With the principle of the rule of law and democratic governance under siege in numerous parts of the world, corporate board members are increasingly considering how global events are creating mounting risks to both their businesses and the bottom line.
These actions are taking place in jurisdictions that have long been high risk for companies. The Democratic Republic of the Congo, Venezuela, and Myanmar, for example, have for some time presented operational challenges as a result of poor governance. In recent years, however, countries thought of as bulwarks for the rule of law have also begun to present challenges for businesses. Some argue that these include the United States, a country that traditionally has been known as a powerful advocate for the rule of law and democratic values and the long-time guarantor of the system of global governance, and the United Kingdom, where the legal and regulatory uncertainty caused by Brexit has seen many investment decisions put on hold.
Just in the last few weeks actions taken by the United States with rule-of-law implications have given some in the business community great pause. US actions regarding Chinese telecom company ZTE Corp. have raised questions as to whether a law enforcement action against a corporate entity can be used as a point of leverage in an international trade negotiation. Notwithstanding policy arguments for and against, the US’s withdrawal from the Iran agreement and pending re-imposition of secondary sanctions create significant uncertainty both for international businesses making investment decisions in Iran, and with respect to the US’s long-term commitments to international agreements. Many also note that America’s executive in chief has imposed considerable pressure on elements of the Federal government whose independence has long underpinned the rule of law in the United States, from individual judges and the judiciary to members of Congress, to law enforcement and the Federal Bureau of Investigation. This pressure has at times taken the form of quite personal attacks that set a concerning precedent, including for businesses that must ask whether they could become a target for a president who dislikes what they may be doing.
It is no secret that businesses do well in jurisdictions where the rule of law is strong: where contracts are enforceable, where fair judicial decisions are rendered without unreasonable delay, where assets aren’t arbitrarily seized or contracts arbitrarily renegotiated, where laws and regulations are transparent and applied fairly, where bribes need not be paid for discretionary actions by government. These are environments where businesses thrive. Indeed, as a 2015 Report by law firm Hogan Lovells and the Bingham Centre for the Rule of Law makes clear, there is a strong correlation between foreign direct investment in a country and the existence of a sound rule of law.
Businesses also do well where basic principles of the rule of law and associated norms are embedded. The separation of powers, the existence of a resilient and independent law enforcement system, and basic respect for truth and fact-based decision making are all important contributors to business success.
Finally, the existence of a strong rule of law correlates with broader societal thriving, making for an invigorated source for customers, employees, partners, and suppliers.
Given this reality, it is imperative that boards be sensitive to the range of rule-of-law issues that impact their businesses, even in jurisdictions where they least expect it. This means considering specific risk factors involving rule of law, above and beyond more generic political risk factors, whenever contemplating entry into new jurisdictions. The same can be said for assessing merger and acquisition or joint venture prospects, even in places where rule of law issues aren’t on the front page of newspapers every day. Indeed, a broad range of rule of law risk factors should be included in standard risk matrices so that business-critical issues such as prospects for the enforceability of contracts, or the ability to get a fair and timely judicial decision, or the independence of law enforcement are specifically considered when assessing risk. Existing governance and compliance frameworks can readily be adapted to reflect rule of law issues, alongside human rights and other risk issues. Rule of law matters should be included on the agenda of board meetings when appropriate.
In addition, boards should consider their companies’ own self-interest in the existence of a strong rule of law, and decide what their role might be in encouraging better governance, both within the companies themselves and in the environments where they operate. Many high-profile businesses have stepped up in recent months to publicly support such issues as countering climate change (as occurred when the US withdrew from the Paris Climate Agreement last year, which precipitated an outpouring of commitments by businesses to meet the goals set out), or in response to gun violence (as with Dick’s Sporting Goods following the Parkland school shooting), for instance.
In this regard, business can serve as a champion of good governance and the rule of law, advocating for improving the standards of governance where appropriate, and initiating collective efforts with like-minded companies with shared interests in stronger rule of law. Chambers of Commerce and other trade associations can be powerful voices when it comes to advocating for a strong rule of law that encourages foreign investment and secures stable business environments. Directors can urge the associations they are involved in to initiate efforts to support the rule of law, helping to bring to bear the influence and credibility of the business community to move the needle, in a positive way, on the quality of governance and the rule of law. Further, there are business-driven associations that provide a platform for collaboration to support the rule of law.
With the rule of law being challenged in so many countries around the world, businesses have both a strong interest in and ability to contribute to fostering a strong rule of law everywhere. Businesses, and their directors, should be part of the urgent work to publicize and mitigate what it is we as a global community will lose if the rule of law is undermined.
Ulysses Smith is a US-based lawyer and director of the Business and the Rule of Law Program at the Bingham Centre for the Rule of Law. All thoughts are his own and do not necessarily reflect those of NACD.
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.”
At a mainstage panel during NACD’s 2016 Global Board Leaders’ Summit on September 19, directors, economists, and former regulators discussed the potential regulatory, economic, and geopolitical implications of the coming election and reflected on how corporate directors and executive teams should adjust to greater levels of ambiguity. One of the panelists, Nicholas M. (Nick) Donofrio, director of Advanced Micro Devices Inc., BNY Mellon Corp., Delphi Automotive PLC, Liberty Mutual Co., the MITRE Corp., and NACD, and the former head of innovation at IBM, characterized today’s external environment as “lumpier and more abrupt than even a few years ago,” forcing companies and their boards to be always on alert and to act quickly in response to change.
The panelists offered a range of projections to help corporate directors assess the business impact of the upcoming elections. They emphasized that aside from a new occupant of the White House, the elections also have the potential to drive significant changes in Congress, major regulatory agencies, and the judicial system. The discussion centered on four major questions of importance for companies and the boards that oversee them.
How likely is a major reform of the tax code?
Reform of the corporate tax code is long overdue, said former U.S. Senator Olympia J. Snowe, director of Aetna, Inc. and the Bipartisan Policy Center. For years, companies have learned to accept the “permanent temporary tax code,” and the resulting policy uncertainty has made investment and capital allocation decisions more challenging. Snowe suggested that even if House and/or Senate control switches from one party to another, it is unlikely that Democratic and Republican congressional leaders will be able to transcend their fundamental differences about taxation and break the current gridlock. Most likely, she believes, the incoming president will use the power of the pen to tweak the current tax code through executive orders.
Should we expect continued regulatory activism?
Troy A. Paredes, director of Electronifie and former Commissioner of the U.S. Securities & Exchange Commission (SEC), shared his concern that “the tidal wave of regulations” seen in the past few years won’t slow down, and it will force companies to commit more time and resources to compliance. “Elections are always major inflection points,” he said, that either sustain or reset the policy priorities of the SEC and other key regulatory bodies such as the Commodity Futures Trading Commission, Federal Trade Commission, and Federal Communications Commission. Meanwhile, Paredes urged directors to be alert as to whether Mary Jo White, the current chair of the SEC, will have enough time in her remaining tenure to finish rule-making on key corporate governance matters covered in Dodd-Frank.
Will our political system address skill shortages in the labor market?
Nick Donofrio offered a mixed view of how the country is addressing the looming crisis in the labor market where current skill sets do not align with the future industry needs. “Our political institutions are too polarized to take meaningful action,” he said. However, it’s crucial that the United States build a digitally competent and productive labor force that can be employed to deliver high-tech manufacturing. “We cannot afford to only create [financial] value in this country, but we must also [manufacture] value here. That means returning much more research and development and production to American soil.” In the absence of government investment, he’s optimistic that the private sector will step up to address this critical challenge and find innovative ways to reskill displaced workers.
How will the United States make itself more competitive globally?
Harry Broadman, a seasoned economist and the CEO and managing partner of Proa Global Partners LLC, reminded the audience that the United States faced a similar set of challenges to its global competitiveness in the 1980s when Japan was projected to become the world’s economic leader. A major difference today may be the backlash against free trade, which could jeopardize the adoption of the Trans-Pacific Partnership and threaten the underpinnings of the European Union. Broadman underlined that it will be critical for U.S. policymakers to remove barriers to foreign investments from high-growth emerging market companies that will contribute to quality job growth. This new generation of enterprises is important to the future of global business, which will no longer be dominated by firms headquartered in the West.
He and other panelists also spoke extensively about the importance of major investments in public infrastructure. America’s crumbling highways, bridges, ports, and technology infrastructure significantly impede further productivity growth, which Broadman believes is the country’s major Achilles’ heel.