The confluence of shareholder, regulatory and legislative demands on today’s public company board directors is unprecedented. The NACD Directorship Boardroom Summit was convened to provide an expert outlook on what’s ahead in corporate governance, and how new and pending changes will affect such boardroom basics as CEO succession planning, the audit committee agenda, the criteria for effective director development and determining executive compensation. It brought together more than 50 corporate governance experts and major public company board directors at The Lotos Club in New York in April. Following the discussion, the audience broke into smaller groups for topic-specific roundtables chaired by renowned subject-matter experts. At the conclusion of those roundtables, the Boardroom Summit experts gathered before the entire audience to share what they had gleaned from their interactions with directors.
For starters, new proxy requirements require fuller disclosures on CEO succession, board directors’ qualifications and experience among other changes. U.S. companies, including American Express, Bank of America and Whole Foods are among a growing number of companies that are currently targeted by shareholders for these issues. The Laborers’ International Union of North America (LIUNA), for example, filed proposals with at least 14 companies asking them to detail succession planning policies and put them to a vote in their annual meetings. LIUNA’s proposals ask companies to “adopt and disclose a written and detailed CEO succession policy,” but stop short of demanding a list of potential candidates for the top job. The expectation is that activism will only increase, especially from other institutional investors and hedge funds. There could be no more opportune time than amid the contentious 2010 proxy season to bring together subject matter experts with public company directors to assess what’s shaping today’s agendas.
Egon Zehnder’s Justus O’Brien believes that shareholder activism is only likely to increase more significantly among small-cap companies. Larger companies who have grown more accustomed to the advances of shareholders are better prepared. “In some sense,” O’Brien said, “smaller-cap companies are more vulnerable.” The legislative and regulatory apparatus is facilitating greater involvement in proxy access, and providing “opportunities for activists to inquire about board qualifications, director qualifications, board composition, diversity issues and CEO succession planning so there’ll be many other points of entry into greater activism on boards.”
The result of that activism isn’t necessarily negative. “One of the interesting insights from our discussions is that the pressure being brought to bear on companies by activists isn’t always necessarily negative and may result in creating more value,” O’Brien said. “Clearly, boards need to really stay in touch with the major shareholders, and talk to them proactively to maintain some control…Also boards benefit from having a good board selection process, clarity around what you’re looking for and clarity around what the appropriate composition of the board is.”
If you serve on an audit committee, you should keep your seatbelt fastened—and perhaps tightened a bit—given the challenges and priorities ahead, suggested Jeff Cunningham. KPMG’s Mary Pat McCarthy noted that new mandates from the SEC and the Internal Revenue Service (IRS) are commanding directors’ attention. Since the publication of the examiner’s report on the Lehman Brothers bankruptcy, the SEC has sent “Dear CFO” letters to financial institutions asking for details on the use of “repurchase agreements” and securities lending transactions. The IRS has proposed a new rule that would require companies to disclose in their corporate tax returns any uncertain tax positions. And oversight of risk—financial and non-financial—was cited as the top concern where KPMG earlier this year polled audit committee members attending the ACI’s annual Audit Committee Issues Conference.
Tone at the top—and in the middle—continues to be a key area of concern for audit committee members, according to McCarthy, particularly in the light of the pressures on companies to achieve results in a difficult economy. Also front-and-center: the uncertainty created by the changing regulatory and legislative landscapes. The implications of new tax policy and healthcare reform warrant robust discussions at both the board and committee level. And, of course, the impact of the economic environment on the company’s financial statements and dis-closures—from fair value to goodwill impariments to pension liabilities—continues to demand sharp focus and attention. Finally, “how audit committees and audit committee chairs interact with the head of internal audit has popped up on the radar for many audit committees,” McCarthy said. “The audit committee should have a robust relationship with internal audit, one where you really get to know each other. The lines of communication should be direct and wide open.”
The Securities and Exchange Commission (SEC) is requiring more disclosure on the backgrounds and experience of its directors and the roles they serve, leading to the imperative question: Is there a new profile of the director emerging? Egon Zehnder’s George Davis believes so: “Boards are starting to look at their own succession planning now…and make sure that their experience aligns with the company’s strategy.”
Plenty of debate ensued over what and who is most influencing the changing profile of today’s public company board director. Do times like these require the broad capabilities of a generalist or the more finely tuned experience of the specialist? Davis believes the answer is dependent on the business cycle. “Are you in a turnaround, growth or diversification play? These are the kinds of issues that are determining the new-director profile,” he said. How to balance the size of the board while bringing on new skill sets is another area of tension. “At that point, there’s always tension about keeping the board the same size and trying to bring new skills into the boardroom, and what are the mechanisms to influence change, and how do you do that,” Davis said. “There’s no right or wrong answer.” There are some pre-qualifiers, however. Given the growing complexity of the board’s responsibilities, the new director needs ample time to invest in board service.
The other critical characteristic of the new board director, Davis said, is patience. “The pound-on-the-table director of the 1960s-era movies is gone. You have to be very subtle, and I think a great point was made about people-influencing skills. The role of the director has changed and to be effective you need to stay current. Even if you’re recently retired, to be a well- serving director, the new directors are going to have to think about keeping themselves fresh and current.” Part of remaining current is to be constantly evaluating both yourself and your peers, which requires that boards engage in healthy dialogue about “how they’re doing and how you’re doing.
“The very real question,” he said, “Is whether you are going to be open enough to have that dialogue within your boardroom. I think that’s part of this new profile.”
Great disparity was found when Egon Zehnder I studied the revenues and board composition of the Standard & Poor’s 500. While 24 percent of the S&P 500’s revenues are derived from countries outside the U.S., only 6 percent of the total number of directors serving the S&P 500 are foreign nationals. These results underscore a need for diversity that goes beyond gender and ethnic frameworks. “I think this is a new worry, and I think what some shareholders are looking for in their directors is a global mindset. It doesn’t matter if you’re at a large- mid- or small-cap company because companies of all sizes are going into foreign markets,” Davis said.
The hot topic of executive compensation commanded the attention of Boardroom Summit delegates as it has outside the boardroom. Leading that discussion was Marc Hodak who suggested that compensation be looked at holistically. The job of the board, he said, is to strike the best balance among competing needs of the company. “You want to be looking at how much do we need to pay managers to retain them, to attract and retain new recruits, how they’re being motivated, and how those incentives are aligned with shareholders,” Hodak said. At the time, the board needs to be achieving “retention and alignment goals at the lowest cost to shareholders.”
Adding an executive summary to the Compensation Disclosure & Analysis (CD&A), filed annually with the SEC, was one practice that may help aid disclosure and understanding. “I think this is a terrific idea,” Hodak said, “partly because your shareholders and your institutional investors are looking for simplicity and understanding. It occurred to me that if you’re putting together an executive summary, it forces the board to be clear itself on what the objectives are, and how you’re trading them off in a very compact and deliberate way.”
One of the board’s key functions—in fact, some governance experts argue that there is no more important job for the board—is CEO succession planning. The SEC has said it will revise its policy promulgated in part by the numerous instances where a company’s in inability to make a successful CEO transition has led to devastating losses in shareholder value. A recent survey conducted by Egon Zehnder found that while 70 percent of respondents said the boards on which they serve did have a CEO succession plan in place, some 53 percent said the succession process “wasn’t very good.”
A thoughtful succession plan provides a forum for internal candidates to be groomed. And internal candidates are preferred because study after study has shown that CEOs hired externally tend to command higher salaries and be more prevalent in companies with no succession plan in place. Even so, how to keep internal candidates who may be competing for the top job “satisfied” as they vie for position also requires careful planning. “Overall, succession planning needs to be a very thorough and thoughtful process and a regular part of the board agenda,” said Egon Zehnder’s KimVan Der Zon. In most cases, outside consultation will significantly ensure that there is a full understanding of the capabilities of the internal candidate that align with a company’s needs at the time.”