E. Thames Fulton

A 2006 research article, Critical Mass on Corporate Boards: Why Three or More Women Enhance Governance, from the Wellesley Centers for Women (WCW) and the University of Western Ontario supports this thesis:  ”The magic number seems to occur when three or more women serve on a board together. Women start being treated as individuals with different personalities, styles and interests. Women bring a collaborative leadership style that benefits boardroom dynamics by increasing the amount of listening, social support and win-win problem solving. Women are more likely than men to ask tough questions and demand direct detailed answers.”

The experience when you have multiple females can help the range of the conversation to be more encompassing—during the business sessions as well as the time between the meetings, the casual time, says experienced director Stephanie Kushner. “In some ways, it was more personal—people connected more on a personal basis. But also, there was a lot of comfort in terms of talking and sharing perspectives. I felt that the board was particularly collegial, collaborative. There was an openness. People expressed their thoughts and opinions more freely.”

Mary Kier

With regard to diversity, women have different experiences and different mindsets from their male counterparts. Men tend to be more individual in their decision making, excelling at taking swift corrective action, according to McKinsey Quarterly’s “Achieving the Promise of Women Executives” from March 2012. Women, on the other hand, tend to be better at collective decision-making and at incorporating the environment and values of the organization. Ultimately, board diversity is about combining alternative and complementary views that lead to more knowledgeable discussions and better board decisions.

Another experienced director, Cindie Jamison, says: “Women on boards leads to good decision-making; you can consider alternate points of view to drive toward the best decision possible. And, when there is critical mass, you can get traction on additional issues—issues that aren’t always discussed or debated and even things no one thought were issues.”

The point here is not to suggest that one way of thinking is better than the other, or that all men and women think and act in narrow gender-defined parameters. Rather, it is to suggest that a diverse blend of thinking improves company performance. Extensive research, including a 2011 Deloitte study, Women in the Boardroom: A Global Perspective, suggests a correlation between the financial bottom line and the proportion of women on boards (or at least in senior management). In fact, the McKinsey study cited earlier shows that companies with three or more women in senior management roles scored higher on criteria related to organizational health and effectiveness.

Perhaps not surprisingly, Fortune 500 companies are doing a better job of including women on their boards than mid-cap companies. The Deloitte study shows 15.7 percent of Fortune 500 board directors are women, while that number falls to just 12.3 percent for a broader sample of nearly 1,800 companies, which of course includes mid-cap companies.

While that might not seem like much of a difference, other studies call attention to the problem for mid-cap companies. A December 2011 report from the InterOrganization Network (ION), an alliance of 14 women’s business organizations in the U.S., says that underrepresentation of women on mid-cap company boards is acute. The report states that “although the Fortune 500 companies in some regions exceed the national benchmark in terms of their percentage of women directors, the comparable percentages on the boards of smaller companies drag down the overall performance.”

The NACD recently published a Blue Ribbon Commission report titled, The Diverse Board: Moving From Interest to Action. Click here to access a copy of the BRC on Diversity.

By their very size and nature, mid-cap companies often fly under the governance spotlight, avoiding the direct pressure to address the issues of gender diversity on boards. While that may be true today and for the short term, regulatory pressures are increasing for all companies. Compounded by the diminishing lack of trust that boards and corporations will “do the right thing,” governance watchdogs and disgruntled investors don’t need much incentive to act.

“Pink” quotas dictating board makeup may only be a reality in Norway, France, Italy, Belgium, Iceland, the Netherlands (where a “comply or explain” policy exists) and Malaysia, but global awareness of this issue is growing. There is similar legislation in the works in Spain and India, and the U.K. and Sweden have embraced voluntary targets. Surely quotas are not out of the realm of possibility in the U.S. if complacency  continues to thwart progress. Why wait to be shamed into doing the right thing?  Boards need not hide behind their generalized “diversity” statements in their proxies, but should lead by example in their board appointments and proactively include more women. What’s more—as if mid-cap companies need another incentive—gender diversity simply is good for business, leading to better decision-making and better organizational dynamics.

Mid-cap companies do face challenges of their own recruiting women to their boards, of course–not the least of which is competing directly for talent with their more prominent counterparts in the Fortune 500. Even so, it is imperative that sitting directors, nominating and governance committee members, and executives of mid-cap companies charge ahead with assertive and coordinated recruiting campaigns to identify talented female executives who will bring diversity of thought to the board.

The decision to include women should start with governance committees,” says experienced director Rita Foley. “Board members should insist on seeing female and diversity candidates on the slate. Think of your daughter; if she were a qualified candidate you would want her to have the same open opportunity. The slate shouldn’t be considered complete if there isn’t diversity on it.”

To accomplish this, mid-cap companies should examine their own proxies as a guide to bolster diversity; most all companies emphasize a commitment to diversity there. Make that commitment serve as more than just empty words:

• Act upon them to bring gender diversity to the board. As an added benefit, including more women on boards can help lead to more women rising up into the ranks of senior management, which in turn expands the pool of potential board candidates over the longer term.
• Be proactive by insisting that women board candidates appear on the slate whenever recruiting board directors. Mid-cap company boards–and their nominating committees–should not consider the slate to be complete unless it has several well-qualified women who align with the company’s strategies and goals. Then, if possible, commit to interview at least one woman for every board vacancy that opens up. Adds Jamison: “In order to draw these female candidates’ strengths out, you need to interview them differently–ask different questions; think about the approach and the situation. The way questions get asked and the way women choose to answer them can be surprising and off-putting. That right there is a gatekeeper. Be open to the way you interview and qualify—take into account the question and the nature of it and how it can be perceived. There are ways to ask things about a woman’s background without being negative that will allow her to demonstrate her expertise and value.”
• Use an executive recruiter to ensure that diversity is a component of every slate of candidates. Partnering with an objective resource like a recruiter helps make the search process run smoothly and efficiently, freeing up senior management to spend their time wisely. It enables the board to embrace a process that introduces candidates at the right time. Recruiters also bring a unique third-party perspective, best-practice experience and a sense of urgency to the search process.
• Encourage radical and creative thinking by casting a wider net to find exceptional female board candidates. Historically, women are scarce among the ranks of sitting CEOs or CFOs. Beyond those top spots, however, consider exploring other functional areas such as legal or human resources, or looking at women who hold important leadership roles in smaller organizations.

Boards often speak about the importance of gender diversity within the organization at the executive and middle management levels; it follows that if such diversity is important at these levels, surely it is important at the board level. At the very least it sets a good example for that rest of the organization and ultimately serves to improve company performance.

E. Thames Fulton is a managing director and head of Board Advisory Services at Cook Associates. Mary Kier is CEO of Cook Associates Executive Search.

Christopher R. O’Dea

In one situation, a Dutch pension fund’s CSR consultant questioned a defense industry stock held in the portfolio of a fund in which the pension fund had invested. The issue: one of the company’s divisions produced land mines that were on a UN prohibited list. Even for this sophisticated firm, the level of detail of the consultant’s mission—to specifically assess compliance with CSR and ESG criteria—was some surprise, as was the requirement to establish a documented internal procedure to review and resolve such inquiries. For less astute companies, the need to create and manage such a detailed new compliance procedure could present a significant barrier to doing business in countries where CSR criteria are on a par with financial reporting requirements.

This is just one illustration of how governance-based and CSR requirements have become sophisticated tools of business strategy and national policy outside the United States and for the most part—Argentina’s seizure of YSF shares owned by Spain’s Repsol notwithstanding—go well beyond blunt instruments like nationalization.

In Chile, the state-owned copper mining company, Codelco, recently demonstrated how a new marriage of resource-based leverage with savvy understanding of the tools and techniques of corporate governance and global capital markets can fuel a new style of fighting for control of nationally critical natural and corporate resources. The Codelco matter drew in two major Japanese banks as financing sources, along with a host of lawyers and IR/PR reps from Santiago to Tokyo and London. The heart of the dispute was an option to buy a major stake in Chile’s Sur copper complex that was granted by the Chilean government to ExxonMobil in 1978 and subsequently renegotiated twice. In October 2011, Codelco moved to exercise its option to buy 49 percent of the Sur mine held by Anglo, arranging a bridge loan from Mitsui to finance the purchase; a month later Anglo sold 24.5 percent of that stake to Mitsubishi, triggering a legal dispute over who could do what—and at what price. Anglo and Codelco settled after nearly a year of intense litigation, cobbling together a four-party arrangement with a separate board of directors to run the Sur mine. The settlement will allow development of the mine to proceed, but the episode provides boards with a template for assessing the risks that might arise from the use of the latest governance and activism techniques in a context of rising resource nationalism, state capitalism and constrained global growth.

While CSR and ESG issues certainly aren’t unknown to American companies, they don’t yet command the respect from American boards and management that such matters receive in the EU and emerging markets. When it comes to CSR topics, “in the U.S. we do not have anywhere near as rich a dialogue as other democracies,” says Steve Coll, president of the New America Foundation and author of Private Empire: ExxonMobil and American Power. Speaking to the Chicago Council on Global Affairs recently, Coll noted that the American political economy hasn’t created U.S. government-owned companies like the oil and other resource/utility companies found in most other developed economies, where those running both companies and the government share a common philosophy about business and the congruence of national with industrial goals. In contrast, the roles of a colossus like ExxonMobil and the United States in the world “are not contiguous,” Coll says. For the U.S., the result is a system where companies evaluate social policies as investment decisions, in stark contrast to other developed economies and emerging markets where social and environmental policies are integrated into both business and political life.

Ernst & Young’s proxy season data show that CSR and environmental resolutions increased to 40 percent of total resolutions in 2011 compared to 30 percent in 2010. While such resolutions are winning more shareholder support, with an average vote in favor of more than 18 percent in 2010 compared to just 7.5 percent in 2000, CSR/E resolutions still fell short of the 30 percent hurdle that garners board attention, with barely more than one-quarter winning that support in 2008. There are indications from professionals in the CSR and environmental fields that boards and top management may merely tolerate, rather than embrace, the entire sector. For example, a recent program offered by the PR University unit of Bulldog Reporter, a public-relations industry website, trumpeted a webinar on CSR with the inauspicious title “Sure-Fire Strategies for Boosting Brand Equity and Proving ROI to the C-Suite.” PR pros were told that “in just 90 information-packed minutes,” they could expect to “discover dozens of new ways of maximizing the return on your CSR efforts.”

Another sign that CSR initiatives perhaps haven’t become embedded at the board strategy level is turf battles among staff departments for influence over governance matters. With say-on-pay discussions, for example, the National Investor Relations Institute says “IR plays a limited—if any—role in say-on-pay discussions, according to a survey earlier this year of 181 US companies by IR Insight, the research arm of IR magazine.” According to NIRI, the corporate secretary tends to take the lead, with just 41 percent of IROs who responded to the survey saying they had any involvement at all in say on pay during 2011. In its e-mail about the survey, NIRI notes, “for IR, one of the challenges of reaching out is that your existing buy-side contacts are normally not involved in pay discussions, so new relationships must be forged with governance teams. Looking at this positively, it’s clear say on pay has helped IR broaden its influence and network of contacts.”

While say-on-pay isn’t directly related to emerging market matters, concerns about staff influence and the lack of organizational clarity for dealing with any governance issues threatens to short-circuit the board’s ability to count on accurate, timely information about complex governance matters in emerging markets—markets that might be major strategic growth targets.

What’s shaping up for all U.S. companies operating internationally is an agenda much like what Coll describes already at ExxonMobil: a portfolio of increasing political, geological and environmental risks. Such a risk profile requires acute sensitivity to local issues and communities in every country where a company operates. Emerging market nations are adopting legal tools from the developed world that will enable consumers and investors to pursue governance initiatives—Mexico last year passed legislation allowing class-action suits for the first time, illustrating that every board overseeing international operations will be well-served to modernize its emerging-market risk assessment matrix and update it frequently.

Complicating the picture, emerging market nations are having trouble meeting their own lofty CSR and ESG goals. Brazil, for instance, has committed to 2020 targets of a nearly 40 percent cut in its growth curve of greenhouse gas emissions and a reduction of Amazon deforestation levels by 80 percent compared to average rates registered for the period of 1996-2005. These are commitments of global interest to the environmental community, but they may be out of reach because of the latest revisions to the Brazilian Forest Code.

Former Brazilian Senator and Environment Minister Marina Silva gave an impassioned sketch of the tension between development and the environment at a private conference in Santiago with the Dean’s International Council of the University of Chicago Harris School of Public Policy, just before the Brazilian Senate passed the controversial rainforest bill. “The bill that was approved by the Senate undermines protection of the forest, provides amnesty for those who deforest and will increase deforestation,” Silva said after the vote.

Part of the problem facing boards is the lack of information about governance practices and CSR issues in emerging markets.  According to the IFC’s Global Corporate Governance Forum, for the past three years, approximately 1,000–1,200 papers have been published each year on the Social Sciences Research Network with the term “corporate governance” appearing as a key word in the abstract—but fewer than 1 percent of these papers focus on emerging markets.  And many of those focus on the board structures of companies that are part of family-controlled groups that are common in emerging market economies. This leaves a gap about emerging substantive trends that could impact financial, operational, legal and regulatory matters.

Filling in that information gap would help every board better evaluate its emerging market risks, and creating a dynamic, streamlined organization that handles CSR matters with the same alacrity as financial reporting would be a sensible first step for many boards.

Christopher O’Dea is a business consultant who focuses on global growth strategy. He can be reached at 312-804-1720 or odeachicago@aol.com.

Of these 48 companies, which account for almost 40 percent of the 124 S&P 500 companies with staggered board structures at the start of 2012, 33 proposals have already gone to a vote, with 27 passing resolutions to institute annual director elections. At least 15 more companies are expected to bring declassification proposals to management in the near future. Thirty-eight companies submitted and passed precatory proposals from SRP-represented investors, “and it is expected that declassifications will take place in many of these companies,” said Bebchuk, who is also director of the Program on Corporate Governance at Harvard Law School.

“There is a significant body of empirical evidence documenting an association between staggered boards and lower firm valuation. Furthermore, there is widespread support for board declassification among institutional investors,” said Bebchuk in an interview with NACD Directorship. Bebchuk has conducted a large amount of research on the effects of staggered board structures and is the co-author of “The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence and Policy.”

The six proposals that did not pass were posed to companies with 80 percent supermajority requirements (Alcoa, CIGNA, Eli Lilly, PPG Industries, St. Jude Medical and Teradata). The 27 companies that implemented measures garnered an average of 99.2 percent of votes cast, and 80.7 percent of votes outstanding.

Of the 90 total shareholder proposals submitted by the SRP, 80 have moved, or may move, the companies to adopt annual election policies.

The 2012 proxy season marked the first year the SRP has partnered with institutional investors to effect boardroom changes. The 2011-2012 advisory board is comprised of Chairman Richard Breeden and Members Jesse Fried, Jeffrey Gordon, Reinier Kraakman, Michael McCauley and Peter Mixon.

The SRP represented and advised six institutional investors in submitting proposals: the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Massachusetts Pension Reserves Investment Management Board, the Nathan Cummings Foundation, the North Carolina State Treasurer and the Ohio Public Employees Retirement System.

“Many of the companies approached have displayed responsiveness to shareholder concerns,” Bebchuk said. “The large-scale declassification to which the work of the SRP and SRP-represented investors has contributed can be expected to benefit shareholders and the economy.”

The decline in numbers coincided with a decline in popularity. According to The New Yorker’s James Surowiecki, “In 2009, for the first time ever, support for unions in the Gallup poll dipped below 50 percent. A 2010 Pew Research poll offered even worse numbers, with just 41 percent of respondents saying they had a favorable view of unions, the lowest level of support in the history of that poll.”

Clout on Capitol Hill and in the Boardroom
Even amid declining membership and softening public support, unions flex their political muscle by endorsing candidates for office and through campaign contributions. In 2011, the AFL-CIO, the nation’s largest labor organization, spent 30 percent, or $56.4 million, of its $200 million budget on lobbying—more than 10 times what it spent on union administration, according to documents filed with the Department of Labor. By way of comparison, spending on politics and lobbying by the National Association of Manufacturers was $9 million; the Business Roundtable, an association of chief executive officers, $11 million; and the U.S. Chamber of Commerce, $40 million.

Corporations are also political spenders. The Citizens United v. Federal Election Commission decision ruled that government couldn’t ban political spending by corporations in candidate elections, paving the way for increased contributions. However, unions are quickly establishing themselves as big political spenders. In 2010, a Wall Street Journal article noted that AFSCME was the biggest outside contributor, spending $87.5 million on that year’s elections after tapping into a $16 million emergency account to help strengthen the Democrats’ hold on Congress. The article added that unions have largely been able to stay out of the spotlight on the debate over spending by outside groups because they typically spend their money on other kinds of political activities, such as get-out-the-vote efforts, while advertising buys from Republican-oriented groups have taken most of the heat.

Paul F. Clark, professor and head of the Department of Labor Studies and Employment Relations at Penn State University, says the main political contribution unions make isn’t money, but members. “What they do have is people,” he says. “If they can mobilize members to vote for a candidate who will work in their best interest, and to knock on doors, man phone banks and get involved, they can have an impact on elections.”

The State of the Unions:

History
Unions as Shareholders
Turning Back Anti-Business Sentiment

The AFL-CIO plans to have 400,000 of its members registering voters and getting out the vote this year. Thanks to Citizens United, those volunteers will be able to knock on all doors as they canvass a neighborhood, not just those of fellow union members. The federation has social-media projects, a super PAC and an experiment that will be studied by both friends and foes this year: It is placing full-time political professionals in Florida, Michigan, Nevada, Ohio, Pennsylvania and Wisconsin. There will be more states to come, says AFL-CIO President Richard Trumka, and the teams will keep working after Election Day, preparing for the next round of local, state and federal campaigns.

The Service Employees International Union (SEIU) has provided $1.5 million in seed money for the main pro-Obama super PAC, Priorities USA Action. And unions representing Teamsters, laborers, firefighters, food and service-industry workers, municipal employees, electricians and teachers have all made six-figure donations (including a combined $920,000, in the case of the Teamsters) to the Democratic Senate or House super PACs.

As economist John Aloysius writes, “Not ironically, the largest proponent of political giving is the AFSCME, a public sector union that puts all its weight behind Democrats, accounting for nearly 10 percent of all spending from pro-Democratic groups.”

So far, the AFL-CIO, SEIU, AFSCME, American Federation of Teachers and Communications Workers of America have all endorsed President Barack Obama in 2012.

Former New York State Comptroller Alan Hevesi standing by attorneys representing WorldCom on April 26, 2005.

They do this in two main ways: via shareholder litigation and through proxy resolutions, often aligning themselves with powerful and prevalent public pension funds to do so. Of the 124 members of the highly influential Council of Institutional Investors, half are public pension funds. The remainder comprises corporate pension funds (32), union pension funds (22) and special-purpose funds (8) such as Ceres. When public pension funds and unions align on matters of Council policy, they hold sway.

A Framework for Shareholder Litigation
When unions sue companies, they are generally suing as shareholders and with other shareholders, notably public pension funds. However, there are times when employee and shareholder interests conflict, as in the case of hostile takeovers that may lead to layoffs. In such cases, the courts have shown themselves to take the high road, looking to the long-term interests of all shareholders and giving boards discretion to determine those interests.

Edgar v. Mite (1982) said boards could not defend companies from takeovers that would enrich shareholders at the expense of other stakeholders such as employees, but CTS Corp. v. Dynamics Corp. of America (1987) found otherwise, opening up a floodgate of state anti-takeover statutes that are now on the books in a majority of states, with the notable exclusion of Delaware, known to be pro-shareholder.

The State of the Unions:

History
Unions’ New Playbook
Turning Back Anti-Business Sentiment

In Unocal v. Mesa Petroleum (1985), the question before the Delaware Chancery Court was whether directors of a corporation could reject a hostile takeover offer on the grounds that rejection was better for employees or other stakeholders even though shareholders might be worse off. The Chancery Court held that it was the board’s fiduciary duty to manage the corporation for the benefit of shareholders. That decision was reversed on appeal to the Delaware Supreme Court, which found that directors had the right to analyze the impact not only on shareholders, but also on creditors, customers, employees and the community.

Then, in Revlon v. McAndrews (1987), that same court held that when the sale of a company is inevitable, directors must put shareholders’ interests first. Subsequent cases have underscored shareholder supremacy in similar scenarios. Shareholder- first decisions are one reason why more than 50 percent of all U.S. publicly traded companies and 63 percent of the Fortune 500 choose Delaware as their legal home.

Shareholder Litigation by Labor Unions and Pension Funds
Shareholder litigation by unions and pension funds is not surprising. A typical union pension fund or public pension fund may hold up to 70 percent in equity securities (the rest being held in debt securities). These plans often litigate against corporations when the value of the equity goes down.

The way for strong union and pension fund power was paved, ironically, through tort reform. The Private Securities Litigation Reform Act of 1995 was intended to ease the burden on companies. It required that every securities case have a qualified lead plaintiff. Since then, activist institutions have spearheaded a majority of cases—and most of those have been unions and/or public pension funds. According to the 2011 PwC Securities Litigation Study, which analyzed U.S. federal securities class-action lawsuits, there were 72 filings in 2011 headed by institutional investors, including 47 led by unions or pension funds. Most of these cases name directors and officers, including the chairman. Pension funds accounted for $2.7 billion of the $3.4 billion in total settlements (or 79 percent) last year.

Lessons from WorldCom: The Director Pays
Two of the most famous lawsuits against directors had union connections. In one, WorldCom directors paid nearly $25 million out of pocket in a settlement with a group of investors for failing to detect an accounting fraud.

After WorldCom declared bankruptcy, New York State Comptroller Alan Hevesi, representing the New York State Common Retirement Fund, served as the lead plaintiff in a class-action lawsuit against officers and directors of the company, among others. The class he represented consisted of “all individuals or entities that purchased or acquired stocks and/ or publicly traded bonds or notes of WorldCom during the period beginning on April 29, 1999, through and including June 25, 2002.” One of the other plaintiffs was HGK Asset Management Inc., a registered investment advisor that “acts as a fiduciary to its union-sponsored pension and benefit plan clients under the Employee Retirement Income Security Act of 1974.”

Hevesi, representing the class, refused to accept D&O insurance money alone and insisted on being paid directly by directors and officers. In a settlement approved Sept. 21, 2005, the total amount of $60.7 million consisted of $24.7 million from the director defendants personally and $36 million from the entities that provided liability insurance for WorldCom’s directors and officers.

Corruption was neither found nor charged against any director. The case revolved around accounting misrepresentations that the directors failed to detect. In the litigious environment post-Enron, the directors clearly felt pressure to settle, even though it meant paying out of their own personal funds. Ironically, Hevesi later pleaded guilty to misconduct at the pension fund.

Illustration by JT Morrow

The continuum of labor negotiations proves that good results—those that satisfy labor, management and shareholders—happen when the parties collaborate. Even today, companies in industries that have a long history of contentious relations, such as automotive, have demonstrated this fact. Ford Motor Co. (see link below, “Turning Back Anti-Business Sentiment,”) is impressively improving conditions for employees, beneficiaries and shareholders by taking a long-term, value-oriented approach to issues of employment and governance.

Boards of directors need to understand this dynamic not only because it affects employees, but also because it often ends up in the complaint box that resides in the boardroom. If a company’s corporate governance policies are outdated or if directors are not up to the challenge of defending a given policy, they are sitting targets for unions and pension fund activists with limited share ownership rallying for change. Directors no longer have the right to choose whether to communicate to these investors—only when and how. They also need to understand their equity ownership profile in great detail and use this information to set priorities that closely mirror major shareholders’.

“The State of the Unions” is NACD Directorship’s report on the role that unions and public pension funds are playing today in corporate governance. It explores the methods and tactics used to fulfill their objectives, which can involve increasing returns to their beneficiaries, establishing a more powerful public image, or achieving political, social and even religious motives. Part I, “The History,” covers the formation of the American labor movement and the creation of government agencies charged with oversight. In Part II, “Unions as Shareholders,” Alexandra R. Lajoux provides insight into why and how unions and public pension funds are affecting corporate governance today. Cheryl L. Soltis reports in Part III, “Unions’ New Playbook,” on the intersection of politics, media and unions. Part IV, “Turning Back Anti-Business Sentiment,” provides a way forward for boards of directors dealing with this dynamic but challenging feature of the governance landscape.

The State of the Unions:

Unions as Shareholders
Unions’ New Playbook
Turning Back Anti-Business Sentiment

I. History
By Jeffrey M. Cunningham

Unionization in America was founded on three labor-management principles still recognizable today.

Producers vs. parasites. Labor and management were united under Terry Powderly, a machinist who led the Knights of Labor through the 1880s. The KoL was among the first unions to welcome African Americans and women. Powderly differentiated between what he called producers, which included both labor and management, and those he referred to as parasites—bankers and lawyers.

President Franklin D. Roosevelt waves to a cheering convention of the Teamsters union in Washington on Sept. 11, 1940, before making his labor campaign speech.

Pragmatic and proud. Samuel Gompers, who founded the precursor to the American Federation of Labor in 1881, served his version of unionism like a martini, straight and neat. He believed in the free market and felt that union involvement in politics was a distraction; his only goal was to win a greater share of America’s wealth for his members.

Change the world. In the 1930s unions enlarged their footprint by becoming instruments of social change and found an understandably receptive audience in a downtrodden workforce. The United Auto Workers were the leading symbol of the movement, and its future president, Walter Reuther, declared that unions would take on broader concern for the quality of society. This would have an impact on union history to the present day.

The Roaring Thirties (at Least for the Unions)
The Great Depression brought millions of workers into union ranks, and President Franklin D. Roosevelt cooperated by encouraging federal labor laws that enhanced union membership. He was the unions’ best friend and advocated what he called “fair competition”—government-blessed price fixing as a quid pro quo to management in return for higher wages. Thus was born the modern collective bargaining triangle composed of unions, management and politicians—and with the glaring absence of shareholders.

In 1935, New York Sen. Robert F. Wagner sponsored the National Labor Relations Act, which established the National Labor Relations Board and made collective bargaining a powerful tool for unions. Throughout most of its history, the NLRB has been union friendly. Not surprisingly, union membership increased from 12 percent to 28 percent of the labor force from 1934 to 1939, according to the National Bureau of Economic Research, the high-water mark for unionization in America.

The Money Pit
Vanguard Group manages more than $1.6 trillion in assets and is rarely confused with a special-interest or activist-investor organization. Its intentions in the executive suite are transparent: to increase shareholder value. Yet, in a note that should concentrate the minds of directors, Glenn Booraem, principal and head of corporate governance at Vanguard, reported that in their discussions with investee company management, their “single biggest topic of conversation tends to be compensation.”

Boards are now highly motivated to get their compensation issues organized for prime time—referring to both the substance and the perception. Compensation is no longer an individual CEO or company issue—it is the single largest driver of anti-business rhetoric and fuels activist popularity. Occupy Wall Street was one of the most effective anti-business movements to come along in recent memory, and among its core issues was a protest against executive compensation. As directors work their way through this difficult but important issue, there are two areas in particular that are of the highest importance today: pay for “performance” and pay “fairness.”

The State of the Unions:

Introduction/History
Unions as Shareholders
Unions’ New Playbook

First, boards need to be aware that the SEC will be issuing a rule on the Dodd-Frank provision requiring companies to report pay for performance. Compensation committees may get ahead of this curve by clearly defining performance and peers, and disclosing results according to their own well-reasoned and well-supported formulas. Directors may also caution the SEC against mandating a pay-for-performance disclosure formula that misses the mark.

While it may be tempting to use the same formula for performance across companies, doing so can be misleading because performance can be defined in myriad nonfinancial ways that have a long-term impact on company value.

Second, boards must be aware of the issue of so-called pay fairness, the Dodd-Frank provision that requires companies to report the ratio of CEO to median employee pay. Not surprisingly, the ratio resembles one tracked by the AFL-CIO’s Executive Pay Watch. These disclosures are likely to raise ire among the shareholder activists, and must be accompanied by clear and compelling disclosure of pay philosophy.

Shifting the Dialogue to Mainstream Shareholders
The powerful combination of populist rhetoric about joblessness and recession—fueled often by misleading stories of unearned executive wealth—has naturally led to stronger ties between unions and politics, with business often seen as the enemy.

It is no surprise that, as The National Journal writes, there has been a corresponding surge in union organizational activity, manifesting itself in political contributions. Boards and management must develop stronger relations with returns-minded shareholders that can come to their defense when faced with anti-shareholder policies.

Supply Chain Risk Assessment – The Seven Questions Directors Must Ask to Mitigate Global Supply Chain Risk
May 15, 2013
Atlanta

Speakers’ Program
May 16, 2013
Research Triangle

NACD Spring Forum: Rethinking the Risk Agenda
May 21, 2013
New York, NY

2013 Outstanding Directors Awards – Joint Event with Dallas Business Journal
May 30, 2013
Dallas, TX

A Meeting of the NACD-CT Family Business Governance Roundtable
June 5, 2013
NACD CT Chapter

Director Professionalism
June 10-11, 2013
Boston, MA

Breakfast Roundtable
June 12, 2013
Raleigh, NC

Master Class
June 13-14, 2013
Boston, MA

June Luncheon
June 19, 2013
Pittsburgh, PA

You Will Be Sued: Protecting Your Wealth and Your Reputation
June 19, 2013
Atlanta, GA

Summer Networking Event
July 18, 2013
Cary, NC

This commentary was originally published by the authors as a PDF and sent via email from Weil Gotshal & Manges.

All corporate governance participants—boards, executive officers, shareholders, proxy advisors, regulators and politicians—have both an interest and a role to play in rebuilding trust in the corporations that are the engine of our economy. In our annual reflection, we offer thoughts on how, without the need for regulatory intervention, boards and shareholders can seize the opportunity to rebuild trust and, by doing so, help resolve some of the tensions that are stalling our economic recovery.

Part I – Opportunities for the Board to Rebuild Trust

1. Focus on the long-term. Boards carry out their fiduciary duties in the face of pressures from the market and short-term traders for immediate results, pressures that too often undermine the long-term planning and investment required for a sustainable enterprise. While management must focus on the day-to-day operations of the company, the board has the ability and responsibility to look forward and consider what is in the best interests of the corporation and its shareholders over a time horizon notably longer than the quarter at hand. The board should bring its objectivity and judgment to issues ranging from dividend policy, strategic direction, risk and executive compensation to corporate social responsibility and ethical culture. When coupled with a clearly articulated strategy, the board’s commitment to the long-term should help a company withstand undue short-term pressures. This requires effective disclosure of board decisions and policies and concerted efforts at shareholder relations and communications, both areas where boards often could focus more attention.

2. Redefine board priorities. The part-time nature of director service combined with ever-expanding expectations about the board’s role and increasing regulatory mandates may lead to an unfocused and overly long board agenda. Boards should delegate to board committees, corporate management and advisors those matters that do not require the attention of the full board so that the board can focus on key priorities. Defining board priorities is the board’s task, one that should be undertaken in an informed manner with advice from management and counsel but not be delegated to them. We suggest that boards consider an 80/20 rule: Approximately 80 percent of board time should be spent on those issues that are reserved by law to the board, that will benefit from the exercise of fiduciary judgment or as to which management has inherent conflicts, such as corporate strategy and the major risks to that strategy, material transactions, management performance and succession, and executive compensation. The board should also reserve “quality time” for matters of its own performance and composition. This is a simplified list and of course every board will need to work it out based on its own challenges and characteristics, but the key is to maintain significant time for the significant and difficult issues. Leading the effort of redefining board priorities and ensuring sufficient agenda time for priority matters are roles for the board’s independent leader – either a separate independent chair or a lead director. We note that the number of companies with separate independent chairs is continuing to rise, and it is now well-accepted that public companies should either have an independent chair or have a lead director with a role that is defined to include a number of tasks that would otherwise typically fall to a board chair.

3.  Apply objectivity and “backbone” to fiduciary judgments. Directors must decide for themselves what is in the best interests of the company. Clearly, management has a view that it will advocate, but the board needs to test the underlying assumptions and come to its own conclusion. While undue deference to management is not appropriate, neither is abdication of fiduciary decisions to shareholders. Fiduciary decision-making cannot be abdicated, even if a majority of shareholders have a definite preference on an issue. This may pose challenges when significant shareholders have strongly held views, or when a proxy advisor takes a stance and in effect serves to coordinate support for that stance among its client shareholders. The bottom line is that directors need to be willing to do what they believe is right, even if doing so jeopardizes re-election.

4. Listen to and communicate with (“engage”) shareholders. Success in withstanding pressures for actions that the board does not believe are in the company’s best interest depends on the board’s ability to communicate effectively with shareholders. The starting point is knowing who your significant shareholders are and what concerns them. (It helps to maintain open channels of communication with the persons who have voting and investing authority, and these roles are often split in large institutional investors.)

Encouraging feedback generates goodwill and can elicit good ideas. Obtaining a preview of concerns also provides opportunity to avoid acrimony by working through issues in advance. Directors should listen hard to what shareholders have to say and consider any disconnects between the views of shareholders and the board, for example, where a management proposal or a director receives a negative (or not overwhelmingly positive) vote at the annual meeting. Boards should work with management to ensure that board decisions are adequately explained to investors, regulators and other users of corporate information. Disclosure documents should be reviewed with a critical eye towards enhancing understandability and slashing boilerplate. Communication with shareholders(and employees) will become even more critical once the SEC adopts new disclosure requirements relating to internal pay equity and pay-for-performance as required by the Dodd-Frank Act of 2010.

5. Be self-critical. If shareholders are to give boards the time and space to take the long view, and generally defer to and support their judgments, they need assurance that boards will bring objectivity and backbone to judgments about the board’s own effectiveness. Re-nomination decisions need to be based on an active assessment of director performance and whether the director continues to be a strong fit. All directors need to have skill sets that continue to be not only relevant but necessary to the evolving direction of the company’s business and be engaged in board and committee activities at a high level.

Board “refreshment” mechanisms such as age limits and term limits should be carefully considered. While they can help to assure compositional change, they are imperfect substitutes for active assessment of individual performance, and they may set an inappropriate expectation of long tenure. Similarly, the annual self-evaluation of the board and its committees provides an opportunity for reflection about areas for improvement. This should not be allowed to become a rote exercise. Consider changing up the methodology from time to time, for example, by every several years taking a deeper dive through an interview method rather than relying on paper questionnaires. No matter what method is used to gather viewpoints from directors, every year the evaluation should result in a focused board discussion of areas for improvement.

6. Pay special attention to “hot button” issues. Boards should make decisions about “hot button” issues in the best interests of the company and persuasively communicate the reasons for those decisions. Proactively discuss any anticipated negative feedback from the proxy advisory firms on relevant issues. The issues requiring special attention will depend on the company, but for most companies will include strategic direction, risk oversight, executive compensation, proxy access, board composition, succession, board leadership, political contributions disclosure, corporate social responsibility and structural defenses.

• Corporate Responsibility. The 2012 presidential election year is likely to bring heightened attention to issues related to corporate responsibility generally and to corporate political power in particular. In 2011, both the number of social and environmental proposals brought by shareholders and the support for these proposals increased. Boards should be prepared for particular scrutiny of their oversight of corporate political spending and should be sensitive to that issue. In addition to calls for greater disclosure of board policies and decisions with respect to political spending, boards should expect calls for greater disclosure regarding corporate impact on natural resources, with an emphasis on water and air quality and supply chain sustainability. Boards should ensure that these topics receive appropriate attention on the board agenda and should keep tabs generally on public sentiment as it relates to the company and issues of corporate responsibility generally. This is an area where the board may be particularly well positioned to assess the general environment and advise management.
• Executive Compensation. Say on pay acted as a “release valve” allowing shareholders to let off steam in 2011, resulting in fewer “withhold” and “against” campaigns targeting individual directors in elections. It will still be high on the shareholder agenda in 2012. To bolster support in the coming year, boards and compensation committees should recognize that many shareholders are looking for them to demonstrate restraint. Expect pay for performance to continue as the primary factor in obtaining shareholder approval, with shareholder sensitivity to pay levels relative to peers and pay increases out of proportion to performance trends. Consider the shareholder perspective on (and public perception of) the company’s executive compensation program and related disclosures, including, how the program matches up the new ISS guidelines (given its influence). Don’t just read a final draft of the proxy statement – advocate early that it explain the company’s compensation philosophy, and the alignment between pay and performance in clear and understandable terms. Finally, be willing and available to follow-up with key shareholders to discuss the board’s approach to say on pay. Boards of companies that failed to receive a majority vote in favor of executive compensation or received a high proportion of negative votes (even though receiving a majority vote in favor) should identify the primary shareholder concerns and take a hard look at whether changes are called for, based on fiduciary judgment.
• Majority Voting. Boards should expect a concerted effort from shareholders to extend majority voting to the remainder of the S&P 500 and beyond to the next tier of companies in 2012. Boards at companies that have not yet adopted a majority voting standard, or a director resignation policy in the event a director fails to receive a majority of the votes, should be prepared to address this issue with shareholders.
• Proxy Access. 2012 is the first year in which shareholders may bring proposals seeking bylaw changes to allow proxy access for shareholder nominations of director candidates in competition with the board’s own nominees. (Any adopted bylaw changes will not be applicable until the next year.). While public pension funds and union funds are expected to bring a relatively focused set of proposals concentrating on high-profile companies that have had significant governance, compliance or performance issues, individual shareholders involved in the U.S. Proxy Exchange (USPX) and the Norwegian Pension Fund Global (NPFG) have already submitted a dozen or more proposals. The non-binding USPX proposals generally ask that the board adopt a bylaw to permit proxy access for director nominees from shareholders that have held continuously for two years percent of the company’s eligible securities and/or any party of 100 shareholders each of whom satisfy the basic SEC Rule 14a-8(b) eligibility standards (holding a $2,000 stake for one year). The NPFG’s proposals are reportedly binding proposals and also have a low threshold, requiring that a shareholder hold a minimum of 1% of company stock for year. Boards should follow developments in this area closely. Maintaining strong relationships with significant shareholders and understanding and, as appropriate, addressing their concerns continues to be the best preparation for a potential proxy access proposal.
• “Vote No” Campaigns. Boards may see an up-tick in the number of campaigns against directors up for re-election. ISS has a fairly long list of circumstances that will cause it to recommend voting against a director in an uncontested election. In addition, “vote no” campaigns may target compensation committee members at companies where shareholders and proxy advisors deem the committee and board unresponsive to the 2011 say on pay vote even where the proposal “passed”. Boards should review ISS’ recently revised policies early to understand where vulnerabilities may lie so that they can take appropriate action, including, if necessary, targeted shareholder outreach.

Part II – Opportunities for Shareholders to Rebuild Trust

1. Focus on the long-term. Shareholders should give the board and management freedom to make decisions over a long-term time horizon. Focusing on the long-term is particularly critical during a downturn. While plowing resources into R&D and other job creation and growth strategies may restrain the bottom line in the near-term, such investments are necessary to reap rewards for the company and its shareholders—and society—later on. Shareholders may need to evaluate their own decision-making structures and ensure that they are not rewarding high-risk behaviors, whether through direct investments or through the monies they invest through other entities.

2. Refine shareholder priorities and reduce “noise.” Boards of public companies are bombarded with a wide array of viewpoints about corporate governance and social and environmental issues. Institutional shareholders should identify the two or three issues (in addition to return on investment) that are most important to them and then clearly and consistently articulate their views. Laundry lists of concerns should be prioritized to ensure that the board can hear and focus on the things that are most important to shareholders. These priorities can also help shareholders to ground their approach to voting analysis (see below).

3. Vote responsibly. With power comes responsibility. Where shareholders do not have the resources to become informed on an issue on a company-specific basis, it makes sense for them to generally defer to the board’s recommendations. We note that many may consider this heresy, but presumably most shareholders have invested in a company because of faith in the direction that the board and management are taking the company. Alternatively, they are investing because the company has been included in an index that the shareholder invests in, deferring to the judgment of others. Deference to board recommendations in most instances would allow shareholders to focus scarce voting analytic resources on companies where a significant performance or other red flag issue is apparent. In such instances, shareholders should apply their resources to becoming well informed prior to voting.

4. Delegate and/or rely on others responsibly. A corollary of the admonition to “vote responsibly” is to delegate or rely on others responsibly. When choosing advisors to assist with voting analysis and recommendations, do so on an informed basis after performing due diligence as to their capabilities. Consider whether they have the resources to provide informed and tailored advice specific to portfolio companies or are unduly reliant on a set of fairly rigid voting guidelines. The more reliant they are on junior seasonal workers who turn over every year, the less likely that they are able to provide rigorous, sophisticated and tailored analysis. If you are having the advisor tailor policies specifically to your specifications, consider using a performance screen and instructing the advisor that so long as the company is performing well and there are no significant red flags (and mere failure to adopt a particular governance policy favored by the advisor shouldn’t count as a red flag), to vote as the board recommends.

5. Speak up, but be willing to listen. Shareholders should share their concerns with boards and should also provide feedback when requested. Shareholders should also be prepared to listen to what boards have to say – communication is a two-way street. Communication can take various forms, from formal meetings conducted in accordance with Regulation FD, to posts on Twitter or other social media tools. Remember in communicating with a board that other shareholders may have different—and even conflicting—views. Also recognize that some means of communicating lack nuance. An example is the up-or-down vote on say on pay resolutions which provides shareholders with an imperfect forum in which to let the board know how it is doing on compensation and, indirectly, on performance generally. Follow up with concrete suggestions and give the board the opportunity to respond. Recognize that it takes time to make significant modifications to a company’s compensation program. Also, remember that while shareholder views about appropriate compensation should be considered, executive compensation is fundamentally the board’s responsibility.

6. Carefully consider private ordering options. Shareholder proposals relating to proxy access—whether by way of precatory resolution or binding bylaw amendment—should include meaningful ownership thresholds and other qualifications to ensure that director elections proceed in an orderly manner and are not hijacked by special interest groups. Proxy access should be viewed as a last-resort mechanism. Engagement with the company’s nominating committee on board composition should always be the preferred course.

Ira M. Millstein is a senior partner at the international law firm Weil, Gotshal & Manges LLP, where, in addition to practicing in the areas of government regulation and antitrust law, he has counseled numerous boards on issues of corporate governance. Holly J. Gregory is a partner in corporate governance at Weil, Gotshal.

The 2010 B. Kenneth West Award Winner Curtis J. Crawford (left), NACD Chair The Honorable Barbara Hackman Franklin, and the 2011 B. Kenneth West Award Winner Jon F. Hanson

Hanson and Britell treated guests to unique insights into the knowledge they have gleaned over their numerous years of corporate leadership experience throughout the two-day forum, along with numerous other C-suite and boardroom experts and advisors.

Joining Hanson onstage was HealthSouth CEO Jay Grinney in a discussion on fostering relationships between executives and directors that best benefit shareholders, moderated by George Davis, Egon Zehnder’s co-managing partner of the Global Board Practice George Davis. Hanson joined HealthSouth mere months before federal regulators began fraud investigations that resulted in five of the company’s previous CFOs pleading guilty and the firing of CEO Richard Scrushy. Today, the company has returned to prominence, benefited by Hanson and Grinney’s commitment to excellence.

“The most important thing a CEO has with a nonexecutive chair is someone who is familiar with the company, but is not a direct report that he can bounce ideas off of,” explained Hanson. The two describe themselves as having a strong chemistry; Hanson noted that Grinney is not much older than his oldest son. “We’ve never had a disagreement, we may have had differing views, but by the time we got off the phone we were on the same page,” he added.

The two have ironed out a process for communications with the full board, as well. Although Hanson is the primary contact for the board between meetings, who summarizes their ideas and concerns for Grinney, individual directors are always welcome to contact Grinney directly. “I am not the gatekeeper, nor do I want to be,” emphasized Hanson.

Grinney noted that an ideal chairman needs to have leadership skills, honesty, integrity and a clear perspective: “You need a nonexecutive chair who truly does not aspire to be CEO, that’s a key prerequisite.”

Michael Kneeland, CEO of United Rentals (left), NACD Chair The Honorable Barbara Hackman Franklin and 2011 NACD Public Company Director of the Year Jenne K. Britell

Director of the Year Britell also faced a dicey situation as a United Rentals board member in 2007, when the Delaware Courts ruled the rental equipment operator could not force Ceberus Capital Management to complete a proposed buyout of the company. The next year, she was named chairman. Britell also led the turnaround of GE Capital Mortgage Services as its CEO from 1996 to 2000.

Britell offered a glimpse into the best practices she learned from these experiences in a panel titled “Turnaround: Dealing with Distress,” one of which being the ability for challenges to unite a board. “Crisis enables faster changes,” she explained. “It forces a board to come together more quickly and more deeply when the only place you can go is up.”

Other panelists, including Levick Strategic Communications President Richard S. Levick and Blockbuster Director Gary Fernandes, noted that the important part of crisis planning is not to develop a plan for specific crises, but rather have a solid leadership structure that works both in good times and bad. “The board and senior management need to share critical values,” Britell said. “The board has a critical role to play but the buck stops with the CEO, even if there is a nonexecutive chair or lead director. They need a consensus on values more than the plan.” (For more on the D100 from the September 2011 issue of NACD Directorship, please click here.)

This year’s keynote was delivered by former U.S. Army General Stanley McChrystal, who now serves on the board of JetBlue, and shared what he learned about leadership as commander of the U.S. Forces and International Security Assistance Force in Afghanistan, and how he uses that knowledge now in the boardroom. He emphasized that a close relationship with allies is necessary for success, noting that situations where many organizations tasked with similar goals created unnecessary roadblocks. “Leadership is not a talent or a gift, it’s a choice,” he said.

Of the 300 forum attendees, a select group were also celebrating the completion of the required educational programs to become an NACD boardroom Leadership Fellow. Prospective NACD Fellows are required to have years of significant board service, and to complete a number of programs to earn the distinction. To learn more about the NACD Fellow program, please click here.

H. Rodgin Cohen, Carol J. Loomis, Edward A. Kangas

“If you have an athlete that all of a sudden performs far above whatever he or she has ever performed, the immediate thought is steroids. Well, risk is the steroid for business, and too often there’s not enough drug testing in the boardroom,” said Cohen, who together with Loomis and Kangas reflected on their years at the top of the business world.

Introducing the Hall of Fame panel was Mark Preisinger, director of corporate governance for the Coca-Cola Company.  “The theme of this year’s forum is the game changers and it’s particularly relevant given all that we in the corporate governance community are dealing with,” Preisinger said, noting that the Dodd-Frank Act and the mid-term elections will result in even more game-changing events for directors who serve public companies.

Loomis, whose articles have informed Fortune readers and in some instances proved transformative for more than 50 years, told an audience of more than 300 that directors need to keep the CEO honest by providing a balance to the chief executive’s power.  “Your biggest job is fingering the CEO who is pleasant and nice and honest but just isn’t any good, and you have to do something about that guy because you just can’t go along in that respect,” said Loomis, accentuating that one duty of boards is to balance the CEO’s power. “Boards must do a much better job than they do about M&A deals. Too often, as far as I can tell, CEOs like nothing better than to do deals, they’re rather obsessive about it, and so the board has to apply the restraint.”

Kangas highlighted the need for boards to work as a respectful and respectable unit, saying, “It’s important to talk straight, play straight, no games. It’s okay to be politically astute in the boardroom; it’s not too good to be political. You learn in time, and it’s something I’ve learned the hard way, that listening is important. I sometimes reflect back on what my mother had to say, she said ‘Eddie, if you press your lips together your ears will work better.’”

“An independent lead director or an independent executive chairman is really important for the effective function of the boardroom,” Kangas continued. “It’s also important if you have a non-executive chairman that they are not chairman of the company. The CEO should be the focal point for every company both inside and outside.”

The Hall of Fame dinner opened the NACD Directorship 100 Forum, which each year convenes to celebrate the Directorship 100, the annual list published in the September issue, of the most influential people in corporate governance.

Let’s be clear from the start, though: metrics do matter. There are certain rules of the game that serve as key benchmarks in creating a uniform understanding of what makes for good governance and good companies. At CalPERS, we have holdings in thousands of companies in dozens of countries. We require a playing field leveled by metric analysis to begin the decision-making process on where to invest. Yet we have only to look at the recent wild financial frontier and the near-collapse of the global economy to know that in so many cases, good governance principles were blindly, even disdainfully, ignored. In these volatile times, governance metrics can help lead the way to safety­—and increased shareowner value.

Take a look at one vitally important area where metrics can help us cut through the dense financial landscape: executive pay. What the statistics show is clear. CEOs now receive nearly 400 times more in compensation than the average employee, sums wholly untethered to any kind of corresponding growth in profitability or creation of wealth. We may not have a metric to tell us how much is too much, but we do have metrics that can tell us if pay has become outrageously detached from performance, if pay is rewarding short-term measures, or if pay has become disturbingly oblivious to risk. Return on invested capital, total shareholder returns, and even share price, as fickle and as imperfect an indicator of performance as it is, can help investors determine whether compensation is anchored to a legitimate long-term strategy or whether it is adrift in a short-term sea of visionless mediocrity.

Still, the clarifying light of good governance metrics can only illuminate so much. This is where critics have rightly challenged proxy voting firms. Not all key corporate operations can be analyzed by marking off columns of boxes during a due diligence review. Not all information yields to metric equations and statements of principle. What’s missing, as Yale’s Jeffrey Sonnenfeld pointed out in his critique of good governance metrics, is “the human side of governance.”

Nowhere can we find a better example of this than the corporate boardroom. To outside observers, for example, an objective laundry list of well-considered metrics detailing the DNA of an independent director may be sufficient, even satisfying, but in reality it’s a two-dimensional document with a defining weakness: It’s an account of what the independent director is not.

The real calculations begin with a list of what the directors are: Competent? Objective? Fearless and energetic? Some proxy ratings firms have constructed good governance blueprints from formulas that neglected to factor in the qualitative aspects of human behavior. Structural issues that follow a uniform, consistent path respond nicely to a nudge from these kinds of metric-based analytics; boardroom actions typically do not.

We’re working with industry colleagues to build a diverse database of potential board candidates, keenly aware that a qualitative metric built around human dynamics is a central component of any serious discussion. Among the core traits we’re looking for are collegiality, the ability to listen and the willingness to be part of a team.

But how do you assess these characteristics? Not easily—and not simply from a cold stare at a matrix of metrics, though the outline of the story might begin there. This is an area where a tale of traits is revealed through hard work, meticulous research…and the simple, uncomplicated act of meeting and talking with a potential candidate. It can’t be done from afar. Do metrics matter? Yes, but…

Anne Simpson is senior portfolio manager for corporate governance at the California Public Employees’ Retirement System (CalPERS).

Too little focus is placed on operational risks. Yet, most publicly traded firms have at least two internal control systems. The Committee of Sponsoring Organizations (COSO), which covers financial reporting, operations and compliance is different from the International Organization for Standardization (ISO), which focuses on operational controls related to quality, the environment and safety. Miscues with operational controls become financial risks that can be easily overlooked. COSO and ISO controls must be coordinated, and reports to the board must contain results from both systems.

Moreover, board members must recognize the value of ISO audit results and demand that management include them.

Advantages of Coordinated Audits
There are numerous advantages for the inclusion of ISO audits in the board’s oversight of risk assessment. In addition to the obvious advantages of more cost-effective audits, elimination of unnecessary audits and more comprehensive risk assessments, boards may be most interested in the regulatory compliance aspects. The new 2010 proxy rules require disclosure of the board’s role, administration and leadership structure as it relates to the oversight of risks. This additional scrutiny of the internal controls process will require boards to increase their knowledge and involvement in this process. Moreover, it will more than likely require boards to enhance the process. Integrating ISO audits in the process can be an effective component to meeting the new disclosure requirements.

In addition, compliance would be improved by meeting the expectations of the Public Company Accounting Oversight Board (PCAOB). The September 2009 PCAOB report titled “Report on the First-Year Implementation of Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements,” indicated that registered PCAOB auditors could improve their audits of publicly traded companies in six areas, including “using the work of others” and “entity-level controls.” Audits could be more efficient if reduced testing of controls at the process or entity levels were done by relying more on the work of others (e.g., the ISO audits), the report concluded. It is highly likely that the PCAOB would agree that the inclusion of ISO audits could improve the efficacy and effectiveness of the board’s oversight responsibility.

Where ISO and COSO Overlap
Many publicly traded companies incur the cost of conducting several independent internal controls audits. Granted, the audits are conducted for different reasons and their impetus is from different sources. Companies voluntarily pay independent ISO audit firms (i.e., registrars) to audit their management systems in order to remain viable as competitors in the marketplace. These same companies pay independent PCAOB-registered audit firms to ensure their management systems comply with the Sarbanes-Oxley Act of 2002. Yet, there are many similarities in the two different audits.

The international management system standards (e.g., ISO 9001, ISO 14001 and ISO 18001) were developed under the coordination of the ISO, a worldwide standards-setting body based in Geneva, Switzerland. The standards have become a widely used marketing tool and operational enhancement vehicle. For many industries, certification to these standards has become a requirement to conduct business. These ISO certifications require that a company design and implement internal controls over its operations, then train some of its employees to conduct annual internal audits to ensure compliance. Under the guidelines of these standards, most companies with such internal control systems also engage an outside independent auditor called a registrar to audit and certify their system annually.

The predominant standard for auditing internal controls over financial reporting was developed by COSO, which is comprised of the major financial and accounting organizations. This standard is typically used as the basis for the CEO and CFO certifications that the internal controls are effective when the quarterly financial reports are filed with the Securities and Exchange Commission. COSO defines internal control as “a process designed to provide reasonable assurance regarding the achievement of objectives in effectiveness and efficiency of operations, reliability of financial reporting and compliance with applicable laws and regulations.”

Many boards seem to be aware that the COSO framework is designed to cover some operational areas and that ISO internal controls cover some financial areas. The COSO framework is primarily a tool of the board and its senior executives, while the ISO internal controls are tools of the operational units. Yet, the two systems essentially perform the same functions, just at different levels in the organization. Companies incur significant expense to manage both internal control systems and are likely to increase their expenditures to perform this function as financial regulatory scrutiny increases.

When the tenets of two internal control systems are studied, it becomes clear that there are significant overlaps in the internal controls for the ISO and COSO systems. Boards need to be aware of opportunities to maximize the cost-effectiveness of merging or coordinating the two systems. Many boards do not understand the intricacies of either internal control system, let alone the value that they could provide if properly coordinated. Still, oversight of the internal controls and risks is one of the primary responsibilities of a board of directors.

Both internal control systems cover all three core elements (see related chart below), but there are some distinct differences. ISO covers all operational controls and some financial reporting and regulatory compliance controls. COSO covers all financial reporting controls and some operational and regulatory compliance controls. Another difference is that ISO-managed risks are typically quantitatively expressed (e.g., statistical process control) whereas COSO-managed risks are typically rated in general terms such as high, medium and low.

However, there are more similarities than differences: both internal control systems require certification by independent third parties, both require annual internal management audits (minimally), both are standards developed by recognized standards bodies, both seek to minimize company risks and enhance performance, both apply to all levels of the company and both are geared toward the achievement of established objectives. There are many similarities that, if adequately coordinated, could yield significant advantages for an enterprise-wide risk management system.

Larry Taylor PhD is the CEO of The Creighton Group, a board advisory services firm based in Los Angeles. He serves on the board of OBN Holdings and The CM Diamonds Foundation.

Participants:
1. Catherine L. Bromilow, partner, Corporate Governance Group, PricewaterhouseCoopers
2. Scott R. Cutler, EVP, co-head U.S. Listings and Cash Execution,
NYSE Euronext
3. Thomas J. Neff, chairman, Spencer Stuart U.S.,  director, Ace Ltd., Hewitt Associates
4. John S. Barry, partner, Corporate Governance Group, PricewaterhouseCoopers
5. Stuart R. Levine
Founder and CEO, Stuart Levine & Associates, director, Broadridge Financial Solutions
6. Julie Hembrock Daum, practice co-leader, North American Board and CEO Practice, Spencer Stuart
7. Kenneth P. Kopelman, partner, Kramer Levin Naftalis & Frankel,
director, Liz Claiborne
8. Robin A. Ferracone
Executive chair, Farient Advisors and CEO, RAF Capital

The handbook focuses on both the role of the individual trustee and the role of the board as a united and functioning entity, outlining the specific skill set and focus that are necessary traits of a successful board. Important tax information is also explained, as well as regulatory and compliance issues.

Click here to read the handbook.