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Five Boardroom Deficiencies: Early Warning Signals

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At the most recent NACD Director Professionalism® Course in Charlotte, North Carolina, faculty member Michael Pocalyko, an experienced director and chairman of TherimuneX Pharmaceuticals, described five boardroom deficiencies that he has observed in almost every recent major corporate scandal or failure.

In his presentation on “Board/C-Suite Relations,” Pocalyko proposed that these elements pervade the board culture at troubled companies—and when identified, directors can use these red flags as a warning system for difficulties ahead:

  • A disconnect between the company’s stated core values and the way its executives, managers, and personnel behave.  “When core values devolve into nice words while the way the company actually operates is antithetical to its codified ethics, serious problems are looming.  Those problems involve not just lawsuits but orange jump suits.”
  • A deferential board of directors.  “Every troubled company, public or private, including the one that will star in the next corporate scandal, has a board that is far too deferential to its CEO.  This happens more often where the chairman and CEO roles are unified.  Courteous challenge and vocal independence should not be perceived as affronts to power.  They are essential to accountability.”
  • Inventive corporate finance.  “When the non-financial board members especially have trouble figuring out exactly what the financial statements are saying, without significant interpretation, someone is being way too creative.  Exotic finance often masks mischief, market gaming, or worse.”
  • Co-opted information technology systems.  “They are tremendously expensive cost centers but absolutely essential to effective internal audit, SEC audit, and reporting.  If the board has only an ephemeral understanding of these complex systems and their role in the audit process, IT can be co-opted fairly easily to the impediment of proper board oversight.”
  • Legal “fitting.”  “Like a tailor fitting a suit, when legal counsel fits an opinion to comport with a desired action—rather than delivering an outright ‘don’t do this’ or even ‘it’s a terrible idea’—right then, the board is being brought complicit into future failure.”

NACD Director Professionalism is the foundation course for aspiring or new corporate directors, providing boardroom insight and skills in a highly interactive, two-day format covering the fundamentals of boardroom effectiveness.  For more information about NACD Director Professionalism, please go to www.NACDonline.org/DP.  During the remainder of 2012, the program will be offered at the following locations and dates:

Thinking Outside the Box

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I recently returned from San Francisco, where we held our first of four Diversity in the Boardroom events during 2012.  The enthusiasm around this topic was infectious, and it reminded me of what NACD has been focused on for the past 35 years—creating strong, effective and efficient boards of directors.

While this topic is not new or unique for NACD—NACD has written numerous Blue Ribbon Commission research reports, white papers and handbooks over the years on almost every key process confronting boards—this topic is unique from an action and orientation perspective.

Without a doubt, nearly every director and aspiring boardroom leader I meet with during our programs agrees with the need for diverse, well-rounded boards of directors.  One may or may not completely endorse the reports from Catalyst and other organizations regarding gender, race or ethnic diversity, but everyone does understand the need for true diversity in the boardroom.

True diversity in the boardroom comes from range of thought, background, perspectives, experience and skill sets. Framing this topic in this context unites the energy and passion around this topic.

So where do we go from here to realize the vision of diverse boards?  NACD developed a five-point action plan last year during our Diversity in the Boardroom events called “Moving the Needle” to support this opportunity:

  1. Nominating/governance chairs and committee members and professional search/recruiting firms:  Expand the definition of the “typical director.”  While most boards seek CEOs of publicly traded companies, companies are restricting the number of boards their CEOs can sit on in addition to their company.
  1. Current directors:  Every director should mentor and support the development of an executive who thinks, acts and looks differently than you do—not to create conflict, but to bring different views and skills into the boardroom.
  1. NACD: Support the development of aspiring and current directors within the context of leading (and next) boardroom practices, diversity and the current environment.
  1. NACD: Provide networking opportunities for aspiring diverse directors to connect with leading directors, and supplement their learning and mentoring.
  1. NACD: Conduct research to document the power of diversity in the boardroom.

With a supply of qualified, diverse board candidates, developed and augmented via the above five points, boards can move the needle.

I hope to see you during NACD’s remaining three Diversity in the Boardroom events during 2012:

Here’s to moving the needle.

Pay Ratios: A Question of When, Not If

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Moving into May and the peak of annual meeting season, executive compensation is one of the top stories in the business media. To date, eight companies have failed their annual say-on-pay votes. With the bulk of annual shareholder meetings in the coming months, this number is expected to increase. This week, an editorial in the New York Times criticized the Securities and Exchange Commission (SEC) for failing to issue rules on another area of executive compensation—pay ratios—claiming the “main problem seems to be foot-dragging in the face of objections from corporate lobbyists.”

The article correctly identifies several factors. The SEC did delay issuing final rules on the CEO pay ratio until the second half of 2012, effectively postponing corporate disclosure of the ratio of chief executive pay to the company’s median salary until the 2013 proxy season. Also, a substantial number of comment letters have already been submitted to the SEC on matters regarding executive compensation disclosures, including some for which there are no rules pending. Lastly, the rules mandated for pay ratios in Dodd-Frank are unlike most other provisions in the legislation, in that Congress did not allow for much flexibility in crafting the final rules.

However, the NYT editorial did not mention several factors that have hindered progress for the SEC. According to the May 2012 Dodd-Frank Progress Report from Davis Polk, of the SEC’s 95 required rulemakings, the agency has missed the deadline for 56. When final rules are actually released, they are often met with criticism and lawsuits. Last summer the U.S. District Court of Appeals overturned the SEC’s proxy access rule on the basis that the agency had not conducted a thorough cost-benefit analysis. The SEC subsequently introduced a more robust economic analysis in its rulemaking process, leading to a missed deadline for releasing a final rule regarding the conflict minerals provision—which will require companies to track and disclose their use of minerals potentially sourced from the Democratic Republic of the Congo.

With the rigid mandates on the pay-ratio disclosure, the SEC is facing difficulties with one area not clearly defined: computing median compensation. While Dodd-Frank was explicit in the calculation of the ratio, it was not clear in how the median total compensation would be measured. This measurement leads to several questions: Does the compensation of every employee at an organization need to be computed? Should part-time employees be included in the calculation? Would international employees be included? If so, what foreign exchange rate would be used? Taking these questions into consideration, last August the AFL-CIO proposed the use of statistical sampling to calculate the median compensation, an option the SEC is taking seriously.

The argument is no longer whether pay ratio disclosures will have the intended effect of changing executive compensation. Instead, it is when and how these rules will be issued.