Topics:   Corporate Governance,Leadership

Topics:   Corporate Governance,Leadership

February 26, 2020

Governance Benchmarks: Do We Measure Up?

February 26, 2020

We routinely use targets and benchmarks to analyze virtually every aspect of company performance: comparing budget to actual spend, noting changes in customer satisfaction ratings, and analyzing the percentage of defects with ferocity. But there is one very important aspect of business performance that too often goes unchecked.

Most companies don’t measure their full system of corporate governance, many do poorly on key components of governance, and boards too often rely on inadequate information and hesitate to challenge what they’re told by management.

These are among the findings of a new scorecard on corporate America, the inaugural American Corporate Governance Index (ACGI), developed through a partnership of The Institute of Internal Auditors and the University of Tennessee, Knoxville’s Neel Corporate Governance Center.

The ACGI doesn’t just look at publicly observable measures of corporate governance (executive compensation reporting, etc.). The index is based on eight principles that define core actions and responsibilities of the board in support of ethical and sustainable corporate governance. These “Guiding Principles of Corporate Governance” reflect the perspectives of leading organizations in the United States and around the world, including NACD, the Business Roundtable, the Committee of Sponsoring Organizations of the Treadway Commission, the King Commission, the New York Stock Exchange, and the Organisation for Economic Co-Operation and Development.

To create the index, US-listed company chief audit executives (CAEs) answered questions that were based on the principles. One of the principles states, for example, “Companies should be purposeful and transparent in choosing and describing their key policies and procedures related to corporate governance.” So, how did surveyed companies score on this front? They received, on average, a “C-.”

Based on this survey of those ideally positioned to have an enterprise-wide view of governance practices and controls—CAEs—the ACGI found that most publicly held companies have no formal mechanism for monitoring or evaluating the full governance system. What’s more, only one in five said they audit their full system of corporate governance on an annual basis.

Overall, the results of the ACGI are sobering. The index gave corporate America a score of only “C+,” and while that seemingly above average grade might not sound so bad, any rating less than “A+” reflects some level of governance deficiencies.

Among key findings of the index:

  • While the overall score on governance was a “C+,” 10 percent of the surveyed companies scored an “F.”
  • More than one-third of board members aren’t willing to challenge their CEO, saying they would yield to a hypothetical chief executive wanting to wait on reporting negative news.
  • When boards receive information, they are not verifying its accuracy. The index gave a “D” rating on board members asking about information’s accuracy or completeness.
  • A higher level of board independence indicates stronger governance, with a higher percentage of independent board members associated with a stronger ACGI score on average.

One of the most troubling—though perhaps not surprising—findings of the ACGI was that many companies are so focused on short-term success that they neglect long-term sustainability. Indeed, the index rated this area a “D” for the surveyed companies. Balancing short- and long-term needs certainly falls primarily on senior management, the ACGI states, but boards “must reinforce their commitment to long-term performance and value.”

What’s measured holds the greatest potential for improvement, but meaningful improvement requires that we measure the right things systematically, thoroughly, and often, using appropriate measurement criteria. Unfortunately, many companies have found that identifying appropriate performance criteria for corporate governance can be a big challenge.

Some directors think of their board’s self-assessments as governance evaluations. Certainly, board performance is a critical element of corporate governance. But corporate governance isn’t limited to board performance. It encompasses all of the systems by which organizations are directed and controlled. It’s about how we make decisions, establish objectives, accomplish those objectives, and monitor our progress. It’s about motivating, disciplining, and rewarding behaviors.

A board self-evaluation considers only a fraction of the total governance system, and it is difficult to be unbiased about the organizations we control. That’s one of the reasons we need objective benchmarks like the ACGI against which we can assess governance. The ACGI will be further developed for this purpose.

Every organization is unique, and effective governance is both an art and a science. Nothing we can do will guarantee that governance will always be effective, but every US public company should monitor and evaluate its full system of governance every year. As well, directors must demand objective, relevant, and timely information, presented in context and with specific benchmarks and trend information, to know whether their governance system is operating as intended. And they need to challenge what they’re told, if necessary. There may be no more important task for ensuring the long-term success of American businesses.

Richard F. Chambers (CIA, QIAL, CGAP, CCSA, CRMA) is 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.

Comments

Hamad S AlomarFebruary 27, 2020

I believe that while Corporate Governance (CG) is important for all business and Public activities designed to enhance shareholders interest or the interest of the public at large, it is more critical for listed companies, semi-public companies and large family businesses which have considerable impact on the economy, the investors and the citizens. A large sum of the CG controls lies with the regulators especially when it is matched by rigorous education, rigors inspection and rigorous penalty codes. The regulator must put in place and communicate such checks and balances and make it clear to the entities and the public. Any addition made at corporate level is to enhance such controls. For corporate boards, It has always been a sensitive balance between enhancing profitability and sustainability.
Regulators sometimes, rightly or wrongly, give in to market players pressure to soften some of rules since regulators themselves have an interest in an active market and that is also a critical balance facing the regulators. Within the Board itself, there might be sometimes conflicting interest between the shareholder entities represented in the Board as the interest not only may differ between one entity and the other but both could differ from the interest of the company. None of this will be explicit as the tone of the discussion will appear as if it is all directed to the interest of the company. Interest groups within Boards may be a fact of life and one can say this is the outcome of a voting system. This leads me to conclude that the ultimate protector of the company’s interest is the regulator, but not any regulator. The regulator who controls on-Site not on-Line.

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