If you are in-house counsel, or advise boards or management teams externally, there are several changes to corporate governance on the horizon of which you should be aware. The volume and velocity of corporate governance changes over the last few years has not been insignificant, to put it mildly, and that trend is expected to continue well into 2014 and 2015. Here are 10 of the top trends as I see them.
- Active owners focused on performance: Expect pressure by activists and institutions for boards to control under-performing management to continue unabated. Boards incapable or unwilling to rein in inefficiencies, improper capital allocation, asset mismanagement, or operational improvements will be targets. Directors whose skills do not support value creation — and ossification, complacency, and atrophy more broadly — will also be targets.
- Shareholder accountability: Expect greater direct communication between boards and major shareholders, with “listening” mode and restricted management access continuing. Look also for pressure on asset owners themselves, by investee companies, for engagement transparency, protocols, and disclosure. Expect proxy access demands by investors to continue; management and retained adviser resistance to it; and potential regulation enabling it in the future.
- Regulation: Continued widespread regulation targeting boards will continue. Industry Canada is contemplating governance reforms in 2014 or beyond. In the U.S., pay-for-performance, clawbacks, pay ratios, and proxy advisory regulations are likely in 2014.
- Director and auditor entrenchment: Expect pressure for board renewal and auditor rotation to continue in 2014. This will take the form of tenure limits, caps on directorships, diversity legislation, director and auditor evaluation, and mandatory requests for audit tender. Expect continued resistance by incumbent directors and the big four, but expect also shareholder pressure and regulation to overcome.
- Cybercrime and other operational and reputation risks: Expect lawsuits targeting boards for data breach and investor loss at Adobe, Skype, Target, Neiman Marcus, and Snapchat that precipitate governance enhancements. Expect greater risk regulation and spends for financial service companies and non-banks.
Many boards and management have immature risk management, deficient — or at times non-existent — controls over IT, operational, and reputation risks. Look for efforts by good boards to have risk expertise on the board; internal oversight functions and third-party reviews reporting to the board; and assurance over the entire risk-appetite framework. Expect lawsuits and increasing regulation for the laggards.
- Focus on longer-term value creation: Expect asset owners to exert pressure on directors and asset managers to develop long-term metrics commensurate with the product and risk cycle of the company. Pay metrics such as health, innovation, culture, R&D, etc. will drive long-term investment. Look for “integrated” reporting and metric maturity in 2014 and 2015, making it easier for corporate boards to direct long-term, non-financial incentive pay and investment.
- Focus on the board chairman/chairwoman: Expect greater movement to non-executive chairs from lead directors in the U.S., and chairman/woman position maturity in other Anglo-American countries. Look for rigorous roles and responsibilities of board chairs developing, beyond formal independence, including driving value creation and company performance for investors.
- Greater clarity on pay for performance: Look for guidance by the U.S. Securities and Exchange Commission, including on realizable pay. Expect movement from short-term, quantitative, financial pay metrics to long-term, non-financial, qualitative, multi-year return metrics, and pay that adjusts for risk and performance over the longer term, with greater discretion to compensation committees and boards — and if necessary shareholders.
- Tightening up of independence standards: Look for boards to tighten up independent standards over lawyers, compensation consultants, auditors, and themselves, to arrive at “non-conflicted directors getting non-conflicted advice.” Look for scrutiny over soft management influence and capture over all of the above. Expect continued regulation if or when boards resist.
- Greater focus on culture, whistleblowing, tone in the middle, and anti-corruption: Expect good boards to go beyond the CEO to scrutinize compensation of “risk takers” anywhere in the organization; share the hiring, firing, and compensation decisions for risk, internal audit, compliance, and the CFO; and receive assurance and reporting over all material risks and controls. CEOs (or any operating or senior management) who block or are not transparent should be regarded as red flags.