Emerging Issues

Commonsense Principles of Corporate Governance

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A group of leading corporate executives, and other business leaders recently published a statement of “Commonsense Principles of Corporate Governance.”  The principles set forth a number of recommendations and guidelines about the roles and responsibilities of boards, public companies and shareholders and are intended to provide guidance on corporate governance that “works in the real world.”  Mary Barra, Jamie Dimon, Jeff Immelt, Larry Fink, Lowell McAdam and Warren Buffett, among others, contributed to the principles.

The principles address board composition, the responsibilities of the board, shareholder rights, public reporting, board leadership, succession planning, compensation of management, and the role of asset managers in corporate governance.

A number of the principles reflect “best practices” that have been adopted by many companies, while others have been adopted on a more episodic basis.  In this vein, the authors of the principles acknowledge that the principles are not intended to be overly prescriptive and are instead intended to facilitate further conversation on what constitutes good corporate governance.

Highlights of the principles include the following:

  1. Earnings Guidance: Companies should not feel obligated to provide earnings guidance — and should do so only if they believe that providing such guidance is beneficial to shareholders.
  2. Non-GAAP Measures and Stock Compensation Expense: While companies may use non-GAAP measures to explain and clarify their results, they never should do so in such a way as to obscure GAAP-reported results.  In particular, since stock or options-based compensation is plainly a cost of doing business, it always should be reflected in non-GAAP measurements of earnings.
  3. Shareholder Engagement:  Effective governance requires constructive engagement between a company and its shareholders. The company’s institutional investors making decisions on proxy issues important to long-term value creation should have access to the company, its management and, in some circumstances, the board.  Similarly, a company, its management and board should have access to institutional investors’ ultimate decision makers on those issues.
  4. Board Diversity: Diverse boards make better decisions, so every board should have members with complementary and diverse skills, backgrounds and experiences. It is also important to balance wisdom and judgment that accompany experience and tenure with the need for fresh thinking and perspectives of new board members.
  5. Board Independence: Truly independent corporate boards are vital to effective governance, so no board should be beholden to the CEO or management. Every board should meet regularly without the CEO present, and every board should have active and direct engagement with executives below the CEO level.
  6. Chairman/CEO: Every board needs a strong leader who is independent of management. The board’s independent directors usually are in the best position to evaluate whether the roles of chairman and CEO should be separate or combined.  If the board decides on a combined role, it is essential that the board have a strong lead independent director with clearly defined authorities and responsibilities.
  7. Director Compensation: Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of director compensation in stock, performance stock units or similar equity-like instruments.
  8. Management Compensation: Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. The vesting or holding period for such equity compensation should be appropriate for the business to further senior management’s economic alignment with the long-term performance of the company. With properly designed performance hurdles, stock options may be one element of effective compensation plans, particularly for the CEO.
  9. Management Succession Planning:  Companies should inform shareholders of the process the board has for succession planning and also should have an appropriate plan if an unexpected, emergency succession is necessary.
  10. Oversight of Significant Risks:  Boards should focus on significant risks, including reputational risks. The board should not be reflexively risk averse; it should seek the proper calibration of risk and reward as it focuses on the long-term interests of the company’s shareholders.

 

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