This newsletter’s Table of Contents is as follows:
- Board composition: Greater than the sum of its parts
- Independent directors: New class of 2017, TOP 6 TRENDS
- Are boards discussing #MeToo risks?
- Netflix Approach to Governance: Genuine Transparency with the Board
- What is the best way to create a succession plan for a family business?
- Engaging with stakeholders on long-term governance, ethics and cultural issues
- “Sustainalytics ESG Ratings” NOW Publicly Available on YOUR Company’s Yahoo Finance Page
- Delaware Court Finds Continued Compensation to Incapacitated Chairman Could Render Directors Liable for Claims of Waste and Bad Faith
1. Board composition: Greater than the sum of its parts
A director’s qualifications to serve on a board are key. Securities and Exchange Commission (SEC) rules have required disclosure of directors’ biographical information for many years, generally in the form of a five-year employment history. In 2009, the SEC expanded the proxy rules to require companies to “briefly discuss the specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director…”1 This “skill set” disclosure generally appears in a short paragraph or a series of bullet points following each director’s biographical information, indicating what the person brings to the board, such as international, management, or financial skills or other types of experience. Despite this expanded disclosure, many institutional investors and others continue to question why members of the board have been selected.
In response to these concerns, some companies have provided a in their proxy statement. While skills matrices can be useful, their use as disclosure tools – or as a means of objectively assessing board composition – may be problematic. Defining a director’s skills is not as easy as it may seem using simple terms in the matrix including technology, international or leadership. Without the , understanding a director’s skills based upon a simple word is difficult.
Other companies have developed possessed by the board as a whole, without attributing specific skills to individual board members. Some institutional investors prefer this approach, as it reflects the abilities of the full board, rather than the skills of each individual board member. Companies should consider clearly communicating their individual board attributes, remembering that the goal is to have the proper individuals with the skills and qualifications necessary to empower the board to properly oversee and advise management.
Source: adapted from Deloitte
2. Independent directors: New class of 2017, TOP 6 TRENDS
Boards are seeking slates of candidates who bring a diverse perspective and a range of functional expertise, including on complex, evolving areas such as digital transformation, e-commerce, public policy, regulation and talent management. As a result, boards are increasingly considering highly qualified, nontraditional candidates, such as non-CEOs, as well as individuals from a wider range of backgrounds. These developments are expanding the short lists of potential director candidates.
A review of Fortune 100 disclosures found THE TOP 6 TRENDS:
A. The class of 2017 tends to be younger.
There appears to be an ongoing shift toward younger directors.
- For the class of 2017 entering directors, the average age of these individuals was 57, compared to 63 for incumbents and 68 for exiting directors.
- Of the entering class, 15% were under 50, an increase from 9% in the prior year.
- And, for the second consecutive year, we observe that over half of the entering class was under the age of 60.
- Exiting directors largely continue to be age 68 or older.
B. The Fortune 100 class of 2017 includes more non-CEOs.
While experience as a CEO is often cited as a traditional first cut for search firms, 54% of the entering class served in other roles, with non-CEO backgrounds including other executive roles or non-corporate backgrounds (academia, scientific organizations, nonprofits, government, military, etc.).
- This represents a slight increase from 2016 with most of the shift stemming from individuals holding or having held other senior executive positions.
- Approximately 30% appear to be joining a Fortune 100 public company board, having never previously served on a public company board – similar to 2016.
C. The class of 2017 brings greater finance and accounting, public policy and regulatory, and operational skills to the table.
Corporate finance and accounting were the most common director qualifications cited by companies in 2017, up from fifth in 2016.
- A couple areas saw notable increases: government and public policy, operations and manufacturing, and transactional finance.
- This year, some areas tied in ranking, and in a twist, corporate references to expertise in strategy fell from third in 2016 to below the top 10 categories of expertise.
- Companies also made fewer references to board service or governance expertise compared to the prior year.
D. Most of the 2017 entering class was assigned to audit committees.
The strength of corporate finance and accounting expertise of the entering class is seen, too, with regards to key committee designations.
- Of the three “key committees” of audit, compensation, and nominating and governance, the 2017 entering class was primarily assigned to serve on audit committees.
- A closer look at the disclosures shows that 63% of the new directors that were assigned to the audit committee were formally designated as audit committee financial experts.
- In comparison, the corresponding figure in the prior year was 59%.
E. The class of 2017 is 40% female.
As in the prior year, 40% of the entering class were women, but overall percentages were largely unchanged, with women directors averaging 28% board representation compared to 27% in 2016.
- Also, there was minimal age difference, with the women directors averaging 57 compared to 58 for male counterparts.
- Among the directors bringing the top categories of expertise, women directors accounted for over one-third of the disclosed director qualifications. In some cases, they represented over half of the disclosed category of expertise.
F. Most Fortune 100 companies welcomed a new independent director in 2017.
This past year, over half of the Fortune 100 companies we reviewed added at least one independent director.
- This figure is a little lower than the prior year; but overall, during the two-year period from 2016 to 2017, over 80% of the companies added at least one independent director.
- Taking into account director exits – whether due to retirement, corporate restructuring, pursuit of new opportunities or other reasons – we found that nearly all of the companies experienced some type of change in board composition during this period.
Source: EY
3. Are boards discussing #MeToo risks?
A new survey conducted by theBoardlist and Qualtrics, as reported by Bloomberg, found that 57% of directors still haven’t had a boardroom discussion about the issues raised by the #MeToo movement, relating to sexually inappropriate behavior in the workplace. The survey is a follow-up to one conducted in October 2017, during the early stages of the #MeToo movement. The new results show significant progress: in October, 77% of directors said their boards had not discussed the topic. The current study found that just 22% of directors said their company has a plan for how to address sexual harassment claims. For board members who reported that their boards still had not discussed the topic, their reasoning included “not seen as relevant,” lack of prioritization” or “threatening to our CEO.
DIRECTOR LENS: How to catch up with #Metoo movement
There may be no general handbook explaining how to root out and prevent sexual misconduct in the workplace, but responsibility lies with boards to review their policies and implement the necessary oversight.
Boards must take the issue of harassment seriously and think more broadly about the workplace environment.
Organizations should have a sexual harassment hotline that is administered by an outside adviser and reports directly to the board.
Organizations that achieve a gender balance in executive and director positions send a message that sexual harassment will not be tolerated.
Sources: PWC and ICD
4. Netflix Approach to Governance: Genuine Transparency with the Board
The hallmark of good corporate governance is an independent minded board of directors to oversee management and represent the interests of shareholders. Its primary responsibilities are to hire and replace the CEO as needed, monitor performance, review and approve strategy, and assess financial reporting and risk management. In a typical corporation, the vast majority of this work is carried out through board meetings and specialized board committees.1
However, it is not clear that directors receive the information they need to make fully informed decisions on all key matters. Partly, this is due to an “information gap” that exists between management and the board: Directors have a less-complete understanding of the company and the market than executives because of their limited exposure to day-to-day activities and their independence from the business. Directors only meet 4 to 8 times per year in full board meetings, and 2 to 8 times in committee meetings.2 The information they review generally consists of dense PowerPoint presentations with extensive tables and graphs that span, in a typical large corporation, hundreds of pages. Some directors find these presentations heavy on data but light on the analysis and insights needed to fully understand the quality of management, decision making, and performance.3
Boardroom dynamics can further impede information flow, particularly in settings where the CEO maintains strict control over the content presented, when presentations are carefully scripted, when follow-up beyond one or two questions is discouraged due to time, and when presentations are made by only a limited number of executives—such as the CEO, CFO, general counsel, and not others. While fiduciary rules allow directors to rely exclusively on information provided by management, dynamics such as these can reduce the quality of that information and impair their ability to make good decisions on behalf of shareholders.
Netflix Board Practices
Netflix takes a radically different approach to information sharing with the goal of significantly and efficiently increasing transparency among the CEO, executive team, and board of directors.4 The Netflix approach incorporates two highly unique practices: (1) board members periodically attend (in an observing capacity only) monthly and quarterly senior management meetings, and (2) board communications are structured as approximately 30-page online memos in narrative form that not only include links to supporting analysis but also allow open access to all data and information on the company’s internal shared systems, including the ability to ask clarifying questions of the subject authors. This quarterly memo is written by and shared with the top 90 executives as well as the board.
Founder and CEO Reed Hastings believes that these two practices improve the ability of the board to provide what he calls an “extreme duty of care” to the corporation: “The board isn’t going to have the confidence to make hard decisions unless they really understand the market and the company.”
Source: Stanford University
5. What is the best way to create a succession plan for a family business?
Succession planning is one of the most important and challenging responsibilities of a board. Despite the significance of the task, however, the complex dynamics of a family business cause many owners to avoid it. According to a recent survey conducted by the Clarkson Centre for Business Ethics and Board Effectiveness for the ICD’s Ontario chapter, “Family members in second-generation businesses report increased concern over the development of the next generation, but still only 22 per cent of companies have a succession plan for owners.”
One reason succession planning is so difficult, particularly for family business boards, is that the CEO and the business often become inextricably intertwined. Under these circumstances, independent directors may be in the best position to help family members tackle the challenge of succession planning. An independent director can “introduce the idea of continuity planning early and often, and as a matter of risk mitigation for the business.” In addition, independent directors can also guide the family business through the process by focusing on the long-term greater good and, consequently, reducing the risk of the family business being driven by personalities and internal conflict.
In some cases, a family business board may choose to set up a formal mechanism for succession planning. The board may wish to establish a continuity committee, made up of independent directors and perhaps a company human resources leader, to report back regularly to the full board on progress. Independent directors are important to the process and can bring much-needed objectivity. They can help establish a process with time horizons and a clear assessment process, and assist with deciding who is best to lead the business forward.”
Good independent directors especially need to practise strong emotional intelligence and demonstrate respect for the family’s achievements and accomplishments while also recognizing their challenges. They will need to invest time and effort to understand the realities, unspoken language, rules and conduct of the family system. In situations of conflict, they may need to channel the family’s passion towards a more rational framework, helping the family board members and executives to rise above the family dynamics towards a process for discussing succession and making decisions from a neutral position.”
Independent directors can also play an important role when an external candidate is chosen as successor, by minimizing internal conflict and helping the new CEO understand the family dynamics.
Source: ICD
6. Engaging with stakeholders on long-term governance, ethics and cultural issues
In the May 2018 Issue of Financier Worldwide, Melissa Sawyer participated in the discussion “Forum: Engaging with stakeholders on long-term governance, ethics and cultural issues.”
The panelists discussed the importance of governance, ethics and cultural issues to businesses operating in today’s market, as well as how to optimize stakeholder interactions to drive governance issues forward and build an ethical culture. Additionally, the interview provides potential advice to organizations looking to implement policies and procedures to enhance governance, ethics and culture. In discussing how an awareness of governance, ethics and cultural issues can mitigate the broad range of corporate risks that organizations face, Melissa said, “risk mitigation is not an end unto itself. A board needs to balance the time it spends overseeing risks against the time it spends overseeing strategy.” In discussing the importance of supporting an open culture within a corporate environment, Melissa added, “A culture that fosters transparent reporting of problematic practices is always desirable, so that management and the board can quickly take action to fix issues. However, companies need to establish thoughtful processes and procedures to handle whistleblower reports so that they can weed out spurious claims and surface real problems effectively.”
Source: Sullivan and Cromwell
7. Sustainalytics ESG Ratings” NOW Publicly Available on YOUR Company’s Yahoo Finance Page
Some companies may not be aware that since February, their Yahoo Finance web page includes a separate tab with the ESG scores from Sustainalytics. The Sustainalytics quote page shows a company’s numerical rating for three categories, environment, social and governance, along with the overall ESG score. Scores range from 1 to 100. There is also a graphic representation of the score that will be tracked against the average in each category and plotted over time. The graph, currently reflecting data from 2014 to now, is intended to display trends of how a company ranks against industry peers. The page also has a chart highlighting “product involvement areas,” which reflects whether the company’s business includes products or issues such as alcoholic beverages, gambling, animal testing, controversial weapons, Catholic values, military contracting, coal and palm oil. In addition, a graph in red denotes the company’s controversy level, ranging from 0 to 5. It is unclear how much investors can glean from the summary data, as many large companies seem to fall within a mid-range. A quick study of the Dow 30 companies indicated that 18 were “average” performers in ESG ratings, while 10 companies were designated “outperformers” and two were “leaders.” Even for their controversy scores, five had “moderate” ratings, 16 were viewed to have “significant” controversies, eight companies had “high” ratings and only one, a pharmaceutical company, was deemed to have “severe” controversies.
Source: Davis Polk
8. Delaware Court Finds Continued Compensation to Incapacitated Chairman Could Render Directors Liable for Claims of Waste and Bad Faith
In an unusual finding, the Delaware Court of Chancery held that demand was partly excused and claims for corporate waste, bad faith and unjust enrichment could proceed against CBS Corporation for compensation paid to its former Executive Chairman, Sumner Redstone, who later became Chairman Emeritus. The plaintiff alleged that Mr. Redstone became incapacitated yet continued to receive compensation for work he did not perform. The court noted that claims of corporate waste and bad faith require a plaintiff to show that the board’s decision was “so egregious or irrational” that it could not be based on a valid assessment of a company’s best interest, and amount to an “extreme factual scenario.” In making its determination, the court reviewed the salary payments made to Mr. Redstone as Executive Chairman pursuant to an employment agreement. Under the agreement, the compensation committee could only increase, but not decrease, Mr. Redstone’s salary. Either party could also terminate the agreement. The agreement required Mr. Redstone to be “actively engaged” in working with the board and management, including providing overall leadership and strategic direction, offering guidance and support, coordinating board activities and communicating with shareholders. According to the court, “it should have been abundantly clear to the members of the board” that instead of being “actively engaged,” Mr. Redstone was no longer providing meaningful services to the company beginning at some point in late 2014 or in 2015, including no longer physically attending any board meetings, only introducing himself on the telephone at multiple board meetings in 2014 and early 2015, not speaking at all at other board meetings held in 2015 and not participating on any analyst calls in 2015. The court also cited to numerous press articles reporting his impairment in 2015. In addition, emails and other correspondence indicate that several directors knew about Mr. Redstone’s condition, including from having visited him personally. The court made clear that it did not expect the board to have terminated Mr. Redstone’s employment immediately after he fell ill, that he was entitled to “be treated in a dignified and respectful manner,” but the company made “no effort” to consider the financial impact of his incapacity for approximately twenty months. The record did not show that his capacity or his ability to perform was “discussed in any meaningful sense.” It was “[g]laringly absent” the lack of a memorandum or other writing “candidly assessing Redstone’s capabilities and the pros and cons of terminating” the employment agreement. The court concluded that Mr. Redstone’s contributions to the company after May 2014 were “so negligible and inadequate” that “no person of ordinary, sound business judgement” would find them worth the millions of dollars of salary that were paid to Mr. Redstone. In addition, the failure to inquire into his health and at least consider terminating the employment agreement over a twenty-month period reflects a “conscious disregard” of the directors’ fiduciary duties. As for payments rendered to him as Chairman Emeritus beginning in early 2016, the court found that the company chose to continue to pay Mr. Redstone a salary for services that it allegedly knew he could not render, and the decision to award him an ongoing salary of a million dollars under the circumstances were wasteful and lacked justification.
Source: Executive Compensation
