The practice of conducting full-board, committee, and/or individual-director evaluations has largely become commonplace. Ninety percent of respondents to the 2016─2107 NACD Public Company Governance Survey: Aggregate Resultssay their companies conduct full-board evaluations. Approximately 78 percent of respondents facilitate committee evaluations, and 41 percent conduct individual director evaluations, the survey finds.
The New York Stock Exchange since 2003 has required listed companies to disclose how their boards address evaluations. Although Nasdaq-listed companies have no such requirements, many conduct these assessments to enhance governance standards. NACD has long been an advocate for routine board, committee, and individual-director evaluations as part of a larger strategy of continuous improvement.
In keeping with these listing requirements and recommendations from our research, NACD recently created the Resource Center on Board Evaluations. Resource centers are repositories for NACD content, services, and events related to top-of-mind issues for directors. In these resource centers, individuals can find practical guidance, tools, and analyses on subjects varying from board diversity to cyber-risk oversight. Below we have highlighted a sample of helpful materials from our new board-evaluations resource center.
The NACD Directorship magazine article “The Argument for Yearly Board Evaluations” by Salvatore Melilli, national audit industry leader for private markets at KPMG, examines the importance of assessments specifically for private company boards. Less than half (48%) of respondents to the 2016─2017 NACD Private Company Governance Survey say their boards conduct full-board evaluations. Melilli’s article highlights several reasons why evaluations are critical to improving oversight evaluations. They can help vet company and board culture, identify gaps in talent or skillsets, and streamline processes for the board to engage in difficult conversations with the executive team.
Boardroom Tools & Templates
This resource center’s boardroom tools and templates are segmented by evaluation type—full-board, committee, and individual-director levels. The tools offer questions and considerations that help boards and directors ask questions that can drive healthy conversations about strengths and areas of improvement.
Videos & Webinars
An NACD video series featured in the resource center focuses on the role board evaluations play in improving governance practices. One video in the series, called “Why Confidentiality is Key,” focuses on the benefits of confidentiality in the evaluation process. Another video, “Transform Insight into Action,” discusses the value of creating tailored educational or development programs based on insights that emerge from evaluations.
If you would like help finding resources on a specific subject matter, please let us know. We welcome the opportunity to engage with directors on pressing needs and concerns.
NACD takes pride in being not only the voice of the director but also a center of knowledge on governance-related topics. Our research team generates thought leadership, issue analysis, and practical guidance in various formats throughout the year—and you may find out about these new resources through e-mail, here on the blog, or by visiting our home page.
Visit the NACD Nominating and Governance Committee Resource Center.
What’s a Resource Center? Resource Centers are online portals curating our most relevant and recent content about major board responsibilities, emerging issues, and core governance requirements. The resource centers also highlight advisory services, upcoming events, and replays of recent webinars.
Resource Centers are the best way to explore the depth and breadth of NACD’s offerings on a particular topic. If we don’t have a resource center now for a particular topic, one is likely in the works.
Our department recently released the Nominating and Governance Committee Resource Center to present our most relevant content on the topic. We aim to help directors solve for hot-button issues like shareholder pressure to diversify the board and C-Suite, and support perennial activities such as strengthening the relationships between independent and inside directors. Complementing our own thought leadership, we recently partnered with Egon Zehnder to bring our readers even more insights about the role and responsibilities of the Nominating and Governance Committee.
Below we have highlighted a sample of helpful materials from this Resource Center, by section.
Egon Zehnder’s Board Effectiveness Reviews (open to all) – The oversight responsibilities of the board have taken on a new level of complexity. Disruptive business models can come from any direction, and the types of risks the board must monitor have multiplied. Board evaluations can help directors review their performance, exceed standards, and satisfy investors.
Guide to Board Composition for Energy Companies Emerging from Bankruptcy (open to all) – Every sector faces unique challenges. While NACD is here first to help with big-picture governance questions, our resources also address granular topics. Egon Zehnder’s report on how to structure board composition for an energy board is a great example of industry-specific knowledge offered to boards.
Corporate directors are confronted with a variety of recently proposed governance standards, while activist investor campaigns are challenging both board composition and board effectiveness by targeting individual directors. Given the high level of personal reputational risk and the associated long-term financial consequences now faced by directors, a hard look at the adequacy of company-sponsored director and officer (D&O) risk mitigation and board compensation strategies is timely.
The Bedrock of Certainty Shifts
Shifting stakeholder expectations are codified in the frequently conflicting governance standards published in recent years. Following the National Association of Corporate Director’s own 2011 Key Agreed Principles, there are now draft voting guidelines from Institutional Shareholder Services (ISS) and Glass Lewis & Co.; standards from groups such as the Office of the Comptroller of the Currency (regulator), CalSTRS (investor), the G20, and the Organisation for Economic Co-operation and Development (influencer); and, most recently, the Commonsense Corporate Governance Principles from a group of CEOs led by JPMorgan Chase & Co.’s Jamie Dimon.
This proliferation of standards reflects differing stakeholder expectations and gives direct rise to new risks for directors. With these new risks and expectations emerge associated questions about the adequacy of current governance strategies, company-sponsored reputation-risk-mitigation packages, and director compensation.
Because the board is the legal structure administering governance, the standards that boards choose to guide their oversight have legal force. Furthermore, detailed, prescriptive standards have instrumental force.
For instance, ISS and CalSTRS are promoting highly prescriptive standards. ISS is exploring specific “warning signs” of impaired governance, including monitoring boards that have not appointed a new director in five years, where the average tenure of directors exceeds 10 or 15 years, or where more than 75 percent of directors have served 10 years or longer. CalSTRS expects two-thirds of a board to be comprised of independent directors, and defines director independence specifically as having held no managerial role in the company during the past five years, equity ownership of less than 20 percent equity, and having a commercial relationship with the company valued at no more than $120,000 per year.
The Commonsense Corporate Governance Principles released this summer was an effort to share the thoughts of the 5,000 or so public companies “responsible for one-third of all private sector employment and one-half of all business capital spending.” Certain background facts may lead some stakeholders to discount the Principles. For example, in addition to Dimon, the list of signatories was comprised mostly of executives who hold the dual company roles of chair and CEO. Also, according to the Financial Times, eyebrows have been raised by CEO performance-linked bonuses of about 24 to 27 times base pay at BlackRock and T. Rowe Price, two asset manager companies with executives who were signatories. Coincidentally, these asset manager companies were ranked among the most lenient investors with respect to the executive pay of their investee companies, according to the research firm Proxy Insight.
These standards can be deployed by checklist, and boards can be audited for compliance to the specifics of the adopted standards. But, more importantly, the very existence of these standards lends them authority through expressive force. What they express—or signal, in behavioral economic parlance—is intent, goodwill, and values. Signaling is valuable in the court of public opinion.
Personal Protection Strategies
As reported in NACD Directorshipmagazine earlier this year, activists often wage battle in the court of public opinion to garner public support when mounting an attack against a company. Emphasizing the personal risks, the Financial Times reported in August that “Corporate names are resilient: when their images get damaged, a change of management or strategy will often revive their fortunes. But personal reputations are fragile: mess with them and it can be fatal.”
Make no mistake: this risk is personal. A director’s damaged personal reputation comes with material costs. Risk Management reported in September that the opportunity costs to the average corporate director arising from public humiliation were estimated at more than $2 million.
Among the many governance standards, pay issues are the third rail of personal reputation risks. “If companies don’t use common sense to control pay outcomes, [shareholders have to question] what else is going on at the organization and the dynamic between the chief executive and the board,” an asset manager with Railpen Investments told the Financial Times recently. Clawbacks may be the most disconcerting pay issue because the tactic places directors personally between both the investment community and regulators.
Governance standards just over the horizon may give boards succor, and reputation-risk-transfer solutions may have immediate benefits. Since 2014, the American Law Institute (ALI) has been developing a framework titled, “Compliance, Enforcement, and Risk Management for Corporations, Nonprofits, and Other Organizations.” Members of the project’s advisory committee include representatives from Goldman Sachs & Co., HSBC, Google, Clorox, and Avon Products; diverse law firms offering governance advisory services; law schools; regulators including the Department of Justice; and representatives from a number of prominent courts. According to the ALI, the project is likely to hold an authority close to that accorded to judicial decisions.
The ALI work product remains a well-protected secret, but the project is expected to recommend standards and best practices on compliance, enforcement, risk management, and governance. It can be expected that the ALI standards will reflect the legal community’s newly acquired recognition of the interactions between the traditional issues of compliance, director and officer liabilities, and economics; and the newer issues of cognitive and behavioral sciences. Such governance standards will likely speak to the fact that while director and officer liability will be adjudicated in the courts of law, director and officer culpability will be adjudicated in the courts of public opinion.
Insurance Solutions Available Now
Boards that qualify for reputational insurances and their expressive force can mitigate risks in the court of public opinion. An NACDDirectorshiparticle noted earlier this year, “ . . . these reputation-based indemnification instruments, structured like a performance bond or warranty with indexed triggers, communicate the quality of governance, essentially absolving board members of damaging insinuations by activists.”
Given the increased personal reputational risks facing directors and the long-term financial consequences arising, it may be time for an omnibus revisit of the adequacy of both director compensation and company-sponsored D&O risk mitigation strategies in the context of an enhanced, board-driven approach to governance, compliance, and risk management.
Following the guidelines of the ALI’s project once they are published is a rational strategy. After all, the work product will be one that will have already been “tested” informally in the community comprising the courts of law, and will be designed to account for the reality of the courts of public opinion. And no firm today has natural immunity to reputation damage—even Warren Buffett’s Berkshire Hathaway appears to be in the ISS crosshairs. Reputational insurances which, like vaccines, boost immunity, are available to qualified boards to counter all that is certain to come at them in this upcoming proxy season. And for those who insist on both belts and suspenders, hazardous duty pay may seal the deal.
Nir Kossovsky is CEO of Steel City Re and an authority on business process risk and reputational value. He can be contacted at email@example.com. Paul Liebman is chief compliance officer and director of University Compliance Services at the University of Texas at Austin. He can be contacted at firstname.lastname@example.org.