As we enter the second half of 2017, investors and activists are paying particularly close attention to board accountability, compensation and diversity.
More and more companies are offering shareholders proxy access. Not long ago, few companies offered it. Today over half of the S&P 500 has proxy access, and shareholders are making the most of it. With that power in hand, they are particularly focused on making sure boards are managing for cyber and environmental risks.
Meanwhile, smaller companies are starting to behave more like large companies in terms of holding board members accountable to shareholder interests—for instance, by imposing annual elections in the director election process. Additionally, “poison pill” plans, a tactic utilized by companies to prevent or discourage hostile takeovers, are becoming increasingly rare.
Of course, performance issues in almost any role are almost always followed by compensation questions. It’s no different now for boards. Between 2012 and 2016, non-employee board member compensation grew by almost 20%, whereas median CEO pay in the S&P 500 grew less than 10%. If CEO compensation is trending up only moderately, it’s natural to wonder or expect board pay to moderate as well. In fact, there has been an uptick in high profile lawsuits where shareholders allege excess pay to board members. The NYSE and NASDAQ are also looking at board member compensation as a metric of “independence” when assessing listing eligibility. And while directors have had to disclose pay for a long time, only recently was the disclosure standardized with a table spanning the previous five years.
Average tenure and whether boards are sufficiently diverse are also growing issues. Diversity is improving very slowly—women account for just over 17% of directorship positions, while about 10% of board members are minorities. To address these concerns, more and more boards are imposing age limits, tenure limits and instituting regular evaluation processes.
Robert Barbetti, Managing Director, is the Global Head of Executive Compensation and Benefits at JP Morgan’s Private Bank. As a senior member of the Private Bank’s Advice Lab, Robert focuses on maximizing and optimizing executive compensation for insiders. His expertise includes managing single stock concentrations, employment and severance packages, pre-IPO planning, M&A transactions and capital market solutions for executive compensation. In particular, Robert focuses on issues related to Sarbanes-Oxley and good corporate governance, especially those challenges faced by boards of directors. He was one of the architects of JP Morgan’s tradable stock option program used by Microsoft in 2003 to cure its “underwater” stock option problem.
In an old issue of the Harvard Business Review, Jeffrey A. Sonnenfeld wrote that a key characteristic of What Makes Great Boards Great is a culture of open dissent. “Directors are, almost without exception, intelligent, accomplished, and comfortable with power. But if you put them into a group that discourages dissent, they nearly always start to conform. The ones that don’t often self-select out,” he wrote.
Most directors at U.S.-listed firms were only recently elected for the year ahead. When investors cast their votes in favor of candidates during the spring meeting cycle, we do so expecting them to act as a check on management and to protect the assets entrusted to their oversight. At Segal Marco, the assets of our clients are the retirement savings for working men and women throughout this country. Our clients invest in the capital markets to earn returns for their retirement plans and receive the collateral benefit of being a driving force in our country’s economic growth.
Investors sit on the outside of the boardroom and must rely on past experience and thoughtful judgment to assess how boards should be structured to allow for sustainable performance. After all, as the recruitment firm Spencer Stuart reports, the majority of boards have an average director tenure of between six and 10 years. In almost all cases, pension funds will own broad-based index stocks for multiple decades.
While investors and directors are aligned in their interest to participate in the success of the company, they may disagree about the means to achieve it. That’s why the process for investor-director engagement is so critical. Shareholder proposals are one way for investors and directors to communicate. They allow investors to propose new ways of thinking about risks and structures. The effort underway with the Financial Choice Act that recently passed the House of Representatives attempts to silence shareholders by taking the cynical view that dissent is harmful. We agree with Sonnenfeld that open dissent is not only helpful, it is a necessary component of greatness.
One new policy that boards might consider during the second half of 2017 is to adopt the Rooney Rule procedure for board recruitment. Adapted from the NFL’s head coach search process, the Rooney Rule says that director searches will include women and minorities in an initial list of qualified candidates. Recent studies by Credit Suisse and McKinsey show diversity drives long-term shareholder value. Of course, every nominee to the board should be intelligent, accomplished and comfortable with power. Every board should consider new directors that look and think differently. Diversity helps create open dissent and that helps build great companies.
Maureen O’Brien is Vice President and Corporate Governance Director at Segal Marco Advisors. She joined the firm in September 2011. At Segal Marco, she engages companies on corporate governance issues and oversees the proxy voting service. Ms. O’Brien serves on the Advisory Council to the Council of Institutional Investors. Ms. O’Brien’s work in shareholder advocacy began in 2003 as a Research Analyst for the Investor Responsibility Research Center. Ms. O’Brien previously served as Head of Engagement at Conflict Risk Network, where she held dialogues with companies operating in Sudan and other conflict zones. In a previous role, she was Research Director at the Center for Political Accountability, a non-profit, non-partisan organization, where she promoted transparency in corporate political spending.
In my view, the main board performance issue that will be on the radar of investors and activists in the second half of 2017 is a fundamental one—board composition.
The last couple of years have turned the spotlight on this issue. Investors are becoming increasingly concerned about board composition, specifically with respect to the issues of director tenure and board diversity. The general lack of refreshment on boards has led to a rise in the tenure of directors, with many directors serving for over 20 years, leading to concerns about their ability to perform their roles effectively.
In addition, gender diversity is still very much lacking in most large public corporations. The recent initiative by State Street to address gender diversity, voting against the chair of a board’s nominating and/or governance committee if a company fails to take action to increase the number of women on its board, exemplifies a general emphasis throughout the investor community on more concrete results in their portfolio companies.
The push for board refreshment, diversity and for a reduction in the number of “over-tenured” directors requires boards to devise concrete plans for a change in boardroom composition. Indeed, activists have already targeted long-tenured directors as part of their campaigns against their targets. Therefore, boards have to be forward-looking in their succession plans, not only in the immediate short term, but also in the long term. Boards need to devise a long-term refreshment plan that addresses tenure and diversity issues in a way that balances short-term needs and long-term refreshment. Finally, boards must be proactive in communicating their long-term refreshment plans and vision for the board’s composition with their investors.
Yaron Nili is an Assistant Professor at the University of Wisconsin Law School where he teaches courses in Corporate and Securities Law. His scholarly interests include corporate law, securities law and corporate governance, with a particular focus on the role and function of the board of directors, shareholder activism, hedge funds and private equity. Professor Nili’s recent publications appear or are forthcoming in the Hastings Law Journal, the Wisconsin Law Review, the Harvard Business Law Review, and the Journal of Corporation Law. Professor Nili’s work is available for download on his SSRN page, at the URL above.
Beyond the classic board performance issues investors and activists focus on, some of these groups will be focusing on the impact on shareholder value and brand equity related to a board and company’s preparation for and ability to deal with various levels of crisis communications.
Long and forever gone are the days when a company controlled much of its messaging through trade/consumer press, investor relations and advertising.
Social media has changed that reality in the most fundamental of ways, but many companies simply have not caught up with the times and are not prepared to deal with the social media tsunami created by a negative incident videoed on a cell phone and then amplified to the nth degree via myriad social channels.
No need to name the companies that have recently not been properly prepared to respond to these types of crisis communication situations. The headlines do that and are a cautionary tale for all boards and companies.
While crisis communication planning has not typically been in the direct purview of boards, given the truly incredible power of social media to create or destroy shareholder value and brand equity, investors and activists will increasingly expect boards to require management teams to have sophisticated crisis communications planning in place that acknowledges and embraces today’s messaging ecosystems.
This means boards need to hold senior management accountable to having proactive and reactive crisis communications and social media strategies and plans in place so when the inevitable happens it’s plug and play. Due to the speed and amplification of communications in 2017, there is no time to figure out, “How should we handle this?”
It also means boards should increasingly be involved in dialogue with C-suite executives to guide and help ensure that the sophisticated digital core competencies to deal with proactive and reactive social media messaging exist within the organization, and that the executive team is united on exactly what to do when that nightmare video or information goes viral.
Steven Borden is Founder and President of Borden Media Consulting, which specializes in high-level management consulting and executive placement for a wide range of media, entertainment and information companies. BMC’s areas of expertise include executive placement, strategic planning, organizational design, process evaluation, values and culture determination, internal/external communications, and executive coaching. Mr. Borden has worked in media and entertainment in a variety of capacities for more than 30 years, including more than 15 years providing senior-level consulting and executive placement services for all types and stages of technology, media and telecom (TMT) companies.
The issues for the second half of 2017 will be culture and accountability. Of course, attention still will be paid to factors that can be measured easily, are comparable readily across companies and generate memorable sound-bites. Investors looking to truly assess board performance in modern times, however, will evaluate the board’s role in setting, measuring, encouraging and holding constituencies accountable for company culture.
Recently, we have seen multiple examples of significant value destruction that have their root cause in corporate culture. Near-instantaneous, mass communication, particularly in the context of rising populist sentiment, has intensified the potential consequences of conduct rooted in negative culture. On the other hand, leaders consistently state that, when a good culture is in place, it can be felt throughout the entire organization. The result of a strong culture is high morale, good employee retention and sustainable long-term success.
Although it is readily accepted that boards are responsible for setting tone at the top, it is difficult for investors to evaluate how effective boards are at doing so. Boards looking to communicate the quality of their oversight of culture could consider answering proactively some of the following types of questions: How has the board acted to establish the company’s purpose, values and culture? Has the company engaged in internal surveys or other benchmarking to assess its culture and how is it progressing toward its goals? How often is culture a board agenda item? How do the company’s incentive and succession programs support its stated culture? How has the company held individuals accountable for significant breaches in culture?
These questions are designed to cover the different facets of the board’s relationship to corporate culture. The board and leadership’s role in culture begins in establishing a clear purpose—why the company exists and what is there to do. One size does not fit all when it comes to culture. A company’s culture must be appropriate for the context in which it operates and there must be alignment between purpose and strategy. After purpose comes measurement. Many companies know where they want their culture to be but few have an objective understanding of the current state. Without establishing a baseline, it is difficult, if not impossible, to measure progress and set next steps.
Succession and compensation are two of the most powerful tools for boards in communicating and encouraging the culture of a company. Culture at its core is what people observe and do. Mostly people look at what succeeds and what does not and then try to align themselves with the former. Finally, it has become increasingly important that individuals are being held accountable for breaches in culture. It is an unstated expectation that significant culture lapses result not only in job loss, but also in the recovery of compensation paid during the period it occurred.
As long-term owners become increasingly sophisticated with respect to corporate governance, they will increasingly turn their attention to healthy corporate culture as a valuable asset, a competitive advantage and a necessary component of long-term value creation.
Marc Treviño is the Head of Sullivan & Cromwell’s corporate governance practice, the Managing Partner of its executive compensation group and a member of its financial institutions group. Mr. Treviño regularly counsels senior executives and boards in significant matters involving reputation, overlapping regulatory regimes and/or fiduciary conflicts, with a particular emphasis on matters involving financial institutions.