The Current Thinking On Corporate Governance

This past month I participated as a panelist at two governance functions – The 3rd Annual Directors Education Workshop sponsored by GE and The Millstein Center for Corporate Governance and Performance at the Yale School of Management. Both were stimulating events that provided an overview of the best thinking today on current, challenging governance issues. Here are some of the highlights that I hope you will find both interesting and useful.

Understanding risk management: Risk can be defined as the degree of uncertainty between expected and actual outcomes or the “potential for failure.” Risk should focus on “catastrophic events” that could be significant to the business as a whole. Effective risk management should be viewed throughout the culture of the organization, including all corporate divisions and management, to identify those major potential risks. Only 5 percent of boards have dedicated, boardlevel risk committees. The model that is being recommended has an internal risk committee that reports to the entire board on a quarterly basis.

Risk models should be combined with a deeper understanding and questioning of inputs and assumptions. Additionally, boards should be involved in hiring the chief risk officer with direct reporting to the board to ensure authority and independence. Compensation should be based on minimizing risk and promoting shareholder and long-term value.

Tying executive compensation to value creation: Before the financial crisis, significant incentive compensation structures had been in place for chief executives to attain increased stock prices without regard for associated risks. This created a massive failure of risk oversight among regulators, financial firms’ boards and internal control systems.

Existing compensations structures are often not aligned with long-term value creation. It is important to design metrics that include intangibles that make for good management, such as corporate culture, product quality and customer service. These more difficult to measure factors are equally as critical to the typical metrics of short-term stock price movement, return on equity or earnings per share.

Board collaboration as good governance: Panelists agreed that the No. 1 governance concern is board composition. Boards need engaged people with the requisite skills to create and maintain a culture of constructive challenge and competence. The skills needed include the ability to work collaboratively; willingness and capacity to self-evaluate; time, energy and focus; at least one board member with in-depth industry knowledge; and the ability to ask objective, independent, knowledgeable questions and to challenge the CEO when necessary.

Typically board bios supplied with proxy voting documents do not give the right kind of information to enable shareholders to make informed decisions regarding board candidates’ specific qualifications and what they bring to the board. Bios should answer the question: “Why should you be on this board; what value do you bring?”

The best boards are small, nimble and incentivized. There was consensus that it is key for the board chair and CEO/president to be different individuals. Inside directors are key to providing an inside view, but they must have independence from the CEO.

The integrity fundamental: Transparency was considered to be a key issue plaguing boards. Boards increasingly recognize that meaningful and transparent disclosure increases the value of the work. It instills process and discipline that improves clarity of thinking and effective actions.

One of the most high-level and important issues that surfaced was the interest in thoughtful dialogue about what kind of society we want to have. With personal gain as the highest aspirational goal of the last decade, combined with the “animal instinct” in our human DNA, this was a very “rich” topic for discussion.

The core of good governance is all about culture, which is linked to our core values. Do good governance and good values drive greater results/investments? According to The OECD Convergence Hypothesis, investors will pay a premium for good governance and the implementation of best practices. Even unregulated, privately held companies are seeking to bring in the elements of good corporate governance to help performance.

My strong feeling is that boards, as well as organizations, are most successful long term when firmly rooted in core values, when they are mission driven and when they are focused on creating long-term sustainable value.