Category: Corporate Governance

Private Company Snapshot: Priorities Vary by Company Type

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Strategy, corporate performance, and corporate growth or restructuring were the most commonly cited governance priorities overall for respondents of the 2015–2016 NACD private company governance survey. But a closer look at the results by the type of business reveals distinct differences in director concerns.

This year, NACD for the first time published its survey report in three separate volumes organized around major ownership structures—family, investor, and employee-owned—to provide more customized analyses that address challenges specific to each company type.

Survey findings are drawn from some 712 responses to a questionnaire e-mailed to NACD members serving on private company boards representing each of the three ownership structures. The questionnaire was in the field between March and May 2015.

PrivCoSurveyDataFamily Business Boards

NACD’s survey results indicate that the boards of family businesses are likely to view long-term strategy and value creation as their top priorities. When considering executive performance horizons, a large portion of respondents from family business boards (49%) define “long-term” as more than three years. Twenty-four percent of respondents identified leadership development as one of the three most time-consuming tasks for their board, alongside strategic planning and corporate performance.

The results also indicate that despite their attention to long-term strategy and leadership development, 24 percent of family business boards do not have a formally written CEO succession plan. The lack of such a plan can complicate the effective transfer of leadership, whether between generations of family executives or from the family to outside management.

For guidance on effective practices for family business boards, see NACD’s handbook The Family Business Board, Volume 2: Governance for Agility and Growth.

Investor-Owned Company Boards

Boards of investor-owned companies or those that are supported by venture capital or private equity firms may comprise a mix of founders, management, and investors, depending on the company’s stage of development.

Venture capitalists and private equity firms, by the very nature of their work, are especially focused on results: they want the valuation of the company to increase, oftentimes at a quick clip. Not surprisingly, investor-owned company boards rigorously scrutinize the performance of the company and its executives. The majority of directors at investor-owned companies (61%), closely monitor profits, while 37 percent monitor sales to gauge the company’s performance and determine executive pay.

A significant 33 percent of respondents use cash flows, which offer insight into where and how the company generates income and how its cash is being deployed. The focus is not solely on financial metrics; 44 percent of investor-owned companies also use customer satisfaction as a gauge of the company’s strength.

Employee-Owned Company Boards

Executive talent management ranks as a high priority for the boards of employee-owned companies, which are owned at least partially by their employees, either directly or indirectly through a trust. The vehicles for employee ownership can take several forms, including employee stock ownership, stock options, and profit-sharing plans.

While profits and sales remain important metrics, a large number of respondents from employee-owned companies use metrics related to employee morale (52%) and employee turnover (32%). The prevalence of these metrics was particularly notable among employee-owned companies.

For further coverage of the private company surveys, please see the forthcoming September/October 2016 edition of NACD Directorship magazine.

To download NACD’s surveys of private companies or view guidance and tools for private companies, please visit the Resource Center for Private Company Governance at www.NACDonline.org/privatecocenter.

 

The Keys to Guarding Reputation

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Jim DeLoach

Jim DeLoach

Reputation is a precious but fragile enterprise asset. What takes decades to build can be lost in a matter of days once the spotlight shines on unethical or illegal practices that place an organization’s stakeholders or the public at risk. Environmental catastrophes, financial restatements, fraudulent reporting to regulators, massive product recalls, efforts to mislead investors, and other highly publicized events erode brands and impair reputation. We define reputation risk as the current and prospective impact on earnings and enterprise value arising from negative stakeholder opinion.

We see 10 key functions of the board’s oversight of reputation risk management, and classify them in five critical areas below.

Strategic Alignment

  1. Effective board oversight – Reputation risk management starts at the top. Strong board oversight on matters of strategy, policy, execution, and transparent reporting is vital to effective corporate governance, a powerful contributor to sustaining reputation, and is the ultimate checkpoint on CEO performance. The board’s active risk oversight effort is important because effective, early identification, and management of risks can reveal major threats to the company’s reputation and ensure that the threats are reduced to an acceptable level.
  2. Integration of risk into strategy-setting and business planning – The board must ensure that risk is not an afterthought in the strategy-setting and business planning processes. Integrating awareness of risks with core management processes makes risk a relevant factor at the decision-making table, facilitates a big picture view to undertaking risk, and intersects risk management with performance In an effort to make the strategy more robust, directors should understand the critical assumptions underlying the strategy; ask tough, constructive questions to challenge assumptions; and consider plausible scenarios that could render one or more assumptions invalid.
  3. Effective communications and image- and brand-building – Building brand recognition unique to a business is vital and, when all else is working well, augments reputation. A good story is easier to tell than one with flaws, but every savvy board knows that some companies are better at telling their stories than others. Therefore, directors need to understand management’s image- and brand-building game plan and how significant changes to that plan could present a significant risk to the company’s reputation.

Cultural Alignment:

  1. Strong corporate values, supported by appropriate performance incentives – The notion that, if tone at the top is good, the organization’s culture must be good, doesn’t always hold. Lower-level employees often pay more attention to the messaging and behavior of their supervisory middle managers than to communications from the organization’s leaders. Boards need to ensure that executive management implements a strong tone at the top, effective escalation processes, and periodic assessments of the tone in the middle and at the bottom. Directors need to ensure that management is paying attention to warning signs posted by independent risk management functions and in audit reports: failure to give these warning signs adequate attention on a timely basis reflects on the tone set by executive management. For example, the executive leadership of Barings ignored warnings from internal audit of the consequences of the lack of segregation of duties in its Singapore operations because those operations were making the bank a lot of money. Ultimately, the hidden trading losses took down the institution.
  2. Positive culture regarding compliance with laws, regulations and internal policies – Few incidents undermine reputation more than serious, highly publicized compliance violations. Directors should ascertain that effective internal controls – including monitoring processes and robust training of employees – over compliance matters are implemented and executive management: “walks the talk” with respect to compliance; periodically conducts a comprehensive risk assessment; refreshes the compliance program for changes arising from new regulatory developments; and understands the players and third-party agents in countries in which the organization does business and monitors their dealings closely.

Quality Commitment:

  1. Priority focus on positive interactions with stakeholders – The board should ensure that there is a passionate focus on improving stakeholder experiences. These are the accumulation of day-to-day interactions that customers, employees, suppliers, regulators, shareholders, lenders, and other stakeholders have with a company as a result of its business operations, branding, and marketing. These interactions constitute moments of truth that, if internalized and acted upon, provide a powerful driving force for improving and sustaining reputation.
  2. Quality public reporting – The markets take quality public reporting at face value. Once a company loses the public’s confidence in its reporting, it’s tough to earn it back. These points suggest that a strong audit committee is an imperative.

Operational Focus:

  1. Strong control environment – A critical component of internal control, the control environment lays the foundation for achieving operational, compliance and reporting objectives. In addition to the board’s oversight and the organization’s commitment to integrity and ethical values, as mentioned above, the control environment consists of: the organizational structure and assignment of authority and responsibility; the processes for attracting, developing and retaining appropriate talent; and the rigor around setting the appropriate performance measures, incentives and rewards that drive accountability for desired results. Embarrassing control breakdowns can tarnish reputation; therefore, boards should demand a strong control environment.
  2. Company performance relative to competitors – Market recognition of success is a huge validation of a company and its management team. Recognition of differentiating strategies, distinctive products and brands, proprietary systems, and innovative processes are intrinsic sources of value that can translate into superior quality, time, cost, and innovation performance relative to the company’s competitors. However, significant performance gaps can diminish reputation if not addressed in a timely manner. These factors should weigh heavily on a board’s evaluation of company performance over time.

Organizational Resiliency:

  1. World-class response to a high-profile crisis – Sooner or later, every company is tested. No company is immune to a crisis. As a crisis event is a severe manifestation of risk, crisis management preparation is a natural follow-on to risk assessment, particularly for high-impact risks with high velocity, high persistence, and low response readiness. The board should ensure that the risk assessment process is designed to identify areas where preparedness and a response team are needed. Fires cannot be fought by committee.

While a one-size-fits-all approach does not exist, the 10 keys listed above offer boards a framework for focusing on whether executive management is focused on the appropriate fundamentals for enhancing and preserving the enterprise’s reputation.


Jim DeLoach is managing director with Protiviti, a global consulting firm. 

Seven Principles for Understanding and Avoiding Short-Termism

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Fornelli_Cindy

Cindy Fornelli

Six years ago, Warren Buffett, John Bogle, Barbara Hackman Franklin, and two dozen other business luminaries sounded the alarm about short-termism by signing Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management. This manifesto highlights an unhealthy focus on short-term results that overwhelms “the desirable long-term growth and sustainable profit objectives of the corporation.”

Despite this call to action, overcoming short-termism remains a stark challenge for many companies. In fact, as the National Association of Corporate Directors’ (NACD) 2015 Blue Ribbon Commission observed, “factors encouraging a short-term focus are stronger now than ever before.” Additionally, in a 2015 report, the Conference Board contemplated whether short-term biases might jeopardize future business prosperity altogether.

Yet if short-termism is a sizable challenge, so too is the commitment to understanding why short-termism is so entrenched as a business practice and the task of mitigating its harmful effects. In July, the Anti-Fraud Collaboration, a group of organizations focused on fighting financial reporting fraud, hosted a webcast on Coming to Terms with Short-Termism. The discussion, which I was privileged to moderate, featured top experts and generated a wealth of useful takeaways for participants across the financial reporting supply chain.

Let’s look at a few key takeaways from the discussion.

1. Acknowledge and Define the Complexities of the Issue

To address the challenge of short-termism, it helps to understand the complexities of what companies are up against. For one thing, “short-termism” doesn’t equate to short-term activity, which isn’t necessarily bad. NACD Chair Karen Horn, director of Simon Property Group, observed at the outset of the webcast that the “long term is made up of many, many short-term actions.”

Another tricky step to understanding the complexities of short-termism is how to define “short-term” at your company. Is it a month? A quarter? A year? “It depends on the company,” said panelist Bill McCracken, president of Executive Consulting Group LLC. McCracken, who previously served as CEO of CA Technologies, added that even within a company the meaning of “short-term” can change according to different contexts, such as strategy or compensation.

2. Think Strategically

However complex a challenge combatting short-termism may seem, there are several simple solutions for directors to consider. One of them is this: think strategically. A strategic mindset helps short-term actions align with long-term goals. “Boards really need to be conversant with the company strategy,” said Horn. McCracken agreed, noting that board members should become “activist directors” who immerse themselves in the details of the company, its strategy, and its industry. This engaged approach, he added, can help directors be prepared to handle situations such as share buybacks or changes to dividend policy where questions of short-termism may arise.

Similarly, strategic thinking can also help directors gauge the validity of the use of non-GAAP measures. “Shouldn’t the use of non-GAAP measures also tie in to the strategy of the entity?” asked Douglas Chia, executive director of the Conference Board’s Governance Center. “Absolutely,” responded fellow panelist and KPMG Partner Jose Rodriguez.

3. Strengthen Tone at the Top…

One danger of short-termism is that it can heighten fraud risk across the enterprise. Companies need to ensure that management is setting the right tone at the top. “I can’t underemphasize tone at the top,” said Rodriquez. “How do [senior executives] talk to employees? Is everything geared around meeting that analyst’s [earnings] expectations?” From his auditor’s viewpoint, he added, “that would be concerning.

4. …But Don’t Forget the “Mood in the Middle” and “Buzz at the Bottom”

While emphasizing tone at the top, panelists also stressed that short-termism shouldn’t be a point of concern for only senior management. Many instances of fraud, noted Rodriguez, occur outside the C-suite. “It’s middle management and lower management that had to get that sales number to a certain amount of dollars,” he said, and this pressure can lead to channel stuffing or other undesirable activity. Such activity is what audit committees, auditors, and the board ought to be looking for, added Bill McCracken.

5. Dial Down the Emphasis on Quarterly Results

“Our entire [financial reporting] structure is built around quarterly reporting,” said McCracken. While eliminating this quarterly focus might not be possible—or even desirable—panelists agreed that reducing the quarter-to-quarter mindset was an important part of addressing short-termism. “Obviously you can’t get entirely away from that,” said Chia, “but there are ways you can reduce the emphasis and build on the timeline that you think is appropriate—not what you’re being told by the analyst community.”

6. Communicate!

Fostering robust communication internal and external communication is a core priority for the Anti-Fraud Collaboration, and communication at all levels was a recurring theme throughout this webcast. When discussing the use of non-GAAP measures, Horn noted that “the chairman of the compensation committee should be talking to the chairman of the audit committee as these measures work their way in to [compensation] programs.”

Likewise, communicating effectively with external investors and other stakeholder parties is critical. “Boards need to really understand investor communications,” said Horn. “The way that we can pursue long-term value creation is in partnership with our investors.”

7. Commit to Continuous Learning

As auditors, boards, managers, and investors grapple with short-termism, they can draw on a growing body of resources on the subject. The Anti-Fraud Collaboration’s website, for example, contains the webinar discussed here, along with articles on corporate culture, publications on building fraud-resistant organizations, videos on ethics, and other resources. All of these resources can help align short-term and long-term goals for the benefit of companies and investors.


A securities lawyer, Cindy Fornelli has served as the Executive Director of the Center for Audit Quality since its establishment in 2007.