Directors can be forgiven for feeling bruised, even though the global economy shows slight signs of recovery. Consumer confidence appears to be picking up as jobless numbers ease, according to the latest figures from The Conference Board. And, chief executive officers seem less anxious about their organizations’ future prospects.
But directors themselves are far more guarded. NACD’s latest Board Confidence Index shows that directors’ confidence in continued growth in the U.S. economy has dropped. In fact, directors who last year characterized their outlook for general economic conditions as moderately positive now see little or no change for the future.
There is no way for directors to magically boost global demand or pull macroeconomic levers. But there are factors they certainly can control that will, over time, substantially improve the operations of the companies on whose boards they sit—not least because those factors will free the board and management team to focus on performance. Heidrick & Struggles identifies five issues that merit immediate and consistent attention.
- Improving communications with shareholders. Do a quick Google search for “shareholder communication with directors” and up come all sorts of boilerplate assurances touting open lines of communication between boards and investors. But in many cases, the fine print betrays just how difficult it can be for shareholders to make themselves heard by directors.
Here’s one example that clearly demonstrates just how out of touch boards can often be in our Facebook and Twitter age: “Any shareholder who wishes to send communications to the Board of Directors should mail them addressed to the intended recipient by name or position in care of: Corporate Secretary [company name and address follows]. Upon receipt of any such communications, the Corporate Secretary will determine the identity of the intended recipient and whether the communication is an appropriate shareholder communication.” Translation: Please don’t bother—we are not open to input.
Increasingly, shareholders want—indeed, demand—more immediate access to the board. It’s not to circumvent proxy voting mechanisms or to subvert established whistleblower channels; it is simply to have more of a voice in issues that shareholders care about—and to know that directors are listening.
Given the well-publicized CEO succession snafus we have seen in recent years—and given the rise of shareholder activism in general—it is easy to see why shareholders are anxious for a real dialogue with the head of the nominating committee, for example. In an era in which corporate reputations can rise and fall with the ebb and flow of social media messages, it is necessary for directors to think anew about how their roles are perceived by investors.
We’re not saying every boardroom debate is up for public consumption or that every director should have a mandate to speak freely and candidly to anyone who asks—media, analyst, or shareholder. It is crucial that when directors speak, they speak with a unified voice.
But there are smart ways to be open. We believe that board openness starts with meetings with select institutional investors—and will soon become a hallmark of best-performing boards. As such, it will set the bar of expectation for shareholders everywhere. The Pfizer board is taking a more proactive approach to fostering open board and shareholder communications. It is sending out a press release announcing a board-shareholder meeting and later sending some of the materials distributed at the meeting between the board and 16 of its major shareholders. The reactions to this move are proving positive.
NACD has included “shareholder communications” as one of its 10 “Key Agreed Principles” to strengthen governance for public U.S. companies and made available a raft of materials for detailed discussion—from webinars to books to reports. Others eloquently support the case for improved communication with investors.
- Mastering CEO succession planning. The old story about corner-office succession planning is that the CEO would keep an envelope tucked away in his or her desk drawer naming the future successor.
The story isn’t so far from the truth. The shock of it is that here, in 2012, CEO succession planning is still done so poorly—when it’s done at all. In recent years—naming no names—there have been some staggeringly awful succession gaffes by companies quite established enough to have known better.
The statistics are not encouraging. NACD’s 2009 research shows that 44 percent of corporations did not have a formal CEO succession plan in place. Although most had some basic process for replacing the CEO in an emergency, many had not planned for succession over a three-to-five year period. A 2010 study by Heidrick & Struggles and The Rock Center for Corporate Governance at Stanford University found that on average, boards spend only two hours a year on CEO succession planning, and only 50 percent have a written document detailing the skills required for the next CEO. Furthermore, in our 2011 Board of Directors survey, we found that only two-thirds of U.S. directors said their boards had vetted at least one viable candidate who could immediately step in as CEO if necessary.
The SEC is on the case. In October 2009, its Division of Corporate Finance issued new guidelines that support shareholders who want boards to provide more transparency about the process. The document pulls no punches: “We now recognize that CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce.”
Yet the benefits of thorough succession planning are not hard to find. Heidrick & Struggles’ research shows that merely announcing who your next CEO is can move the market value of your company by 5 percent or more. McDonald’s is the high-water mark for how to do succession planning right. When CEO Jim Cantalupo died unexpectedly in 2004, the board was quick to name veteran Charlie Bell—then president and chief operating officer—as Cantalupo’s successor. But shortly thereafter, Bell learned that he had cancer. The directors had a plan: Their continual preparation and development of a years-long leadership pipeline meant they did not have to go outside the company to replace Bell.
We have worked with a company that has pursued an exemplary board practice: It has run mock board meetings to identify a CEO successor in case of a sudden event like that which befell McDonald’s. The mock meeting was tasked to a specific committee, and individual directors had clear responsibilities for roles such as communicating to the executive team, to investment analysts, and others. That is the kind of initiative we have to see more often.
- Aligning executive compensation with performance. This has long been a heated issue for boards, and it never seems to be resolved to the satisfaction of shareholders. Now, more than ever, it is the board’s responsibility to cool down the debate over executive pay.
The Occupy Wall Street movement is the least of directors’ concerns. Much more pressing are the increasingly shrill calls for fair play when CEOs are awarded epic sums for negative performance (and there were some jaw-dropping examples in 2011)—or in quite a few cases, for no performance, in the form of “golden hello” handouts when a new CEO signs on. In some instances, the “hello” envelopes have been downright incendiary for some shareholders—and for the media—whether or not the sums have been inducements or “make whole” compensation for monies the executive may have left on the table at the previous employer.
Dodd-Frank, enacted in mid-2010, now gives shareholders some say on pay via non-binding votes on executive compensation and golden parachutes. But we contend that all too many directors—especially the members of compensation committees—are tone-deaf to the hard connection between performance and pay. We fully expect that institutional heavyweights such as CalPERS will, with Dodd-Frank behind them, wade more forcefully into compensation affairs. And we expect to hear a lot more from longtime activist investors such as Carl Icahn, Relational Investors, and others.
That said, we know plenty of directors who are frustrated by the compensation excesses they see all around them. They are more than happy to reward CEOs handsomely when those executives knock corporate performance out of the park, but they find themselves competing with decisions from directors at other companies who listen far too closely to what the compensation consultants have to say.
In their hearts, directors know that not all executives are somehow “above average.” Now they must confront this realization head-on.
- Ensuring more diverse boards. Over the last three or four years, it is fair to say that diversity in boardrooms took something of a backseat. There is an excuse, of course: the economic downturn focused everyone’s attention on performance. But now it’s time to return to the admittedly hard job of building boards that represent the rich diversity found on any city street in the United States or in most offices and factory floors.
The pressure is on: There’s a striking example in the letter that CalSTRS earlier this year wrote to Facebook, urging that the company strengthen its corporate governance and increase the diversity of its board. The European Union is forging ahead with plans for quotas (always a controversial topic) to increase the percentage of women on boards. And we fully expect that organizations such as Catalyst—and increasingly influential efforts like Stanford University Graduate School of Business’s Stanford Women on Boards Initiative—will increase the drumbeat to appoint more female directors.
The calls for ethnic diversity may be less strident right now, but they are not likely to be mute for long. The rise of sovereign wealth funds, surging middle classes in emerging markets, and the growth of global markets are just some of the factors that are converging to pressure boards into mirroring the make-up of their shareholders worldwide.
Of course, it is one thing to be willing to build a more diverse board and quite another to do so. Heidrick & Struggles’ surveys show that nearly two-thirds of directors find it tough to hire well-qualified ethnic minorities, and more than half say it’s hard to hire qualified women directors. Nor is there widespread trust in the mechanisms for fostering diversity: Among men on boards, only 13 percent support quotas compared with 41 percent of women directors.
But those diverse hires have to happen. For a start, nominating committees have got to expand their director searches beyond their usual Rolodexes (86 percent of directors rely on their own contacts when looking for new directors, according to our research). Directors also have to proactively seek out and use the cornucopia of tools available to help accelerate diversity efforts—from the Diverse Director DataSource set up in April 2011 by CalPERS and CalSTRS to the wealth of board-succession planning tools offered by NACD.
Put simply: boards ignore the diversity issue at their peril.
- Getting ahead of proxy access. Directors must begin taking this issue seriously. Even though a federal appeals court last year overturned the SEC’s interpretation of shareholders’ rights to nominate their own directors, most boards still have to get their arms around what the final rulings entail.
We agree with the experts that the SEC’s market-wide proxy access rule won’t much affect the 2012 proxy season. However, a wild card is now inf play. Following the court’s ruling, what we are left with is the very real prospect of “private ordering” whereby irate shareholders can bring forward all manner of their own proposals to push proxy access in forms that they can determine, and whatever their intentions.
There is no telling how widespread such responses might be. But it is our bet that there will be a flurry of alarming though disparate assaults on individual companies. So it is incumbent on boards to get ahead of the proxy-access issue, possibly by developing their own rules and gauging the limits of those rules against likely shareholder advocacy.
As the Boy Scouts say, “It’s always better to be prepared.”
We don’t pretend that the five points made here represent the entirety of what should be on the board’s future agenda. But in our experience, the boards that adhere to the tenets we have outlined stand a far better chance of ensuring that their companies outrun and outlast their competitors.