All becoming clear?
As US listed companies begin to file their proxy statements, the governance community is looking closely to see how they respond to new SEC disclosure directives. A key challenge, introduced in the wake of the obvious board failures contributing to the financial crisis, is to offer more information about how they recruit and select directors. Beyond disclosure, however, many directors are taking steps to uncover what people really think about them and to work out how they can improve their standing with investors, regulators and the general public.
In place of what has normally been scant disclosure, the SEC is asking for details on the specific experience, attributes, skills and qualifications that led the board to the conclusion that a particular person should serve as a director. ‘That’s substantially different from just listing their names and former titles,’ says Karen Kane, who heads an Oak Brook, Illinois-based CEO and board communications advisory firm.
Ordering this exercise is meant to push companies to seat better boards and change the perception that many of them were asleep at the switch during the downturn of the past two years. Under the new order, it would seem difficult to justify the nomination of such arguably ill-suited candidates as an actress and socialite to Lehman Brothers’ board or a CEO’s child’s former elementary school principal to Disney’s. ‘I’m paraphrasing RiskMetrics’ Pat McGurn here, but a board appointment as a lifetime achievement award is not in the best interests of shareholders,’ says Kane, a former board secretary.
Doubt and skepticism
In this season’s crop of proxy statement filings, companies are responding. Citibank, for example, states that it puts value on skepticism and candidates who will check and balance management. ‘Each has been chosen to stand for election in part because of his or her ability and willingness to ask difficult questions, understand Citi’s unique challenges and evaluate the strategies proposed by management, as well as their implementation,’ states the disclosure in Citi’s preliminary proxy statement, filed in late February.
Despite some progress, many companies aren’t yet doing much to fulfill the SEC’s directive, which went into effect on February 28. The Corporate Governance Research Program at Stanford University’s Graduate School of Business is reading new filings with an eye to the new developments. On Corporate Governance Wire, produced in partnership with executive compensation research firm Equilar, it reports a disappointing pattern to SunTrust Bank’s 2010 disclosure, which is criticized for being repetitive and disclosing nothing of value. According to SunTrust: ‘AD Correll’s long and varied business career, including service as chairman and CEO of a large, publicly traded company, well qualifies him to serve on our board’; ‘David Hughes’ long and varied business career, including service as chairman and CEO of a large, publicly traded company, well qualifies him to serve on our board’; and ‘Douglas Ivester’s long and varied business career, including service as chairman and CEO of a large, publicly traded company, well qualifies him to serve on our board.’ Notice a theme here?
Improving board culture
David Zweig, co-author with John Gillespie of Money for nothing: how the failure of corporate boards is ruining American business and costing us trillions, welcomes the new disclosure requirements, noting that they force companies to leave at least ‘footprints in the snow’. Yet he says he is well aware of all the internal battles to be won ahead of such disclosure. ‘It could become a check-the-box exercise that doesn’t result in real change,’ Zweig says. ‘That’s our concern.’
Zweig and Gillespie’s new book is a highly readable analysis of the flaws they see in the current corporate governance structure. They look at what they call the ripple effects of policies and practices that permit a CEO to also be chairman of the board and a director to serve on numerous boards, an absence of term limits, staggered boards, majority voting and a lack of proxy access. Also central to their study are group dynamics and the pressure directors face to be agreeable and withhold dissent. In many cases when nominating directors, companies almost seem to be looking for candidates who won’t be asking questions, Zweig argues.
In their book, the authors note that in CEO searches, recruiting firms do thorough behavioral and psychological tests to find candidates who look at problems with a full spectrum of thought processes. Given that the tools obviously exist, they should also be used in director searches to find candidates with much-needed ‘perceptual diversity’, the authors suggest.
Zweig and Gillespie present boards of private equity-owned companies as good models. Far more so than at public companies, these boards comprise and reflect the views of major owners of the stock. They can also take a longer-term view, freed as they are from public reporting of quarterly results. ‘These are not the rob-and-run people,’ Zweig says. ‘These boards take good people, empower them and give them unfettered access. They’re seen as huge assets.’
Gillespie says public company directors owe it to shareholders to hold themselves to an equally high standard. He notes that he and Zweig come to this subject not as antagonists, but from training and employment ‘at the hub of the American business world’, including the Harvard MBA program and roles at Lehman Brothers, Morgan Stanley and Dow Jones. The market collapse in 2008 had the effect of scaring capital from equity and debt markets, which continues to cause huge problems, Gillespie says, adding: ‘It’s market-enhancing to have reforms to improve the culture of boards.’
The authors say companies should be focused on finding directors capable of, and willing to share, wide-ranging thinking. They also want to see processes in place where such people can be nominated and elected. ‘Everyone is fixated on regulations and legislation,’ Zweig says. ‘One good, strong director is worth a ton of that, and can yield much better results.’
Another important issue is that of how to evaluate directors already in place. Some in the corporate governance community have put forward the idea of a board perception study, similar to an investor perception study, with a focus on board performance. Kane says she can see this happening as part of the shift from directors being behind-the-scenes advisers to being highly accountable public figures. ‘All of this is coming,’ she predicts. ‘I’m not seeing a lot of it, but it’s coming.’
Lev Janashvili, senior vice president of investor relations and financial communications firm the IGB Group, says he likes the idea of using perception research more methodically to assess board performance. ‘I hope the idea gains broader acceptance, but I think it would be premature to view it as an inevitability,’ he says. ‘Likewise, I see the potential for the broader use of perception research by boards of directors to assess the performance of senior management.’
Janashvili says it is currently rare to ask questions in a survey about specific directors or to get comments unprompted, although overall governance is an increasing point of investor concern. Topics broached include share structure, board independence, compensation practices and poison pills. Brian Rivel, president of Rivel Research Group, also says he hasn’t seen a huge call for board-specific questions, yet his firm did a recent investor perception study entirely devoted to a single corporate governance issue: executive compensation.
There is also room for better board self-evaluation. The Sarbanes-Oxley Act mandated an annual evaluation process, but critics say this is also prone to being a check-the-box exercise. Kane says what is called for is probing one-on-one interviews with directors who subject themselves and others to a 360-degree review.
Gillespie says a good result can be achieved if the sponsor is an outsider who takes the assignment with a sense of bravery. ‘You need someone who is willing to be fired tomorrow,’ he observes. Kane agrees, having had such assignments. ‘It’s easier if you have a clean sheet and it’s coming from someone who won’t be in future meetings,’ she asserts.
Sharing the results of a board perception study or board self-assessment could be a good lead-in to the annual meeting. ‘It’s a great opportunity to demonstrate shareholder engagement,’ Kane says. ‘In the past, it was perfectly legitimate to operate behind closed doors. This is no longer the case.’
There is an increasing call for boards to initiate more such communications with shareholders, in part to demonstrate their independence from management. Until now, few have done so unless triggered by scandal or public investigation. Gillespie and Zweig suggest small steps like putting a director on the phone with securities analysts in quarterly conference calls.
Kane sees another opportunity with the new SEC disclosure requirements forcing companies to outline their director nominees’ competencies. For example, a company could make room in shareholder communications for a letter from the board chairman or lead director introducing the changes to this year’s proxy statements. ‘This is new, so we’ll see what kinds of best practice come out of this proxy season,’ she says.
Kane says this gets to the heart of a vital question, particularly as companies face a future with some kind of proxy access. ‘Is the proxy statement a legal document or a communications document?’ she asks. ‘What is the spirit of the law, rather than the letter?’