This newsletter’s Table of Contents is as follows:
1.Elizabeth Warren’s Accountable Capitalism Act
2. Legislation coming on Human Capital Management Reporting
3. The shifting sands of auditing should send signal to boards
4. Does Our Board Have the Right Perspective and Experience?
5. (Artificial) Intelligence without trust: a risky business
6. CEO Turnover
7. At a Snail’s Pace: Corporate Board Practices in the S&P 500 and Russell 3000: 2019 Edition
8. CMOs on Boards: Is Change Coming?
1. Elizabeth Warren’s Accountable Capitalism Act
Delaware’s supreme court chief justice sees merit in calling for employee representation in the boardroom and ESG disclosure for all large companies — public and private.
Last year, U.S. Sen. Elizabeth Warren, D-Mass., who is also running for president, introduced the Accountable Capitalism Act, calling for a host of requirements including “substantial” employee representation on corporate boards; environmental, social and governance (ESG) disclosure; and an obligation for company directors to consider the interests of all corporate stakeholders, not just those who hold stock.
Leo Strine, Delaware supreme court chief justice, weighs in on whether Warren’s bill will help move the inequality needle.
“One of the most interesting things about the bill is that she actually deals with the power and purpose issue very explicitly by requiring that a segment of the board be elected by the workers,” he explains.
Strine says he finds it humorous when people call proposals like this “radical,” or “almost like communism” given that such systems are working in other nations, “places where really wealthy people look to buy their cars and their watches.” Germany, he points out, has labor representatives on boards and the country “has a pretty kick-butt economy. Scandinavia has one of the other better functioning economies in the world and they have a higher level of labor participation. In the U.S. whether this is realistic, that’s for others to decide.”
In the UK, he notes, the new corporate governance code is going in that direction. “You either have to have a director elected by the workers, one who is specifically charged with having the perspective of the workers and caring about their best interest, or you have to form a board committee focused on employee welfare.”
That concept may be less fundamental than Warren’s bill, he says, “but you could see that being achievable in the U.S.”
Warren’s focus on social-responsibility disclosure is also useful, Strine explains, but he believes it should extend to institutional investors.
“It’s unrealistic to just focus on the directors. We shouldn’t just have the directors in the companies talking about social responsibility. The institutional investors should be talking about how they take these factors into account.”
Another worthwhile component of her bill, he adds, is that ESG disclosure is focused on the size of the company, not whether the firm is publicly traded.
Given that the ultimate goal is to encourage companies not to pollute, mistreat employees, use child labor or thwart consumer rights, he says, whether a company is publicly traded or not shouldn’t matter.
“If we’re going to go to ESG disclosure, we don’t want to create another incentive for companies to go private and not be public,” he stresses.
The growing trend by companies to bypass the public route, he maintains, may be narrowing the window into the U.S. economy, “because when you don’t have as many public companies as a percentage of your economy, what you actually know about what’s going on in your economy is less.”
Source: Directors & Boards
2.Legislation coming on Human Capital Management Reporting
What Were the Topics?
1. Mandatory HCM Reporting. Representative Cynthia Axne (D. Iowa) introduced a draft bill to amend the Securities Exchange Act of 1934 (Exchange Act) to require issuers to disclose information about human capital management (HCM) in annual reports on topics such as demographics, compensation, composition, skills, culture, health, safety, and productivity. Many of these topics were previously raised in the 2017 rulemaking petition to the SEC by the Human Capital Management Coalition and in the recommendations to the SEC in March 2019 by the SEC Investor Advisory Committee, which we previously wrote about.
2. Number of Outsourced Corporate Jobs. In a separately drafted bill, Rep. Axne further proposed that public companies annually disclose the total number of employees in each state and foreign country, as well as the percentage change from the previous year. The draft bill exempts smaller and newly public companies from this requirement.
3. Rate of Pay Raises—Executives vs Employees. The legislative proposal submitted by Representative Dean Phillips (D-MN) requires public companies to disclose “the percentage increase in the median of the annual total compensation of all executive officers” and that of all its employees over the past year and compare each to the rate of inflation. The proposed bill requires disclosure of the ratio between the two pay raise percentages.
Source: Davis Polk
3. The shifting sands of auditing should send signal to boards
Back in mid-2015 the Australian Securities and Investments Commission – or ASIC – announced its push to make it easier to prosecute company executives and directors for overseeing poor business culture that leads to very poor business performance.
This represented a seismic shift on the governance landscape and the rumblings continue, this time in the corridors of some of the world’s most prestigious accounting firms.
Just recently, KPMG announced that it has broken with a century-long tradition of hiring only accounting and economics graduates for its auditing section by taking on 42 graduates in this area who boast none of these qualifications. Rather, they come with what are termed “soft skills” – in areas such as mathematics, IT, social science…and even counter terrorism.
What’s more, KPMG anticipates that one-third of its almost 400 audit graduate intake this year will have no accounting background.
And it’s all because of the shifting sands of what was traditionally the auditing environment. The anticipated new corporate reporting rules will demand that the modern external auditor of today and tomorrow is no longer required to audit only accounts, look at revenue and expenses and carry out random spot checks on internal controls and financial systems before signing off on a company’s accounts.
It’s poised to be an altogether more sophisticated undertaking, where, with so much these days being done by IT systems, data analytics will become increasingly central to the audit process.
It seems clear that the auditor of the future will be a very different animal from that of even five years ago and will be required to also look into the corporate culture on the grounds that bad culture often leads to bad conduct and equally bad outcomes.
This will allow them to appreciate how culture influences conduct and best of all, will place them in a position – and hopefully early in the piece – where they can flag cultural issues that could lead to corporate collapse and advise and assist accordingly.
Now, if the big accounting firms are increasingly seeking a mix of accounting and economics graduates and those with lateral, innovative and social skills, that should tell us where the corporate world is heading?
And that’s where forward-thinking boards should already be – or at least be heading.
Source: Corporate Governance Institute
4. Does Our Board Have the Right Perspective and Experience?
Use Diversity to Your Advantage.
The most effective means of avoiding groupthink and cognitive dissonance is a diverse board. Diversity of age, gender, ethnicity and geography is powerful and can be a competitive advantage. Although the quick consensus of homogeneity may make decision-making more efficient, it also threatens the board’s ability to detect threats and recognize opportunities. Diversity also brings unique experiences that can foster innovation, provide deeper consumer understanding, and richer brainstorming.
Link Board Makeup to the Future
Experiential diversity is also an important link to strategy. Most companies’ boards reflect their past, yet the most important threats, opportunities, and decisions are future-looking. Under CEO Immelt, GE’s strategy included becoming a global top ten software company by 2020. Yet, only one person of sixteen on the GE board had significant experience in the tech industry. In order to provide evaluation of the company’s strategy and oversight of its execution, the Board should have adequate industry-specific knowledge to be able to constructively challenge the CEO.
Source: Lessons learned from GE
5. (Artificial) Intelligence without trust: a risky business
Artificial intelligence (AI) mimics the learning function of the human brain, which means it could be deliberately or accidently corrupted and even adopt human biases, potentially resulting in mistakes and unethical decisions. Control of AI systems by the wrong hands is also a concern. Any AI system failure could have profound ramifications on security, decision-making and credibility, and may lead to costly litigation, reputational damage, regulatory scrutiny, and reduced stakeholder trust and profitability.
AI will eventually transform the business landscape, but its pace of development is hampered by a lack of trust. To addresses some of these concerns, the Singapore government published the Model AI Governance Framework for public consultation, guided by two key principles: Firstly, the AI decision-making process must be explainable, transparent and fair. Secondly, the AI solution should be human-centric.
Questions for boards:
- Does the board understand the potential impact of AI on the business model, culture, strategy and sector?
- Has the management assessed how the adoption of AI impacts the integrity of its finance function and its financial statements?
- Are there sufficient human overrides to ensure oversight and compliance for AI-driven processes and transactions?
- How are the insights and outcome of the AI model explained and deployed in a sensitive and defendable manner?
- Does the board believe that the past will be a good predictor of the future? If not, how can an AI model be built to work in the future?
Source: EY
6. CEO Turnover
PwC released the results of its 19th annual CEO Success Study: Succeeding the long-serving legend in the corner office, analyzing CEO turnover between 2004 and 2018 at the world’s largest 2,500 companies. This year’s study focused on long-serving CEOs (defined as having been in the role for 10 or more years), their successors and a deep dive into 2018 CEO turnover.
The study found that nearly 18% of CEOs left their role in 2018, the highest turnover rate since the inception of the study.
The paper notes the following:
- Long-serving CEOs are more likely to have been internal candidates (84%) compared to those chosen outside with shorter tenures (77%).
- CEOs succeeding long-serving CEOs are more likely to have shorter tenures. They have lower Total Shareholder Return (TSR) and are more likely to be forced out of the role, compared to long-serving CEOs.
- For the first time in the study’s history, in 2018, more CEOs were dismissed because of ethical lapses than due to board struggles or financial performance.
The strong overrepresentation of long-serving CEOs suggests that succession decisions may be delayed in North America compared with the rest of the world, increasing the risk of a failed succession.
Boards have to take care not to become complacent. Term limits, mandatory retirement ages, or other mechanisms aimed at limiting CEO tenure are not a panacea.
Boards need to acknowledge that statistically speaking, successors to long-serving CEOs start with the deck stacked against them. As a result, the board needs to make clear that the new CEO has their support, and that they are not constraining the successor as he or she is thinking through a plan for the company’s future. This issue can be particularly dicey when the outgoing CEO is also the board chair: The rest of the board should be wary of the chair continuing to run the company and impeding the successor.
Boards should be generally mindful of the merits of separating the roles of chief executive and board chair. We do know that combining the roles increases the risk of ethical lapses.
Boards should also consider whether the best candidate to succeed a long-serving CEO may be an outsider rather than an insider. In five of the last six years, when we examined the performance of departing CEOs, those who had come in as outsiders outperformed insiders. One hypothesis for this differential is that in the current climate of disruption, technological advances, and changing competitive dynamics, the most effective candidates may be those whose backgrounds, perspectives, and skill sets are different from those possessed by the in-house candidates.
Source: PWC
7. At a Snail’s Pace: Corporate Board Practices in the S&P 500 and Russell 3000: 2019 Edition
The Corporate board practices in the russell 3000 and S&P 500; 2019 edition, documents corporate governance trends and developments at 2,854 companies registered with the US Securities and Exchange Commission (SEC).
Findings from the report illustrate the state of board practices, which may vary markedly depending on the size of the organization or its business industry:
Directors are in for a long ride: their average tenure exceeds 10 years. About one-fourth of Russell 3000 directors who step down do so after more than 15 years of service.
Despite demand for more inclusiveness and a diverse array of skills, in their director selection companies continue to value prior board experience. Only a quarter of organizations elect a director who has never served on a public company board before.
Corporate boards remain quite inaccessible to younger generations of business leaders, with the highest number of directors under age 60 seen in new-economy sectors such as information technology and communications. Only 10 percent of Russell 3000 directors and 6.3 percent of S&P 500 directors are aged 50 or younger.
While progress on gender diversity of corporate directors is being reported, a staggering 20 percent of firms in the Russell 3000 index still have no female representatives on their board. And almost all board chair positions remain held by men (only 4.1 percent of Russell 3000 companies have a female board chair).
Periodically evaluating director performance is critical to a more meritocratic and dynamic boardroom. Only 14.2 percent of companies disclose that the contribution of individual directors is reviewed annually.
Among smaller companies, staggered board structures also stand in the way of change. Almost 60 percent of firms with revenue under $1 billion continue to retain a classified board and hold annual elections only for one class of their directors, not all.
Though declining in popularity, a simple plurality voting standard remains prevalent. This voting standard allows incumbents in uncontested elections to be re-elected to the board even if a majority of the shares were voted against them. In the Russell 3000, 51.5 percent of directors retain plurality voting.
Only 15.5 percent of the Russell 3000 companies have adopted some type of proxy access bylaws. Such bylaws allow qualified shareholders to include their own director nominees on the proxy ballot, alongside candidates proposed by management. In all other companies, shareholders that want to bring forward a different slate of nominees need to incur the expense of circulating their own proxy materials.
Source: Harvard Law
8.CMOs on Boards: Is Change Coming?
On paper, it would seem that today’s boards of directors should have an obvious interest in bringing marketers to the table.
After all, the current business environment has changed dramatically from just a few years ago: Now, senior marketing executives play a key role in such areas as digital transformation and social media — in addition to the task of managing engagement and the crucial relationship between customers and brands. Today’s companies must know their customers, and with the growing use of data and analytics, it’s marketers who are able to bring the deep knowledge of what clients want and can help create a more personalized customer journey.
Nevertheless, the number of marketers serving as directors on Fortune 1000 company boards remains surprisingly low: Our research finds that only 26 of the thousands of public company board seats are currently occupied by marketing leaders. As boards look beyond CEOs as a pool of director talent — including executives with experience in technology, finance, marketing and other areas —the good news is that the tide may be turning. As we have watched an increasing number of talented marketers ascend into CEO- and president-level roles, it is apparent that their chances of landing board roles (as general managers) will increase.
And importantly, it is worth noting that most boards naturally skew older — the average age of S&P 500 directors is 63, according to our 33rd annual United States Spencer Stuart Board Index (SSBI) — and the majority of directors on publicly traded boards simply aren’t as fluent as CMOs in newer/disruptive business models and strategies. Consequently, we believe more boards will seek out the specialized knowledge that marketers possess, helping to facilitate a more “modern” conversation among non-executive directors. The CMO’s presence also likely will bring down the average age of the board as well.
Source: Spencer Stuart
