Are Boards on Way to Better Practices?
October 22 2009 by Fayazuddin A. Shirazi
Marred by persistent clamoring from shareholders on their effectiveness as tools of corporate governance, corporate boards are apparently falling in line. A recent study on boards’ performance and practices revealed that corporate boards and its members are well on their way to better practices shedding long held accusations of inefficacy against them.
The study of S&P 500 corporations by Stuart Spencer, the NY based executive search consulting firm disclosed that boards of directors have shifted governance practices in line with popular demand and the proposed legislative reforms. Thanks to the shareholder say on pay and the challenging market conditions, majority of the polled boards believed directors who do not enjoy shareholder confidence should be shown the doors.
The 24th annual Spencer Stuart Board Index (SSBI), which picked up the information from an analysis of the proxy data, said that in line with corporate governance best practices, about 65 percent of boards report that they require directors who fail to secure a majority vote from shareholders to resign from their board membership. This is up from 56 percent with majority voting requirements a year ago. In addition, one-year terms for directors are now the norm in 68 percent of S&P 500 corporations versus 38 percent 10 years ago, the study said.
While Sarbanes-Oxley triggered much attention prompting boards to improve their performance, challenging market conditions, growing intensity and complexity of global business have forced boards to fall in line with better governance practices, feels Julie Hembrock Daum, CEO succession practice leader at the Spencer Stuart’s North American board.
Speaking to CE Online, Julie Daum said boards have now realized the need for better governance practices mostly because of the growing competition and the complexity of global business and risk management. “Boards understand they need to improve if their companies are to win in the changed and demanding global marketplace,” she says.
Additionally, the increase in shareholder scrutiny and activism is also one of the factors, she says adding, shareholders have moved from a passive to a vocal force in corporate governance. “Boards have become more independent now; they are acquiring increasing number of experts on issues relevant to them and are also establishing specialized committees to address new governance standards. They have evolved significantly over the past five years,” Julie Daum added.
Besides, the study also revealed that there is an increased level of shareholder engagement with boards. Two-thirds of the polled boards reported that shareholders have either initiated contact with their board or management. Of this group, 59 percent said, shareholders contacted managements to discuss a particular issue or to get on the boards’ agenda; and 28 percent reported that shareholders contacted board members directly.
Not surprisingly, the leading shareholder issues during the last year were executive compensation, “say-on-pay” and majority voting for directors, the study report noted. Boards responded by focusing on CEO pay and their role in strategy and risk management in light of the recession, followed by director recruitment, CEO succession planning and specific shareholder concerns, the study report revealed.
While shareholder interest in say-on-pay has increased significantly and some U.S. companies have also adopted it, figures from the U.S department of Treasury are interesting to note. According to a recent update from the U.S. department of Treasury, shareholder requests seeking say on pay proposals at their companies have increased from over 50 in 2007, to over 100 in 2009.
These proposals, which are usually non-binding requests to institute say-on-pay votes in the future, enjoy support from a growing number of shareholders – with average vote totals increasing from 42.5 percent in 2007 to 46.7 percent so far this year. In 2009, proposals requesting say-on-pay have garnered majority support at no fewer than 19 companies, up from roughly 14 in 2008 as against eight in 2007.
Alongside, in response to investor proposals, roughly 15 companies provided shareholders with say-on-pay in 2009, and a handful of other firms have announced plans to hold say-on-pay votes in future years, the Treasury report said.
Julie Daum believes boards have been listening and responding to criticism about their effectiveness and are moving to better practices.
“While there are still calls for greater transparency and governance, boards are demonstrating they are well aware of what they need to do to serve shareholders,” she says.
However, Julie Daum thinks boards need to do a lot more before they can be recognized as effective tools of corporate governance. While some boards are already in the bracket of good performers they lack perfection and their performances invariably differ, she says.
Although directors have a duty to shareholders in preserving the value of the company through informed decisions and reasonable business judgment, they also need to put in place effective board evaluation processes and create a transparent working atmosphere, feels Julie Daum.
“Beyond the routine duties towards shareholders, boards should tell shareholders who is in the room and why. The level of transparency should come to this extent,” Daum pointed out in an interview to CE Online.
According to her, board effectiveness is not just about rules and best practices. It is also about the talent, the experience, the courage and the wisdom of the directors in the room.
Responding to queries on the alleged government meddling with CEO pay, Julie Daum is of the opinion that companies should proactively fight against this and shouldn’t lose control on business matters to the government. “Boards should denounce such moves and proactively work against the government meddling. History has shown that if businesses do not reform themselves and bring in changes accordingly, they will come under severe regulatory pressure from the government agencies, which of course will not be in the interests of the companies and their ability to compete for talent in the marketplace.
Additionally, Julie Daum also believes, boards have a fiduciary responsibility to make sure executive compensation is aligned to the right incentives and correct strategies and are in the interest of the company. With transparency in executive compensation in place through new proxy rules, shareholders can determine for themselves what level of compensation is appropriate for executives, she says. “Boards can set compensation, and shareholders are free to agree or disagree with the board decision,” adds Julie Daum.
Interestingly, even executive pay analysts such as Bruce Ellig says if the boards do not take stock of the excessive executive pay issue, they will lose control to the government. Author of “The Complete Guide to Executive Compensation” Bruce Ellig believes that the Federal Reserve’s announcement that it intends to reject any compensation plan for bank employees that encourages too much risk is only the latest government response to take over the responsibility for approving pay packages from the boards of directors.”
Even though the board and the compensation committee can – and should to some extent – rely on the company’s head of human resources and the external pay consultant hired by the committee, Ellig points out that there needs to be at least one person on the compensation committee who understands the basics of executive compensation.
He says this will be similar to the Sarbanes-Oxley requirement of having at least one person on the audit committee who is capable of reading financial statements. “If the compensation committee does not include such a person, it should look to the board and identify a person (perhaps with a financial background) to undergo a training program developed by HR and the external pay consultant,” Bruce Ellig remarks in an advisory note to corporate boards.
“Never has the need for understanding executive pay at the board level been greater, and it is unlikely to diminish,” he adds.
Meantime, the Spencer study also found that there are fewer active CEOs among new directors – 26 percent in 2009 versus 53 percent 10 years ago – and the CEO is the sole insider on 50 percent of boards.
Boards have also placed limits on additional board services. A total of 67 percent of boards restrict the number of outside boards on which directors can serve by comparison to 27 percent as recently as 2006. Most boards (94 percent) now evaluate their performance annually, and a mandatory retirement age is becoming the standard with 75 percent of boards having specific retirement times versus 57 percent 10 years ago.
A board survey of corporate secretaries and general counsel, which is part of the yearly SSBI study, revealed that annual CEO succession planning is a regular part of the agenda on 55 percent of the respondents’ boards, while 39 percent of responding boards take up CEO succession more than once a year. In addition, 43 percent of respondents use a formal process to review internal candidates for the top job.