Corporate Governance and the Board - What Works Best

Corporate Governance and the Board -- What Works Best

Financial Executives SummitScottsdale

May 7, 2001

Richard M. Steinberg

Leader, Corporate Governance

Why We Care About Corporate Governance

Impetus for the PwC Study

Why All the Interest?

• Corporate upheavals, failures, misstated financial reports

• Increased regulatory scrutiny -- Blue Ribbon Committee-based new SEC and listing rules

• Shareholder activism -- institutional investors (CalPERS, TIAA-CREF), social investors (PIRC)

• Legal liability -- Federal Sentencing Guidelines, Caremark

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Organizational Drivers - The US

• Corporate Director’s Guidebook, American Bar Association, 1994

• Standards issued by investor groups such as CalPERS & TIAA-CREF

• Statement on Corporate Governance, Business Round Table, 1997

• Principles of Corporate Governance: Analysis and Recommendations, American Law Institute, 1994

• National Association of Corporate Directors

• SEC, NYSE, NASD and AMEX adopted new audit committee rules in December 1999

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Around the World

• Canada -- Dey (’94), CICA (‘95,’99)

• UK -- Cadbury (’92), Hampel (‘98), Turnbull (’99)

• France -- Vienot (’95,’99)

• The Netherlands -- Peters (’97)

• Belgium -- Cardon (’98)

• Germany -- KonTraG (’98)

• South Africa -- King (’94)

• Australia -- Bosch (’95)

• Hong Kong -- Hong Kong Exchange (’99)

• Japan -- Principles (’97)

• OECD -- Advisory Group (’98)

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The Study

Corporate Governance and the Board -- What Works Best

Conducted, written: PricewaterhouseCoopers

Sponsored, published: Institute of Internal Auditors Research Foundation

Our Objective

To help boards of directors improve the effectiveness of their oversight, thereby enabling them to enhance shareholder value

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Methodology

• Reviewed over 200 publications• Survey

– 72 directors, thought leaders in 9 countries

• In-person, in-depth interviews– 28 directors in 5 countries

• PricewaterhouseCoopers’ experience in serving boards

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Corporate Governance Responsibilities

Board Responsibilities

• Corporate strategy and planning

• Risk management

• Values & ethics -- tone at the top

• Measuring and monitoring performance

• Major transactions

• Management evaluation, compensation and succession

• Communications & disclosure

• Board structure & operations

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1. Strategy and Planning

• Board contribution to strategy is lacking

• Area most in need of improvement

• One director says --

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“If the board isn’t comfortable with

the strategy . . . it should tell

management to rethink it, and come

back with something better. But, the

board shouldn’t be involved in

developing the strategy. That is,

noses in, fingers out.”

U.S. director11

1. Strategy Pitfalls

Management

• Intractably committed to one course

• Impatient with directors not sharing commitment to chosen path

• Holding on to bad strategy too long

• Highly controlled strategy- discussion agenda

Directors

• Hesitant to aggressively, constructively challenge

• Insufficiently prepared

• Fearing isolation, replacement

• Insufficient time, resources

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Critical Elements for Effectiveness:• Enough time, atmosphere for full, frank

strategy discussions• Aggressive but constructive debates, bringing

directors’ skills, knowledge, insight• The right information on risks,

interdependencies, resources, competitors • Application of lessons learned from past

successful, unsuccessful strategies

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Critical Elements for Effectiveness:• Management uses robust process to develop

strategy, with full buy-in• Comfortable with planned extent of change:

incremental, substantial or transformational• Satisfied tactical plans will result in successful

implementation• Consensus with management on performance

measures for judging strategy

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“There’s nothing like a big screw up

to make a board get into the bowels

of the real problem.”

U.S. director

2. Risk Management

Another top issue on the board agenda:

Directors witness examples of unmanaged, unknown risk bringing other companies to their knees, and they want to avoid unpleasant surprises at their companies

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2. Risk Management

Pitfalls• No common terminology -- talking at cross

purposes• Shortcutting the process, looking first at risk

instead of strategic objectives• Responsibility at too low organizational level • Failing to eliminate programs not aligned with

objectives• Taking “snapshot” instead of ongoing program

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2. Risk Management

Critical Elements for Effectiveness:• Management has effective, robust process to

identify, assess, manage risk• Align risk management actions with company’s

strategy, business objectives• Understands significant risks, and comfortable

with how management addresses them • Culture that assigns responsibility for and

rewards appropriate risk management

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“Corporations are getting away from their

core activities and competencies into areas

which have far higher risk, without

properly understanding those risks.”

Australian director

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3. Tone at the Top

Critical Elements for Effectiveness:• Management practices desired values-based culture• Robust code of conduct in place and adhered to, with

effective communication channels• Contact employees, customers, suppliers to

independently assess de facto culture • Focus on ethical issues in mergers and other major

transactions -- including partner companies• Directors’ ethics demonstrate desired values to

management, employees, the world

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“I’ve met some CEOs who had no

respect for ethical principles. They

got ahead over the strewn bodies of

associates.”

U.S. director

4. Measuring and Monitoring Performance

A major issue boards grapple with today:

• Few companies measure and track the right elements. Many companies don’t understand what drives their shareholder value.

• Directors are reluctant to raise concerns about potential impending trouble, because conclusive evidence is often lacking.

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Shareholder Value

Strategies &Tactics

RiskManagement

PerformanceMeasures

IncentiveCompensation

Performance Measurement Linkages

Value Drivers

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Critical Elements for Effectiveness:• Measures link to strategy, tactics, value drivers• Measures balance:

– financial with non-financial– forward looking with retrospective– benchmarking against competitors, peers and best practice– key scorecard categories: operations, customers,

employees, etc.

• Targets set are tough, but not disincentives

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Critical Elements for Effectiveness:• Comfortable information systems provide reliable,

timely information• Measures link to rewards throughout the company,

so all are pulling toward common goals• Rigorous follow up, identifying reasons for missed

targets -- both under performing and greatly over performing

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“Although boards hate bad news

. . . executives need to get bad news on

the table, and get it on the table early.”

Australian director

5. Transformational Transactions

Critical Elements for Effectiveness:• Complete comfort with business reasons for

proposed transaction, including how it links to current strategy

• Critical evaluation of management’s information, transaction assumptions, ability to integrate target successfully

• Application of lessons learned from past successful and unsuccessful transactions

• Courage to walk away from a bad deal

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5. Transformational Transactions

Critical Elements for Effectiveness:• Obtaining counsel of objective advisors• Recognize change in allegiance and differing

objectives of management in to-be-divested units

• Ensure company has right partners, reliable due diligence and properly structured deal before entering joint venture or alliance

• Critical review of proposed capital expenditures, ensuring link to strategy

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6. Management Evaluation, Compensation and Succession

• Tends to be a sticky issue for directors, given natural discomfort with judging peers

Boards increasingly proactive in replacing executives who are not working out -- but problems might have been avoided

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“High executive turnover does not

bode well. It indicates a CEO that is

fickle, intolerant or difficult to work

for.”

U.S. director

Critical Elements for Effectiveness:• Agree upon performance criteria, targets, link to desired

behavior• Continually monitor performance, providing clear,

constructive feedback to the CEO• Ensure compensation helps retain the best talent, while

paying for desired performance• Courage to replace CEO if necessary • Evaluate, develop relationships with key executives• Comfortable with succession plans

6. Management Evaluation, Compensation and Succession

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7. External Communications

•

• Financial reporting reliability in spotlight, with close regulator attention to incidents of improper financial reporting

Market focus increasingly quarterly, short-term. Also witnessing markets moving on non-financial information

• SEC focus on fair disclosure -- Reg FD

•

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Critical Elements for Effectiveness:• Ensure skilled directors evaluate financial reports • Understand operating information disclosed by

company, and how reliability is assured• Satisfaction management has effective

communications policies and processes• Comfortable market-sensitive information properly

handled to protect current, future shareholders

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•

• For leading audit committee practices, see the companion report:

Improving Audit Committee Performance - What Works Best, 2nd edition

•

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8. Board Dynamics

• Most corporate governance recommendations focus on matters of board form, as surrogates for improved board performance:

– independence– board size– committee structure– number of meetings

• While useful, these don’t ensure effectiveness

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“I would rather see a smaller board

wrestle with all the problems than a

larger board delegate everything out.”

American director

“Once you get beyond 10 or 12 at a

board table, you don’t discuss -- you

wait for your turn to speak.”

British director

8. Board DynamicsBad

• Board is a necessary evil

• Good meeting: short meeting

• Rigid agenda, regimented meetings

• Impatience with directors

• Directors beholden to CEO

• All information from manage-ment, little analysis, no options

Good

• CEO believes he/she can learn from board

• Real discussion in meetings

• Relationships outside boardroom

• Atmosphere of openness, trust

• Process, not event -- continuous responsibility

• Assertive, constructive engagement

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“Directors need to see their role as a

process, not an event. Their role goes

beyond attending meetings.”

American thought leader

8. Board Dynamics

•

• Thought leaders agree

Directors need to spend more time fulfilling their duties, and need to be paid more

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Contact Information

Richard M. Steinberg

PricewaterhouseCoopers, Leader, Corporate Governance

e-mail: [email protected]

phone: (973) 236-7280

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Corporate Governance and the Board - What Works Best

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