Navigating the Pandemic: Risk Oversight Considerations from Fortune 500 Committee Chairs

As companies are still confronting the immediate challenges resulting from the crisis precipitated by COVID-19, boards are beginning to turn their attention to the potential aftershocks of the pandemic to help shape their organizations’ post-crisis strategy amid great uncertainty and continued turbulence. Second- and third-degree risks, such as the credit risks of a customer’s customers or a supplier’s suppliers, are only beginning to emerge, and companies have little time to adapt to this new wave of challenges. At the same time, boards are considering the longer-term implications and opportunities that may result from the pandemic.

NACD, along with PwC and Sidley Austin, recently convened 50 Fortune 500 risk and audit committee chairs for a virtual meeting of the NACD Risk Oversight Advisory Council. With representation across industries, many unique risks were surfaced, but common themes arose throughout the dialogue. And while the threat to employee health and safety and corporate performance remains acute, boards have begun to turn their attention to what comes next.

Deepen Your Understanding of New Ecosystem Risks

One delegate pointed out that now, more than ever, it is important to know and understand your company’s entire ecosystem. When considering supply chains, employees, communities, and customers, boards should ensure that management is thinking not only about direct risks, but also about risks that are two or three degrees removed.

Supply-chain risk received particular focus in the discussion. For example, while a company may have set up a payment structure with a customer, what happens if that customer’s customers stop paying? Is your customer’s risk-management program effective? Is the company prepared for taking on that risk?

While the pandemic crisis remains the major focus of directors, cyber risk has emerged as a prevalent secondary and related risk. Attendees noted that boards must engage with management to understand how the threat landscape has changed, particularly in the unexpected remote work environment that traditional security controls were not designed to protect. Additionally, with increased phishing attempts, schemes around transferring funds, and other risks that arise in the remote work environment, constantly monitoring the threat landscape is key to ensuring that companies can quickly prevent, detect, and mitigate new cyber risks. Management should discuss with the board when it is necessary to escalate cyber-risk threats to the board, as the nature of a remote working environment may require more frequent and active engagement. Similarly, the board should reaffirm which board committee has primary ownership of cyber-risk oversight or if it will be a full-board responsibility, given the heightened nature of the risk today.

It’s no Surprise, but Robust Risk Governance Really Matters

The board should be reevaluating its governance posture, particularly around takeover defenses. The decline in the stock price of many companies has increased the risk of hedge fund activism and unsolicited takeovers. Investors and proxy advisors have indicated that in the current environment, they will overlook the adoption of protective measures like poison pills. Boards should consider whether to adopt such measures and, if so, which measures might be appropriate given the current market volatility.

Strong oversight of the company’s enterprise risk management (ERM) function had proven to be key in helping mitigate risk prior to the coronavirus crisis. One director mentioned that benchmarking their current risks against those of their industry peers ensured that the company remained on top of emerging risks. Another director mentioned that the 2008 financial crisis forced the company to reimagine their ERM program along three main principles:

Focus on a finite set of enterprise risks. Broader risks should be managed by individual business functions.Ensure that enterprise risk is integrated into the business process. Risk shouldn’t be the last consideration, but rather a lens for all business processes.Be outcome based. Have management reflect on whether they are simply reporting risk or reporting risks and mitigation strategies.Boards should ensure that the company has a strong ERM process, and management should have an effective reporting structure in place—one that will bring key emerging and possibly disruptive risks to the board’s attention and facilitate responsive action when appropriate.

At the end of the day, it is during calamities such as the COVID-19 pandemic that the board’s role can come into stark focus. How the board responds can make a significant difference for the company. Tom Kim, a partner with Sidley Austin, said that “The board should ask, ‘Has management thought deeply enough about how they are responding to COVID-19?’ And then the board should itself ask that same question and go through that same exercise. The resulting discussions will inform corporate disclosures and conversations with investors. And those conversations and disclosures will be more effective because of it.”

Address Today’s Risks and Focus on Tomorrow’s Opportunities

As management teams continue to confront the most pressing and immediate impacts of the crisis, including employee health and safety, financial health, and operational risks, boards have an opportunity to start shaping the post-crisis strategy by assessing longer-term opportunities and risks in a much-changed business landscape. Delegates discussed the increased use of scenario and contingency planning to map different paths for the company.

Several delegates spoke positively of the opportunities that exist for those companies able to make the necessary strategic and structural changes. For example, some industries will see regulatory changes that will shape how their businesses function in the years to come. Businesses can have a positive impact on those developments if they work carefully with regulators. Other industries may see opportunities to reorient their capital expenditures to develop certain business lines over others given emerging consumer behaviors.

Delegates discussed the need to consider the potential business implications of supply-chain diversification, US-China decoupling, the repatriation of operations to the United States, more digital and remote work, increased industry concentration, and an amplified role of government in the economy and as a customer. These are all possible trends that could create a starkly different operating reality; boards should begin to anticipate and engage management on these trends. One delegate thoughtfully noted, “As a board, the three things to think about are how do we emerge from this stronger than before, where are there inorganic growth opportunities, and what changes do we need to make to our strategy?”

As companies move to the next phase of the crisis, in what one delegate referred to as the “bridge to recovery,” boards are turning toward taking control of the situation and their own fates. Government policy will significantly influence how and when the economy starts up again. As we enter the next phase of this prolonged crisis, companies can effectively partner with the public sector and share their expertise in a way that creates opportunity and reduces risks for the entire company ecosystem. As one delegate said in closing remarks, “It is times like these when I really love the capitalist system that we are all a part of. There are hundreds of companies right now working toward solutions to this health crisis that will ultimately serve our communities and save lives. And those companies know that if they do it best, they will succeed, too. We have the best minds working on these issues, because the economic system we have encourages and supports them.”

Note: The meeting was held using a modified version of the Chatham House Rule, under which participants’ quotes are not attributed to individuals or their organizations, with the exception of cohosts.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

A Director’s Perspective on COVID-19: An Interview with Robert C. Pozen

The COVID-19 pandemic has raised a number of essential, and time-sensitive, questions for companies and their directors. Robert C. Pozen, a senior lecturer at the MIT Sloan School of Management and a nonresident senior fellow at the Brookings Institution, spoke recently with Oliver Wyman partner Chaitra Chandrasekhar about COVID-19 and the board’s role throughout this crisis.

Pozen, the former executive chair of MFS Investment Management and the former president of Fidelity Investments, was also a director of BCE (the parent company of Bell Canada) and of Medtronic, where he was chair of the finance committee. He is currently on the boards of Nielsen Holdings and IFC Asset Management Co. (a subsidiary of the World Bank Group), and he was previously on the boards of several nonprofits; he is also a senior advisor to Oliver Wyman. At Oliver Wyman, Chandrasekhar advises senior decision-makers across the private and public sectors on questions related to strategy, digital transformation, and data-driven innovation. She served as a 2019 NACD Blue Ribbon Commission commissioner.

Some insights from their Zoom conversation in mid-April are below:

Chaitra Chandrasekhar: How does a crisis change the role of the board?

Robert C. Pozen: The board needs to be more proactive, but it can’t be micromanaging. That’s the overarching challenge. The solution is for the board to be proactive in asking management to present information to them quicker and in more depth than before. As a result, a board that [usually] meets four to six times a year is going to meet a lot more often. One board I was on during a crisis met 19 times in a year. You can meet via Zoom or on conference calls.

Chandrasekhar: What do you mean by “proactive”?

Pozen: I see three steps in dealing with a crisis. The first is the board needs to understand the nature of the crisis and how it impacts the company. The directors need to be particularly sensitive to downside risk in these crises: compliance fines, projected cash flows, reduced capital expenditures. They need to know what the impact is on the annual operating plan.

The second step—which may be part of step one or at least follow quickly—is to ask management to present an action plan to deal with the crisis. This is in part a revision to the annual operating plan. Management writes the plan, and the board approves or modifies it. It should address the financial side. Are we going to, for instance, reduce or eliminate stock repurchases? Are we going to go to the banks and ask for covenant relief, or can we ask to draw down our credit lines? Are we going to cancel planned transactions or capital expenditures? Do we need to start new projects to deal with the crisis?

The third part is ongoing monitoring. The first two steps happen fast; the third is ongoing—starting after the immediate response to the crisis and going on for a year or more. From a process point of view, the board allocates responsibility to different committees. The compensation committee needs to focus on whether and how to revise [compensation] plans if the stock price drops radically. The governance committee may want to focus on succession issues. The audit committee needs to become proactive about financial statements and reports, like 10-Ks.

Chandrasekhar: How fine is the line between oversight and micromanaging?

Pozen: It’s a very fine line. One danger is that you just get in management’s way, making it more difficult for them to do their job. Another is that management won’t feel accountable if they feel like they haven’t made all these decisions, if they feel the board has second-guessed them.

Consistency is important. If the board says, “We really want to see your revised operating plan and what you’re proposing on capital allocation,” then management still has responsibility and the board can choose to modify the strategy. But once everyone agrees on the revised operating plan and strategy, the board has to let management carry that out. The board can’t say, for instance, “We decided we were going to cut out all share repurchases,” and then a month later say, “We want to reinstate them all.”

Chandrasekhar: Is there a difference between crises that impact a single company versus a broader group? Are there lessons from other crises, like the 2008 financial crisis, that apply to the COVID-19 crisis?

Pozen: Most crises affect individual companies or industries, or regions. Although the 2008 financial crisis was broad, it did not extend to all countries and all industries. And the fact that it was caused by the financial industry means there was a much narrower focus. It was more easily understood.

This COVID-19 crisis is different in that it affects every country in the world. And the level of uncertainty is much higher because there are so many things we don’t know. A board faced with such uncertainty needs to ask management for a number of scenarios, from best case to worst case to something in between. And ask how the company will respond to these different scenarios.

Chandrasekhar: How and when should broader strategic questions be considered? “Is our five-year plan still on track or does it need to be revised?” Or, “Are there new opportunities surfacing that may not have existed before the crisis?”

Pozen: This is part of the third phase, the monitoring. In a broad crisis like this, there will be important implications for your three-year, five-year, or whatever plan. It’s up to the directors to say, “Now that we’re somewhat stabilized after the crisis has ebbed, let’s think now about the strategic implications.”

There may be opportunities to buy companies that have been beaten down by the crisis. Maybe we need to consider being acquired because we can’t remain viable in this situation. Or we’ve always thought of ourselves as having a physical presence, but now maybe we need to really shift to being 90 percent online up from 30 percent. Maybe we’ve learned something important about technological innovation. Maybe we need to change our supply lines because we’re not going to be able to depend on certain countries or companies.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

Preparing for Board Compensation in Times of Distress

When companies prepare for a potential restructuring, making adjustments to compensation programs for executives and key employees is common practice. However, adjustments to nonemployee director compensation are often overlooked.

Director compensation is normally comprised of two elements: cash retainers (including an annual board retainer and committee retainers) and an equity retainer (typically restricted stock that vests if a director remains on the board for one to three years from grant). At the time of a potential restructuring, however, previous equity awards issued by a company typically have little to no value, and the company may not have enough available equity to properly compensate its board members. 

According to the 2018–2019 NACD Public Company Governance Survey, the average public company director’s time commitment is roughly 245 hours each year—and the workload significantly increases both in preparation for and during a restructuring. This is particularly true in the early stages when many important decisions require the board’s timely attention. The increased time commitment is one factor that should be considered when evaluating board compensation practices and levels during a restructuring.

Moreover, in a bankruptcy setting, board members are also likely working themselves out of a job. Based on our analysis of bankruptcy filings and companies emerging from bankruptcy, 98 percent of board members, on average, turn over after a company emerges from bankruptcy either with new owners or after a company is sold. These factors highlight the need to appropriately compensate essential board members in order to maximize the value of a company over the course of the restructuring process.

Prior to making any changes, boards should evaluate market levels of pay by benchmarking compensation at similar companies. Appropriate compensation is essential to maintaining directors’ focus during a time of distress and increased workload. Benchmarking director compensation also provides assurance to companies that their board members are being compensated fairly and within current market standards, which may reduce a company’s risk associated with utilizing out-of-market pay practices. Using that information as a baseline, boards will usually make the following changes to director compensation when the call of duty demands increased time and commitment.

Conversion to Cash Compensation

As a company approaches a restructuring event, equity compensation generally does not provide an appropriate incentive due to its diminished value. During this time, boards frequently conduct a market analysis to ensure competitive levels of compensation and then convert the board compensation to a fully cash-based program. For example, a company with a $100,000 cash retainer and a $150,000 equity retainer would convert to a $250,000 cash retainer.

Adjustments to payout timing are also considered in order to maintain directors’ focus throughout the restructuring process. For example, companies with programs that pay out annually often convert to a quarterly program that is payable in advance of the beginning of the quarter. Additionally, increased director time commitment should be considered when evaluating potential changes to compensation after the restructuring has been completed, as additional compensation may be warranted.

Remuneration for Special Service

In certain cases, the board will form a separate restructuring committee in anticipation of the specialized tasks associated with the restructuring.  The restructuring committee remains in place for the period in which the company is in bankruptcy. Or, a board member might be appointed the chief restructuring officer (CRO). In exchange for service on the special committee or as a CRO, additional compensation commensurate with a director’s additional duties is warranted. The amount and the form of that compensation will vary widely, depending on the company’s needs and the individual director’s contributions.

Return to Meeting Fees

Under normal operating circumstances, boards have moved away from paying meeting fees and instead use a fixed retainer structure. In the context of a restructuring, some companies consider reverting back to meeting fees to reflect the additional workload and greater board engagement required during the restructuring process. However, other companies stick with the fixed retainer, which simplifies the administrative process and removes the challenge of determining what is considered a board meeting.

When approaching a potential restructuring, companies should ensure board compensation plans are fair, reasonable, and aligned with market practices. Not only is this best practice, but doing so demonstrates a company’s commitment to its board and accountability to stakeholders during the restructuring process.  

Brian Cumberland is a national managing director with Alvarez & Marsal and leads the restructuring compensation practice. J. D. Ivy is a national managing director with Alvarez & Marsal and leads the compensation and benefit practice.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

Pandemic Response: Considerations from Fortune 500 Compensation Committee Chairs

Tasked with rewarding and incenting executive leadership appropriately and in keeping with the company’s strategy, today’s compensation committee faces challenges on a variety of fronts, including the highly volatile stock market and uncertainty regarding the nation’s health, economic, and business conditions resulting from the COVID-19 pandemic for the remainder of 2020 and beyond.

NACD, along with Farient Advisors and Weil, Gotshal & Manges, recently convened 50 Fortune 500 compensation committee chairs for a meeting of the NACD Compensation Committee Chair Advisory Council. The delegates represented companies across various industries, and the companies they serve have been affected by the crisis in an uneven fashion. But whether a company is experiencing a boom or is going through a severe contraction, a steadfast board focus on ensuring long-term viability remains critical.

Early Implications on Executive Pay

Even with the underpinning of fundamental good governance, compensation committees are challenged to deploy the right tools to meet both short- and long-term objectives. Multiple delegates noted that while many of the measures that can be taken are reversible, the cultural and shareholder ramifications will live on. Delegates discussed board actions for all of the elements of compensation:

Reduce base salaries. One delegate’s committee took swift action on compensation, implementing a 5 to 10 percent pay cut for executives, and a 20 percent pay cut for directors.Defer cash compensation. A delegate noted that their board is deferring 20 percent of pay for salaried employees, which will be paid out next year with a small interest payment.Give stock in lieu of cash. Exchange cash salary for stock in order to preserve cash.The discussions also focused on the potential changes that the crisis might bring to long-term executive compensation practices. While delegates pointed out that patience is a useful tool, they also shared concerns over short-term market volatility and issuing stock when prices are depressed. As prices recover, grants made during the crisis could result in a perceived “windfall of compensation” for executives. Several delegates suggested taking a 30-, 60-, or 90-day average for stock-valuation purposes, rather than using the value on the date of the grant, though clear guidance on when the clock starts for these averages is hard to come by.

Discretion (manual adjustments to final pay outcomes) should be used judiciously by compensation committees. “In an environment where we can’t reasonably say what the future holds, we are thinking about the short, medium, and long term in decisions we are making now,” said one delegate. “This is why discretion is so important. It offers flexibility. The compensation committee is in the best position to assess what is right and what is fair.”

For director compensation, many delegates struggled with the difference between stock price used for executive grants made pre-crisis and the director grants made mid-crisis. “Many of us granted shares to executives in February at two or three times higher than the upcoming director grants in May,” commented one delegate. One remedy offered by Robin Ferracone, CEO of Farient Advisors, is to use the same price for directors as the earlier grant to executives: “If employees were granted stock at one price and the price now differs for directors, you can use the executive grant price to determine the number of shares a director should receive, essentially using the same price to translate value in shares.”

Crisis Strategies for the Compensation Committee

Having an established playbook that compensation committees can work from but also make adjustments to in response to changing conditions can help bring stability and order to their discussions.

Compensation chairs should consider what issues need to be addressed immediately because of their urgency, which questions are better left to the midyear discussions as the situation plays out, and which decisions are best handled at the end of the year with the benefit of full perspective. Delegates highlighted the following items for committee focus:

Protect the quality of decisions. In any crisis, there is a tension between acting swiftly and acting with complete information. One director opined, “It’s not the time to rush and take actions and panic—that may bite us in the future. Rushing to deal with the series of comp issues that affect an important subcomponent is something you should think long and hard about.”Use your compensation philosophy as a guidepost. As one delegate thoughtfully noted, “Get out your comp philosophy and principles. Keep with them. That lens will serve us well as we come out of this.”Use scenario planning to quickly course correct. Consider not only what the right thing to do for the business is right now—such as pay adjustments—but also that action’s long-term impact on the strategy. “It’s important to think about the potential impact of granting a lot of equity right now; we could see share dilution and deplete our share reserve quickly,” one delegate observed.Coordinate closely with other committees. The crisis is impacting all facets of the company and the board, making open communication with other committees more important than ever. One delegate said, “My early observation is that committees and boards are becoming extremely collegial and making better decisions as a group and leaning on each other to get to the right inclusion.”A Time to Demonstrate Leadership

Among the environmental, social, and governance (ESG) factors, the S (for social) currently stands out the most for compensation committees. The committee must consider how to continue to motivate and reward behavior consistent with the company’s culture, and many are using the crisis as an opportunity to further align with their stakeholders, especially employees. Concern for workers’ safety is paramount, but mental health is also top of mind during the crisis. Delegates pointed out that in some instances, this is bringing organizations closer together. In some notable examples, executive teams, directors, and employees themselves are contributing to employee emergency funds to support their colleagues in their time of need.

Strong, compassionate, and empathetic leadership clearly matters more than ever. Now may be a time for high-performing CEOs to impress outside stakeholders through action in the ESG area. “I think that ‘tier one’ CEOs are doing exactly what the ESG pundits seek—that is, demonstrating leadership on corporate purpose, and focusing on long-term sustainability of the organization. Let’s see if that gets recognized,” said one delegate.

Model Your Values

Speakers and delegates both underscored that while this is a time for making the hard decisions—from layoffs and furloughs to reductions and deferrals—it is important to note that being forthright in communications and honest about what the company can and cannot do can make the difference between success and failure with stakeholders, including employees.

“It may sound counterintuitive, but talking to HR, employee engagement is increasing because of our communication,” one delegate said. Honest communication can lead to increased engagement, retention, and goodwill in the communities where employees live.

Howard Dicker, a partner at Weil, Gotshal & Manges, further noted that regulatory filings may be necessary for employee reductions and other material actions taken during this time. “It’s all about transparency about how decisions were made,” Dicker shared. “Investors, in particular, may be more forgiving in this environment, but will want to understand the rationale and process behind the decision.”

In this turbulent time, the role of the compensation committee will be heightened and come under intense scrutiny. The path forward may not be easy to spot or to traverse. As one delegate asked, “What if our assumptions are wrong—that this is more than just a shock for a quarter or two? What framework should compensation committees be using if this level of volatility is the new normal?” Only time will answer that question.

For now, bright spots do exist. Committees and boards are coming together more than ever before, and whether this time is a one-and-done or the start of a new normal, as one delegate said, “We may well emerge from this [crisis] with deeper and greater long-term employee engagement.” Behaviors refined now to survive the COVID-19 crisis may set a standard for new relationships with employees, customers, suppliers, and investors going forward.

And that will take leadership from the top.

A full summary of the April 2020 meeting of the Compensation Committee Chair Advisory Council can be found here.

Editor’s note: The meeting was held using a modified version of the Chatham House Rule, under which participants’ quotes are not attributed to those individuals or their organizations, with the exception of cohosts.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

Think Carefully Before Rewarding Executives Who Cut Their Salaries

During the early stages of the pandemic, we have seen many executives take salary cuts, especially in industries substantially closed down by travel restrictions or shelter-in-place orders. These cuts are consistent with past economic crises, as they reduce expenses, preserve cash, and demonstrate compassion for employees and customers who are suffering economically—or even physically in this case.

In past crises—the 2008 financial crisis, for example—we saw many instances of compensation committees “reimbursing” executives for their salary cuts with outsized equity grants. Some also made up for unearned annual bonus plans with equity grants in the name of retention and alignment with shareholders. Grants came at times of depressed stock prices and were usually for a larger number of shares than normal since grants were generally determined according to the then-current stock price of the underlying equity.

As the market recovered, these grants accrued significant value. With the proxy statement reporting the dollar value at the time of grant, these later gains were not apparent until executive officers reported their gains upon disposition of their shares (often, years after the grant). While there were a few academic studies of these gains, they attracted no lasting attention from investors or the press.

Given the market’s tepid response to executive gains from equity granted at the time of salary cuts and zero bonus payouts, why not do it again? After all, those arguments about retention and shareholder alignment are very appealing. And the recovery of any particular company is not a slam dunk, particularly in the current unique market circumstances.

Despite what a jaded investor might say, an equity grant today is not a sure road to riches. Still, we urge caution in approaching a decision to make such a grant and some care in determining the size of the grant if you choose to make one.

Many directors will remember the uncertainty of the financial crisis and the circumstances under which they were making compensation decisions. This time, there are weighty differences in both the economic situation and the social background against which we will be making these decisions.

How COVID-19 Is Different

First, to set the context: COVID-19 is truly an exogenous factor impacting businesses. In the 2008 financial crisis, many people in a number of industries related to mortgage finance and homebuilding had participated in or benefited from the overheated housing market—it was a systemic outcome.

From these facts, one can argue that we should be more protective of executive interests today than we were back then. But that claim is countered by a much bigger factor—people are facing potential illness and death, in addition to job losses. This is a level of threat far beyond not being able to pay your bills. Although executives can and will die, too, the broader workforce is especially affected, particularly those in essential services.

Second, the pandemic has been compared to war, and war profiteering is one of the behaviors most repugnant to our societal conscience. We have already seen it in the public reaction to people buying up face masks to resell at outrageous prices in order to make a quick buck. Combine this with changes in social media, which is a much greater factor today than it was 10 years ago: Perceived offenses by corporations and their executives light up the Internet like never before, and we all know that perception can quickly become reality.

Third, we have known from the outset that entire industries are going to be transformed after the recovery due to consumer experiences shopping from home, people remaining reluctant to attend large gatherings, and reduced recreational and business travel. These transformations are going to seriously impact a very large proportion of the workforce. For others in less directly public-facing sectors, working from home may become more permanent, which will also significantly alter those businesses and workers and will likely then have ripple effects on transportation, commercial real estate, and other industries.

Finally, societal and investor demands are different today than they were a decade ago. In the United States, the increasing demand for social support services, especially health care and unemployment protection, will be accelerated by the nature of this crisis and the uneven governmental response.

Even prior to this crisis, investors have increased their demands for corporate action on sustainability, social, and environmental issues over the past several years. The economic impact of COVID-19 will probably result in a slowing of the pace of these broader demands as investors worry about earnings and stock prices, but this movement is not going away and may become sharply focused on the social services element.

What This Means for Equity Grants

Looking ahead three to five years, when the economy has fully recovered and stock prices are again robust, the executives who have been given extra equity grants today will begin cashing in on their gains. Data relative to these transactions are easy to obtain, and studies about them will be published.

Unlike similar studies published in the middle of the last decade, these reports are likely to attract major attention. Investors are likely to hold the directors who gave out those equity grants, and the executives who are still active, accountable. The consequences for both individuals and organizations could be much greater than they were the last time around, especially if those studies are published in an election year when the political climate is even more turbulent than normal (and there is little reason to expect that is going to settle down). While it is human nature to forget quickly, it is risky to rely on that happening a second time.

So, back to our original question: How does a director approach the issue of equity grants in an environment of salary cuts and zero bonuses? Here are some questions to ask.

Was our stock price in early March truly reflective of our economic value? Just as today’s price may be too low, the high price was probably on the generous side relative to performance—so what is an appropriate “normal” price for the stock?What is your estimate of how much cash the executive will lose in foregone salary and unearned bonus?If you make an equity grant now (whether a regularly scheduled award or a special grant), how much will the executive gain when the stock price gets back to “normal”? After all, the investor is only breaking even when “normal” is achieved, so asking whether the executive wins in that scenario is appropriate. A typical dollar-value grant made when the stock price is unfairly depressed can make up for a lot of foregone cash compensation (putting aside the temporary stress of the executive’s reduced cash flow).What else are you doing for the executives in terms of adjustments to incentive award calculations or using discretion in determining awards?Is the retention argument compelling in your case? Relatively few executives are truly vulnerable in the best of times, and in the worst of times, few competitors have an appetite for poaching due to their own problems. True retention issues in reasonably performing companies are almost always individual-specific and do not apply to the executive population as a whole.By answering these questions, you can better determine whether you need to do something to compensate executives for their salary cuts and, if so, what a reasonable, well-thought-out approach is to doing so. Further, in being purposeful about how you determine if it’s appropriate to “make whole,” you have already established a solid basis for the next action: creating a proactive public communication plan.

David Swinford is president and CEO of Pearl Meyer.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

Conversations on Governing During a Pandemic: Thoughts from Two Fortune 500 Company Directors

If we each had a quarter for every time we’ve heard or read
the word “unprecedented” since the declaration of the Coronavirus Disease 2019
(COVID-19) pandemic, we would have plenty of money despite the nosediving stock
market. In these—dare I say—unprecedented times, boards and the companies they
serve are faced with new governance challenges and opportunities.

To get some real-time governance perspective, I spoke to two
highly accomplished directors about their insights on this front: Jan Babiak
serves on the boards of the Walgreens Boots Alliance and the Bank of Montreal and
works with large private companies across different industry sectors, and Greg
Sandfort is a director and the former president and CEO for Tractor Supply Co.
and a director for the WD-40 Co. Some important themes emerged from the

Help management fight
the alligators rather than fighting them yourself. Babiak has a colorful
analogy for the role of the board during this crisis: “Imagine that management
is in the swamp fighting alligators,” she said. “The board should be on the
bank, pointing out the alligators management can’t see, while at the same time
keeping one eye on the horizon for a meteor on its way.”

Board members should not become needy during this time, she
advised. “Don’t ask unnecessary questions. Do your homework—read the website,
look at the company’s internal and external communications like their LinkedIn
posts, and review what analysts are saying—before asking management obvious
questions about what they are doing,” she said.

Pull together,
virtually, while management goes “red team, blue team.” Sandfort’s board meetings
have gone virtual, just as thousands of his companies’ employees are now working
from home. “On one of my boards, we were using Webex for a two-day virtual
meeting with people from all over the world. The connection went completely
dark in the middle of the meeting, but we just regrouped and carried on,” he

Sandfort believes the key to making virtual meetings a
success is for board members to come fully prepared, having read the materials
and being ready with smart questions that are relevant to the crisis. He is
having weekly calls for his boards, and one company will have both a virtual
board meeting and a virtual shareholder meeting this May.

Babiak stresses the need for board member flexibility, such as adding calls to her calendar on short notice (including the call with me). She has also seen management teams that cannot go fully virtual split into “red teams” and “blue teams,” working on different floors and never crossing paths in person. “If a leader gets sick on one team, then we have a second team that is already up and running,” she said.

Now is the time to live company values. “People are our number one priority,” said Sandfort of the companies he serves. “And our people will remember how they were treated when this is over.” His companies continue to pay staff in the United States and abroad, including in China, even in cases where workers are unable to be present onsite because of pandemic-related restrictions. They have also looked at issues such as health insurance coverage for virus testing.

Babiak likewise sees “a lot of heart” in what is happening during
the COVID-19 pandemic and is doubling down on sensitivity. “I noticed a CEO was
struggling on a subject during a recent board call,” she said. “Instead of
saying something at the time, I reached out to a fellow board member with
expertise in the area and suggested that he call the CEO with an offer of
support. Now is not the time to undermine management.”

Cash (or access to it) is king. Both Babiak and Sandfort mentioned that access to operating cash was an early concern during the pandemic. One of Sandfort’s companies pulled in a revolving line of credit despite a strong balance sheet. According to Babiak, who serves in the banking sector, banks are—in a sense—fortunate to have lived through the 2008 financial crisis because they have been through stress tests and now operate under significant capital requirements. They have also moved beyond single debt models, which is a stabilizing factor.

Challenges may overshadow opportunities right now, but keep your eyes
peeled. “Opportunities” seems like an odd word to be associated with the
current state of the world, but they do exist. Internal opportunities such as
improved information technology connectedness and communications are bright
spots, according to Sandfort.

Also, the need to be
flexible during this time can benefit employees and customers alike, leading to
innovation and perhaps enhanced online revenue. “I serve on the board of a
company that is a needs-based business for customers, and our suppliers will
run trucks if our stores are open,” he explained. “So, the company shortened
store hours, using the evening hours for deep cleaning. And the company is
offering curbside pickup for online orders.”

Babiak also believes the
board should be proactive in thinking about possible mergers and acquisitions and
about senior talent acquisition opportunities to help ensure companies are
ready when the time is right to act. “The board should be monitoring weak competitors
as we keep an eye on the horizon,” she said.

Experience counts.
Babiak firmly believes in the value of experience and of being on multiple
boards. For example, during this time she can, with permission, share best
practices from one company to another. As an experienced audit committee chair,
she sees audit practices across multiple companies, while each company’s chief
financial officer may only see them once in practice.

With her background, Babiak is confident in being flexible.
“One head of internal audit called me to ask if we could redeploy internal
audit staff to help the finance and operation staff during the crisis,” she
said. “After determining how to ensure we do not create an issue around self-audit
on the other side of the crisis, it’s all hands on deck right now, and I was
fine with that.”

Foresight can be
20/20. Two years ago, one of the companies Sandfort serves developed a
crisis plan that assumed the entire corporate office was wiped out. The
disaster plan was tested at the time and has now been put into effect with
modifications for the specifics of the COVID-19 pandemic. “The company was very
fortunate to have that plan in place,” said Sandfort. Other companies may not
be so lucky, but foresight for the next crisis begins now.

In these troubled times, it is clear that compassion and
common sense are hot commodities in the boardroom, standing shoulder to
shoulder with strategy, risk oversight, compensation, and the like. Let us hope
that exemplary crisis-time governance will be seen at levels just as
unprecedented as the spread of the microscopic adversary we all face.

Kimberly Simpson is director of strategic content for NACD, leading NACD’s credentialing programs (NACD Directorship Certification and NACD Fellowship®), coleading the organization’s Fortune 500 advisory councils, and routinely contributing to NACD member education through blogs and articles. Simpson, a former general counsel, was a US Marshall Memorial Fellow to Europe in 2005.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

COVID-19’s Impact on the Workplace: A Test of the Board’s Resiliency

The unprecedented nature of the Coronavirus Disease 2019 (COVID-19) pandemic has set in motion one of the most abrupt disruptions in decades, leaving organizations reeling. For that reason, it could present the ultimate test of resiliency for everyone leading companies in every industry—including the board. How well companies pivot in this environment and in the aftermath could have a lasting effect on their reputations and brands. More importantly, as organizations focus on transitioning their people to a remote workplace, opportunities may come about to learn new ways of doing business for the long-term. This is a time when the board can prove its mettle as a strategic advisor to the CEO.

As the pandemic brings many businesses to a halt, the effects of quarantine, isolation, and travel restriction strategies are having a brutal impact on the economy and multiple industries, with the financial markets punishing investors with steep declines. Up to this point, new and total infections, fatality rates, reductions in economic activity, and massive fiscal and monetary measures by the public sector have overshadowed the impact on people in the workplace and what companies must do to sustain operations as best they can under the most extenuating of circumstances. But that is fast changing.

Now that countries, provinces, states, and
cities are instituting lockdowns, shelter-in-place directives, or similar
requirements to limit the spread of this highly contagious virus, companies are
focused on transitioning their organizations and workforces to environments
where their managers and employees will be working remotely for an indeterminable
period of time. Given these optics, what role should the board play as their
organizations transition to a distributed workplace?

There are a number of items boards should consider acting on as CEOs and organizations grapple with the people-related challenges of the COVID-19 crisis. Ten suggestions for boards are offered below, some of which relate to the basics found in any crisis management playbook. Rather than addressing the decisions associated with navigating an economic slowdown (e.g., downsizing headcount; compensation adjustments; asset divestitures; selling, general, and administrative expense cuts; and other options) the focus is on managing the effects of transitioning to a distributed workplace, including the impact on organizational culture.

1. Know the board’s place at the table. The board’s role should be delineated from management’s role. Management is responsible for developing and implementing the overall strategy to protect the health of the workforce while putting it in a position to continue to work productively. The board is responsible for advising the management team as it executes the company’s response and monitors progress. Directors need to resist getting too hands-on. The CEO’s job is tough enough at the moment.

2. Understand management’s internal communications plan. Communications are vital during any crisis. While disclosing the impact of the crisis is important, the most important communications are to the organization’s employees. What is the plan, its objectives, and its tone? Is there an appropriate cadence of communications from various leaders so that employees know when to expect messages, as opposed to feeling left in the dark? Do internal communications convey empathy to employees? Are they forward-looking to give everyone an idea as to what’s happening around the company? In lieu of droning on in negativity, offering something grounding and trustworthy can be valuable in these difficult times.

3. Ask management how the company’s transition to a remote work environment is going. Highly mobile organizations can make the transition to a remote, work-from-home workplace relatively seamless—that is, among employees who can work remotely. But this transition can present formidable challenges to organizations that are anchored to their offices and physical facilities. During check-ins with management on crisis response, ask what the company is doing to support the technology, tools, and cultural challenges created by the sudden shift to virtual work, if applicable.

4. Encourage a watchful eye for new leaders who emerge from the fire. These are extraordinary times. Everyone in the organization from top to bottom will be battle-tested. Boards should encourage management to watch for those who flourish in this environment and to support them as they provide leadership. History teaches us about many generations of leaders who have been steeled by extraordinary events. This fluid environment creates a unique opportunity for team members to shine and show what they are made of.

5. When the sun rises, request management to conduct a post-crisis assessment in the cool of day. For companies unprepared for this crisis, a process should be put in place to capture the lessons learned in real time.Before memories fade, company plans and procedures for navigating abrupt business disruptions—including a global pandemic—should be updated using these lessons. And, as stated above, the employees who took the initiative to lead should be noted.

6. Ensure that the organization focuses on its customers. The crisis may present opportunities to deepen relationships with customers. Now is the time for out-of-the-box thinking on how to help customers, particularly for those companies that may be struggling to survive. This will help to differentiate the companies that are flexible and agile from those who are not.

7. Point out the opportunity to improve remote work policies and procedures. Whether deployed selectively or mandated outright, decisions to work remotely—beyond present remote arrangements—offer an opportunity to learn how to ensure that such arrangements work effectively and efficiently into the future. These lessons may be invaluable for companies as the trend toward telework continues to evolve, worker flexibility programs expand, and the volume is turned up on improving quality of life.

8. Suggest that management make it a priority to regroup on a regular basis. Keeping everyone on the same page in a remote environment requires special attention. The unique stresses, pressures, and concerns the COVID-19 crisis presents to employees create a difficult environment for preserving morale. Whether as a small group, the whole team, or even through one-on-one interactions, remote workers should meet at least weekly to stay in touch and ensure that everyone is on the same page about specific expectations, project deliverables, and timelines using the tools the organization has available. It is especially helpful when those tools allow for face-to-face meetings as nonverbal cues and body language are an important part of human interactions.

As the “touch” in the workplace is removed, the “trust” between colleagues and senior leadership becomes even more important. Through appropriate electronic tools, leaders should spread awareness of successes in order to build motivation and develop social involvement among employees. In uncertain times, employees can be motivated by seeing positive actions recognized and a strong focus on the future from their leaders.

9. Ask the question: When the crisis passes, what will we have learned about how we do business? Two years from now when the CEO and executive team look back on this crisis, what will they observe? Will they recognize that what they learned from temporary transitions, as discussed above, served as a catalyst for accelerated shifts in workplace design? Will what they learned inform ways of altering company strategy, including the way the company does business and goes to market? Will the lessons from the crisis alter management’s views regarding the organization’s real estate needs? These important questions point to the power of technology to transform how and where people work.

10. Ask another question: Will our people be more or less loyal based on how we managed the crisis? The crisis presents an opportunity for leaders to let their people know that the company truly cares about them and their well-being. Their actions in both word and deed carry the possibility of strengthening culture. Does the company’s response to the crisis meet this test?

The COVID-19 crisis is a new test of resiliency for directors, managers, and employees alike and everyone must learn how to meet it together, with a focus on continuous improvement, shared values, and mutual trust. It also presents a test of leadership. Prioritizing and reprioritizing tasks and activities is going to be a necessary art for most organizations over the next several weeks. Keeping teams focused on the greatest issues and risks, avoiding needless distractions, positioning themselves to ramp back up to normal operations, and building a culture of trust and empathy is the name of the game.

For an expanded discussion, see Protiviti’s companion piece.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

COVID-19 Pulse Survey Reveals Boards Have Confidence in Management

NACD this week polled nearly 200 members to better understand how directors and their boards are responding to the coronavirus disease 2019 (COVID-19) pandemic. While the economic, social, and political impacts remain in flux—evidenced in one dimension by the S&P 500 declines and gains of nearly 10 percent last week—corporate boards are in a unique position to help management respond effectively to the short- and long-term implications of the crisis.

Director responses to the pulse survey reflect the early actions boards are taking to combat the crisis, and their responses may have shifted in the time since. NACD’s Resource Center: Responding to the COVID-19 Crisis can help directors govern more effectively through these uncertain times. And NACD’s March 2020 poll reveals how boards have been doing so in real-time over the last week. Several findings stand out:

Boards are proactively engaging with management to address the COVID-19 response.

Nearly 3 of 4 directors (76%) report that their boards have discussed COVID-19 with management. In such times, board collaboration with management is likely to be less hierarchical, more frequent, and can blur traditional lines of demarcation between board and management activities. Many respondents report that they have already taken a serious look at what management has done to prepare their staff and position the organization for a very different operating reality. About half (49%) report that they have reviewed internal corporate communications strategies and slightly fewer (42%) have worked to establish expectations for board/management communications. Further, only 45 percent of boards are pressure testing management assumptions about the business impact of the virus.

Source: NACD March 2020 COVID-19 Pulse SurveyOrganizations are putting their people first.

The majority of directors responding report that their organizations are currently focused on the health and well-being of their employee population. Many companies have started to rigorously assess the impact of employee and business exposure to the virus (74%). Most have reviewed the Centers for Disease Control and Prevention guidance for employers (64%) and developed internal communications strategies (66%) to keep employees up to date on evolving plans. Further, in their next board meetings, two thirds (67%) of directors indicate that they intend to evaluate the effectiveness of management plans to protect the health and welfare of the employee population.

Source: NACD March 2020 COVID-19 Pulse SurveyDirectors are comfortable with the effectiveness of management’s crisis response at this moment.

Directors generally give their organizations high marks for their initial crisis response and collaboration with the board. Seventy-four percent report that their board gets sufficient information from management and 71 percent find management’s response so far to be effective. In general, directors report confidence in the ability of management to handle the near-term effects of the crisis and are satisfied with what they see.

Many anticipate a short-term business impact.

As of March 16, about a third of S&P 500 companies had disclosed COVID-19 in their risk factors (30%) and earnings calls (33%), according to MyLogIQ, a public company disclosure information aggregator. Numbers are similar for the Russell 3000, where risk-factor mentions jumped from 29 percent to 39 percent between March 12 and 16, per MyLogIQ. In the NACD poll, most directors saw the largest likely disruption in the demand for their products (28%) followed by employee productivity (19%), and impacts to their supply chain (16%) and the capital markets (14%).

Source: MyLogIQ (based on keyword search “coronavirus” and “COVID-19” in public filings from 03/12/2019 to 03/16/2020)At the moment, few have turned toward the longer-term implications of the crisis.

While much of what is described above displays director’s confidence in the near term, few have looked toward the longer-term implications of the crisis. Somewhat surprisingly, just 14 percent report reviewing risk-transfer options management might have at their disposal, such as insurance coverage on property, supply chains, or business continuity. Just 13 percent report making a decision to postpone a major 2020 investment. Further, only 16 percent report discussing post-crisis plans with management. 

At this early stage in the crisis, NACD’s director
members report having initiated conversations with management that revolve
around the following types of questions:

are the trigger points for incremental policy actions (to protect employees)
and financial actions (to respond to declining product or service demand,
material, or labor availability)?If
we had to close the books for the first quarter remotely and issue results,
could we do it, and could our auditors perform the necessary procedures
are alternative sources of supply for the materials/goods we use? How quickly
can an alternative supply source be deployed and at what change in costs? What
does this mean for our budget?How
do we address or mitigate key risks locally, and, if appropriate, abroad?This quick poll shows that boards have confidence in
management to support their employee populations and deal with the early stages
of the crisis.

NACD will continue to gauge the pulse of its membership as the crisis evolves and becomes more complex to understand the changing governance challenges faced by members and help to identify potential solutions. This includes virtual board and annual meeting management and planning both for potential recession and recovery.

NACD’s March 2020 COVID-19 Pulse Survey results were featured in a Wall Street Journal article on March 18, 2020.

COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.It’s essential that directors know what to focus on and when.

Become an NACD member today.

NACD: Tools and resources to help guide you in unpredictable times.

Achieving Harmony on Pay, Retention When Companies Merge

Strategically merging
companies is critical to driving new growth and unlocking value for both
organizations involved in a mergers and acquisitions (M&A) transaction. But
beyond the operational and market awareness challenges, management and human
resources teams face pressure when the merging organizations have major
differences in culture and compensation philosophy.

integrating companies, retention and engagement are crucial; in particular, compensation
plays a huge role in accomplishing those objectives. Since mergers often
include companies in the same industry with similar talent dynamics, the
likelihood of major discrepancies in pay philosophy is probably minimal.

But in today’s executive compensation environment, and nearly a decade after the advent of say on pay, companies are becoming more willing to push the boundaries on pay philosophy to attract and retain talent. One popular example is Netflix, where executives can choose how they want their compensation delivered between salary and stock options. (I hope no one has buyer’s remorse!)

So, what
happens when two merging companies have completely different compensation
philosophies? Imagine that a company with a pay mix philosophy that is heavier
on cash (versus equity) merges with a company that is lower on cash but
delivers more equity: The combined company probably can’t afford to increase
cash for one group of employees and increase equity for another to create consistency.
Additionally, companies can also have other philosophical differences on issues
like equity grant practices (e.g., time-based restricted stock versus options
versus performance-based restricted stock) or cash incentive designs (e.g., formulaic
versus discretionary versus no program).

What philosophy
will win the day, and how do you harmonize the programs while integrating the
businesses? Boards and their organizations can take several key steps:

1. Determine the rationale. Boards should start with the strategic rationale behind the merger—that is, “What are the business objectives we believe we can achieve?”—and then ask, “What is the talent strategy necessary to achieve the business strategy?” A compensation philosophy is sub-optimal if it does not support the organization’s underlying business, talent, and culture, which makes articulating the talent strategy essential.

Let’s go back to the previous
example of companies with different pay mix philosophies: If the merged
company’s talent strategy is to drive a heightened performance culture through
equity ownership, then the low-on-cash, high-on-equity philosophy may be the
right path forward. This doesn’t necessarily mean that the organization needs to
immediately replace cash with equity for individuals that were previously high
on cash and low on equity. Rather, the company should develop a strategy on how
to manage this issue over time.

2. Assess the pay philosophies. After defining the talent strategy, management teams should consider conducting an assessment on key elements of the pay philosophy to recognize where similarities and differences exist on issues such as the prominence of pay, market positioning, and mix of incentives. Developing this framework will help determine the scope of the issues and develop a timeline with priorities.

Throughout this process, it’s important
to recognize that harmonizing pay programs will not happen overnight and may take
a couple of years. As with any other change to an organization, articulating
and communicating the desired compensation philosophy going forward can help
management teams transition to the desired end state.

3. Focus on retention and engagement. Once the compensation
philosophy is articulated and has a roadmap, the company can turn to the issue at
hand—retention and engagement through the transition. Retention actions are not
always necessary but can be used on a targeted basis.

For those individuals for whom specific
actions may be appropriate, there is a spectrum of approaches to consider. The
decision often depends on the criticality of the role, the desired retention
and engagement period (i.e., short-term versus long-term), and if there are any
specific performance milestones to achieve. A few approaches include increasing
severance protections for a period of time before sunsetting to original
protections, delivering cash stay bonuses for near-term transitions, or
awarding meaningful equity grants for those critical to the long-term
succession plans of the organization.

The best
outcome when going through a merger is to reduce (and, if possible, eliminate)
any distraction that takes focus away from the business needs. A clear
compensation philosophy and framework based on future business objectives can
allow a company to move forward rather than being stuck starting with the
programs of the past.

Partnering the pay philosophy with a thoughtful approach to retention allows companies to spend more time thinking about the next strategic business decision to drive shareholder value rather than worrying about the loss of talent and delayed integration efforts.

Michael Gorski is a senior consultant with Semler Brossy Consulting Group working out of the Los Angeles office.

Governance Benchmarks: Do We Measure Up?

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, 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.