The regulatory burden on U.S. public companies continues to increase and the government’s role has expanded from that of just regulator to, in some cases, shareholder. That might leave some directors wondering how far into the boardroom Uncle Sam can reach.
A panel of financial industry and government experts convened last fall to discuss the influence of the federal government when it acts as either a shareholder or a regulator. The Clearing House Association and the University of Delaware’s John L. Weinberg Center for Corporate Governance facilitated the discussion with a program called The Government as Regulator and/or Shareholder—The Impact on Director Duties, which included the following speakers and panel members:
Rolin P. Bissell, partner, Young Conaway Stargatt & Taylor LLP
Amy Borrus, interim executive director, Council of Institutional Investors
Laban P. Jackson, Jr., director, JP Morgan Chase & Co.
Peter A. Langerman, CEO, Franklin Mutual Advisers, LLC
Giovanni P. Prezioso, partner, Cleary Gottlieb Steen & Hamilton LLP
Gregg L. Rozansky, managing director, The Clearing House Association
Mary Schapiro, former chair, U.S. Securities and Exchange Commission (SEC)
Collins J. Seitz, Jr., justice, Supreme Court of Delaware
Charles M. Elson, director of the Weinberg Center and professor of finance, moderated the discussion.
The panel offered a wide range of perspectives, but a few common themes emerged that are applicable to directors across a variety of industries.
Most panelists agreed that the 2010 Dodd-Frank Act was a response proportional to the 2008 global financial crisis, butexpressed frustration with certain government bailouts and the political motivations influencing them. Several panelists indicated they felt uneasy about the broad scale of intervention that the federal government made into the private sector to bail out failing companies. The panelists cited the example of the U.S. Federal Reserve Bank’s $85 billion bailout of American International Group (AIG) to illustrate how far agencies reached—even in the face of the internal corruption at the company. AIG’s credit default swaps lost the company $30 billion and are often blamed as a major reason the company collapsed in 2008. Controversy swirled when in March 2009, publicly disclosed information revealed that after the bailout, employees of AIG’s financial services division were going to be paid $218 million in bonuses. A June 2010 report by the Congressional Oversight Panel (COP)—a five-member group created by Congress in 2008 to oversee the U.S. Treasury’s actions—concluded that the Federal Reserve Board’s close relations to powerful people on Wall Street influenced its decision to help AIG.
While the panelists were critical of the bailouts, they agreed that Dodd-Frank was a reasonable response to help prevent future failure of companies. Directors’ bandwidth, however, to address their corporation’s most important strategic matters, including emerging risks, may be limited by the need to spend time ensuring compliance with Dodd-Frank. Most agreed that they do not expect a lessening of regulations in the near future.
Panelists also agreed that the Delaware court system—one of the most powerful legal arbiters of U.S. corporate governance—is not designed to address scenarios in which the federal government acts as an investor. When the federal government intervenes by investing in a company to salvage it, the government becomes a shareholder with greater legal privileges than a traditional, human shareholder who might challenge corporate decisions in the Delaware courts. In the event that the government challenges a company in the federal court system, the federal government would be tried in legal institutions where the ultimate power of appeal is granted by its own founding documents. Challenges to federal sovereign immunity and the federal government as shareholder would be difficult, if not impossible, to navigate.
The line between the government as a stockholder and regulator could be blurred when the regulatory influence over the company is pervasive. This issue may be particularly acute for wholly owned subsidiaries of public companies when the government closely reviews company decision-making and expresses views on what is in the best interest of the subsidiary.
Relationships between regulators and directors—though once strained by mistrust after the financial crisis—are beginning to improve. A panelist observed that, in several global markets, relationships between regulators and directors have steadily normalized over the past year and a half, in contrast to more tense interactions of previous years. As global regulatory standards are established, markets recover and stabilize, and businesses and regulators deepen their understanding of each other.
Forming relationships with regulators should be a strategic priority for directors. Most panelists insisted that good relationships with representatives from regulatory agencies are essential. Boards should aim to keep a level of candor with regulatory contacts that could be helpful when pushing back against regulatory action and when directors have suggestions for upcoming regulations. Directors should also acknowledge that regulators have an important function to carry out in a high-pressure, multi-stakes market environment that is a challenge to navigate for regulators and companies alike. A “kicking and screaming” approach to relationships with regulators was frowned upon, as it is not productive and is insensitive to the fact that developing or implementing regulation is demanding and complex.
Directors seeking to strengthen their oversight of corporate compliance and ethics programs can access the National Association of Corporate Directors’ (NACD) publication Director Essentials: Strengthening Compliance and Ethics Oversight. The guide provides an overview of the board’s role in compliance oversight and offers practical insights about fulfilling regulatory expectations.
Front and center for boards and senior management is the call to align the company’s day-to-day activities with long-term value creation, said Bill McCracken, co-chair of the NACD Blue Ribbon Commission (BRC) that produced the newly-released report on The Board and Long-Term Value Creation. McCracken, who is also a director of NACD and the MDU Resources Group, president of Executive Consulting Group, and the former CEO of CA Technologies, co-chaired the commission with Dr. Karen Horn, director of Eli Lilly & Co., Norfolk Southern Corp., and T. Rowe Price Mutual Funds, and vice chair of the NACD board.
What’s the first step for boards in creating long-term value? “Draw a clear line between the daily objectives and long-term strategy,” said McCracken. “Ask, ‘Have we done a good job articulating that? Do investors buy into the strategy? And does the company have the capabilities it needs to execute that strategy?’”
Dona D. Young—chair of the nominating and governance committee for Foot Locker Inc. and a director of Aegon N.V. and Save the Children—served as moderator for a panel that also included Margaret M. Foran, a director at Occidental Petroleum and the chief governance officer, vice president, and corporate secretary of Prudential Financial; and Brian L. Schorr, partner and chief legal officer of Trian Fund Management LP, director of the Bronx High School of Science Endowment Fund, and a trustee of the New York University School of Law. Young and Foran were both BRC Commissioners in 2015; Schorr was a member of the 2014 BRC, which focused on the board’s role in strategy development.
The panel discussion amplified four key findings from this report:
Make short-term goals the building blocks of long-term strategy.
“It’s clear that short-term is not at odds with long-term,” Young said. “How do we integrate that concept in our companies?”
Panelists agreed that directors should determine how to break down long-term goals into measureable short-term milestones at the quarterly, half-year, and annual marks. As Schorr noted, “performance can’t be back-loaded: if a company consistently misses those short-term marks year-after-year, shareholders will question the integrity of the long-term goal you’re moving toward.” Among the BRC report’s tools for directors are examples of long-term-oriented performance metrics in nine different categories.
Directors also need to test the organization’s alignment between short-term metrics and long-term strategy with actual performance. Start off with your premise—or the long-term goal your organization is moving toward—and conduct historical look-backs on a regular basis, Foran said. “Were we right about our predictions? Did we reward the right things?”
Independent inquiry is not optional.
In order to be effective at setting those long-term goals and their relevant short-term milestones, directors must be knowledgeable about both the company and industry.
“We have to do our own homework and not rely solely on management [for information],” Young said. “How do board members engage in independent inquiry without making management feel like we don’t trust them?”
Directors should be reading press releases and analyst reports—not only those issued by their own company but also those of peers and competitors within the industry—to get a sense of what the trends are, Foran said. Trade publications and conferences are other key sources of data.
Schorr described an approach he himself uses: “At Trian, we focus on the income statement. We look at indicators such as EPS growth and EBITDA margins—do we see underperformance relative to what we believe is the company’s potential? Balance-sheet activists look for signs of excess cash, lower leverage ratios, or dividend payout ratios that are out of balance. We ask why. There may be a perfectly good reason; it’s just not well-articulated by management.”
Conduct regular individual-director evaluations.
McCracken highlighted the report’s recommendation on the need for long-term succession planning. When considering your company’s board composition, ask whether you have the capabilities and talent that will be needed to guide the company toward future goals, he said.
“We do strenuous 360-degree evaluations with management,” McCracken noted. “Why can’t we hold ourselves, as board members, to the same standard?” And since board members are peers, it is helpful to have a third party conduct the assessments. Young shared an example from her own experience in which individual director evaluations were truly 360-degree, incorporating input from senior management: “It was tremendously enlightening, really eye-opening.”
Be prepared to engage with shareholders.
The importance of regularly scheduled meetings with shareholders cannot be overestimated. “Don’t just wait for a problem to arise,” Shorr advised, noting that information exchange is a two-way street. The board should also have ways to gather unfiltered information about shareholders’ priorities and concerns.
McCracken emphasized this point: “In today’s world, board members need to talk to shareholders. Regulation FD is a non-issue, a red herring, and directors can’t use it as an excuse.” The BRC report provides detailed guidance that directors can use to prepare for shareholder meetings.
The BRC Report on the Board and Long-Term Value Creation is a natural extension of last year’s BRC report, which recommended that directors get involved in strategy decisions early on and remain involved with them, Schorr said. Doing so can help push management toward goals that promote long-term value creation with links to interim performance milestones that are clear to shareholders. “It’s more than understanding and doing defensive analysis. It’s getting into the boardroom and doing a lot of the things activists are doing,” Schorr said.
Moderator Young summarized the report’s significance this way: “This report helps directors to take a systems approach to engaging with management on strategy and driving value creation.”
This timely publication is the NACD’s twenty-second BRC report and represents the thought leadership of more than 20 eminent directors and trailblazers in business and government. Distributed to attendees of the GBLS and available to NACD members at www.nacdonline.org/value, the report contains the following practical guidance for the directors and boards of public, private, and nonprofit organizations:
Ten recommendations on the board’s role in driving long-term value creation
Eleven red flags that indicate a lack of alignment between short-term goals and long-term strategy
Specific steps directors can take regarding CEO selection and evaluation, capital allocation, and other elements related to long-term value creation
Eight appendices that offer detailed insights and practical boardroom tools
What happens when a company places service before leadership? Wawa Inc. did just that, and its chain of convenience stores has soared as a result. Jeffrey M. Cunningham, founder of NACD Directorship magazine and professor of leadership and innovation at Arizona State University, spoke with Wawa Chair Richard D. (“Dick”) Wood Jr. on the main stage at NACD’s 2015 Global Board Leaders’ Summit about the inner workings of the regional convenience-store chain that has grown into a $9 billion empire.
Originally an iron foundry established in New Jersey in 1803, the Wawa company has weathered many rounds of disruption to become one of three genuine cult businesses in the country, the other two being In-N-Out Burgers and Chic-fil-A. Wood ascribed his success at the privately-owned company that he has served since 1970 to the concepts of servant leadership and being a steward of investment in advanced technologies and innovations. A member of Wawa’s legal counsel at the beginning of his career, this descendant of the founder now serves as non-executive chair of the company’s nine-person board.
For the first half of the event, Cunningham interviewed Wood about the history of the company and Wood’s commitment to the philosophy of servant leadership. In a business context, this philosophy puts service to every stakeholder before any other facet of the enterprise. Wood takes justifiable pride in Wawa’s commitment to its 26,000 employees, including their ownership in the company. Wawa’s Employee Stock Ownership Program (ESOP) has created such value for employees at every level that the organization last year received 300,000 applications for its available 3,000 open positions. The Wawa model has proven to be profitable not in spite of but because of its commitment to family and service.
Once the conversation opened up to questions from the floor, Wood described some of the business challenges he’s faced over the years and how he has surmounted them. When asked about his reputation as “Chief Paranoia Officer” and how even good CEOs often misread the signs, Wood said, “Every time it comes back to hubris. It always comes back to hubris. CEOs didn’t have enough paranoia.”
Wood’s observations on a form of CEO self-awareness that some dub paranoia was fascinating in relation to the earlier keynote presentation by Kwame Anthony Appiah on honor’s place in business. One way that Wood practices honor in his business is to ensure that Wawa’s six core values—Value People, Delight Customers, Embrace Change, Do the Right Thing, Do Things Right, and Passion for Winning—are so thoroughly woven into the company culture that every employee can recite them; and dozens of times each month, Wawa employees recognize their peers in writing for exemplifying those values day to day. Wood’s leadership of Wawa illustrates the type of professional ethics that Appiah touched on in his keynote speech.
Before closing, Wood addressed Wawa’s next step in its innovation cycle: a move toward diesel fuel. “Two big products are going to disappear,” Wood declared. “One is cigarettes, and the other is gasoline. We’re looking into alternatives to replace a commodity we think will disappear.” To support diesel as the anticipated new market source in fuel, Wawa plans to retrofit its filling stations.
Katie Grills is assistant editor at NACD Directorship magazine.