February 16, 2021
February 16, 2021
The work of boards has never been more challenging, and it only promises to bring even greater tests over the coming years. Disruptive technology; the growing influence of environmental, diversity, and social movements; activist investors; and traditional shareholder demands each heighten the need for boards to act wisely and increase the pressure for quick and decisive action. The fallout from a still-raging global pandemic only further complicates the challenge.
Key to surviving and thriving under such demanding conditions is sound corporate governance, which helps ensure an organization’s long-term performance and value creation. However, a recently published index from the Institute of Internal Auditors (IIA) and the University of Tennessee Neel Corporate Governance Center reports mediocre corporate governance grades for a broad spectrum of metrics for publicly traded US companies. Worse yet, two of the weakest areas across the companies studied are the board’s willingness to challenge management and questioning whether information it receives is accurate and complete.
The 2020 American Corporate Governance Index (ACGI) reports a slight improvement in overall corporate governance scores, from a C+ in 2019 to a B- in 2020. While scores improved marginally across all eight of the index’s guiding principles in 2020, there remain troubling questions about the give and take between the board and C-suite. The guiding principles are as follows:
Indeed, the index, which surveyed chief audit executives (CAEs) from 131 companies, found that more than one-third of respondents (34%) believe their boards are not willing to offer contrary opinions or push back against the CEO.
Of all the guiding principles, the 2020 ACGI reported some of the biggest improvements in board performance (principle 3), which saw a five-point jump year over year led by solid progress in boards’ technical expertise on risks, self-evaluation, and follow-through on improving weaknesses. Yet, CAE evaluations of their boards’ willingness to offer opinions that conflict with the CEO remained relatively flat.
Boards must be invested in understanding and monitoring the health of corporate governance within their organizations, and the index provides helpful insights on a number of metrics to measure that health. Two of these insights further support the notion that clear and direct communication with the C-suite enhances overall governance.
The data show that certain management reporting structures and internal audit reporting lines correlate to stronger governance in companies reporting annual revenue under $10 billion. Respondents who described reporting structures as “fairly simple”—where material issues make their way to the CEO within one or two reporting lines—are “substantially more likely to have high governance grades,” according to the index report. As for internal audit reporting lines, 43 percent of responding CAEs who report administratively to the audit committee and 42 percent who report directly to the CEO rated their organizational governance as high. In contrast, just 29 percent of CAEs who report administratively to the chief financial officer rated their governance as high.
Another key observation in the ACGI report should give board members pause. The index principle that measures how organizations evaluate corporate governance (principle 8) was the least effective of all principles for the second consecutive year. While it saw some improvement—boards are discussing the issue more and seeking feedback on corporate governance efficacy—routine formal evaluations of overall corporate governance remain weak, according to respondents. “Without effective evaluations, organizations risk missing warning signs of weaknesses or vulnerabilities that can lead to governance breakdowns,” according to the report.
When the IIA and the Neel Corporate Governance Center developed and introduced the index, the intent was to have it foster the highest level of corporate governance. Some may take comfort in the slight improvement in 2020 index score, particularly amid the COVID-19 pandemic, but attaining the highest level of corporate governance should be the aspirational goal of every organization. Any rating less than A+ reflects room for improvement—and that there may be too much civility in the boardroom.
Now more than ever, board members must stay informed and be willing to ask probing questions, challenge management assumptions, rock the boat if necessary, and, frankly, risk their future on the board by being less (if only a by a little) civil. In short, board members have an obligation to bring professional skepticism to their roles.
Richard F. Chambers (CIA, QIAL, CGAP, CCSA, CRMA) is the outgoing president and CEO of the Institute of Internal Auditors. In his weekly blog ChambersOnTheProfession.org, he shares insights on topical issues and trends related to organizational effectiveness, governance, accountability, and leadership based on more than 40 years of experience in the internal audit profession.
NACD: Tools and resources to help guide you in unpredictable times.