Tag Archive: Key Agreed Principles

Turning ‘Commonsense’ Governance Into Common Practice

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Friso van der Oord

Friso van der Oord

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.

For more information, please review the brief NACD Audit Committee Chair Advisory Council: Audit Committee Oversight of Non-GAAP Financial Measures.

Further Guidance

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.

 

Corporate Governance Lessons from the Girl with the Dragon Tattoo

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Fifty years old and I still haven’t kicked the habit of the end-of-summer book report. Sad really.

The Girl with the Dragon Tatoo

I must admit I didn’t think that Steig Larsson’s first thriller would provide food for NACD thought, but listen up all you private company directors, nomination and governance chairs worried about CEO succession, and anyone concerned with boardroom ethics and director independence. This book review is for you.

Several things are well known about the author of The Girl with the Dragon Tattoo author, Steig Larsson:

  • He died before his trilogy of crime stories became best sellers.
  •  He was Swedish.
  •  He was a former journalist who was expert in covering right-wing extremism.

It is not known how much he knew or cared about fiduciary responsibility or the governance practices of the best-run family businesses, and midway through the book it becomes obvious that the corporation and the magazine company around which most of the action is set, have not based their governance practices on the NACD Key Agreed Principles. Sure, both are private (not public) companies and being based in the frozen north of Sweden and in Stockholm respectively, are not bound by U.S. law. Nonetheless, the conditions under which old man Vanger joins the magazine company board, and the threats subsequently made to the company co-founders, would raise the eyebrows of anyone with even a rudimentary knowledge of the Duty of Loyalty. Transparency is not a core value and self-interest rules the day.

The Vanger family who run the company—and, indeed, the community at the heart of the book—would benefit from attending the family business session at this year’s NACD conference. As usual, the session will be facilitated by Jack Moore, a member of the Benjamin Moore Paint family and well-seasoned in helping directors and executives of family-run companies deal with some very sensitive interpersonal issues. Jack will be joined by Linda Thomas, the CEO of Wilcox Farms, an egg distribution company based in the Pacific Northwest. Chris Wilcox, one of the family members now involved with running the 100-year-old egg farm, will be there too. This will be textbook—not crime thriller—corporate governance, but the panel have promised some lively stories even if they can’t manage mystery and intrigue. Don’t miss it.

Later in Larsson’s novel (and I must be careful not to give away the plot) there are serious questions about who should lead the Vanger empire, although the old man is still very much alive at the end of the story. It all comes out all right in the end, but there’s no doubt that their succession planning and executive evaluation process was sadly lacking. The company counsel, Frode, is pretty much a good guy throughout, but really questions must be asked about the board process and how he allowed it to become so compromised. HealthSouth director and law professor Charles Elson, Heidrick and Struggles’ Bonnie Gwin, and Peter Wiley, chairman and former CEO of Wiley and Sons, will discuss C-suite succession planning at the NACD Conference. Join them to find out how it should be done.

And if a girl with a dragon tattoo offers to invest in your latest venture, give her a wide berth. I have reason to believe her fortune was not made honestly.

 

The M&A Litmus Test: Part 4

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Today is the penultimate day of your M&A Litmus Test, so we’ll continue by testing your board’s…

…Info Flow.

How good is your information flow? For the board, knowledge is not merely a source of power; it is the very key to effectiveness. The following wisdom is adapted almost verbatim from the Report of the NACD Blue Ribbon Commission on Director Liability.

When it comes to M&A information, flow is critical.  The type, quantity, format, timing, and source of the information that fuels board knowledge will vary from board to board and will also change over time for a particular board. It will also vary among board members, who have different levels of experience and expertise with different topics.

Information flow is critical for directors with respect to capital allocation decisions—in particular, mergers and acquisitions. This area requires special attention to the long-term interests of the corporation and the ways in which management’s interests may affect transactions. As the report noted, the board and management need to regularly discuss the opportunities for and threats to the company, even in the absence of any planned or foreseen transactions, so that directors have an understanding of the business context in which these issues may arise.

Depending on the size and business context of the company, notes the report, directors should periodically receive information related to, and discuss with management, the following:

  • Comparative studies and analysis concerning whether the company would be more viable by merging with, or entering into alliances with, another candidate, or standing alone;
  • Possible acquisition candidates. When discussing the fulfillment of certain of the company’s business strategies, such as entering into new lines of business, directors should receive information on possible alternatives, such as an acquisition or strategic alliance, to achieve the same objectives; and
  • The merger activity of competitors, including the impact of recent activities on the company’s market share. Competitive analysis as to other suitors for the same potential acquisition candidates might also be warranted.

Maintaining an up-to-date understanding of these issues will help directors to remain prepared for the time when management actually proposes a transaction. This is particularly critical for directors of public companies, who should understand the company’s plans and legal options for responding to unsolicited takeover offers.

In evaluating a particular transaction, notes the Report, directors should seek specific information about the price, timing, and certainty of the transaction, and should be proactive in overseeing negotiations. Directors should understand how the transaction will be financed, and the projected financial impact on the company under reasonably likely scenarios. Where the sale of the transaction warrants it, directors should seek independent financial advice from outside experts to consider together with management’s financial assessment.

Directors should also obtain a high-level analysis of the merger documentation, including an understanding of the most important representations, covenants, and indemnities contained therein and their application to the company and the transaction. In addition, directors should receive input from market and investor relations experts about the best manner in which to position the transaction and the likely reception from investors and creditors. As with any other matter before them, directors should crucially evaluate all the information they have obtained and arrive at an independent assessment instead of relying exclusively on management’s views.

Directors should also be alert to differences between management and shareholder interests in negotiating a particular transaction. For example, shareholders will be far less interested than managers in knowing who will continue to work for the merged company and with what responsibilities. These employment issues are important but they should not override concerns about long-term returns to shareholders.

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