Public company leaders need to carefully consider how to comply with recently expanded SEC disclosure rules concerning corporate governance. While meeting this year’s new requirements, directors and managers need to think broadly about how this publicly-available information will be received within and outside their organizations.
The new disclosure requirements cover director qualifications, board leadership structure, and compensation policies (executive and non-executive). In the next few years, these new rules may leave their mark on corporate governance in publicly traded companies and beyond.
As is often the case, the devil is in the details. Here is some food for thought:
Director Qualifications: The new rules require companies to disclose the “specific experience, qualifications, attributes or skills” for each director (or nominee for director) that justifies each member’s service, given the company’s “business and structure”. The requirement covers all board members (including members of management). If diversity (of any sort) is part of the selection criteria, its role should be explained.
Leaders and boards, however, need to be cognizant of the impact of the disclosures.
Employees may be distressed to see that a certain population segment or skill set is over, under or not represented on the board. Executives may tailor their board presentations to suit individual directors’ “hot buttons”.
Directors serving on multiple boards may find their biographical data and skill sets presented differently from company to company. How a director’s qualifications are presented may be compared and contrasted. The ability to attract prospective board candidates may be influenced by this presentation. Conversely, board searches may be influenced by how a candidate is, or was, presented in another company’s proxy statement.
A board member may not want to be singled out as representing a given ethnicity, gender, age grouping, etc. Would a hypothetical director want to be known as the baby boomer, Chinese-American, female, finance expert on the board? Does finance get lost in that list of qualifications? Is her ethnicity more important? Does that make our fictional board member less (or more) attractive to another organization?
Boards may lose sight of the fact that diversity is a quality of the board as a whole, and not the province of one or two “diverse” board members. Yet, that message may be difficult to communicate across the individual directors’ biographical data.
A weak presentation of director qualifications may cause the investment community to question the leadership and direction of the company and could set the stage for future contested elections. Shareholders may compare director qualifications across a particular industry and identify actual or apparent gaps and weaknesses at a given company. Too much focus on more specific skills and experience may also cause “soft” skills such as intelligence or communication to be obscured.
Board Leadership Structure: The rationale for a company’s board leadership structure, particularly whether the same person serves as principal executive officer and chairman of the board, must now be delineated. A discussion of the board’s role in the oversight of risk management must also be included.
Leaders will want to balance these new requirements with a need to maintain flexibility in how they choose to manage their organization. However, a poor presentation could draw criticism from the investment community.
Compensation and Risk: A company must disclose the relationship between its compensation policies and risk if the resulting risks are “reasonably likely to have a material adverse effect” on the company. Each organization must consider its own risk profile and compensation practices, at all levels, to determine whether disclosure is required.
However, given recent events, how do we know which events are producing “risk”? Three years ago, AAA-rated mortgage-backed securities were purchased as safe investments. Today, these securities have proven to be anything but virtually riskless.
The rule outlines a number of situations that could trigger disclosure, but judgment is necessary as not all of them may lead to risky behavior.
One such situation is where a business unit’s compensation system differs from that of other units within the same organization. The difference may be completely appropriate based on industry practice or other factors. Engineers and sales people, for example, have different business objectives. In a diversified organization, a one size fits all compensation plan may not be appropriate.
Another scenario is where a business unit carries a significant portion of the company’s risk profile. Yet, a unit’s impact on risk may only be known in retrospect. The group that outsourced Toyota parts clearly created risk for Toyota; yet, at the time, they were finding the low cost provider. Is it the financial incentives or the business objectives that caused the massive recall?
It is prudent of course, for a company to consider what behaviors its compensation arrangements incentivize. Company leaders and their boards need to ensure that these plans are aligned with the firm’s strategic goals.
Conclusion: It will be interesting to see how the new disclosures are received by the SEC and the investment community. Will SEC examiners challenge management about a board’s composition and its leadership structure? Will they ask for more information about how risk is measured?
Shareholders and the investment community will now have access to more data points, possibly providing more fodder for activist investors and potential investors. Leaders must be cognizant of this new reality.
Following the old football advice, the best defense is a good offense. Strategic leaders need to ensure that they have clearly defined board selection and compensation plans that can withstand scrutiny.
Charlotte Nad consults with leaders and senior managers on business and organizational effectiveness. Bonnie Roe is a securities partner in the New York office of Davies Ward Philips & Vineberg, LLP.
