Topics: Compensation,Corporate Governance,ESG,Strategy
Topics: Compensation,Corporate Governance,ESG,Strategy
January 18, 2023
January 18, 2023
When you ponder the year ahead and all the trials it will bring, a potential recession as well as supply chain and talent troubles may come to mind. To prepare for these issues and more 2023 trends, NACD gathered experts and board members at the Leading Minds of Governance event on Dec. 13 in Scottsdale, Arizona.
Greg Griffith, senior director of partnerships and corporate development at NACD, moderated the event. Dayna L. Harris, a partner at Farient Advisors; Vada O. Manager, CEO and founder of Manager Global Holdings, a principal and board member of Think TRUE, and a board member at Helios Education Foundation and Valvoline; Debra McCormack, managing director, global board effectiveness and sustainability lead at Accenture; Karen A. Smith Bogart, the president of Smith Bogart Consulting, chair of the Fielding Graduate University board of trustees, and a director of Michelman, Mohawk Industries, and the NACD Pacific Southwest Chapter; and Warren de Wied, a partner at Fried, Frank, Harris, Shriver & Jacobson, served on the panel. Below are key questions and answers from that conversation.
What have you seen, from the last recessions that we’ve had, that corporate [boards] need to do to get through this [potential] recession?
de Wied: History tells us that a financial crisis comes along about every eight to ten years. Companies sometimes forget that bad news may be just around the corner—and we went through an unusually long financial boom. When there’s a reset, certain fundamental values come back into vogue, values that people may abandon during a boom economy, values like balance sheet flexibility, profitability and free cash flow, disciplined M&A [mergers and acquisitions], and not over-leveraging the future. These are lessons that we often seem to have to relearn as the cycle turns, but a well-functioning board anticipates the possibility that things go in a different direction and builds flexibility into its planning.
What we’ve seen in the in the past few months is something of a pullback from ESG [environmental, social, and governance]. It’s important to have a focus on employee issues, on climate risks; indeed, you must have a focus on these areas because they impact the bottom line, they impact the basic functioning of companies. But what you see when the business environment changes is that companies still have to put profitability first. In the last few months, companies have shown that that’s the case. They’ve scaled back ESG programs, and of course we have seen significant workforce reductions, in some cases companies have let ten thousand or more employees go. Companies always have to balance their ESG objectives with the economic realities of business.
The keynote of all of this is that companies need balance; they need balance in their financial and operational execution, they need balance in their social focus. When you get out of balance, usually, something to the downside happens.
When should boards get involved in social and political issues that might affect their businesses, and why?
Smith Bogart: Companies have stakeholders, and therefore they need profitability to reinvest in the firm and invest in the strategy. They need to be clear about what are the critical elements of the strategy and their values and commitments and use those for determining when they want to engage. Often the place where they can make a big impact are with the non-glorious, the non-glamorous issues. I’ve seen companies get actively involved in municipal issues around the funding of bus systems so their employees can get to work. It’s not glamorous. But it’s critical to manufacturing operations, for instance. Other issues where companies have gotten very involved is working with different states around apprenticeship programs, re-training programs that are critical for the capability of the company. I think where companies get into trouble is when they lead with the latest issue, they lead with latest fad, and they’re not germane to the fundamental strategy of investments and where the company’s going short term and long term.
What are the top three governance issues on the minds of directors?
Manager: The bedrock issue… is to really determine and monitor and measure risk. There’s been a fair amount of reexamination of Caremark. For example, with Boeing [the courts] allowed a Caremark issue to go forward because of the duty of safety and duty of care failure. On the other hand, there were a couple other cases that they allowed duty of care to stay in place because they wanted to apply a gross negligence standard versus another standard. That’s something we need to constantly keep in mind and watch. It’s not going to be one-size-fits-all in duty of care….
Second is this issue of ESG [environmental, social, and governance] in the world of corporations. We saw that play out at Disney in a big way in Florida, the governor, officials getting involved. We have a new congress coming in…. ESG covers a wide category and directors can still discharge the responsibilities of ESG [and] make progress on those issues without falling into the traps and some of the issues around stakeholders; our shareholders, in many cases, are putting more measures and standards and expectations with regard to ESG before corporations.
Third… is universal proxy, and how that is also changing the landscape of how directors are being selected…. As you may have even seen and read in different publications and different research and analyses, shareholder actions are up… as a result of the adoption of it, which went into place somewhere around August of 2022. The threshold is lower; it allows individual directors to be more targeted for removal than it does whole board slates under the old system. This is something that we all have to look at as well. It’s even allowing smaller players; your Icahns and your Elliotts aren’t the only players in this anymore.
What are the… key things for your customers and clients to implement in 2023 to work more efficiently and effectively?
McCormack: Board evaluations. Who is doing them? How are they being done? Are you having your individual directors evaluated? This is something that you’re hearing the proxy advisory firms talk about, this is something you’re hearing the investors talk about. We’ve seen that the disclosures around board evaluations have been going up; 60 percent of the S&P 500 reported that they have actually now done a board evaluation and they mentioned specifically that they’ve covered the board, the committees, and the individuals and they’re finding at the group discussions that it’s not good. There’s a lack of true, inspired, down and difficult discussions that you can have when the full group is there. It’s getting the board members one-on-one and having that discussion. How was your performance? How do you think your committee did? What do you think we could do better as a board?
By the way, 49 percent of the board members that were interviewed said that they think one person on their board needs to go away, 19 percent said two people need to be kicked off the board, and 4 percent said three or more need to be kicked off the board. Are you being honest with one another during the evaluations? Are you truly taking a step back and asking if the skills and competencies of the individuals on your board are the skills and competencies that belong for where your strategy is going tomorrow? We’re finding that it’s a difficult time…. It’s really hard when this person is your friend to say, “You know what, I don’t know that you’re right for the board any longer.” When we have that feeling, are we also saying, “Gosh, we shouldn’t be on the board any longer”?
How should compensation committees build a more resilient compensation program based on the unexpected nature of what’s going on in business?
Harris: What a resilient program consists of is several things besides a short-term incentive that allows you to be setting your goals every year for that which is coming down the pike that you can foresee far more easily. The long-term incentive plan ought to be established in a way that allows it to work both in good times and in bad times. That often means a combination of long-term incentive vehicles. Something like your performance stock, performance share units that are highly performance-focused [where] you require certain performance measures in order to have any of them vest and at the same time [that are] balanced with something like restricted stock units or something that has a significant retentive power and is tangible, and that actually works when times are bad. It’s better to have these things set up in the first place, rather than as you approach what you think is going to be a recessionary environment. You’re suddenly scrambling to change and say, “Oh, by the way, we want to add restricted stock to our program when we never had it before.” Then your proxy advisors and investors may say, “Well, why are you doing that? You were so focused on performance.” […]
If you have something that’s not necessarily an objective and quantifiable measure is there something that you can do to ensure that in an environment where you don’t achieve your financial goals, you’re not paying out way above target on your strategic measures? For a resilient program you would think about that. You might have some type of a governor that applies to those strategic measures, something that says our earnings need to be a certain level for us to pay above target in that kind of an environment, when, in fact, perhaps management has knocked the lights out with respect to those strategic measures.
NACD: Tools and resources to help guide you in unpredictable times.