18 Oct. 2019 | Comments (0)
On Governance is a series of guest blog posts from corporate governance thought leaders. The series, which is curated by the ESG Center research team, is meant to serve to spark discussion on some of the most important corporate governance issues.
Traditionally, there have been three basic board committees; audit, compensation and nominating. That said, board committees are evolving. Forward-thinking boards of directors have reviewed their company’s strategy and operations and looked at how the board does its work. They have asked, “do we have the right board committee structure for our company, one that helps directors do their work most effectively?”
In answering this question, some boards determined that additional committees were appropriate. For example, there might be a cyber or a risk or a safety committee. And, of course, there are the periodic “special” committees. In addition to potentially adding a committee, standard board committees are being realigned. For audit and compensation committee members, this is not new news, they know their responsibilities have expanded in recent years. Now it is the nominating committee’s turn for reordering.
Nominating committees have changed a bit over the past two decades, many have been renamed nominating & governance to reflect the importance of adopting good board governance practices. Now it’s time to go one step further – ditch the “nominating committee” and rename the committee simply the governance committee. This new committee might have seven distinct areas of responsibility: board oversight, nominating, risk review, shareholder engagement, corporate culture, ESG and CEO succession planning.
Why the changes? Simply put, we live in a more complex world. Our work environment has changed. To mention a few shifts, look at the changes in the workforce, technology, social media, expectations of shareholders, broadening of stakeholder scope, more regulations around how boards work. Clearly, the board’s oversight responsibility has morphed into boards becoming not only overseers, but also thought partners (with careful attention to not crossing that management/board line).
To work with these changes, compensation and audit committees have been reconstituted and charters updated. Recognizing that its work is no longer limited to setting the CEO’s compensation, approving long-term management awards and reviewing compensation for senior management, the compensation committee is now often the compensation and management development committee or the HRM committee. It has added to its repertoire compensation strategy, succession planning, and leadership development.
Many of the audit committee’s increased duties came from increased regulation, e.g. Sarbanes Oxley. Audit committee duties may now include review of accounting principles and financial statement presentations, internal quality control, evaluating the independent auditor’s performance and qualifications, audit strategy, risk oversight, cybersecurity, business model disruption, just to name a few agenda topics.
Because board work has greatly expanded and directors feel increased pressure from investors, activists, employees and others, the need for committees to do more heavy lifting has also grown. Asking committees to take responsibility for “first cut” reviews on important topics is one way for directors to manage too-full board agendas. “Deep diving” on key issues in smaller groups allows more time to fully vet ideas with management.
However, a board cannot delegate accountability to carrying out its fiduciary duties, so it is important for committee chairs to review with the full board the topics discussed at each committee meeting. In some instances, the committee chair may tee up a subject for a more robust full board conversation or indicate full board discussion was not necessary at this time, or she might offer recommendations for a specific action. Occasionally, when a board delegated limited authority to act, the committee may report on the specific action taken.
Board agendas are busy and as agenda setting has evolved from a perfunctory obligation to a strategy exercise, assigning traditional committees additional responsibilities allows directors to better schedule their work and to do it more efficiently and effectively.
Now, let’s look at each of the governance committee’s potential responsibility buckets.
1. Board oversight. The governance committee has responsibility for ensuring the board does its job. Key points include periodically reviewing the board’s governance guidelines to ensure it is effectively carrying out its responsibilities, using the right committee structure, performing board and committee assessments and staying abreast of “hot topics” related to board governance.
2. Nominating – new nominations and re-nominations. Too often the nominating process is only referenced when the board is looking for a new director, at which time it facilitates the “what-skills- we-need” conversation and it may initiate discussions with a recruiter. This is important, especially in light of the spotlight on board diversity.
There is another component to nominating that is too often forgotten. Directors, in most cases, are elected annually. This annual election process should be more than a proxy statement drafting exercise completed by the corporate secretary. Each director standing for re-election should be asked such questions as, “do you want to stand for re-election, “do you think the skills you bring to the board are still relevant? “are you thinking about retirement?” what additional skills do we need on the board?” The answers to these questions, along with the independent lead director’s thoughts on the director’s board contributions and the results of the peer-to-peer assessment, when used, should be considered before the slate of directors is presented to shareholders. Pointing out this annual review process during board orientation, along with conscious use of the annual board assessment process, often eliminates the need for arbitrary tenure lines such as term or age limits.
3. Overall review of risk governance. When “risk review” became a hot topic in board governance circles, most companies responded by adding this to the audit committee’s agenda. Then we realized that the compensation plan might incentivize the wrong performance and some risk review was delegated to the compensation committee. (Let’s not forget SEC rules require a stand-alone discussion in the annual proxy, independent from the Compensation Discussion and Analysis (CD&A), of a company’s compensation programs as they relate to risk management and risk-taking incentives.) Because overview of risk strategies should remain a full board responsibility, with appropriate deeper dive committee delegations, the governance committee should ensure key business risks have been identified and that a good-faith integrated system for monitoring is in place. It should periodically ask if the committee delegations are appropriate and ensure the board is getting the appropriate information for effective oversight.
4. Shareholder engagement. Engagement between companies and investors is increasing. Investors are demanding it. Defining what “engagement” means for your company likely involves conversations with the company’s investor relations team and the corporate secretary’s office. The board represents shareholders and must understand current investor “hot topics,” how the company compares and what modifications it might, and might not, consider.
5. Corporate culture. Culture is no longer just a fuzzy word that is immeasurable. The largest institutional investors believe that bad culture poses financial risks and good culture drives long-term value. It is a business issue that can be measured. Quantifiable metrics include information gathered around employee retention/promotions/movability, material ethics line calls, exit interviews, periodic employee surveys. The governance committee is in the best position to preview and challenge management’s take on the current state of culture, how this compares to the desired culture and how gaps will be handled. [Given what is said above, shouldn’t this topic fit under HRM Committee? Or shouldn’t it be at least something to consider?]
6. Corporate Social Responsibility/Environment, Social and Governance. Despite anyone’s personal views on corporate social responsibility and environmental and sustainability matters, it is a topic that boards of directors must address. The Business Roundtable’s recent decision to put shareholder primacy aside, the world has changed a lot since most directors began their professional careers. There is more conversation about climate, inclusion, human rights and many investment strategies consider ESG factors. Younger employees (and we all need talent) are committed to social concerns and more balance in their lives and we are all interested in the sustainability of our companies. It might be time for a board committee to add this to their expanding list of responsibilities. (As a side note, I have never understood the why of the ESG label. I respect the importance of E&S, environmental and sustainability concerns, but the “G” doesn’t seem to belong here – but that’s for another blog.)
7. CEO succession planning. At some companies, CEO succession planning is not delegated to any committee because it is the top responsibility of the board of directors. Sometimes the initial “first-cut” reviews are assigned to the compensation committee. Some companies assign overall succession planning to the compensation committee and CEO succession planning to the governance committee. It is important for every board to have a dialogue about the process it will use for succession planning and whether or not a board committee will facilitate.
Does all this sound like a lot more work for the governance committee? It is. However, it is this committee’s turn at receiving increased responsibilities in order to help the board work more effectively, stay focused on strategy and ask more challenging questions.
So, let’s get out the nominating committee charter and start rewriting.
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