The most powerful names in U.S. business have published guidance on Commonsense Principles of Corporate Governance (Commonsense Principles) to provide a framework to improve corporate governance and make it more long-term–oriented. Warren Buffett of Berkshire Hathaway, Laurence D. Fink of BlackRock, Jamie Dimon of JPMorgan Chase & Co., and others have outlined principles covering nine broad categories of governance issues that, while nonbinding, will likely spark an important dialogue in boardrooms. Eight of the categories have direct and far-reaching implications for boards, while the final group of principles relates to the role asset managers play in the governance arena. What makes this announcement unique is the unified position these leaders have taken behind one set of commonsense principles.
At the National Association of Corporate Directors (NACD), an organization that is advancing exemplary leadership among our community of 17,000 director members, our position is clear: We agree with many of the principles outlined and we can help boards implement effective governance practices. In fact, the Commonsense Principles reinforce the Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded Companies that we introduced a few years ago.
While recognizing that the principles are not a one-size-fits-all solution, and that practices will likely differ based on size, industry, and specific company, we’ve included a practical list of next steps below that boards can take to implement the principles.
The Case for Improved Governance
Key drivers behind the 50+ nonbinding principles are the decline in the number of publicly traded firms, with many highly performing private companies delaying initial public offerings (IPOs), essentially reducing available investment opportunities; the current lack of trust between shareholders, boards, and management teams; concerns about the dominance of short-termism in the management of companies; and the complexity of current corporate governance rules.
The Commonsense Principles identify several areas for improvement:
Board agendas should include a focus on major strategic issues (including material mergers and acquisitions and major capital commitments) and long-term strategy, ensuring thorough consideration of operational and financial plans, quantitative and qualitative key performance indicators, and assessment of organic and inorganic growth, among other issues. A company should not feel obligated to provide earnings guidance, the business leaders suggest, and should determine whether providing earnings guidance for the company’s shareholders does more harm than good. Companies should frame their required quarterly reporting in the broader context of their articulated strategy and provide an outlook, as appropriate, for trends and metrics that reflect progress (or lack of progress) on long-term goals.
Every board needs a strong leader who is independent of management, the principles emphasize. The board’s independent directors usually are in the best position to evaluate whether the roles of chair and CEO should be separate or combined, and if the board decides on a combined role, it is essential that the board have a strong lead independent director with clearly defined authorities and responsibilities.
Diverse boards make better decisions, so every board should have members with complementary and diverse skills, backgrounds, and experiences. It’s also important to balance the wisdom and judgment that accompany experience and tenure with the need for the fresh thinking and perspectives that new board members can bring.
In financial reporting, the use of Generally Accepted Accounting Principles (GAAP) should not be obscured by the use of non-GAAP metrics.
Action Steps for Directors
You and your board/company may consider taking certain steps:
Review the principles in detail and benchmark your current governance approach against them.
Determine if identified differences are areas ripe for further discussion and possible change.
Engage your largest investors to get their take on the principles and how they plan to use them when assessing corporate governance effectiveness.
NACD Alignment With Commonsense Principles
Below I’ve highlighted just a few examples of how NACD aligns with the most significant principles. I have included links to NACD reports that can help boards make the Commonsense Principles common practice.
Focus on Long-Term Value Creation
The principles advocate for the creation of long-term shareholder value. Our guidance to members over the past several years has skewed unabashedly toward boards prioritizing long-term value creation. In fact, our 2015 Report of the NACD Blue Ribbon Commission on the Board and Long-Term Value Creation emphasizes the need for directors to align short-term goals—and executive compensation—with long-term strategy. The report provides tools and practical recommendations including, among others, the following:
Boards should consider recommending a move away from quarterly earnings guidance in favor of broader guidance parameters tied to long-term performance and strategic objectives.
The board’s CEO selection and evaluation processes should include an assessment of the extent to which he or she can be an effective advocate for the firm’s long-term strategy.
The nominating and governance committee should approach board composition and succession planning with long-term needs in mind, based on the director skills that will be most relevant to the company’s strategy in three, five, or more years.
Role of the Lead Director
The role of the lead independent director emerged as another key area where board effectiveness can improve. We at NACD believe that the lead independent director should spearhead efforts to intensify the board’s efficacy by identifying and addressing weaknesses in process and individual director performance. An effective lead independent director should be able to provide criticism that is both respectful and objective, and be able to ensure every director’s voice is heard. To put it simply, the lead independent director should bring out the very best in the board. Our NACD Blue Ribbon Commission Report on the Effective Lead Director provides practical guidance on how to do that.
Board Composition and Diversity
Public-company boards should have a diverse and complimentary mix of backgrounds, experiences, and skills, according to the Commonsense Principles. While this is an area in which we’ve not seen much movement—aside from a slight increase in gender diversity, with 79 percent of NACD survey respondents reporting they have at least one woman director on their board compared with 77 percent in 2014—our Report of the NACD Blue Ribbon Commission on the Diverse Board: Moving From Interest to Action provides very practical advice and tools, including a board-level discussion guide on diversity, that can help boards make diverse board composition a priority. Additional information can be found in NACD’s Board Diversity Resource Center.
Non-GAAP Financial Metrics
The use of non-GAAP metrics in financial reporting has been widely scrutinized by regulators. Mary Jo White, chair of the U.S. Securities and Exchange Commission, stated last December that non-GAAP metrics deserve “close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices.” NACD’s Audit Committee Chair Advisory Council, a prestigious group of Fortune 500 committee chairs, met a few months ago to discuss the use of non-GAAP metrics. The council made an important recommendation:
From a governance perspective, audit committees should ensure that there are adequate controls in place to help mitigate the risk of management bias in measuring and reporting non-GAAP measures, and that these controls are frequently assessed.
Our resources and messaging have always been—and will continue to be—shaped by directors who actively contribute to better board-governance practice. As the largest gathering of directors in the United States, NACD’s 2016 Global Board Leaders’ Summit will convene some of the best minds in governance to continue the dialogue on how boards can adopt leading practices. We believe in and strongly support good corporate governance and will continue to provide resources to help directors effectively oversee U.S. businesses. For more information on the governance principles NACD has established, please review our Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded Companies.
The twenty-first session of the Conference of Parties (COP) convened in Paris Nov. 30-Dec. 11 last year to negotiate a legally binding international agreement on mitigating the effects of climate change. Known as both COP21 and the 2015 Paris Climate Conference, this historic meeting of parties to the United Nations Framework Convention on Climate Change (UNFCCC) resulted in the first-ever unanimous accord, with 187 countries pledging collective action to cut carbon emissions. Despite a U.S. Supreme Court setback to environmental regulations on February 10, this deal will have significant consequences for business worldwide—consequences that will unfold as governments establish regulations that enact their support for and compliance with the Paris agreement.
(Photo: Climate Action/The Sustainable Innovation Forum 2015)
What are the key elements of the agreement?
The COP21 accord seeks to accomplish specific major goals:
To restrict the increase of global temperatures to “well below” 2.0°C beyond those of the pre-industrial era, and to endeavor to limit their rise to a maximum of 1.5°C above pre-industrial averages.
Curtailing the amount of greenhouse gases (GHGs) generated by human activity to levels that trees, soil, and oceans can absorb naturally by sometime within the latter half of this century.
To review each country’s contribution to emissions reduction every five years so they can scale up to the challenge.
For wealthy countries to provide “climate financing” that will enable poorer countries to adapt to climate change and switch from fossil fuels to renewable energy sources.
How can countries understand and manage their own emissions?
Like any business goal, understanding and managing emissions requires three basic steps: measurement—determining where you are and where you need to go; management—determining opportunities, challenges and actions; and reporting—monitoring and disclosing performance over time.
Among the most significant outcomes of COP21 are action plans for the ten largest CO2 emitters by country. These countries include (in order of the size of their emissions) China, the United States, the European Union (28 member states), India, Russia, Japan, South Korea, Canada, Iran, and Saudi Arabia. The major global economic sectors emitting the highest amounts of GHGs are establishing mitigation objectives (i.e., emission reduction targets) referred to as Intended Nationally Determined Contributions (INDCs). For instance, the European Union has set a target of at least a 40% reduction by 2030, and the United States is aiming for a 26%–28% reduction by 2025.
Such a global effort will have credibility only if these INDCs are made publicly available. The five-page United States INDC published on the UNFCCC site outlines how the country is planning to measure, manage, and report its performance; it also references existing U.S. laws and standards and draws on the EPA’s Greenhouse Gas Inventory Report: 1990–2013. This report breaks down responsibility for sources of GHG emissions over time and by major industry sector.
A significant amount of research went into the target of a 26%–28% reduction by 2025. The U.S. federal government is already taking steps to reduce emissions, and public-private collaborations have developed that will enable these sectors to leverage high-efficiency, low-missions solutions and incentivize market and technology innovations in response to the challenge.
What kind of impact will climate change and the Paris Agreement have on a company’s valuation?
In an update to the Annual Study of Intangible Asset Market Value, Ocean Tomo LLC reveals that the intangible asset value of the S&P 500 grew to an average of 84% by January 1, 2015, which represents an increase of four percentage points over 10 years. As management of intangible assets has become increasingly critical to a company’s valuation, expectations for transparency about how these ‘intangible’ risks are managed have risen. These risks now extend to climate change and the costs and benefits of reducing GHG emissions.
Companies can show that they are actively managing climate-change risks and reducing their GHG emissions through research surveys like the CDP (formerly known as the Carbon Disclosure Project). The CDP was founded in 2000 in order to collect data related to carbon emissions and distribute it to interested investors. What began as a small group of activists has grown to include more than 800 institutional investors representing assets in excess of US $95 trillion.
Interested investors (asset owners and managers) have demonstrated their support of the CDP by becoming CDP signatories and being involved in a range of investment-related projects. The list of CDP Signatories and Members includes some of the largest institutional investors, such as Bank of America, BlackRock, BNY Mellon, CalPERS & CalSTRS, Goldman Sachs, Morgan Stanley, Northern Trust, Oppenheimer Funds, State Street, TIAA-CREF, T. Rowe Price, and Wells Fargo. The CDP is by far the most influential organization specializing in this area, and it maintains a comprehensive public collection of corporate performance information.
Data posted on the CDP website can be organized by country, index, industry, or company, and is also presented in reports such as the following:
These reports can be helpful to any company seeking to establish its own GHG emissions strategy. Drawing from public sources also allows a company to see the commitments and disclosures of industry peers, what customers may expect, and how suppliers are improving their own efficiency. In addition, GHG-specific data such as that reported through the CDP is now being integrated into specialized research tools, for example, analyses on Bloomberg’s Sustainable Business & Finance website. Any company (or investor) with a Bloomberg subscription can quickly compare and contrast a range of GHG-related factors, ranging from policies (i.e., climate change policy, energy efficiency policy, environmental supply chain policy) to specific GHG metrics (i.e., energy consumption per revenue, total GHG emissions per revenue, percentage of renewable energy consumption).
Do corporate and institutional customers care?
Consider the manner in which new market demands ripple through supply chains: ISO 9000, Y2K, Dodd–Frank/Conflict Minerals, etc. That same dynamic is playing out around GHG emissions. Once an organization makes a commitment to understand its own GHG footprint, it soon recognizes the degree to which its purchasing decisions influence its overall GHG footprint.
In 2010, Wal-Mart Stores Inc. announced its goal to eliminate 20 million metric tons of GHG emissions from its global supply chain by the end of 2015. The company actually exceeded its commitment by eliminating 28.2 million metric tons, which is the equivalent of taking more than 5.9 million cars off the road for an entire year. Wal-Mart achieved this reduction by implementing innovative measures across both its global operations and those of its suppliers: enhancing energy efficiency, executing numerous renewable energy projects, and collaborating with suppliers on the Sustainability Index to track progress toward reducing products’ overall carbon footprint. By 2017, Wal-Mart will buy 70% of the goods its sells in U.S. stores from suppliers that participate in this Index.
Then, of course, there is the world’s largest single procurement agency, the United States’ General Services Administration (GSA), which spends more than $600 billion annually. The GSA and the U.S. Department of Defense (DoD) are both actively involved in the management of GHGs in their supply chains. These and other federal agencies are working closely with the White House Council on Environmental Quality to understand the GHG footprint of the government’s purchasing decisions and to engage and educate suppliers on GHG reduction strategies. The Federal Supplier Greenhouse Gas Management Scorecard lists the largest suppliers to the US government by spend and identifies whether the supplier discloses its emissions and whether it has set emissions targets. This information is drawn from public sources, and, like the CDP, this scorecard creates added market pressure on public and private companies to measure, manage, and report on GHG-related activities.
Do consumers care?
In 2015, Cone Communications partnered with Ebiquity to field its third survey of global attitudes, perceptions, and behaviors around sustainability and corporate responsibility. They conducted an online survey of more than 9,500 consumers in nine of the largest countries as measured by GDP: the United States, Canada, Brazil, the United Kingdom, Germany, France, China, India, and Japan. The survey broadly described corporate social responsibility (CSR) to respondents as “companies changing their business practices and giving their support to help address the social and environmental issues the world faces today.” Respondents were then asked whether in the preceding 12 months they had:
What does the agreement mean for your business?
Awareness about fossil fuel use, carbon and GHG emissions, and climate change impact is proliferating in all segments of the economy—public and private companies; federal, state, and local governments; employees, customers, and shareholders; etc. Today’s management teams and directors need to understand where their company stands on the risk/opportunity spectrum. To begin or advance the boardroom conversation on climate-change risks and strategies for reducing GHG emissions, consider the following:
Look across the company’s value chain. Where is the company most vulnerable geographically? Which facilities are purchasing power from the highest and lowest carbon emitting electric utilities? Are their GHG reduction opportunities through our electric utility or through other energy providers in our region?
Have we taken a public position on reducing GHG emissions? Have we set goals and targets? If not, why not? If so, how are we performing? Do we have quantifiable and verifiable information?
What positions have our largest customers taken on the issue of GHG emissions? What are their expectations of us as a supplier?
Is our industry sector a leader or a laggard? How is our organization doing in comparison with our peers?
As part of the lead-up to COP21, the Science Based Targets (SBT) initiative was formed to actively engage companies in setting GHG emission reduction targets. A collaboration among the CDP, the UN Global Compact, the World Resources Institute, and the World Wildlife Fund, the SBT initiative publishes the emission reduction targets set by more than 100 of the world’s largest companies. Here are just a few examples:
Coca-Cola Enterprises has committed to a 50% reduction of absolute GHG emissions from their core business operations by 2020, using 2007 as the base year. Coca-Cola Enterprises also commits to a 33% reduction of the GHG emissions associated with manufacturing of their products by 2020, using 2007 as the base year.
General Mills has committed to reducing absolute emissions by 28% across their entire value chain from farm to fork to landfill by 2025, using a 2010 base-year. These reductions include total GHG emissions across all relevant categories, with a focus on purchased goods and services (dairy, row crops, and packaging) as well as delivery and distribution.
Procter & Gamble has committed to cutting emissions from operations by 30% from 2010 levels by 2020.
Sony has committed to reducing GHG emissions from its operations by 42% below fiscal year 2000 levels by fiscal year 2020. The company also has a long-term plan for reducing its environmental footprint to zero by 2050, requiring a 90% reduction in emissions over 2008 levels by 2050.
In October 2015, more than 80 major U.S. corporations signed the American Business Act on Climate Pledge, among them such companies as Alcoa, American Express, Apple, AT&T, Berkshire Hathaway Energy, Dell, GE, General Motors, Goldman Sachs, Google, Johnson & Johnson, McDonald’s, Nike, Pepsi, Pacific Gas & Electric, Salesforce, Starbucks, UPS, etc. A range of quantitative GHG-emission reduction goals and targets are available for public review on the SBT website.
In addition, entire industries—such as the fashion and hospitality industries—are working together to set their own targets. These types of voluntary public commitments are setting precedents and thus expectations for others within and across industries and economic sectors.
Given the pending presidential election in the United States and the existing regulations referenced in the United States’ own INDC, it is unlikely that significant regulatory changes will impact business in 2016. It is likely, however, that existing standards and Executive Orders will shape the conduct and actions of specific industries.
Growing interest in the federal government’s own footprint and those of its suppliers may constitute the most significant impetus for change. As the GSA and the DoD increasingly seek suppliers with the lowest GHG emissions, these suppliers (public and private) will be incentivized to measure, manage, disclose, and verify their GHG emissions.
(Photo: Climate Action/The Sustainable Innovation Forum 2015)
What do directors need to do now?
First and foremost, become familiar with your company’s carbon profile and sustainability image. You need to know the carbon footprint of your company, the company’s plans to reduce that footprint, and the company’s messaging about those plans.
Whether your company is public or private, make sure that its customers know the company’s story. Business-to-business customers expect suppliers to measure, manage, and report on carbon emissions. Directors can ensure that a credible and compelling message is communicated to customers.
Conversely, directors can ensure that the company exhibits GHG consciousness when choosing major suppliers. In a choice between two qualified vendors, why not pick the one that is also better for the sustainability of your business and the planet?
If you serve on the board of a public company, look for the names of your largest investors on the list of CDP signatories, realizing that more and more of these investors are conducting due diligence on carbon emissions in their portfolio companies. Urge your CEO to announce carbon reductions in any communications with your company’s climate-oriented investors.
Develop your business case for carbon reduction and other sustainability measures. Reducing carbon emissions means the reduction in the use of fossil fuels, which translates to cost savings. Diversifying the firm’s energy portfolio to include lower emission sources is also a strategic move in today’s market. Seeking out and procuring lower-emissions goods and services has become commonplace. Leverage your procurement spend to help reduce your overall GHG footprint.
Urge management to reach out to sources knowledgeable about climate change in order to learn more from them or even to consider them as possible business partners. Wall Street firms, private equity investors, lenders, insurers, rating agencies, and stock exchanges are all becoming involved in climate issues and can be valuable partners in identifying future risks and opportunities, as well as crafting new strategies.
Ensure your investors understand and appreciate the value of investments your company makes to reduce its carbon footprint and improve the sustainability of its operations.
BrownFlynn is a corporate sustainability and governance consulting firm with 20 years of experience supporting public and private corporations in the development and implementation of strategic corporate responsibility and sustainability programs. www.brownflynn.com
Barb Brown, co-founder and principal, has led the firm since 1996, when it was established to address the growing demand from shareholders on intangible issues such as corporate responsibility; sustainability; environmental, social, and governance topics. Recognized as a pioneer in the industry, Brown is a sought-after speaker, author, and thought leader and has contributed her expertise to a range of professional and industry groups, as well as numerous multinational corporations.
Mike Wallace is managing director at BrownFlynn. An NACD member, he has been a regular contributor to NACD programs and publications. He has worked in the field of corporate responsibility/sustainability for more than 20 years and has presented on these topics to audiences at NACD Master Classes, the NACD Global Board Leaders’ Summit, and meetings of the Society of Corporate Secretaries, and the National Investor Relations Institute. He advises public and private companies as well as boards and board committees on these issues.
The regulatory burden on U.S. public companies continues to increase and the government’s role has expanded from that of just regulator to, in some cases, shareholder. That might leave some directors wondering how far into the boardroom Uncle Sam can reach.
A panel of financial industry and government experts convened last fall to discuss the influence of the federal government when it acts as either a shareholder or a regulator. The Clearing House Association and the University of Delaware’s John L. Weinberg Center for Corporate Governance facilitated the discussion with a program called The Government as Regulator and/or Shareholder—The Impact on Director Duties, which included the following speakers and panel members:
Rolin P. Bissell, partner, Young Conaway Stargatt & Taylor LLP
Amy Borrus, interim executive director, Council of Institutional Investors
Laban P. Jackson, Jr., director, JP Morgan Chase & Co.
Peter A. Langerman, CEO, Franklin Mutual Advisers, LLC
Giovanni P. Prezioso, partner, Cleary Gottlieb Steen & Hamilton LLP
Gregg L. Rozansky, managing director, The Clearing House Association
Mary Schapiro, former chair, U.S. Securities and Exchange Commission (SEC)
Collins J. Seitz, Jr., justice, Supreme Court of Delaware
Charles M. Elson, director of the Weinberg Center and professor of finance, moderated the discussion.
The panel offered a wide range of perspectives, but a few common themes emerged that are applicable to directors across a variety of industries.
Most panelists agreed that the 2010 Dodd-Frank Act was a response proportional to the 2008 global financial crisis, butexpressed frustration with certain government bailouts and the political motivations influencing them. Several panelists indicated they felt uneasy about the broad scale of intervention that the federal government made into the private sector to bail out failing companies. The panelists cited the example of the U.S. Federal Reserve Bank’s $85 billion bailout of American International Group (AIG) to illustrate how far agencies reached—even in the face of the internal corruption at the company. AIG’s credit default swaps lost the company $30 billion and are often blamed as a major reason the company collapsed in 2008. Controversy swirled when in March 2009, publicly disclosed information revealed that after the bailout, employees of AIG’s financial services division were going to be paid $218 million in bonuses. A June 2010 report by the Congressional Oversight Panel (COP)—a five-member group created by Congress in 2008 to oversee the U.S. Treasury’s actions—concluded that the Federal Reserve Board’s close relations to powerful people on Wall Street influenced its decision to help AIG.
While the panelists were critical of the bailouts, they agreed that Dodd-Frank was a reasonable response to help prevent future failure of companies. Directors’ bandwidth, however, to address their corporation’s most important strategic matters, including emerging risks, may be limited by the need to spend time ensuring compliance with Dodd-Frank. Most agreed that they do not expect a lessening of regulations in the near future.
Panelists also agreed that the Delaware court system—one of the most powerful legal arbiters of U.S. corporate governance—is not designed to address scenarios in which the federal government acts as an investor. When the federal government intervenes by investing in a company to salvage it, the government becomes a shareholder with greater legal privileges than a traditional, human shareholder who might challenge corporate decisions in the Delaware courts. In the event that the government challenges a company in the federal court system, the federal government would be tried in legal institutions where the ultimate power of appeal is granted by its own founding documents. Challenges to federal sovereign immunity and the federal government as shareholder would be difficult, if not impossible, to navigate.
The line between the government as a stockholder and regulator could be blurred when the regulatory influence over the company is pervasive. This issue may be particularly acute for wholly owned subsidiaries of public companies when the government closely reviews company decision-making and expresses views on what is in the best interest of the subsidiary.
Relationships between regulators and directors—though once strained by mistrust after the financial crisis—are beginning to improve. A panelist observed that, in several global markets, relationships between regulators and directors have steadily normalized over the past year and a half, in contrast to more tense interactions of previous years. As global regulatory standards are established, markets recover and stabilize, and businesses and regulators deepen their understanding of each other.
Forming relationships with regulators should be a strategic priority for directors. Most panelists insisted that good relationships with representatives from regulatory agencies are essential. Boards should aim to keep a level of candor with regulatory contacts that could be helpful when pushing back against regulatory action and when directors have suggestions for upcoming regulations. Directors should also acknowledge that regulators have an important function to carry out in a high-pressure, multi-stakes market environment that is a challenge to navigate for regulators and companies alike. A “kicking and screaming” approach to relationships with regulators was frowned upon, as it is not productive and is insensitive to the fact that developing or implementing regulation is demanding and complex.
Directors seeking to strengthen their oversight of corporate compliance and ethics programs can access the National Association of Corporate Directors’ (NACD) publication Director Essentials: Strengthening Compliance and Ethics Oversight. The guide provides an overview of the board’s role in compliance oversight and offers practical insights about fulfilling regulatory expectations.