Investors now see corporate governance as a hallmark of the board’s effectiveness and one of the best sources of insight into the way companies operate. In response to this trend, Farient Advisors LLC, in partnership with the Global Governance and Executive Compensation Group, produced the report 2017—Global Trends in Corporate Governance, an analysis of corporate governance practices in the areas of executive compensation, board structure and composition, and shareholder rights covering 17 countries across six continents.
NACD, Farient Advisors LLC, and Katten Muchin Rosenman LLP cohosted a meeting of the NACD Compensation Committee Chair Advisory Council on April 4, 2017, during which Fortune 500 compensation committee chairs discussed the report’s findings in the context of the current proxy season. The discussion was held using a modified version of the Chatham House Rule, under which participants’ quotes (italicized below) are not attributed to those individuals or their organizations, with the exception of cohosts. A list of attendees’ names are available here.
Global Governance Trends
2017—Global Trends in Corporate Governance finds that governance standards around the world have strengthened in response to financial crises and breakdowns in corporate ethics and compliance. Those crises and breakdowns have led to greater pressure from governments and investors, who are demanding economic stability and safe capital markets. In regard to executive compensation, the report notes a number of global governance trends:
Source: Farient Advisors, 2017—Global Trends in Corporate Governance, p. 18.
Most of the 17 countries surveyed (94%) require executive compensation disclosure, although the disclosures made and the quality of these disclosures varies from country to country. Surveyed countries that had the least developed disclosures are South Africa, China, Brazil, and Mexico.
Say-on-pay voting is mandatory in most developed countries, although there is variance on whether the votes are binding or not. For developed countries where the vote is voluntary (e.g., Canada, Belgium, Germany, and Ireland), it still remains a leading practice.
Common leading practices are to use competitive benchmarks, such as peer groups to establish rationales for pay, and to provide investors with information on components of pay packages and performance goals.
2017 Proxy Season Developments
Meeting participants shared a number of observations and practices from the current proxy season:
Continuous improvement on disclosures Council participants indicated they are sharing more information with shareholders, in a more consumable way. “We want to be in the front ranks as far as providing information to shareholders,” said one director. “Instead of asking ‘why should we share that?’ we’re starting to ask ‘why not?’” Another director added, “Over the last few years we’ve moved from a very dense legalistic document to something that’s much more readable. Our board set up a process to do a deep-dive review every two years; this fall is our next review. It’s a way to ensure our disclosures keep pace with current practices and also reflect where we are as a company and board.”
Council members also discussed the status of Dodd-Frank rulemaking, given the new presidential administration and SEC commission. S. Ward Atterbury, partner at Katten Muchin Rosenmann LLP, said, “While it’s unclear exactly what the SEC will do with Dodd-Frank requirements in the future, investors have spoken on some of the issues, especially on things like say on pay and pay for performance. There may be less formal regulation, but the expectations on companies and boards are still there [to provide pay-for-performance disclosure].”
Growing interest in board processes According to one director, “We’re hearing more interest about CEO succession as it relates to strategy. Investors are asking us to describe our process—they understand we can’t discuss specifics.”
Director Pay Dayna Harris, partner at Farient Advisors LLC, discussed the increased focus on director pay: “Given the recent law suits regarding excessive director compensation and an increase in director pay proposals in 2016, Institutional Shareholder Services (ISS) created a new framework for shareholder ratification of director pay programs and equity plans.” ISS’ framework evaluates director pay programs based on stock ownership guidelines and holding requirements, equity vesting, mix of cash and equity, meaningful limits on director pay, and quality of director pay disclosure. ISS’ updated factors for evaluating director equity plans include relative pay magnitude and meaningful pay limits.
Environmental, social, and governance (ESG) issues Meeting participants agreed that social issues, such as ESG and gender pay equity, are increasing in popularity among investors. In particular, nonbinding shareholder proposals on climate change received majority support this year at Exxon Mobil Corp., Occidental Petroleum Corp., and PPL Corp.
Refining approaches to outreach and engagement with investors Meeting participants discussed leading practices for engaging shareholders. Some directors indicated that investors have turned down their offers to speak on a regular basis because of time constraints. One delegate emphasized that just making the offer to meet with shareholders is appreciated, even if that offer is turned down. One director said, “We invited one of our major long-term shareholders to speak at one of our off-site [meetings] as part of a board-education session. It was a different type of engagement and very valuable.”
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.