Category: Corporate Governance

Five Governance Myths and What Directors Can Do About Them

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I take governance very seriously, having spent 32 years in the field (ouch! I’m old!), so when it came time to write my blog, it was more like a block (as in writer’s block). Today, in desperation, the NACD “Blogmeister” gave me a simple assignment: name Five Governance Myths.

Where to begin? There are hundreds of them—and we at NACD spend much of our time dispelling them. Our main tool for setting the record straight is our set of Key Agreed Principles, reflecting a consensus of managers, shareholders and directors.

So, what are some of the myths, why do they matter, and how can directors overcome them through action?

Governance Myth Number 1: The fundamental purpose of the board is to represent the desires of shareholders.

This “agency theory” is close, but no cigar. The truth is that the board is there to build the long-term value and sustainability of the corporation on behalf of shareholders and all stakeholders. Believing the agency theory myth causes problems because it cuts other constituents (for example, rank-and-file employees) out of the picture.

Action step for directors: When requesting reports from management, ask for long-term financial projections and constituency impact statements (with proper disclaimers, of course).

Governance Myth Number 2: The main job of the board is to monitor management.

There goes that agency theory again. This isn’t even close, and frankly, it’s insulting (makes it sound like all CEOs and CFOs are crooks). The main job of the board is to select and develop a CEO, who will in turn select and develop a management team that will in turn select talent that can create and market worthwhile products and services. Believing the monitoring myth creates headaches because it puts everybody on the defensive and impairs productivity.

Action step for directors: Work with senior management and the head of human resources to develop and implement a CEO succession plan that empowers managers to be the best they can be.

Governance Myth Number 3: The main purpose of a board or committee meeting is to hear, discuss and vote on proposals from management.

This is fine for Civics 101, but the real world delivers more board value. If your company is using directors in this way, it is wasting a powerful resource. When a company has a fully engaged board, not all ideas come from management; sometimes they come from the board. There are times when instead of giving a long proposal to the board, management is better off making a very short proposal and then asking a question: What do you think? The board meeting then becomes a living proposal. (Indeed, this was exactly how we came up with our Key Agreed Principles mentioned above!)  The idea that directors are there only as a sounding board deprives a company of board brainpower.

Action step for directors: Insist that the meeting agendas have short timeframes for presentations and long timeframes for discussion.

Governance Myth Number 4: When considering management proposals, directors only know what senior management tells them.

The fancy name for this is “information asymmetry.”  It’s a problem but hardly a universal law. Directors receive information from many sources—including from the results of their own research, and reports from the consultants they are empowered to hire. Under Sarbanes-Oxley Act Section 301, “Each audit committee shall have the authority to engage independent counsel and other advisers as it determines necessary to carry out its duties,” and “each issuer shall provide for appropriate funding  … to any advisers employed by the audit committee under paragraph (5).”

Also, remember that audit committees receive direct reports from the internal audit function, which may or may not be part of senior management, and hotlines bring the information connection down to the shop floor. Most governance guidelines specifically permit board members to make and receive direct contact with any employee, as long as they inform the CEO of any non-routine contact. Believing otherwise impedes communication.

Action step for directors: Learn as much as you can about the companies you serve, from as many sources as you can. Rob Galford’s recent post on this subject is a good place to start.

Governance Myth Number 5. When it comes to governance, process is everything.

This is a half-myth, because it’s almost true, but it still misses the mark. To be sure, it is much more important for the board to make a decision the right way than to make the right decision. This is the basic idea behind the judicial concept called the Business Judgment Rule, and it was the great lesson of the 2005 Disney case decided by the Delaware Chancery Court as well. But the problem with believing in this half-myth is that if directors believe process is everything, they may start focusing too much on the mechanics of decision making and avoid making any decisions based on their own experience and intuition, which can sometimes transcend procedures:

Action step for directors: Go through all the proper steps—but don’t get so hung up in process that you miss a chance to make a good decision.

A Political Casualty: Majority Voting

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Call it a political casualty. With the release of the Dodd-Frank Wall Street Reform and Consumer Protection Act earlier this week, we finally are face-to-face with the long debated and discussed “governance reform” that has been a topic of boardroom banter for the past two years.

A “Gimme”

Interestingly enough, the requirement for majority voting was dropped from the long list of governance provisions and is not part of the final bill. In basketball terms, majority voting was a lay-up; for you golfers out there, a “gimme.”

According to our surveys, 47 percent of companies have already adopted some form of majority voting on their own, without the need for course-correcting legislation. Both sides can debate the need for much of what is included in the reform bill, but the governance provisions included in the original draft have remained relatively consistent throughout the years of debate.

Rumor Has It…

The bill started with rumors and predictions, but the political machine quickly took over. The rumors turned into proposed legislation, which quickly morphed into campaign promises, which then turned into multiple pieces of proposed legislation, debate, new proposed legislation, House passage, more debate, lobbying by all sides, last minute changes suggested by the White House, deals struck, and finally we have a bill. The House passed it on June 30, and it will go to the Senate and then on to President Obama following the Fourth of July Recess.

For those of us positioned firmly inside the Beltway, this bill has been a loooong time coming—not because we were hoping for some magical one-size-fits all legislation on board governance, but because of the non-stop media coverage and the fact that it seemed to be going around and around Capitol Hill like some sort of rollercoaster car on a legislative track.

What We Don’t Know

The major provisions of the bill related to financial reform dwarf the governance reforms included under the investor protections section of the 2,300 page bill. However, there are still a lot of unknowns out there.

The bill gave the SEC the authority to implement proxy access, but we don’t know how that will happen yet. We also don’t know how many of the enhanced disclosure provisions will be implemented and whether they will achieve their intended result. The “clawback” of executive compensation sounds pretty ominous, but we’ve had clawbacks under Sarbanes-Oxley, and I can’t recall many, if any, actually being executed.

So, with all the contentious governance provisions in the bill, why did our legislators drop the generally accepted majority voting provision? I don’t have an answer, but I’m guessing it was deemed a “gimme” by a Senator who was willing to trade it up on a piece of the financial reform that was more hotly contested as both sides wrestled with the legislation. A political casualty indeed.

Staying Connected to Your Companies

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In the past few weeks, I have spent time with individual directors and entire boards in a particularly wide range of companies. The companies they serve represent the entire spectrum of publicly traded entities, from high-tech entities with $100 million market caps to multi-billion dollar multi-national spectaculars.

Maybe because we’ve been lucky or maybe because the corporate directors who choose to interact with NACD are among the more conscientious of the category, our impression is that, for the most part, the people in these roles are diligent in their efforts to serve the stakeholders they represent.

While most corporate directors seem to be actively engaged with the basics of the company’s performance and how shareowners and the public view the company– reading press releases, checking out earnings reports and perusing company web sites – there may still be a disconnect in understanding what is going on at a ground level.

Here are a few starting points corporate directors can use to gain a deeper understanding:

  1. Set up a Google Alert for news about the company and read what’s being written.
  2. Troll the job websites to see what people are saying about what it’s like to work there. LinkedIn, particularly, is revealing of corporate culture and diversity. Search for your company (and check out NACD’s LinkedIn group!).
  3. Read relevant consumer and industry blogs, and/or go on to see how the company shows up in the eyes of others.
  4. Regularly have an inexpensive lunch or have coffee or meet in other informal settings with company employees other than the CEO and the executive team.
  5. Listen in on earnings/analyst calls.
  6. Sit quietly at employee “town meetings.”
  7. Sit through new-employee orientations.
  8. Purchase company products or interact with the company in the exact same way as the general public does, with no special treatment (or even awareness) on the part of company employees.

How else do you keep your finger on the pulse? Share your practices and ideas below.