By Kresimir Peharda, Partner.
On July 21, 2016, a blue ribbon panel of 13 individuals issued a set of guidelines for corporate governance for U.S. public companies. The guidelines are fittingly called Commonsense Principles for Corporate Governance. To view the principles click here http://www.governanceprinciples.org/wpcontent/uploads/2016/07/GovernancePrinciples_Principles.pdf . The principles cover the topics of board composition, board functioning, agendas for board meetings, management succession planning, and management compensation.
While geared towards large, US based public companies, the ideas can be utilized by smaller and private companies. The following is a selection of ideas that may apply to all companies regardless of size.
Board of Directors
Key insights about composition and functioning include:
- Directors’ loyalty should be to the shareholders and the company. A board must not be beholden to the CEO or management.
- Ideally, in order to facilitate engaged and informed oversight of the company and the performance of its management, a subset of directors will have professional experiences directly related to the company’s business.
- Directors should have complementary and diverse skill sets, backgrounds and experiences. Director candidates should be drawn from a rigorously diverse pool.
- Boards need to be large enough to allow for a variety of perspectives, as well as to manage required board processes – they generally should be as small as practicable so as to promote an open dialogue among directors.
- Directors need to commit substantial time and energy to the role. Therefore, a board should assess the ability of its members to maintain appropriate focus and not be distracted by competing responsibilities.
- A company is more likely to attract and retain strong directors if the board focuses on big-picture issues and can delegate other matters to management.
- Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of director compensation in stock, performance stock units or similar equity-like instruments. Companies also should consider requiring directors to retain a significant portion of their equity compensation for the duration of their tenure to further directors’ economic alignment with the long-term performance of the company.
- Board refreshment should always be considered in order to ensure that the board’s skill set and perspectives remain sufficiently current and broad in dealing with fast-changing business dynamics.
- Boards should have a robust process to evaluate themselves on a regular basis, led by the non-executive chair, lead independent director or appropriate committee chair. The board should have the fortitude to replace ineffective directors.
Over the course of the year, the agenda should include the following:
- A robust, forward-looking discussion of the business.
- The performance of the current CEO and other key members of management and succession planning for each of them.
- Creation of shareholder value, with a focus on the long term.
- Major strategic issues (including material mergers and acquisitions and major capital commitments) and long-term strategy, including thorough consideration of operational and financial plans, quantitative and qualitative key performance indicators, and assessment of organic and inorganic growth, among others.
- The board should receive a balanced assessment on strategic fit, risks and valuation in connection with material mergers and acquisitions.
- Significant risks, including reputational risks. The board should not be reflexively risk averse; it should seek the proper calibration of risk and reward as it focuses on the long-term interests of the company’s shareholders.
- Standards of performance, including the maintaining and strengthening of the company’s culture and values.
- Material corporate responsibility matters.
- Shareholder proposals and key shareholder concerns.
- The board (or appropriate board committee) should determine the best approach to compensate management, taking into account all the factors it deems appropriate, including corporate and individual performance and other qualitative and quantitative factors
Critical Activities of the Board
The principles set forth activities critical to proper board functioning such as:
- The full board (including, where appropriate, through the non-executive chair or lead independent director) should have input into the setting of the board agenda.
- A board should be continually educated on the company and its industry. If a Board feels it would be productive, outside experts and advisors should be brought in to inform directors on issues and events affecting the company.
- As authorized and coordinated by the board, directors should have unfettered access to management, including those below the CEO’s direct reports.
- At each meeting, to ensure open and free discussion, the board should meet in executive session without the CEO or other members of management.
- The board (or appropriate board committee) should discuss and approve the CEO’s compensation.
Management Succession Planning
While some companies are too small to have formal plans nevertheless they would do well to consider the following concept:
- Companies should inform shareholders of the process the board has for succession planning and also should have an appropriate plan if an unexpected, emergency succession is necessary.
The principles detail essential components of a compensation philosophy including:
- Compensation plans should be appropriately tailored to the nature of the company’s business and the industry in which it competes.
- Compensation should have both a current component and a long-term component.
- Compensation should not be entirely formula based, and companies should retain discretion (appropriately disclosed) to consider qualitative factors, such as integrity, work ethic, effectiveness, openness, etc.
- Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. The vesting or holding period for such equity compensation should be appropriate for the business to further senior management’s economic alignment with the long-term performance of the company.
- Companies should maintain claw-back policies for both cash and equity compensation.
While these principles are not legally binding they are likely to be used as reference point for evaluating performance of boards of public companies and maybe all larger entities. Companies large and small could benefit from using these guidelines as a benchmark for their own boards. In so doing, enterprises may strengthen their position in shareholder litigation involving the company’s board of directors.