We routinely use targets and benchmarks to analyze virtually every
aspect of company performance: comparing budget to actual spend, noting changes
in customer satisfaction ratings, and analyzing the percentage of defects with
ferocity. But there is one very important aspect of business performance that too
often goes unchecked.
Most companies don’t measure their full system of corporate
governance, many do poorly on key components of governance, and boards too
often rely on inadequate information and hesitate to challenge what they’re
told by management.
These are among the findings of a new scorecard on corporate America, the inaugural American Corporate Governance Index (ACGI), developed through a partnership of The Institute of Internal Auditors and the University of Tennessee, Knoxville’s Neel Corporate Governance Center.
The ACGI doesn’t just look at publicly observable measures of corporate governance (executive compensation reporting, etc.). The index is based on eight principles that define core actions and responsibilities of the board in support of ethical and sustainable corporate governance. These “Guiding Principles of Corporate Governance” reflect the perspectives of leading organizations in the United States and around the world, including NACD, the Business Roundtable, the Committee of Sponsoring Organizations of the Treadway Commission, the King Commission, the New York Stock Exchange, and the Organisation for Economic Co-Operation and Development.
To create the index, US-listed company chief audit executives
(CAEs) answered questions that were based on the principles. One of the
principles states, for example, “Companies should be purposeful and transparent
in choosing and describing their key policies and procedures related to
corporate governance.” So, how did surveyed companies score on this front? They
received, on average, a “C-.”
Based on this survey of those ideally positioned to have an
enterprise-wide view of governance practices and controls—CAEs—the ACGI found
that most publicly held companies have no formal mechanism for monitoring or
evaluating the full governance system. What’s more, only one in five said they
audit their full system of corporate governance on an annual basis.
Overall, the results of the ACGI are sobering. The index gave corporate America a score of only “C+,” and while that seemingly above average grade might not sound so bad, any rating less than “A+” reflects some level of governance deficiencies.
Among key findings of the index:
While the overall score on governance was a “C+,”
10 percent of the surveyed companies scored an “F.”More than one-third of board members aren’t
willing to challenge their CEO, saying they would yield to a hypothetical chief
executive wanting to wait on reporting negative news.When boards receive information, they are not
verifying its accuracy. The index gave a “D” rating on board members asking
about information’s accuracy or completeness. A higher level of board independence indicates
stronger governance, with a higher percentage of independent board members
associated with a stronger ACGI score on average.One of the most troubling—though perhaps not surprising—findings
of the ACGI was that many companies are so focused on short-term success that
they neglect long-term sustainability. Indeed, the index rated this area a “D”
for the surveyed companies. Balancing short- and long-term needs certainly
falls primarily on senior management, the ACGI states, but boards “must
reinforce their commitment to long-term performance and value.”
What’s measured holds the greatest potential for improvement, but
meaningful improvement requires that we measure the right things
systematically, thoroughly, and often, using appropriate measurement criteria. Unfortunately,
many companies have found that identifying appropriate performance criteria for
corporate governance can be a big challenge.
Some directors think of their board’s self-assessments as
governance evaluations. Certainly, board performance is a critical element of
corporate governance. But corporate governance isn’t limited to board
performance. It encompasses all of the systems by which organizations are
directed and controlled. It’s about how we make decisions, establish
objectives, accomplish those objectives, and monitor our progress. It’s about
motivating, disciplining, and rewarding behaviors.
A board self-evaluation considers only a fraction of the total
governance system, and it is difficult to be unbiased about the organizations
we control. That’s one of the reasons we need objective benchmarks like the
ACGI against which we can assess governance. The ACGI will be further developed
for this purpose.
Every organization is unique, and effective governance is both
an art and a science. Nothing we can do will guarantee that governance will
always be effective, but every US public company should monitor and evaluate its full
system of governance every year. As well, directors must demand objective, relevant,
and timely information, presented in context and with specific benchmarks and trend
information, to know whether their governance system is operating as intended. And
they need to challenge what they’re told, if necessary. There may be no more
important task for ensuring the long-term success of American businesses.
Richard F. Chambers (CIA, QIAL, CGAP, CCSA, CRMA) is president and CEO of The Institute of Internal Auditors. In his weekly blog ChambersOnTheProfession.org, he shares insights on topical issues and trends related to organizational effectiveness, governance, accountability, and leadership based on more than 40 years of experience in the internal audit profession.