Reflecting on the second anniversary of the passing of the Dodd-Frank financial reform legislation, the business media were quick to notice regulatory agencies’ slow pace in putting the mandates into effect. For the past two years, directors have waited for the numerous rules on corporate governance as promulgated by the landmark legislation to become final.
Although regulators are not nearly finished with the resulting rules from Dodd-Frank, the role of the boardroom is to provide oversight while considering the challenges coming around the corner. Directors must monitor current corporate performance with an eye on the company’s long-term strategy.
NACD’s latest publication, Governance Challenges–2012 and Beyond, offers a forward-looking perspective on the priority topics dominating boardroom discussion. Governance Challenges–2012 and Beyond features current guidance and thought leadership from six of NACD’s Strategic Content Partners, on issues ranging from executive compensation and director liability to risk oversight and board effectiveness.
Here are just a few highlights:
Mastering CEO succession planning from Heidrick and Struggles, CEO succession is critical to the long-term success of any company. Today, full board engagement is necessary for proper management of the leadership pipeline. That means ongoing boardroom involvement to ensure that succession plans can be readily adapted to changing circumstances, with a particular eye toward both predictable and unpredictable leadership disruption. Among other practicable suggestions, the report suggests mock board meetings to identify CEO successors and strategies to ease the transition.
Do financial statements and disclosures tell the company’s whole story? According to KPMG’s Audit Committee Institute, this question has become more important than ever, given the call for greater transparency from regulators and investors. In disclosures, directors should go beyond what is required to address expectations and provide a clearer context for the decisions made. To assist in this process, the board may choose to enlist the management-level disclosure committee.
Understanding the drivers of the business. In this section, Marsh and McLennan Companies continues this discussion originally visited in 2010 by the Report of the NACD Blue Ribbon Commission on Performance Metrics. To effectively identify and mitigate risks, it is critical that directors understand what drives profit and growth throughout the organization. While directors often receive an abundance of data on performance, they are less likely to receive information on the paths that lead to profit or loss. As Marsh & McLennan suggests, the board needs information on the trajectory of the enterprise if they are to serve as a strategic asset.
Legislators, regulators and shareholders have had greater influence on the boardroom than ever before. With insights and practical guidance from the nation’s leading boardroom experts, Governance Challenges–2012 and Beyond is an essential resource for directors who understand the need to stay ahead of the curve.
Dr. Howell’s remarks were grounded in one key theme: Free cash flow is king. All other performance metrics are secondary when understanding how much value an enterprise has created (or destroyed). As Dr. Howell states, “What other metric can you take to the bank? Do you walk up to the bank teller and say, ‘I’d like to deposit 25 earnings per share (EPS) or 50 returns on equity (ROE)?’ No. You go to the bank and deposit cash. All other metrics are based on accounting techniques and can be engineered. You load up cash and take it to the bank.”
From a background perspective, it’s important to realize that Dr. Howell is a distinguished professor at Dartmouth College’s Tuck School of Business. He has been the CFO of two very large publicly traded companies, and he’s been involved in practicing and teaching finance for over 50 years. Dr. Howell is an icon of finance, and all directors focused on demonstrating exemplary board leadership will benefit from Bob’s guidance and insights. As one attendee stated, “That session was worth the price of admission. I have been a director on public company boards for over 10 years, and I have never heard finance positioned in such a simple manner. All directors should come to NACD’s Director Professionalism program.”
The session started with a brief discussion of how much time directors and corporate governance executives spend, or should allocate, on various phases of the business:
Monitoring the firm’s performance
Challenging results and practices
Assessing projected performance
Driving sound economic decisions, and
Increasing firm value
Attendees’ perspectives on time allocation across these five phases varied. While most admitted that they wished the majority of time was on numbers three to five (the future), many were challenged to really determine the most effective way to quickly define numbers one and two (the past) and allocate more time to overseeing strategy and future efforts to unleash potential shareholder value.
During the two-hour interactive discussion, Dr. Howell emphasized the importance of selecting the right performance metrics and focusing the board’s role on the financial objective of the firm: driving long-term shareholder value. Specifically, through the future stream of cash flows, management’s mission is to generate more cash, preferably sooner than later, and at a lower discount rate. Many performance metrics were discussed, and Professor Howell stated that “Traditional metrics are lousy descriptors of value. Good ones are grounded in cash flow. ROIC (return on invested capital) and ROEmarket (return on equity, based on market value) are probably the two best. Read NACD’s new Report of the NACD Blue Ribbon Commission on Performance Metrics: Understanding the Board’s Role to get a good understanding of how to identify, prioritize and measure performance of management and your company.”
Through the right combination of compensation, metrics and value creation, the board can efficiently scrutinize financial statements and add valuable oversight for management. These efforts enable directors to disaggregate the component parts of the business and determine which are creating (or destroying) value.
Thanks, Bob, for a fantastic session, and we look forward to seeing you in 2011. The directors and board leaders of Corporate America, the guardians of capitalism, are dependent upon your insights, tutelage and guidance.
This morning’s plenary on “Performance Metrics That Make a Difference,” brought together the two co-chairs of the 2010 NACD Blue Ribbon Commission on Performance Metrics, John Dillon and Bill White, as well as NACD Chairman Barbara Hackman Franklin and Jannice Koors from Pearl Meyer & Partners.
When it comes to financial metrics, NACD Chairman Franklin stressed that the board “sometimes… just takes what management gives us.” The board must “make sure that senior management really buys into [the established] strategy, goals, and performance measures,” agreed Jan Koors. It’s important to “trust, but verify,” and for the board to take a more proactive role in overseeing performance metrics.
The panelists agreed that a conversation on performance metrics easily lends itself to a discussion about compensation. However, what boards should be trying to accomplish is a wholesome, deeper dive into all of the various components of the enterprise. Understanding information about your company provides clarity into what can be improved and ultimately perform better.
A lively Q& A session from the crowd of 750 directors at the 2010 NACD Corporate Governance Conference
John Dillon, who serves on boards including Caterpillar and DuPont, emphasized that, while boards currently address performance metrics in proxy statements, the board needs to think more broadly and engage leadership to get an appropriate number of financial and nonfinancial metrics to understand what is going on in the company.
Jan Koors summed it up best when she said “boards do a good job at telling shareholders what the metrics are, but less good at telling why these metrics were chosen and how they relate to strategy and moving the company forward.”