How Boards Can Help Build Trusted Companies

This is an abbreviated version of a more thorough Directorship magazine article exclusively for NACD members. If you are an officer or director of a public, private, or nonprofit organization, you can become an NACD member to view the complete article and related resources.

In June, hedge fund manager Christopher James, with just 0.02 percent of company stock, convinced Exxon Mobil institutional investors to vote in three handpicked board members who will press the company to respond more directly and with greater speed to the strategic imperative of climate change. James’ victory is an example of moving from theory to action on the principle of stakeholder capitalism. This idea represents the foundation of trust against which companies and their boards are judged.

Corporate leaders have a responsibility to craft and implement strategy—that’s their job—but the board stands for the interests of the corporation as a whole, and thus is the place where the navigation between the outside and the inside is expected to take place. Boards are the linchpin between interested parties outside the corporation (investors, regulators, the public, nongovernmental organizations, government) and the leadership inside the corporation.

The board’s guidance to Nokia during its restructuring remains an enduring example of how a board must straddle both the internal dynamics of the company while being cognizant of the demands of the external world. In 2008, Nokia shut down a plant in Bochum, Germany, laying off 2,300 employees, shortly after announcing a 67 percent increase in profits. The outrage was so great that Nokia ended up paying 80,000 euro ($95,000) per employee to close the plant. Fast forward to 2011, when Nokia was facing losses for the first time in its history. The board knew that Nokia would have to restructure because it was being out competed in smartphones and was losing share to lower-cost phones from Asia. The scope was huge, affecting 18,000 employees spread across 13 countries. But the board was committed to avoiding the mistakes of 2008. It charged senior executives with the task of coming up with a way to better manage the impending layoffs.

The result was the Nokia Bridge program, which was essentially a bet on trust: Nokia asked employees to stay on at the company—some for as many as two years—while it managed the restructuring. In exchange, Nokia promised employees a soft landing. The Bridge program gave employees a choice of paths to a new future: find a new job at Nokia, find a new job outside Nokia, get funding to start a new business, train for something new, or receive financial support to do something else entirely.

The senior leaders who created the program insisted on obtaining board approval. They explained that during the restructuring they would prioritize the interests of employees over the company’s, and they intended to be transparent about the program and its aims. The bet paid off: 60 percent of affected employees knew their next step the day they left the firm. And Nokia didn’t suffer from the departures and disengagement that usually follow a layoff announcement. In fact, employees brought in 33 percent of revenues from new products, the same proportion they’d brought in before the layoffs were announced. Eventually Nokia’s program was adapted by the Finnish government as a best practice for managing layoffs.

Embracing the goal of building a trusted company—and regaining lost trust—provides a lens through which this kind of navigation and prioritization of interests can take place. Nokia’s shareholders expected actions that would shore up the company’s shaky foundations and return it to profitability, while Nokia’s employees expected job security. Managing trust is in the familiar terrain of managing relationships. What makes it complex in companies is that the interests of groups are unique and at times can conflict; these interests need to be understood, prioritized, and balanced.

We’ve developed a four-element framework that explains why people choose to trust: competence, motives, means (or fairness), and impact. It provides a structure for understanding the actions that need to be taken to build trust.

To read the full article and dive into this framework, see the July/August 2021 issue of Directorship magazine. Check out the full and previous issues of the magazine here.

Sandra J. Sucher is a professor of management practice and Shalene Gupta is a research assistant at Harvard Business School. Before Harvard, Gupta covered tech and diversity at Fortune. They are the coauthors of The Power of Trust: How Companies Build It, Lose It, Regain It (PublicAffairs, Hachette Book Group, 2021).

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Are Universal Proxies in the Cards for 2022?

The US Securities and Exchange Commission (SEC) has been active on various fronts, including enforcement. For corporate directors, one significant development so far this year has been the revival of a previously proposed universal proxy rule, largely favored by institutional investors but opposed by many corporations. Based on the SEC’s stated plans, the revived proposal is the first of many rules to come.

Wide-Ranging Activity

Since Chair Gary Gensler was confirmed in mid-April, the SEC has posted more than 30 accounting and enforcement releases; ordered more than 40 trading suspensions; issued more than 100 litigation releases; and initiated or closed more than 100 administrative proceedings, according to the agency’s “Enforcement” web page. In addition, the SEC has made 15 whistleblower awards worth more than $100 million, reports its Office of the Whistleblower. The agency also recently approved Nasdaq’s new listing rule mandating board diversity disclosures.

As far as new SEC rules go, however, the agency has proceeded with caution under both Gensler and his immediate predecessor, Allison H. Lee, who served as acting chair from January 2021 to mid-April. As of August 17, 2021, the agency under Lee and Gensler issued one interim rule on auditors used by foreign firms. Other than two filing modifications, it has not published a single final rule or proposed rule other than the universal proxy rule discussed here. What is happening instead is a great deal of preparation that is likely to result in a cluster of rules into early 2022.

Topics on the Horizon

The SEC’s current Agency Rule List discloses more than 30 rules set to be created or modified before April 2022, including potential new rules on the following topics:

climate change disclosure
corporate board diversity
cybersecurity risk governance
human capital management disclosure

clawbacks (to be written as a new rule based on a previously proposed rule, which sparked this NACD comment letter)

pay versus performance (proposed in May 2015; see this original NACD comment letter)

universal proxy (originally proposed November 2016 as a 243-page rule and reopened for comment with a 14-page release in April 2021)

Universal Proxies

At this time, the SEC is most actively focused on the universal proxy rule.

Normally, at annual shareholder meetings investors receive one ballot with the names of directors recommended for appointment by the nominating committee. A separate rule from 2004 attempted to encourage shareholder nominations by requiring nominating committees to disclose the source of nomination by category (e.g., shareholder, recruiter, board member, CEO). However, there are still times when shareholders want to propose their own slate directly to other shareholders. If an election is contested in this way (the case in about 1 percent of elections) there must be two ballots—one from the board (commonly referred to as the management slate, though this is a misnomer) and one from the dissidents.

The SEC wants to require the use of universal proxies for contested elections in public companies with certain exceptions—namely for exempt solicitations, registered investment companies, and business development companies. Although such an option has always been available to shareholders voting in-person at the annual meeting, it has not been available by proxy.

The universal proxy rule, proposed on and off since the proxy rule reforms of 1992, would dictate the use of one ballot rather than two, and thus shareholders could mix and match their votes.

This process is not easy to do under the following rules currently in place:    

The “bona fide nominee” rule, adopted in 1966, which allows for some mix-and-match capability but requires each side of a proxy contest to obtain consent before listing candidates from the other side
The so-called “short slate” rule, adopted in 1992, which provides a limited exemption from the requirement to obtain consent. A dissident can include candidates recommended by the nominating committee in addition to its own candidates, as long as the slate proposes filling less than half of board seats

Comments are still coming in on the universal proxy rule, most of them from institutional shareholders and their affiliates, such as the California Public Employees’ Retirement System, the Council of Institutional Investors, and Institutional Shareholder Services; as these links show, the letters were supportive. However, a half dozen comments representing corporations’ interests expressed concerns about reviving the proposed rule. Cautionary messages were filed by the US Chamber of Commerce and the Society for Corporate Governance. The most detailed letter (listing 20 pages of legal concerns) came from law firm Sidley Austin and was signed by several partners, including Holly Gregory. A common theme in letters opposing the rule is that, as the Chamber letter states, the rule could “increase the frequency and ease of proxy fights for dissident shareholders.”

The number of proxy contests that occur in any given year is low, ranging from a handful to a couple dozen, wrote Fried, Frank, Harris, Shriver & Jacobson in a client memo. Even so, the law firm noted, “Activists routinely threaten to conduct a proxy contest and frequently initiate the process to conduct a proxy fight, including nominating directors, engaging in investor and public relations activities, and making preliminary filings with the SEC.”

NACD has not yet responded to the reissued rule, but the NACD comment letter submitted January 3, 2017 registered opposition to universal ballots because “the ‘mix and match’ voting approach that they empower could result in a final group of directors that might not be optimal for the specific company they would be serving.” NACD added that “the election process should assemble a board of directors whose skill sets are complementary and who are capable of working together to advance corporate strategy.” As a nonprofit, NACD attempts to forge a middle ground on behalf of all directors.

The clash of views between investors and businesses poses a dilemma for the SEC, which according to its three-part mission serves constituencies and markets alike. It is not uncommon for the SEC to go back and forth between a focus on issuers and a focus on shareholders as presidential administrations change. Public company board members, both incumbent and aspiring, have a stake in the outcome of this proposed rule.

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Heavier Committee Work Calls for Coordination, Communication

With standing committees playing an increasingly vital role in helping boards carry out their oversight responsibilities, there is a premium placed on coordination and communication among committees. The overarching challenge—which we see lead directors and nominating and governance committee chairs tackling in various ways—is to help prevent critical risks from falling through the cracks and provide committees with a coordinated, holistic view of how they should oversee vital issues.

This is not a new challenge. Companies and their boards have long dealt with a complex and demanding business and risk environment—from technology and business model disruption to cybersecurity and data governance to investor scrutiny, regulatory and political uncertainty, and geopolitical risk. But the COVID-19 crisis and other events of the past two years have made the business and risk environment even more challenging, with an increased volume of investor and stakeholder demands regarding corporate purpose; environmental, social, and governance (ESG) issues; human capital management (HCM); diversity, equity, and inclusion (DE&I); and more.

As a result, many boards are delegating specific oversight duties to standing committees—beyond those prescribed to the audit, compensation, and governance committees by stock exchange listing requirements—for a more intensive review of issues and risks. For example, depending on the company size, industry, and other unique company considerations, we see boards delegating to various standing committees responsibility for supporting the board’s oversight of ESG, HCM, cybersecurity and data governance, legal and regulatory compliance, mergers and acquisitions, and culture.

Multiple committees may have responsibility for specific aspects of one issue. For example, elements of ESG frequently reside across the nominating and governance, compensation, and audit committees. Cybersecurity is often on the audit committee’s plate but may also fall under the purview of a technology or other committee. HCM issues, meanwhile, may span both the compensation and governance committees. Boards should expect such overlapping oversight responsibilities. But in the absence of close coordination and communication, there is a risk that the board may become balkanized, with each standing committee focused on its own oversight activities and thus failing to share important information that other committees and the entire board may need for their respective oversight.

Effective communication and coordination among committees is an ongoing challenge that can be exacerbated by several factors, including overloaded committee agendas; the absence of clear delineation of oversight responsibilities; a lack of sensitivity to (or understanding of) the information needs of each committee; a “default mentality” in which directors or committees assume that the audit committee (or another committee) has sole responsibility for specific risks; simultaneous committee meetings that prevent directors from attending the meetings of other committees as a way to stay apprised of issues potentially affecting their own committee’s oversight activities; and boilerplate committee reporting to the board.

To help promote effective information sharing and coordination among committees, boards can do the following:

Identify areas where committee oversight responsibilities may overlap and develop a process for frequent communication, sharing, and discussion of oversight activities in these areas.
Maintain overlapping committee memberships or informal cross-attendance at committee meetings when inter-committee coordination is of strategic importance and hold joint committee meetings periodically.
Hold regular meetings of standing committee chairs to discuss oversight activities.
Insist on robust committee reports to the entire board. Well-focused and appropriately detailed information can help keep all standing committees informed of matters potentially affecting their oversight responsibilities.

Patrick A. Lee is a senior advisor with the KPMG Board Leadership Center.

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Climate Governance Must Include Lobbying Oversight

One of the key themes of the 2021 proxy season was the dramatic surge in investor interest in climate lobbying. Five winning shareholder proposals asked companies to report on how their lobbying aligned with the Paris Agreement, a trend that is sure to spur even more investor action in 2022. 

Ceres recently assessed publicly available information on 96 large, US-based companies to understand how they are engaging in climate policy. What we found is that while these businesses increasingly recognize the threat of climate change and are oftentimes reducing their own greenhouse gas emissions, they seldom advocate for ambitious climate policies.

More specifically, among the assessed companies, 74 percent publicly acknowledge climate change as a material risk to their enterprises, 88 percent formally charge their boards with the responsibility to oversee climate or sustainability, and 92 percent are setting emissions reduction goals for their own operations. Essentially, they recognize the problem and commit to individual action—steps that show enormous progress.

Unfortunately, we cannot solve the climate crisis unilaterally. Since emissions anywhere contribute to climate change everywhere, collective action is necessary to ensure a level playing field where all emitters act responsibly. Companies that face climate risks should support strong policy solutions, but they often focus on the constraints rather than the benefits. 

Of the companies we assessed, only 40 percent have engaged directly with lawmakers on the importance of specific science-based climate policies (i.e., policies aiming to keep global warming within 1.5 degrees Celsius of pre-industrial temperatures). Twenty-one percent have lobbied in opposition to such policies, and these were often the same companies that were establishing targets and lobbying for climate regulation in other contexts. These misalignments raise serious issues around climate governance, which boards should address by taking the following three steps:

1. Assess the value-creation opportunities that open with climate regulation in place. Firms generally prefer free markets over increased regulation, but what would uncontrolled climate change really look like for your organization? Chances are, increased storm activity, wildfires, droughts, and populations displaced as a result of these climatic changes would negatively impact operations. Meanwhile, investment in low-carbon product development would be more challenging without government support—think of electric cars, which can benefit from public investment in charging infrastructure.

Boards can engage management to embed climate risks within the larger enterprise risk management (ERM) system. This embedding process should consider the latest climate science, including projections of the physical and transition risks of climate change that could affect a company’s operations and value chain. An assessment of the current regulatory environment and how that environment is projected to change in the coming years is similarly crucial. A helpful reference while conducting these assessments is the 2018 guidance on how to integrate environmental, social, and governance (ESG) issues into the traditional ERM process from the World Business Council for Sustainable Development and the Committee of Sponsoring Organizations of the Treadway Commission. 

2. Systematize decision-making on climate change across the company. Boards with an explicit mandate to oversee both climate change and public policy are best positioned to consider these issues and the overlap between them regularly and robustly. If your company does not yet formalize this responsibility within the board, it’s time to consider embedding that language in the appropriate board committee charter.

Stakeholders, including investors and regulatory bodies such as the US Securities and Exchange Commission, are increasingly holding boards accountable for perceived greenwashing. Professing to have strong climate policies while supporting lobbyist efforts to the contrary potentially opens boards and their companies to criticism and consequences.

3. Regularly conduct an audit of the company’s climate positions to ensure consistency. A growing number of investors are calling on companies to conduct internal audits, which the board should oversee, into the extent to which lobbying efforts are aligned with science-based climate policy. These audits should cover both direct lobbying with policymakers and indirect lobbying conducted on a company’s behalf by the trade associations to which it belongs. 

Boards should oversee these internal audits at regular intervals as the scope and context of climate impacts evolve, and they should systematize concrete steps and timelines to address any misalignment that the audits reveal. Amid investors’ growing interest in companies’ lobbying efforts, it is also strongly recommended that companies disclose the results of those audits as well as the steps companies plan to take to tackle any misalignment they find. 

Ultimately, this helps satisfy investors and other stakeholders and mitigate the company’s own climate-related risk exposures.

Margaret Fleming is a governance associate and Melissa Paschall is manager of governance with the Ceres Accelerator for Sustainable Capital Markets.

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Meet Your New Boss

This is an abbreviated version of a more thorough Directorship magazine article exclusively for NACD members. If you are an officer or director of a public, private, or nonprofit organization, you can become an NACD member to view the complete article and related resources.

A sea change in the relationship between investors and the companies they put money into was initiated at a Drexel University corporate governance event more than a decade ago when Vanguard CEO F. William McNabb III suggested that boards engage with investors. Since then, the symbiosis between shareholders and stakeholders has firmly taken root amid growing concerns about how companies manage and how boards oversee environmental, social, and governance (ESG) issues.

As the board’s role has grown more complex, management consultant Ram Charan has spent much of the last six decades traveling the globe to advise CEOs and boards on leadership and governance. Charan translates some of his collected wisdom into books; he has authored or coauthored more than two dozen volumes on subjects ranging from leadership to talent development.

During the pandemic, Charan, dubbed a “CEO whisperer,” stayed put for a few months in Hawaii, where his walks on the beach ultimately culminated in an idea for another book, this one to be cowritten with Dennis Carey, the vice chair at Korn Ferry with vast experience placing executives in C-suites and on boards. Carey and Charan have collaborated on two previous books.

Charan suggested a third perspective—that of the investor—and reached out to McNabb, who in 2018 stepped down as chair of Vanguard, one of the world’s largest institutional investors. Since then, McNabb has become an active independent director. He currently sits on the public company boards of UnitedHealth Group, IBM Corp., and Axiom Law, and also chairs EY’s independent audit committee.

These three extraordinarily different and ambitious men collaborated on the newly published book Talent, Strategy, Risk: How Investors and Boards Are Redefining TSR (Harvard Business Review). The slim volume is written specifically for investors and directors of private, public, and family-owned companies, and the title concept is substantially more than mere wordplay. It provides clear-eyed advice on how boards, management teams, and the investment community can more effectively navigate their sometimes conflicted roles.

In the introduction, McNabb exhorts companies—led by their boards—to focus their attention on the new TSR: “From the perspective of permanent capital and long-term value creation, we think the best way to create total shareholder return is by focusing on talent, strategy, and risk—the new TSR.”

In an interview with Directorship editor Judy Warner in mid-June, Charan and Carey (McNabb was not available) talked about their collaboration to provide directors a deeper look into their big idea.

To read the interview, see the July/August 2021 issue of Directorship magazine. Check out the full and previous issues of the magazine here.

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Boards Face Pressure to Act on Climate Change

This is an abbreviated version of the July/August 2021 Directorship magazine cover story, exclusively for NACD members. If you are an officer or director of a public, private, or nonprofit organization, you can become an NACD member to view the complete article and related resources.

Following an earthquake, aftershocks can continue for weeks, months, or even years.

Similarly, boards and companies across sectors are still processing what happened at Exxon Mobil Corp.’s annual shareholder meeting on May 26. Engine No. 1, an investment firm that reportedly owns 0.02 percent of ExxonMobil, reshaped the company’s board by ousting three directors. The firm put forward a slate of four candidates and three were elected: Gregory J. Goff, former CEO of petroleum refining and marketing company Andeavor; Kaisa Hietala, former executive vice president at Neste, also a petroleum refining and marketing company; and Alexander Karsner, senior strategist at X (formerly Google X).

Engine No. 1 describes itself as “purpose-built to create long-term value by driving positive impact through active ownership.” Its challenge to Exxon’s board to think about its position in the transition to a carbon-free energy future was backed by powerful investors in the oil and gas giant: BlackRock, the world’s largest asset manager, and the country’s two largest public pension funds—the California Public Employees’ Retirement System and the California State Teachers’ Retirement System (CalSTRS). The Exxon vote is a cautionary tale for boards across industries that shareholders are clamoring for companies to address climate change.

“Our economy is littered with companies that couldn’t adapt to change, whether that be technology shifts or, in this case, climate change,” said Aeisha C. Mastagni, portfolio manager at CalSTRS. “You only have to look at some of those companies that couldn’t adapt and couldn’t be resilient in the face of change to demonstrate how there’s an urgency here.”

The Harvard Law School Forum on Corporate Governance found that while activist investor campaigns in general have had mixed success since 2017, the number of campaigns increased sharply for the most part in 2020. These campaigns are on pace to continue after a drop-off during a year dominated by COVID-19.

Activists are also zeroing in on boards, according to separate research from Insightia, which tracks data on shareholder activism. In the first quarter of this year alone, 41 percent of activist campaigns have focused on boards, which is only slightly lower than the figure for all of 2019.

A Dutch climate activist group offered three separate resolutions in May calling on Chevron Corp., ConocoPhillips, and Phillips 66 to reduce their emissions. All received strong support from shareholders: 61 percent, 58 percent, and 80 percent, respectively. Activist investors like Engine No. 1 teaming up with more established shareholders is another sign of change.

Mastagni believes the Exxon vote reflects a new dynamic between investors and boards, and a new way that companies will be scrutinized on their climate change efforts. “I do think that the vote represents how investors are going to continually hold corporate boards accountable for underperformance or a lack of strategy to compete as we transition to a low-carbon economy,” she said.

BlackRock raised a similar point in its vote bulletin on last year’s Exxon annual meeting: “the risks of climate change and the transition to a lower carbon economy present material regulatory, reputation, and legal risks to companies that may significantly impair [Exxon’s] financial position and ability to remain competitive going forward.” In its bulletin this year, BlackRock noted progress made by the company on climate commitments and disclosures, but said more needed to be done on both long-term strategy and short-term actions.

“We’ve all been focused on the significant risks associated with sustainability issues, but there are also significant opportunities—financial and investment opportunities—for companies that are first movers in terms of investing in innovation,” said Michelle Edkins, managing director of BlackRock’s investment stewardship team.

CGI Appeals to SEC for Mandatory Climate Disclosure

Based on the premise that “successful corporate action on climate change depends on a productive collaboration between business and policy makers,” the global Climate Governance Initiative (CGI), launched in collaboration with the World Economic Forum, issued a comment letter to the US Securities and Exchange Commission (SEC) in response to its March 15 request for feedback on the agency’s climate disclosure project. Input from the member chapters of the CGI, which includes NACD as its US representative, was reflected in the recommendations submitted by the CGI in a letter signed by its chair, Karina A. Litvack.

The CGI’s specific recommendations to the SEC, as detailed in its letter, include the following.

Reinforce the view that climate change will have significant implications for all companies and their boards, requiring them to revisit their corporate strategies to respond to it, and to integrate all relevant impacts within the financial statements and disclosures.
Set minimum disclosure requirements that apply to all companies, allow for comparability, and cover the entire value chain, as well as define some specific disclosure requirements that will be necessary for certain industries.
Frame its guidance as a mandatory standard that requires compliance but allows for the presentation of alternative performance measures (accompanied by reconciliations to those prescribed by the standard) and supported by fulsome explanations.

To read the full story and learn more about how to oversee climate change from the boardroom, keep an eye out for the upcoming July/August 2021 issue of Directorship magazine and check out NACD’s recently released Director FAQ on Climate Governance.

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Five Areas of Focus to Be Ready for Your Next Deal

Deal-making is back. After a recovery period following the initial shocks of the pandemic, mergers and acquisitions (M&A) activity has rebounded to reach historic levels. A company’s directors can play a critical role in determining whether this uptick in activity will be accretive for those companies that pursue M&A as a growth strategy.

The current environment in mind, here are five areas that boards should focus on when providing strategic oversight and guidance for their companies’ next deals.

M&A Readiness: Be Involved Before a Deal Is on the Table

Be proactive about understanding management’s readiness and preparedness to execute. Determine the following in advance:

What types of deals will the board be involved in? What types of deals (if any) will it not?
Does the company have the leadership, skills, capabilities, capacity, processes, scale, and advisors to successfully execute the deal?
Does the organization have leaders with M&A (or specific deal type) expertise?
What processes and tools does the business have for pipeline management, due diligence, and integration?
What have the board and company learned from prior deals?

Diligence Oversight: Emphasize the Qualitative, Moderate the Pace

Validate the quantitative, and drill deep on the qualitative. Be sure to:

Probe externalities such as market factors, culture, brand, and perception.
Ensure there is a strong focus on broad and deep diligence.  
Incorporate new considerations for areas such as people; culture dynamics; environmental, social, and governance issues; and cybersecurity.
Help moderate the pace, and don’t let the deal gain unsubstantiated momentum.

Also ask: How difficult will it be to achieve the operational objectives that will drive synergies? Where will changes drive the most opposition from stakeholders, and what is the company’s plan to address this opposition? If deal models and integration plans are predicated on unrealistic operational changes, the value won’t materialize. Good operational due diligence is just as—if not more—important than good financial due diligence, and it materially impacts speed to value. Make sure the company has objective inputs with the right industry and integration experience to evaluate and validate model and integration feasibility.

Integration: Stay in the Game for All Four Quarters

Set expectations on the metrics you will monitor over the course of the full integration, and be mindful of the time frame. Retention is a great example of an area in which the organization’s measurement needs to extend beyond key personnel. Similarly, the time horizon for measuring retention should be years, not months, after close. Slow and quiet value leakage from poor retention is extremely expensive.

Be ready to pivot when the company finds things that were not uncovered during due diligence. The best plans are encapsulated in an agile decision-making framework. Establish the rapport and processes with management that allow the company to adjust, resolve, and reposition if new information prompts different priorities.

Portfolio Optimization: Evaluate the Full Portfolio

Look beyond the next deal to scrutinize how management evaluates its deal-making over time. Most corporations don’t actively manage their portfolios like their private-equity counterparts do, at least not until there is a problem.

The issue with this approach is twofold: First, it assumes all deals are done well and for life. The reality is that tomorrow will likely not look like today, and deals that delivered on their objectives yesterday might not serve the organization’s future vision or needs. Second, waiting until there is a problem compromises the organization’s ability to optimize the value of any deal. No one pays top dollar for a “do-or-die” deal. M&A capital allocation needs to be a proactive, deliberate process.

Ask the management team to describe its enterprise portfolio optimization process, which could also include having a third party complete regular, objective reviews. The process should consider substantive differences in performance across portfolio companies, divisions, or business units; capital funding requirements; valuations; and alignment to the company’s current strategy and future direction. Outputs should include an executable road map that identifies performance improvement opportunities, considerations for restructuring or divestitures, and recommendations for targeted organic or inorganic growth.

Divestiture: Be Prepared Sell-Side

Following a consistent enterprise portfolio review process will no doubt yield strong candidates for divestiture. Although transparency to buyers has not been the norm historically, the limitations of the pandemic (e.g., a lack of in-person management meetings and site visits) have revealed some of the potential advantages of increased transparency. Buyer visibility into synergy opportunities, road maps, examples of quick wins, and clear separation and integration plans increase speed and value and also reduce risk, friction, and transaction costs—creating win-win outcomes. Transparency can also help the company pressure-test the decision to divest, as it may reveal entanglements and new assumptions about markets.

As one of our clients says, “High-consequence decisions are always improved by high-quality debate.” The board has an important role to play in scrutinizing a company’s M&A activity for strategic alignment, readiness, and progress against expected outcomes, in both the short and long term. Furthermore, ensuring management has processes in place for ongoing enterprise portfolio optimization is equally critical. Focusing on the right areas with management and deal teams can determine how much value an organization’s next deal can realize.

Colin Harvey is a managing director with Alvarez & Marsal’s Corporate Performance Improvement (CPI) practice in Austin and the national solution leader for CPI’s Corporate M&A Services.

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What Directors Should Know About Wage-Fixing and No-Poach Agreements

On July 9, President Joseph R. Biden Jr. issued an executive order to promote competition and antitrust enforcement in certain key sectors, with a focus on the labor market. The order includes a call to action to ban noncompete agreements and other clauses that may unfairly limit worker mobility, and it looks to strengthen guidance on collaboration to prevent the suppression of wages and benefits among employers. In addition, the US Department of Justice (DOJ) Antitrust Division, Federal Trade Commission (FTC), US Department of the Treasury, and US Department of Labor will be reviewing and reporting on the impact of competition in the labor market.

Corporate directors should expect to see further regulation as a result of this order, in particular as the agencies begin to implement the initiatives. That means it’s vital for directors to understand the context surrounding the order, the current rules, and what their organizations should be doing now.

Where did this all start, and why is it important?

In 2016, the DOJ and FTC published guidance outlining the types of agreements and information-sharing that could raise antitrust concerns with respect to the labor market. It states the widely accepted principle that employers’ agreements to not poach each other’s employees or to fix salaries or benefits may be unlawful. What is particularly noteworthy, however, is that the guidance states that so-called “naked” agreements—no-poach agreements among competitors that are not ancillary to a separate legal transaction or collaboration—are per se illegal.

Historically, this conduct was pursued as a civil violation. The 2016 guidance brought forth a major policy shift by introducing the possibility of criminal charges for these labor market violations. This triggered an onslaught of scrutiny in the market, and we have since observed an increase in investigations and enforcement of this conduct.

Almost five years after the guidance was issued, the DOJ began following through on its promise of potential prosecution. The agency has brought several wage-fixing cases in the health-care space: In December, the DOJ brought its first criminal wage-fixing case, and only a month later, a federal grand jury returned a two-count indictment against the company owner for alleged anticompetitive no-poach agreements. In a superseding indictment, another executive at the same company was charged in April with wage-fixing and obstruction. In March, a separate health-care staffing company and local area manager were indicted for allegedly colluding to suppress wages and not poach each other’s nurses at one school district in Las Vegas.

We are starting to see the agencies enforce these “naked” no-poach or wage-fixing agreements in the same way they enforce agreements for price-fixing or market allocation. We expect to see more indictments of both individuals and businesses for these alleged anticompetitive agreements and increased regulation surrounding this market. The agencies have indicated that they will continue investigating this conduct in the same way the DOJ traditionally investigates and prosecutes cartels.

First, directors should know what’s not allowed. Federal agencies have deemed the following practices to be per se illegal:

Wage-fixing agreements between organizations on how much to pay their employees and what types of benefits to provide, and those that impose salary maximums or a cap or that withhold pay raises or bonuses;
No-poach agreements that restrict the movement of employees between competitor employers, which can prevent mobility and career development; and
Exchanging sensitive information related to employees, such as their salaries, benefits, bonuses, and health care options. Such employee information should be treated the same way as any other competitively sensitive data within a company and should not be shared with competing employers.

“Naked” no-poach or wage-fixing agreements are agreements that are neither vertical in nature nor ancillary to certain legitimate agreements, as noted in the 2016 guidance’s exceptions. Ancillary restraints—agreements that are reasonably necessary to a legitimate business collaboration—are not per se illegal. A no-poach agreement may be allowed when contained within a reasonable business transaction, such as if the provision or agreement is reasonably necessary for a joint venture or a merger and acquisition.

If a business needs an agreement in this area, there should be a broader pro-competitive goal. The no-poach or wage-fixing aspect should not be the reason behind the agreement, and the application should be tailored. Businesses should avoid agreements with a broad scope and they should tailor agreements to a smaller group of high-level employees. Agreements that apply to entry-level attorneys, for example, are unlikely to be found to be necessary to accomplish a transaction.

Companies can also limit the duration of the relevant provision, such as only during a joint venture or merger. A business may be better able to justify these provisions during a contract with a fixed term rather than one that has a lengthy or indefinite period. The key is to narrow the scope: the less restrictive the provision, the less chance of scrutiny from the authorities. 

Directors should monitor competitive trends and activity in the market. Certain skills being in high demand but short supply, or a particular competitor going on a hiring spree, could create risky conditions that lead to illicit discussions or agreements. Companies should consider what their legitimate options may be to ensure they have adequate and appropriate protections in place.

Top Three Actions: Tailor, Train, Test

We recommend that boards work with management to take the following actions to avoid running afoul of antitrust laws:

Tailor. Review your employment agreements for risk, and tailor these agreements to adhere to the proper scope. Confirm that any existing or future non-solicitation clauses are within permitted boundaries.

Train. Educate your staff on the personal and company risks of illegal no-poach and wage-fixing arrangements. Develop clear policies to keep your personnel educated and informed.

Test. Health-check your human resources team. You should be aware of which industry group meetings and conferences they attend, which email and messaging listservs they’re on, whether they communicate with counterparts at rival employers, and whether they understand competition law limits. Encourage them to come forward with concerns, and spot-check emails or messages to identify risks. Consider legal privilege throughout this process.

Ashley Eickhof is a senior associate in Baker & McKenzie’s North America Antitrust & Competition practice group, and Jeffrey Martino is a partner in the firm’s Litigation and Government Enforcement practice group.

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Elevating Corporate Purpose, ESG, and Stakeholder Issues: Insights from Lead Directors

The forces reshaping the business landscape—the COVID-19 pandemic; accelerating megatrends; a Biden administration policy agenda focused on climate, racial justice, and other social issues; and calls for companies to address the concerns of stakeholders—are prompting introspection in the boardroom.

In our ongoing work as part of the KPMG Board Leadership Center Lead Director Initiative, the lead directors and independent chairs we interviewed (under Chatham House Rule) collectively highlighted key areas of focus for lead directors to help their boards raise their game and add value to their businesses.

It is clear from our discussions that the shift toward purpose; environmental, social, and governance (ESG) issues; and stakeholders is real—and these issues are now priorities for most companies, as well as their stakeholders. While for many companies, addressing ESG and stakeholder issues as strategic issues has been a formidable challenge, COVID-19 and the events of the past year have brought to light the importance of these issues, particularly the “S” concerns, and have helped companies identify the ESG issues that are most critical to creating long-term value. What is the role of the board in helping to ensure that these issues are priorities for the company—and that the company is “walking the walk”?

These are the key messages we heard:

Help focus the ESG conversation. While management should drive the ESG conversation, lead directors emphasized that if that isn’t happening, board leaders must help foster the discussion by asking direct questions about where their companies are on their ESG journeys.

“As lead director, it’s my job to help keep the boardroom conversation focused on the ESG issues that matter most to the business and understand how management is addressing them,” one director said.

Keep stakeholders front and center. As one lead director noted, the board can play an essential role in listening for instances in which management “may be tone-deaf or may be prioritizing shareholders and not giving other stakeholders proper consideration.” Another said, “Boards today need to be more aware of the context in which the decisions are made, particularly on issues such as ESG and [diversity, equity, and inclusion], and understand the importance of these issues to key stakeholders.”

Help ensure ESG is driven by strategy and linked to incentives. The lead directors we spoke to agreed that tying ESG performance to executive compensation signals the importance that the board places on defining ESG and how it fits into strategy. While companies often have meaningful initiatives at the operating level, said one leader, “finding a way to embed these initiatives in compensation incentives is a helpful signaling device and rewards those activities.”

Have a disclosure framework and a disciplined process. Finding the right ESG disclosure framework for the company is key: “It has to be the story that you want to tell about how you are stewarding E, S, and G,” one director said.

Once you have a framework, have a process for engaging the full board and its committees to determine what is material to the company. For instance, one nominating and governance committee chair said she views her role as that of the “ringleader,” coordinating those discussions and ensuring that they happen—and not solely at the nominating and governance committee level.

“Your ESG story should be about what is material to the company, and that varies greatly across industries and company size,” she said. “Figuring out what is material is part of the larger discussion of strategy and risk, so that disclosure flows from what is informing your business plans as a company.”

Since companies can have legal liability even for ESG statements not required in US Securities and Exchange Commission (SEC) filings, board leaders said it’s important to have an internal process for validating company-presented data that is as rigorous as the disclosure controls and procedures in place for information included in SEC filings.

Understand that ESG-related proxy activity is intensifying. ESG has been front and center in shareholder proposals this proxy season, consistent with the trend over the last five years. This season is also seeing “Say on Climate” proposals (asking for shareholder votes on how companies are addressing climate risk) and proposals seeking to tie compensation to ESG metrics.

Institutional investors have set specific expectations for ESG disclosure on, for example, board and C-suite diversity, diversity-related data, sustainability, and climate-related risk. Management teams and directors should be prepared to respond to those perspectives.

Set expectations for the CEO speaking out on social or political issues. A number of lead directors we spoke to (but not all) felt that CEOs should be speaking out on issues that reflect a company’s values. In those cases, one lead director said, “the board should be kept informed. It doesn’t have to be a formal conversation every time, but I think it would behoove the CEO to have some conversations with at least a set of directors, if not the full board.”

And, as another lead director noted, “Remember that saying nothing is saying something.”

Patrick A. Lee is a senior advisor with the KPMG Board Leadership Center.

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Getting the People Side Right: Five Questions to Ask to Protect Your M&A Deal

We are in a period of intense business model transformation. Many enterprises are looking to reflect new consumer and competitor realities—and they need to act fast. Mergers and acquisitions (M&A), and other transactions, offer one strategic path to rapid change, so it’s unsurprising that our research shows that 57 percent of business leaders anticipate an increase in deal activity in 2021 and 2022.

Deals, however, are not without their challenges. About half will not be completed, with an even higher number failing to deliver the promised value. There are many reasons for this, but Mercer research released in May reveals a striking fact: 47 percent of deals that fail do so primarily due to a lack of strategic planning and execution rigor related to people risks. The report, Delivering the Deal: The Unrealized Potential of People in Deal Value Creation, was based on data sourced from PitchBook or collected through a survey that captured the insights of over 750 experienced deal leaders from Fortune 1000 companies or private equity professionals.

People as a Revenue Driver, Not Just a Cost Center

The pandemic hammered home how crucial an agile and resilient workforce is to the bottom line, yet many businesses fail to translate the importance of people to deals. Why the disconnect?

Traditionally, when envisioning a deal’s cost and revenue synergies, most leaders think of people only on the cost side—forgetting that it’s people who will ultimately bring any new revenue-driving strategy to life.

For example, if your deal thesis depends on cross-selling the products of two merged companies to increase revenue, you must ensure you have salespeople with the right skill sets, incentives, and understanding of how they need to act differently to deliver your vision. Without this, nothing will change, and your plans for generating new revenue will suffer.

Based on our experience supporting nearly 1,400 deals per year worldwide, we have seen the effects of this people disconnect. For example:

We stepped in to develop a culture, communication, and change-integration plan and talent retention strategy for a multibillion-dollar deal threatened by employee turnover caused by misaligned leadership and diversity approaches.
We executed a rapid change management and culture alignment effort in three weeks across 40 countries when the stock value of an acquiring organization was under pressure due to the failure to produce promised synergy targets.
We developed a new workforce geographic strategy when one company’s deal team did not realize until formal due diligence that the deal hypothesis for a $500 million acquisition did not accurately reflect local works council and dismissal-charge issues.

These examples demonstrate the impact people have on delivering revenue-related deal value and the need to apply the same rigor to people as to other deal aspects. As one business leader told us in our research, “In a deal, people cannot be left to chance. Failure to address pain points in your people strategy can have catastrophic consequences.”

Here are five questions that boards should ask management during any M&A activity to avoid deal failure:

Are the people opportunities and impacts defined in the deal hypothesis? When examining the benefits of a potential merger, a business leader who thinks of people only as costs is unlikely to anticipate how people might impact theorized revenue synergies. It is critical to move beyond headcount reductions and strategically anticipate how people will need to change their behaviors and what skills are required to deliver this new organization. Too frequently, it is assumed that people will “figure out” what they need to do post-close. But to extract value from the deal, you need to develop an initial people hypothesis and rigorously test and refine that hypothesis into a pragmatic execution plan.

With what degree of rigor are the people-related impacts represented in the financial modeling? Nearly half of executives told us in our study that workforce impacts were not quantified or built into financial models. This is a significant omission because, in most instances, what is not modeled will not be proactively acted on. Fully understanding and anticipating what is needed from the workforce must be built into your financial model if you’re to deliver as promised to stakeholders.

How are we assessing people impact during quality of earnings (Q of E) diligence? A seller’s goal is to maximize the company’s financial attractiveness. Frequently, decisions are made to improve the short term without concern for the longer-term consequences. Workforce adequacy and human resources (HR) operations are two areas prone to this thinking. If a seller cuts back on HR delivery, it may destabilize the workforce. The short-term impact on earnings will be positive (lowered labor and function support costs), but the post-close impact will be lasting and negative. A rigorous look at people even during Q of E diligence will create a foundation for deal success.

How does talent factor into target identification? A good understanding of what talent a potential acquisition brings is just as important as understanding the product portfolio or customer base. Yet, this is often neglected. Creating a process to capture some level of understanding of talent assets when evaluating targets is critical, as this becomes a key input to the initial deal thesis. It is also important for this evaluation to not only be a static assessment of today but also consider the future skills needed to deliver value.

Do we have a people advisor who can provide on-the-ground execution support? After examining the issues above, you then need a strategic partner focused on all things people. This means an advisor who not only offers strategic advice but also has the on-the-ground resources to execute your vision. By selecting a partner who specializes in talent and applies the same rigor of thought and execution to your deal’s people aspects as you do, you can ensure the people-related elements align to deliver the desired deal value.

Robustly factoring in the people impact, from target identification to deal thesis formation to financial modeling and Q of E diligence, and working with an experienced partner on deal execution can protect the bottom line and realize maximum value from your most important asset—your people.

Jeff Black is partner and global and North America mergers and acquisitions advisory services leader at Mercer.

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