Front and center for boards and senior management is the call to align the company’s day-to-day activities with long-term value creation, said Bill McCracken, co-chair of the NACD Blue Ribbon Commission (BRC) that produced the newly-released report on The Board and Long-Term Value Creation. McCracken, who is also a director of NACD and the MDU Resources Group, president of Executive Consulting Group, and the former CEO of CA Technologies, co-chaired the commission with Dr. Karen Horn, director of Eli Lilly & Co., Norfolk Southern Corp., and T. Rowe Price Mutual Funds, and vice chair of the NACD board.
What’s the first step for boards in creating long-term value? “Draw a clear line between the daily objectives and long-term strategy,” said McCracken. “Ask, ‘Have we done a good job articulating that? Do investors buy into the strategy? And does the company have the capabilities it needs to execute that strategy?’”
Dona D. Young—chair of the nominating and governance committee for Foot Locker Inc. and a director of Aegon N.V. and Save the Children—served as moderator for a panel that also included Margaret M. Foran, a director at Occidental Petroleum and the chief governance officer, vice president, and corporate secretary of Prudential Financial; and Brian L. Schorr, partner and chief legal officer of Trian Fund Management LP, director of the Bronx High School of Science Endowment Fund, and a trustee of the New York University School of Law. Young and Foran were both BRC Commissioners in 2015; Schorr was a member of the 2014 BRC, which focused on the board’s role in strategy development.
The panel discussion amplified four key findings from this report:
Make short-term goals the building blocks of long-term strategy.
“It’s clear that short-term is not at odds with long-term,” Young said. “How do we integrate that concept in our companies?”
Panelists agreed that directors should determine how to break down long-term goals into measureable short-term milestones at the quarterly, half-year, and annual marks. As Schorr noted, “performance can’t be back-loaded: if a company consistently misses those short-term marks year-after-year, shareholders will question the integrity of the long-term goal you’re moving toward.” Among the BRC report’s tools for directors are examples of long-term-oriented performance metrics in nine different categories.
Directors also need to test the organization’s alignment between short-term metrics and long-term strategy with actual performance. Start off with your premise—or the long-term goal your organization is moving toward—and conduct historical look-backs on a regular basis, Foran said. “Were we right about our predictions? Did we reward the right things?”
Independent inquiry is not optional.
In order to be effective at setting those long-term goals and their relevant short-term milestones, directors must be knowledgeable about both the company and industry.
“We have to do our own homework and not rely solely on management [for information],” Young said. “How do board members engage in independent inquiry without making management feel like we don’t trust them?”
Directors should be reading press releases and analyst reports—not only those issued by their own company but also those of peers and competitors within the industry—to get a sense of what the trends are, Foran said. Trade publications and conferences are other key sources of data.
Schorr described an approach he himself uses: “At Trian, we focus on the income statement. We look at indicators such as EPS growth and EBITDA margins—do we see underperformance relative to what we believe is the company’s potential? Balance-sheet activists look for signs of excess cash, lower leverage ratios, or dividend payout ratios that are out of balance. We ask why. There may be a perfectly good reason; it’s just not well-articulated by management.”
Conduct regular individual-director evaluations.
McCracken highlighted the report’s recommendation on the need for long-term succession planning. When considering your company’s board composition, ask whether you have the capabilities and talent that will be needed to guide the company toward future goals, he said.
“We do strenuous 360-degree evaluations with management,” McCracken noted. “Why can’t we hold ourselves, as board members, to the same standard?” And since board members are peers, it is helpful to have a third party conduct the assessments. Young shared an example from her own experience in which individual director evaluations were truly 360-degree, incorporating input from senior management: “It was tremendously enlightening, really eye-opening.”
Be prepared to engage with shareholders.
The importance of regularly scheduled meetings with shareholders cannot be overestimated. “Don’t just wait for a problem to arise,” Shorr advised, noting that information exchange is a two-way street. The board should also have ways to gather unfiltered information about shareholders’ priorities and concerns.
McCracken emphasized this point: “In today’s world, board members need to talk to shareholders. Regulation FD is a non-issue, a red herring, and directors can’t use it as an excuse.” The BRC report provides detailed guidance that directors can use to prepare for shareholder meetings.
The BRC Report on the Board and Long-Term Value Creation is a natural extension of last year’s BRC report, which recommended that directors get involved in strategy decisions early on and remain involved with them, Schorr said. Doing so can help push management toward goals that promote long-term value creation with links to interim performance milestones that are clear to shareholders. “It’s more than understanding and doing defensive analysis. It’s getting into the boardroom and doing a lot of the things activists are doing,” Schorr said.
Moderator Young summarized the report’s significance this way: “This report helps directors to take a systems approach to engaging with management on strategy and driving value creation.”
This timely publication is the NACD’s twenty-second BRC report and represents the thought leadership of more than 20 eminent directors and trailblazers in business and government. Distributed to attendees of the GBLS and available to NACD members at www.nacdonline.org/value, the report contains the following practical guidance for the directors and boards of public, private, and nonprofit organizations:
Ten recommendations on the board’s role in driving long-term value creation
Eleven red flags that indicate a lack of alignment between short-term goals and long-term strategy
Specific steps directors can take regarding CEO selection and evaluation, capital allocation, and other elements related to long-term value creation
Eight appendices that offer detailed insights and practical boardroom tools
If a tree falls in the forest, and no one hears it, does it make a sound?
If an NACD Blue Ribbon Commission (BRC) makes a recommendation, and no one heeds it, does it have an impact?
The answer to both questions may be no, but neither question is realistic. You can’t have a forest without living creatures to hear its noises, and you can’t have a BRC without a community to hear its message. So let’s ask instead: “How much do readers of the BRC reports hear?” and “What do they do about it?” Certainly these matters are worth pondering. After all, what is the point of giving guidance if few follow it?
The current issue of NACD Directorship brings this question to life as Ashley M. Marchand interviews past chair Robert E. (“Bob”) Hallagan about the BRCs’ potential for shaping board practices. This blog validates that claim with some of the more convincing findings from NACD’s annual public company governance surveys, referred to here by the year the survey data was collected (titling conventions have varied over time). In conclusion, we will ponder what it all means.
1993 – The BRC on Executive Compensation recommended pay for performance. Before vs. After: Taking NACD’s 1992 and 1995 surveys as respective before and after snapshots, we see directors paying more attention to performance in the wake of this very first BRC report. The 1992 survey showed that corporate performance was the #1 corporate governance issue for only 15% of respondents. By 1995, corporate performance had become a top issue for 52% of respondents.
1995 – The BRC on Director Compensation recommended director payment in equity, with dismantling of benefits. Before vs. After: Whereas in 1995 it was common for directors to receive benefits but no stock, by 1999 the trend was the opposite. By then nearly two-thirds of companies included stock as part of director pay, and under 10% paid benefits.
1996 – The BRC on Director Professionalism recommended executive sessions. Before vs. After: The 1997 survey showed that 10% of companies held executive sessions; the 1999 survey recorded a rise to 44%. The Director Professionalism sold 10,000 copies in its first printing and has been reissued with updated notes and appendices several times since. It was cited in Brehm v. Eisner (2000) for its emphasis on director independence. The Brehm case would lead to the In Re Walt Disney Derivative Litigation (Del. Chancery 2005, Del. Supreme, 2006) over compensation awarded to Michael Ovitz. Also, Justice Jack Jacobs of the Delaware Supreme Court later made the following statement (in a talk at the University of Delaware): “Are corporate guidelines relevant? Yes of course. Consider the Report of the NACD Blue Ribbon Commission on Director Professionalism. With perfect hindsight, one would think that the persons who drafted this document were clairvoyant, because many of their suggestions for best practices have now become law in one form or another” (Delaware Discourses: Governance Guidelines , p. 19).
1998 – The BRC on CEO Succession recommended board engagement in succession. Before vs. After: The 1997 survey showed that CEO succession ranked #5 as a board concern at that time. But the following three surveys would show a steady rise from #3 to #2 to #1 in 20013.
1999 – The BRC on the Audit Committee recommended all-independent membership for the AC (as did a competing “Blue Ribbon Committee” report sponsored by the New York Stock Exchange that same year—a recommendation that would eventually lead to a listing requirement under the Sarbanes-Oxley Act of 2002). Before vs. After: Prior to 1999, audit committees only had to have a majority of independence members, so all-independent audit committees were relatively rare and not even the subject of a survey question. The 2001 survey did ask about committee independence and showed 70% of audit committees as entirely independent. (Percentages went up from there due to passage of new stock-exchange requirements for listed company governance in the wake of Sarbanes-Oxley: the 2003 survey showed that 75.3% of companies reported having only outside directors on their audit committee. By 2005, that percentage had risen to 86.3%.)
2000 – The BRC on the Role of the Board in Strategy recommended that boards make strategy a higher priority. Response to this recommendation was delayed, but decisive. Before vs. After: In 1999, strategy ranked second, after corporate performance. From 2001 to 2004, in seeming contradiction to the Commission’s recommendation, it dropped progressively lower. But in 2005 it rose to number 1 and has held that place ever since.
2001 – The BRC on Board and Director Evaluation recommended formal evaluation of boards and directors. Before vs. After: The NACD had visited the topic of CEO and board evaluation in 1994, but its recommendations at the time had little impact (so it is not listed above). This 2001 BRC came at a better time to ride a wave of interest. The 1999 survey showed 32% of boards conducted evaluations; the 2003 survey showed that 85% did so. This was no doubt due to stock exchange requirements referenced immediately above. But the stock exchange rules themselves were born in part out of the BRC process. In 2001, NACD CEO and President Roger W. Raber testified before the House Energy and Commerce Committee, which asked him to make listing recommendations to the stock exchanges. He submitted those in a letter dated March 4, 2002. Nine of NACD’s 10 recommendations—all based on Blue Ribbon Commission recommendations—subsequently became stock exchange listing requirements.
2002 –The BRC on Risk Oversight recommended that the board play an active role in overseeing risk management. Before vs. After: The 2001 survey showed that only 5% of respondents ranked this issue among their top three. The 2003 survey saw this percentage increase to 26.1%, and the 2005 survey saw it rise to 33.2%—more than one in three respondents.
2003 –The BRC on Executive Compensation recommended an entirely independent compensation committee for all public companies (not just those covered by the Sarbanes-Oxley–mandated stock-exchange rules that would be issued in November of that year). Before vs. After: The 2005 survey showed a rise in overall independence of compensation committees compared to 2003. “Three-fourths (75.9%) of firms overall, up from 65.5% in 2003, indicated that they had only independent outsiders on their compensation committees.”
2004 – The BRC on Board Leadership recommended that boards consider using an independent lead director in cases where they did not have an independent chair.
Before vs. After: In the immediate and near-term aftermath of this report there was an apparent surge in the use of the lead director—even greater than that seen when the “presiding director” disclosure requirement of the New York Stock Exchange became effective in 2003. The 2005 survey indicates that over a third (38.5%) of the boards studied had a designated lead director, almost four times the number (10.0%) shown in the 2003 survey.” The 2007 survey says that “44.8% of respondents’ boards have a designated lead director.”
2005 – The BRC on Director Liability recommended active board oversight of ethics and compliance. Before vs. After: In 2005 the prevalence of board committees to oversee ethics and compliance was 5% (with one in five committees combining with another committee, such as audit or governance). In 2007 the prevalence of a standing committee to focus on ethics and compliance doubled to 11.2%.
2007 – The BRC on the Governance Committee recommended director orientation (as well as ongoing director education). Before vs. After: In 2007, 60% of respondents said that their boards had a policy or program on director education. In 2009, 72.8% said they had such a program.
2008 – The BRC on Board-Shareholder Communications made several recommendations on improving relations with shareholders. Before vs. After: The 2007 survey showed that 80% of respondents considered relations with shareholders to be critical or important; the 2009 survey showed a rise in interest, with 90% seeing the issue as critical or important.
2009 – The BRC on Risk Governance, building on its 2002 predecessor, recommended strong board oversight of key risk factors. Before vs. After. Risk oversight had already been on the rise as a top of mind issue at the time of this survey, moving from a ranking of 14th in 2007 and 2008 up to 6th in 2009, partly as a result of the financial crisis. By 2011 it would rank 3rd.
2010 – The BRC on Performance Metrics recommended inclusion of non-financial metrics when assessing executive performance and awarding compensation.Before vs. After. The 2010 survey explored the use of non-financial metrics such as customer satisfaction, workplace safety, and workplace diversity in setting executive pay. In that year, between 14% and 54% of boards used specific nonfinancial metrics for this purpose. The 2011 survey showed a range of 13% to 50%, and the 2012 survey showed a range of 11% to 39%. So for the near term, at least, this BRC clearlydid not change board behavior. The 2015 BRC report, which will focus on the importance of long-term value, will revisit this issue and build on this foundation.
2010 – Issued in the same year as the BRC study of performance metrics, the BRC on the Audit Committee recommended that the AC and board assess the “tone at the top,” including ethical performance of senior management. Before vs. After. The 2010 survey showed that 76.6% of companies measured ethics; the 2011 survey showed that 79.3% measured did so; and the 2012survey showed that 82.1 did.
2011 – The BRC on Lead Director (like its predecessor on board leadership) recommended continued use of the lead-director role as a viable alternative to an independent chair. Before vs. After: The 2011 survey showed that 65.4% of respondents sat on boards with lead directors; the 2012 survey showed 82.8% had a lead director; the 2013 survey showed “three quarters.”
2012 – The BRC on Board Diversity recommended inclusion of diversity of personal identity as one of several value-adding dimensions (along with diversity of experience and expertise). Before vs. After: In 2014, 77% of boards had at least one woman director%, up from 72.6% in 2012 and 68% in 2011 (no data for 2013). Impact on minority representation was not as positive.
2013 – The BRC on Talent Development recommended that the board put more focus on talent—and that talent cascade. Talent management stayed flat before, during, and after this BRC was issued. Surveys from 2010 to 2014 all showed that talent management ranked 5th—so the BRC did not raise this issue any higher than it had been. Note, however, that this was up from a much lower ranking (16th, calculated by a slightly different method) in 2009. In this case the survey was a lead, and the BRC was a lag.
2014 – The BRC on Strategy Development recommended that the board get involved in strategy earlier and more dynamically. Our 2015 survey just went into the field, so we don’t yet have results.
In 2015, the NACD’S Blue Ribbon Commission will focus on Value Creation, reprising the theme of the performance metrics BRC, which was a good half decade ahead of its time. The new Commission’s first meeting on April 9 included a lively exchange on the intersection of public and private interests, with both public servants and corporate directors engaged in the discussion. Luminaries in the room included not only this year’s BRC co-chairs Karen Horn (board member at Eli Lilly & Co.) and Bill McCracken (former CEO and chair of CA Technologies [now CA Inc.]) but also former Gov. John Engler of Michigan and former Sen. Olympia Snow of Maine, both retired from political leadership but active on corporate boards. NACD Chair Reatha Clark King and other BRC veterans (notably including NACD president and longtime BRC ex-officio member Peter Gleason) carried forward past wisdom even as all looked ahead.
Caveats and Conclusions
So, based on the foregoing, can we say that NACD BRC reports change the governance world? Maybe not, but they certainly do make ripples.
With 21 BRCs to date, and multiple recommendations per BRC (typically 10), overall impact is hard to trace. Proof of impact is more circumstantial than scientific, even with the many positive findings above. The surveys themselves present a moving target, as field dates, wording, response rates, and target populations have changed over time. Even BRC release dates vary, as some took more than a year to produce (there were no reports in 1997 or in 2006). Furthermore, there are other factors—such as new laws and investor pressure—affecting board behavior; so a mere change in a BRC-compatible direction does not mean much in itself. And even when change does occur in the wake of a BRC recommendation, independent of any other known causal factor, we can’t know for certain which came first: the respondent boards’ impetus to change or the BRC they read. (That is, did NACD foresee an impending change and thus mirror or reinforce it in their recommendations, or did the BRC reports in fact alter reality?)
All these caveats aside, survey findings have been instructive in assessing BRC impact. My “null hypothesis” was that no correlation exists between BRC recommendations and subsequent board behavior. My challenge was to disprove this hypothesis—to show that, in some cases, there is indeed a positive correlation. I made this case by comparing what the survey data showed about the issue shortly before and shortly after a BRC recommendation. The raw data stream indicates that, even when legislative and investor co-impacts are taken into account, BRCs accurately predicted trends and/or may have influenced them.
To be sure, there were negative or flat examples as well—two instances in which the data stayed the same or moved in the opposite direction from a recommendation, indicating ignorance or disregard of a key recommendation. These instances were rare, however, and may have needed more time to play out. The 1994 BRC on evaluating the CEO and the board did not change behavior, but it laid the groundwork for the 2001 BRC on evaluation, which did. And the 2010 BRC on performance metrics and 2012 BRC on board diversity have not yet moved the needle, but their influence may unfold over time. NACD will revisit both topics in 2015. As mentioned earlier, this year’s BRC will focus on value creation, and we plan to launch a new diversity initiative, paying sustained attention to the related issue of talent.
Clearly, there will always be a sound somewhere when a tree falls in a forest, just as there will always be some impact when a new BRC emerges. Get ready for the boom!
The following links lead to the most recent editions of these uniquely useful reports.
For years, boards have discussed diversity but little action has been taken. Demographic shifts and the continuing focus on global competitiveness point to change on the horizon. While it won’t happen tomorrow, all signs point to increasing diversity within the next few decades — when the current millennials are in their 50s, the boardroom will be much more racially diverse.
I recently addressed two highly engaged groups in Washington, D.C., and the attendees reflected very similar attributes and a common aspiration — a desire to gain their first board seat. My advice for gaining that first board seat was clear. It’s all about who — and what — you know.
The first group I met with was from Ascend, and the second group was from Women in the Boardroom. While the composition and mission of the latter is evident, the former may be new to you. Ascend is an association consisting of nearly 50,000 Pan-Asian leaders who are passionate about ascending the highest ranks of business. I spoke during Ascend’s recent global conference of more than 2,500 people.
NACD believes diversity is a global business imperative. I mentioned during my talks that NACD has been a champion of diversity in the boardroom for more than 37 years, dedicating content, events and actions to the issue. Further, we don’t define boardroom diversity as being simply about color or gender. It’s about diversity of thought, perspectives and experience – from a cognitive perspective. Ideally, the skills, experiences and perspectives of a company’s directors should reflect those required to proactively oversee the company’s strategy.