Prescriptive Standards or Governance Principles?
Plenary Session
Tuesday, October 21, 11:30 am
| Ira M. Millstein | Senior Partner, Weil, Gotshal & Manges LLP, and Senior Associate Dean for Corporate Governance, Yale School of Management |
| Sanjai Bhagat | Director, Integra Ventures; Professor of Finance at the University of Colorado at Boulder; Colorado NACD Chapter, Program Committee Chair |
| John J. Castellani | President, Business Roundtable |
Christianna Wood |
Trustee, International Corporate Governance Network |
During the opening session of the 2008 NACD Corporate Governance Conference, audience participants overwhelmingly predicted the creation of new rules, regulations, and laws-which will not only affect individual directors, but which are likely to significantly re-shape the future of corporate governance.
| Unlikely |  2% |
| Somewhat likely | 23% |
| Very likely | 75% |
Total Responses: 151 |
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Navigation of the proliferation of prescriptive-and sometimes conflicting-governance standards issued by ratings agencies, interest groups, and stakeholders is already challenging-and these challenges will only increase in the coming months.
Digested from the panelists' discussion:
Ira Millstein:
First, please remember that corporate governance has to do with performance.
Second, this is not an attack on ratings agencies. Their ratings information is useful: Useful for what? It's useful for people who look at and think about the practices. But it's not useful for predicting performance. To even things out, though, I'd like to mention that the governance ratings agencies did a lot better at predicting performance than the people who rate credit.
We all need to take action to restore public and investor confidence in the governance of corporations. There are a lot of different best practice recommendations being put forward by a lot of different groups-but these recommendations agree on many key points. As a starting point, to help us all move beyond rigid standards, we've boiled these shared principles into ten points:
- Governance structures and practices should be designed by the board to position the board to fulfill its duties effectively and efficiently.
- Governance structures and practices should be transparent- and transparency is more important than strictly following any particular set of best practice recommendations.
- Governance structures and practices should be designed to ensure the competency and commitment of directors.
- Governance structures and practices should be designed to ensure the accountability of the board to shareholders and the objectivity of board decisions.
- Governance structures and practices should be designed to provide some form of leadership for the board distinct from management.
- Governance structures and practices should be designed to promote an appropriate corporate culture of integrity, ethics, and corporate social responsibility.
- Governance structures and practices should be designed to support the board in determining its own priorities, resultant agenda, and information needs and to assist the board in focusing on strategy (and associated risks).
- Governance structures and practices should encourage the board to refresh itself.
- Governance structures and practices should be designed to encourage meaningful shareholder involvement in the selection of directors.
- Governance structures and practices should be designed to encourage communication with shareholders.
Different practices make sense for different boards at different times. The process behind these Key Agreed Principles is about increasing professionalism in the board room by asking the board to sit and think about the principles in the boardroom.
Sanjai Bhagat:
I don't want to pick on anyone: But none of the agencies can predict stock market performance. There have been claims that these agencies can beat the market-but if you look carefully, they don't add up.
Our research has found that no established set of prescriptive standards-no academic or commercial governance ratings system-can reliably predict corporate performance as measured by stock price.
(A PowerPoint Presentation summarizing the research on "The Promise and Peril of Corporate Governance Indices" can be downloaded here.)
What does all this mean?
- Commercial indices do not predict stock performance
- Our research does not support one-size-fits all governance
- Our research does not support the uniform governance mandates advocated by ISS/RiskMetrics Group
Ira Millstein:
Essentially, we've moved beyond the subject of whether you like or dislike governance ratings. You can't use them to predict performance. But you can use them as input to look at which items will help you build a better board.
John Castellani:
Of course Business Roundtable has been supporting the reforms implemented over the past 6 years. But we have been focusing on the mechanisms, on what the ratings agencies and proxy services want us to do. The question remains: Have we gotten better governance out of it? More important, have we gotten better performance?
Boards are so myopic about compliance, that we risk being the best in the world at compliance and the worst at governance and management.
Principles-based compliance puts the onus back on the board to ensure they have the best governance for their individual company's, management's, and shareholders' circumstances.
Ira Millstein:
NACD completely agrees that we've been thinking too much about compliance, and not enough about performance. What should we be doing to have better performance? Make the board think about the important issues (risk, strategy) and spend less time listening to lawyers.
Christianna Wood:
The principles are a good start; they are valuable guidelines. There are several points which ICGN agrees with.
There are also a few points were ICGN would like to see stronger language-especially with respect to shareholder votes, and especially regarding anti-takeover provisions.
When considering the current environment, it's instructive to look at the companies who did well in the crisis, and to look at what they did well.
At one company which did well, for example, four directors spent four hours a week just looking at risk management.
One reaction is: That's too much time for the directors to be spending.
The other reaction is: That's exactly what the directors should be doing-other troubled companies wouldn't be where they are today if their board have given this level of attention to risk.
Ira Millstein:
The board doesn't have to sit down and do the risk management; it does need to sit down and oversee the risk management.
If our ideal board wasn't working away at ticking boxes-they would have had time to talk about risk management.
John Castellani:
One year from now, two years from now, how will we unwind ourselves? For all the problems the system caused, it did provide a very good capital market. However, boards should have printed a single statement in large letters on the wall: "Valuations don't always go up."
There is an incredible focus on short-term results. The average tenure of a Business Roundtable CEO is now 4 years. I don't think you will find anyone who would say the ideal CEO tenure is 4 year. Of course no one would say 20 or 30 years either.
The primary reason for the high turnover is stock performance over a relatively short period of time. Even if underlying indicators of performance are good-as a CEO, you're still measured on that one index over one very, very short period of time.
On the other hand, how many directors of the firms which did well through this crisis-how many of them would have been criticized if this had not collapsed? Directors who would block the company from entering a market that was creating shareholder returns--they would have been heavily criticized.
Sanjai Bhagat:
In the morning we had an hour-long session on executive compensation, but I think Nell Minow had it just right. I am recommending that the executive contract should be simplified-you should only think about restricted stock and restricted stock options.
A lot of scandals-like Enron-would not have happened if the CEO and CFO compensation was tied to restrictions for three years after they retired from the company. The compensation consultants have made this way too complex. You should give executives some cash-but not a large amount.
Ira Millstein:
I think we're saying that a thoughtful board would design compensation differently.
John Castellani:
We don't agree with Sanjai's proposal, but I agree boards have to be careful in how they design compensation. Almost everyone's agenda can come down to dissatisfaction with compensation-that is an issue used by every side when talking about how boards should be structured, and how governance should go forward in the future.
Compensation-and getting it better-is at the root of all of this. It absolutely cannot be perceived as being paid for failure.
Boards have to design for the circumstance of their own companies, according to principles-it has to be transparent, and it has to be tied to performance.
Christianna Wood:
Not everyone is that unhappy with compensation. I'm not sure Fuld-and other people whose families will be wealthy for generations-are that unhappy with how they were paid. That's what happens when industries fail to self regulate. Legislatures try to put their own English on the situation. Barney Frank will have a field day with legislation, and we all see that coming.
Ira Millstein:
We are all saying that this is a complicated issue-and you don't have to take anyone's advice-but you should look at all the views, and the board should wrestle with it and pick a side. If you pick something rational, and explain why it fits you and your firm, shareholders will feel very comfortable about it.
Figure out which view works for your company, disclose it, and disclose it in something people can understand. And we think intelligent shareholders will respond well.
Christianna Wood:
I want to assure every director in the room that people really read the proxies. If you're not sure whether transparency is important-it absolutely is.
Whatever the topic is, if you can explain to us why this makes sense for your company, we'll listen.
Ira Millstein:
Business Roundtable might recommend one thing; the shareholders might recommend another-but in the end, the board should just tell the truth: Why does this fit you?
Audience Question: Isn't it time to retire the ratings? That is, do ratings really give legal protection to companies, if they adhere to the governance recommendations?
Ira Millstein:
I'll answer this one: No.
Audience Question: For the principles to get buy in, directors have to redefine themselves. Right now, we're a group that looks for bright lines. How do we become a group that makes their own guidelines?
John Castellani:
No one should know your company better than you do as directors.
You should stop having to listen to someone else. The "rules" should be made by the same person who knows the company, knows the shareholders, and knows the management.
Boards should be able to do what they need to do in risk management. We have to avoid the cause of most airline accidents: "Controlled Flight into Terrain." When everyone is focusing on the problem, no one is focusing on flying the plane. Someone needs to fly the plane.
There is no one who can tell you what you should be doing, because you, along with management, should know it best.
Christianna Wood:
There is no simple answer on how to re-tool the board of directors:
- Get the right skill sets
- Get the right education
- Get good instincts
I think those key things will help, as well as the general guidelines-and other resources that are there to support directors.
Ira Millstein:
We were all pleased to participant in this panel, and in the creation of the Agreed Principles-because it really is up to you.
This will only happen if you believe that that this is the right way to do corporate governance.
PowerPoint Presentation/Handouts
For More Information:
The Key Agreed Principles and Appendices are now available for download from the NACD website.
