposed to follow.  Large institutional investors also have their own rules, each guided by their views on how public companies should be run.  But it’s impossible to have a “one-size-fits-all” approach to corporate governance.  Every company is different.  Every board and management team is wrestling with different issues.  Consequently, boards and management teams need to be mindful of popular corporate governance practices, but customize corporate governance implementation that is right for their company.

Here are some key issues in corporate

governance that should be considered carefully for each firm

1)    Chairman and CEO.  There has been a lot of pressure from advocates to separate the Chairman and CEO titles.  The belief is that these are two separate roles and that having one person responsible for both vests too much power in that individual.  But today, most boards have a Lead or Presiding Director to interface between the CEO and board, to chair the executive sessions of the board, and to lead the board on issues where the involvement of the CEO would be inappropriate.  Further, whereas historically a chairman would have sole control over the agenda, all

board members today can contribute to establishment of the board agendas.  Governance committees lay out the master plan of topics for each meeting and each board committee insures their key topics are covered.  So the role of chairman largely has become a title only.

When an independent board member is made chairman, the person usually takes on extra duties related to coaching a new CEO, or dealing with a specific business issue.  That chairman has responsibility and authority greater than a lead director who is an equal to other board members.  The decision of split or joint role should be driven by the needs of each individual company.

2)    Executive Compensation.  Many advocates want a formula used for executive compensation to be established as a multiplier of other salaries in the company.  One goal is to limit compensation to executives but the other goal is to raise compensation of lower level employees.  Either way, neither shareholders nor proxy advisory firms are as close to the situations of each individual company.  The board has accountability to oversee the governance of the company and is closest to each situation.  Boards need to be given the latitude to set compensation as they feel is appropriate.

3)    Mandatory retirement.  Many governance rules demand that directors retire at a specific age, say 72 or 75; or after a certain term on the board.  Here again, the objective should be to make sure that boards don’t become entrenched or beholden to management.  Rather than specifying certain ages or tenure, governance committees should ensure that there is new experience and thinking brought to the board every year or two, that committee chairs rotate every few years, that committee members rotate, and that the Lead Director role rotates.  This way boards can refresh oversight and decision making within a board without losing the collective experience of the board.  But these decisions should be made with the needs of each company considered rather than formulaically.

4)    Proxy Access.  Activists want proxies to be open for anyone to “run” in the election and for director elections to be contested.  The theory is that this will make for more responsive directors and result in directors working harder to create shareholder value.  But it is the accountability of management to create value and for boards to provide guidance and oversight.  Boards need to work as cohesive units in a collegial fashion with management, focused on an agreed-upon strategic plan to create value.  Contested elections have not driven greater shareholder value creation historically.  Hostile directors will not make for better performance.  Shareholders would be better off working through the boards to help drive greater value rather than contesting elections.  But there are cases where unresponsive boards need to be awaken and the current proxy rules allow this to happen

Net, activists should focus on driving alignment of objectives rather than forcing specific “one-size-fits-all” rules on boards.

– Steve Odland

 

Posted in Board, Board of Directors, Corporate ethics, Corporate Governance, Ethics | Tagged , , , , , , | Leave a comment

5 Ways To Get The Governance We Want

Posted on January 10, 2012 by Steve Odland

The best-written set of ethics principles will fail if all corporate individuals do not practice the principles. That’s why we must communicate our principles constantly by deeds and behavior throughout the corporation. CEOs should evaluate the ethics programs of their companies on an ongoing basis to ensure their current program is robust enough to head off the new problems of tomorrow.

Financial breakdowns and outright fraud have shaken the trust and confidence in our system. Public concern followed sensationalized stories of misdeeds, and government followed with new laws and regulations on corporations. Over the past decade many “fixes” have been implemented including the New York Stock Exchange and NASDAQ listing standards for public corporations, the Sarbanes-Oxley Act, and Dodd-Frank.

But we must be careful. We need to know when enough is enough – and that too much tampering with the system could drive unintended consequences. Ironically, many of the issues of the past decade resulted from violations of pre-existing rules and laws. So did we really need the latest avalanche of new regulations and rules or would we have been better off with enforcement of the old ones?

We also have to be careful not to criminalize honest mistakes. As long as we employ human beings, there will be mistakes. Mistakes are inherent in risk-taking and risk-taking is vital to competing in world markets. We would harm ourselves greatly if the threat of regulatory, civil, and criminal sanctions became so pervasive that corporations reduced or stopped taking risks. Risks are inherent in overall corporate growth and the U.S. economy is dependent upon that growth. Yet for corporations to grow, innovation is required in new products, scientific breakthroughs, new markets, and foreign economies where the “lay of the land” is far from stable.

The corporate community has been through a difficult ethical period. This same period was accompanied by scandals plaguing other institutions as well, including issues among political leaders, lawyers, journalists and even clergy.

But we also need to be introspective and ask ourselves what we could have done inside companies to make sure we were implementing programs to ensure our people were following our values. Ultimately good corporate governance is driven by the ethical behavior of individuals in the company.

Ethics problems seem more pervasive in today’s corporation than they have been in the past. Perhaps it is due to the secularization of society. Perhaps it is due to the liberalization of pop culture. Perhaps it is due to the pervasiveness of the Internet and social media, which is still the “wild, wild west” of communications where few rules or constraints apply. Perhaps corporations simply mirror society itself. Whatever the reason, there is a glaring need for new approaches.

CEOs need to be sensitive and watchful for generational differences in ethics. According to a study by The Ethics Resource Center, “all younger workers but especially Millenials are a significant area of vulnerability in terms of observed misconduct.” Corporations cannot assume that everyone has the same sense of right and wrong. So what 30 years ago may have been taken for granted in terms of expected behavior, cannot be assumed today.

So what can CEOs do?

  • Every company must have a written code of ethics and CEOs must talk about them constantly; “Tone at the Top” is an absolute requisite and CEOs must ensure that tone reaches all levels of an organization.
  • Best practices today include situational workshops among all associates, role-playing, scenario training, case studies, debate about gray areas, and constant discussion and modeling of behavior.
  • Companies should have an 800-number advice or ombudsman lines to assist employees and managers with ethical issues separate from the anonymous 800-number hotlines for reports of malfeasance.
  • Since most complaints currently are taken to an employee’s direct supervisor, thorough manager training is required on how to deal with them.
  • CEOs should add Chief Ethics Officer positions reporting directly to them. These need to be separate from Chief Compliance Officers. Compliance Officers are charged with finding violations and violators. Ethics Officers should be more proactive in risk assessment, training, counseling, and hopefully head off future issues before they happen. If you were an associate, with whom would you be most comfortable, a cop or an advisor?

CEOs should build ethics requirements into personal objectives for their people. These performance metrics or competencies can include:

  • Good communication of ethics;
  • Personal modeling of ethical behaviors;
  • Keeping commitments;
  • Maintaining accountability among all employees across the business;
  • Visible support for the ethics and compliance programs; and

Performance can be measured periodically with 360-degree surveys, gaining input from peers, subordinates, and senior leaders.

Any company undergoing “change” is especially vulnerable. Mergers and acquisitions add new cultures–and risk. Expansion into other countries adds Foreign Corrupt Practices Act (FCPA) risk and cultural complexity. And even change in organizational structure or IT programs can create process gaps that leave corporations vulnerable. “Change management” programs need to add values-based ethics training in addition to process change training.

Compliance is about rules, ethics are about values. Rules simply cannot be written to address every possible breakdown in behavior, especially when companies are represented by tens of thousands of people, and millions of customer and stakeholder interactions, all in real time. CEOs cannot assume that all employees have the same ethics. Instead, they need to introduce training programs and role-playing to instill ethical values, and ultimately lead to better decision-making and a more ethical culture.

While not perfect, the U.S. has the best corporate governance, financial reporting, and securities markets in the world. These systems work because of the adoption of best practices by public companies within a framework of laws and regulations. This system can be greatly enhanced by further commitment beyond the rules, to values-based governance. Then we will be in the best position to face unexpected challenges, overcome them, and prosper.

– Steve Odland

 

http://chiefexecutive.net/5-ways-to-get-the-governance-we-want

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Buy Green Be Green Sell Green

Posted on January 1, 2012 by Steve Odland

http://klatcher.com/ExecDigital/Exclusive_Interview__Steve_Odland

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Back To School

Posted on December 29, 2011 by Steve Odland

http://video.foxbusiness.com/v/4294915/office-depot-ceo-on-back-to-school-sales

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Ethics: The Foundation for Corporate Governance

Posted on December 9, 2011 by Steve Odland

Much has been written in the last few years about corporate governance. Despite all the new rules and regulations developed, the key to good corporate governance remains a strong commitment to ethics.

It is that commitment that makes all the difference – not simply an ethics statement or codification. The best-written set of ethics principles will fail if all corporate individuals do not practice the principles. That’s why we must communicate our principles constantly through deeds and behavior to every employee and stakeholder in the corporation. At the same time, directors and management of corporations should evaluate the ethics programs of their companies on an ongoing basis. They should be willing to ask themselves tough questions, such as: is our program today enough to head off the problems of tomorrow?

Corporations are involved in every type of human activity today. The purpose of corporations is to provide goods and services while creating shareholder value over time. Our businesses have advanced the well-being of society with breakthroughs in science, medicine, technology, and the creation of virtually all wealth. Public corporations offer a way for everyone to access ownership of a piece of our economy, and the wealth-creating opportunities afforded to them by the public markets. The “public” in public companies refers to the ability of people to invest in America through stock markets. But public companies are part of the private sector, and should not be confused with the public sector or government-controlled entities.

Corporations form the underpinnings of most things we know about America, including our economic power and all things driven by those resources. Four of the five largest corporations in the world are American. The largest is Wal-Mart with nearly $450 billion dollars in sales and over 2 million employees. There are about 15,000 U.S. public corporations. Investments in these companies form the basis of most pension funds, mutual funds, and retirement plans. Virtually all of the $14.6 trillion U.S. GDP is driven by the private sector—American corporations are our economy.

The corporate community has been through a difficult ethical period. But this same period was accompanied by scandals plaguing other institutions as well, including issues among political leaders, lawyers, journalists and even clergy. What does it say about our society as a whole when none of our hallowed institutions are free from issues?

Financial breakdowns and outright fraud have shaken the trust and confidence of Americans who rely on business for their jobs, for their savings, and for their retirement security. Public concern followed sensationalized stories of misdeeds, and federal and state officials followed in turn with new laws and regulations on corporations.

These events not only got the attention of the public and government officials. Responsible business leaders were embarrassed by these scandals. We could not – and must not – let the misdeeds of a relatively few people jeopardize the public trust in our economic system. That trust is the basis of our free market system. There are millions of Americans who rely on this system for jobs, their retirement security, and their wealth. Without this underlying trust, the markets would not exist and our economy would collapse.

It was clear that the corporate community needed improvements and that we needed to demonstrate a commitment to reform and a commitment to restoring investor confidence. And it was important that the private sector rather than the government led these reforms.

Many private sector organizations have committed to improvements in corporate governance. The Business Roundtable, for example, took an early lead and developed its Principles of Corporate Governance. The Roundtable followed up those recommendations by spelling out Principles of Executive Compensation. They established the Business Roundtable Institute for Corporate Ethics in conjunction with the Darden School of Business at the University of Virginia. Other groups formed to work on these issues including the Milstein Center for Corporate Governance at Yale University, the Aspen Institute Corporate Values Strategy Group. And long-established groups like the Ethics Resource Center stepped up their interaction with these ethics issues.

Over the past decade, New York Stock Exchange and NASDAQ listing standards for public corporations have changed, significantly strengthening financial and governance requirements. The landmark Public Company Accounting Reform and Investor Protection Act – better known as the Sarbanes-Oxley Act – as well as Dodd-Frank have been enacted. The new regulatory requirements don’t come cheap. The average large corporation is spending millions of dollars to reach and maintain compliance, with all the laws and regulations passed in just the last few years. Collectively, these changes represent the most far-reaching corporate reform legislation in sixty years. And the rules and regulations continue to be written.

But we must be careful. We need to know when enough is enough – and that too much tampering with the system could drive unintended consequences. Ironically, many of the issues of the past decade resulted from violations of pre-existing rules and laws. So did we really need the latest avalanche of new regulations and rules or would we have been better off with stronger enforcement of the old ones? We cannot strive so hard to legislate away every last problem that we ignore the very real possibility of collateral damage to our economy, job creation, and shareholder value creation.

We also have to be careful not to criminalize honest mistakes. As long as we employ human beings, there will be mistakes. Mistakes are inherent in risk-taking and risk-taking is vital to competing in world markets. We would harm ourselves greatly if the threat of regulatory, civil, and criminal sanctions became so pervasive that corporations reduced or stopped taking risks. Risks are inherent in overall corporate growth and the U.S. economy is dependent upon that growth. Yet for corporations to grow, innovation is required in new products, scientific breakthroughs, new markets, and foreign economies where the “lay of the land” is far from stable. Well-intentioned growing companies have to do business in areas that require significant risk, and honest mistakes occur. Without risk-taking, most progress could simply come to a halt. Other countries could overtake the U.S. in economic growth and job creation as capital investment flowed to other parts of the world.

After all of these changes in corporate governance, the question becomes: Have we finished the job? The answer is: How will we ever know? Just when we think we’ve put yesterday’s scandals to rest, something new comes up. But we won’t solve these and similar problems simply by adding more laws and regulations or by introducing more voluntary corporate governance changes.

Law professor Larry D. Thompson, a fellow at the Brookings Institution, has noted that every fresh business scandal brings calls for new regulations to prevent such a scandal from ever happening again. “Regulations expand with each ensuing scandal,” he stated, “to encompass every possible abuse – except the next one.”

We should continue to refine needed regulations, of course, imposing more corporate governance changes will not ensure ethical behavior. Ultimately good corporate governance is driven by the ethics of the individuals in the company. Real, lasting change can come only from improving every corporate culture with a genuine commitment to ethical behavior. That involves moving beyond corporate “rules-based” behavior to “values-based” behavior. Or to put it another way, for people in corporations to do the right thing even when the rules don’t precisely cover it or when they don’t think that anyone’s watching. In a word, they need to act ethically.

The way corporations treat their people is another way to measure its commitment to ethical behavior. Such a commitment is attainable with a values-based approach that includes five practices:

• First, people should know what you stand for – both as the Board and as a corporation. That involves a clear statement of ethical principles.
• Second, employees and officers should be able to push back – they should report concerns and propose improvements without fear of retribution. The environment must be made safe for people to do the right thing.
• Third, there should be access to management by all constituents.
• Fourth, the organization should be transparent and open.
• Fifth, everyone must understand how we in the corporation should treat each other.
• Sixth, everyone should know what happens when we don’t uphold our values. People who violate values should be held accountable. Reports of misconduct should be investigated, and when substantiated, discipline should occur. Without accountability, values are toothless.

Knowing what’s right is a constant learning process. That often involves venturing into uncharted territory as new choices present themselves. We are forced to manage our lives and businesses with imperfect foresight in a world that judges other people based on perfect hindsight. That’s where a values-based approach comes in – to help guide us in new situations.

Ethics problems are more pervasive in today’s corporation than they have been in the past. Perhaps it is due to the secularization of society. Perhaps it is due to the liberalization of pop culture. Perhaps it is due to the pervasiveness of the Internet and social media, which is still the “wild, wild west” of communications where few rules or constraints apply. Perhaps corporations simply mirror society itself. Whatever the reason, there is a glaring need for new approaches.

Boards and management teams need to be sensitive and watchful for generational differences in ethics. According to a study by The Ethics Resource Center, “all younger workers but especially Millenials are a significant area of vulnerability in terms of observed misconduct.” Corporations cannot assume that everyone has the same sense of right and wrong. So what 30 years ago may have been taken for granted in terms of expected behavior, cannot be assumed today.

While written codes of ethics are necessary and a good first step, more is needed. “Tone at the Top” is an absolute requisite. But leaders must ensure that positive tone reaches all levels of an organization. Best practices today include situational workshops among all associates, role-playing, scenario training, case studies, and constant discussion and modeling of behavior. Most companies have anonymous 800-number hotlines for reports of malfeasance. Equally important are 800-number advice or ombudsman lines to assist all associates and managers in dealing with issues. Experience shows that most complaints currently are taken to an employee’s direct supervisor. So thorough training is required for these lower and middle level supervisors on how to deal with employee concerns and reports.

In addition to Chief Compliance Officers, many corporations now are adding Chief Ethics Officer positions. Although currently at some companies the same person performs both roles, the roles are not the same. Compliance Officers usually audit and seek to find breakdowns in compliance. Stated simply, they are charged with finding violations and violators. Ethics Officers are more proactive in risk assessment, training, counseling, and hopefully heading off future issues before they happen. If you were an associate, with whom would you be most comfortable, a cop or a counselor?

Some companies now are building ethics requirements into personal objectives for their people. These performance metrics or competencies can include good communication of ethics by leaders at all levels; personal modeling of ethical behaviors; keeping commitments; maintaining accountability among all employees across the business; visible support for the ethics and compliance programs; and performance consistent with codes of ethics. Performance can be measured periodically with 360-degree surveys, gaining input from peers, subordinates, and senior leaders.

Values-based ethics programs should be introduced in all companies to ensure future issues are identified before they occur. Any company undergoing “change” is especially vulnerable. Mergers and acquisitions add new cultures–and risk. Expansion into other countries adds Foreign Corrupt Practices Act (FCPA) risk and cultural complexity. And even change in organizational structure or IT programs can create process gaps that leave corporations vulnerable. “Change management” programs need to add values-based ethics training in addition to process change training. For new operations, this includes bringing new associates up to speed, setting expectations for behavior, and ensuring cultural consistency at the highest level of ethics.

These suggestions are very consistent with a values-based approach. Compliance is about rules, ethics are about values. Rules simply cannot be written to address every possible breakdown in behavior, especially when companies are represented by tens of thousands of people, and millions of customer and stakeholder interactions, all in real time. So a values-based approach dismisses the assumption that all employees have the same ethics and all but the odd, rogue individual will “make the right call.” Instead, instilling values requires more time, more care, more debate about all the gray areas, and ultimately leads to better decision-making and a more ethical climate.

Corporations cannot exist without the people who work there, who buy products from them, and who sit in boardrooms overseeing the overall company’s performance. People are imperfect. But people are also capable of learning and changing. That’s what a healthy, ethical corporate culture—a values-based culture–can encourage and ensure. Strong corporate governance and high ethical standards are not simply matters of personal and public morality. But they are also essential for long-term corporate success and world economic leadership by this nation. Unethical behavior and outright fraud are corrosive and ultimately betray the free market system. They discourage hard work, degrade our productivity and competitiveness, cheapen our daily lives, weaken the bonds of trust, and lead to a society in which none of us wants to live.

While not perfect, the U.S. has the best corporate governance, financial reporting, and securities markets in the world. These systems work because of the adoption of best practices by public companies within a framework of laws and regulations. While there have been exceptions to the overall record of success, generally the system has worked very well. But this system can be greatly enhanced by further commitment beyond the rules, to values-based governance. Then we will be in the best position to face unexpected challenges, overcome them, and prosper. And as long as we can keep that idea central, we can continue to look forward to a 21st century of greater prosperity and progress.

– Steve Odland

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We the Directors

Posted on January 29, 2011 by Steve Odland

Years ago being a director of a public company was a much simpler proposition.  Directors were invited to join the board by the chairman, usually a friend or close acquaintance in the same hometown.  Boards were small, board members knew each other very well, were friends, were like-minded, and were parochial.  Boards served largely to act as advisors to their friends and colleagues who managed the business.  This system worked reasonably well for much of the 19th and 20th centuries.  So what changed?

Well, business changed.  After decades of mergers and acquisitions, business became larger–national and multi-national.  Companies became more complex with a greater variety of businesses and models that were difficult to understand.  Rules and regulations exploded.  Shareholders expanded from a small number in the community to strangers, foreigners, pension funds, and professional risk takers.  And financial and operating risk increased.  All of this required a different type of director.

Today’s boards of public companies in some ways resemble those of old, with a relatively small group of people voted upon by shareholders.  But directors now are recruited mostly by search firms, often are strangers to each other, and are more diverse in experience, gender, race, and geographic origination.  They no longer are friends and colleagues of management.  This has led to a different kind of board, with best practices drawn from guidelines written by government, shareholder groups, business groups, etc.  The system has changed rapidly over the past ten years to adapt to the changing environment as well as the various business crises that erupted.

To overstate it:  boards have evolved from a business advisory model to a risk/compliance model.  The intent is to avoid more business failures and breakdowns in compliance that created dramatic business failures and shareholder loss.  This evolution obviously was necessary.  The positives are evident as nobody likes to see a company’s constituencies harmed.  But we also need to be mindful of the cons. We directors need to ensure that the risk/compliance activities don’t distance us from management.  We can’t switch totally to a risk/compliance group and simply outsource our advisory role to external consultants.  We need to be sure we continue to provide the advice and counsel to the companies that boards have traditionally provided.  We need to have a trusting, collegial, relationship with management.

Yes, we the directors need to augment our roles to adapt to the current environment and needs of the modern corporation.  But we need also to remember our traditional roles, and be a safe place for managements to turn for advice and counsel.  It is in this balance is where our highest and best contribution lies.

– Steve Odland

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