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Corporate Governance Resolutions For The New Year

Richard M. Steinberg | January 18, 2005

By the time this edition of Compliance Week hits the proverbial streets, the year 2004 will be long gone. And all the great battles of that year—stock option expensing, the election, Disney, etc.—will be fading from memory.

But at the time this column is being penned, the wounds of those battle are still fresh; in fact, the new year’s bells are still ringing in my ears.

But such are the vagaries of magazine publishing … today for me is yesterday for you

Actually, now that I think about it, the four-week limbo that exists between the creation and distribution of these words is pretty surreal. From my perspective, you’re actually in the future, reading words I’m yet to write, and I’m currently four weeks behind you, trying to catch up.

Which means you’re smarter than me by one month, minimum, and that assumes no postal backlog.

Anyway, the notion of “time” has me looking forward to 2005, and though you’ve already been there for a month, I want to share with you a list of “corporate governance resolutions” that I believe directors (together with their companies’ senior executives) would do well to consider.

The list deals specifically with the subject of information—what better information can be garnered at the board level, and how it can be used for enhanced corporate governance. Now, surely some boards already do many of these things, and do them well. But based on what I’ve personally witnessed at boards around the country, many do not. This column is directed at those who don’t, or who perhaps could do these things better.

  1. Use The Right Performance Metrics.

    We’ve heard a great deal from institutional investors and others about CEO “pay for performance.” Many boards of directors have already moved beyond using stock price as the only measure, but others are still trying to figure out what makes sense for their companies.

    Suggested resolution for 2005: Recognize the pitfalls in focusing solely on stock price movement, and with your senior management, identify the most appropriate performance goals for your company. That means you need to collectively identify the right balance of historical and forward-looking metrics, including relevant non-financial measures, to provide effective motivations and relevant rewards for long-term shareowner growth.

    Deciding for what executives should be rewarded is critical, and it differs by company. So be thoughtful and strategic, and seek input from experts.

  2. Know Your Company’s Risks.

    As you’ve likely noticed, there’s been a great deal of noise and activity around “risk,” “risk management” and “enterprise risk management.” While some companies have sophisticated ERM processes, the vast majority of companies look at risk in an ad hoc fashion. Unfortunately, directors in the latter group of companies cannot be sure that management is positioned to inform the board of the most significant risks.

    Suggested resolution for 2005: Ensure that management recognizes the critical importance of enterprise risk management, and takes responsibility for developing an effective ERM process. That means having the mechanisms and protocols to identify and manage a broad range of risks before problems materialize, and proactively discussing the most important risks with the board.

    As a director, you need to know the critical risks, and must not assume that you and your fellow directors—or even your company’s senior managers—do already.

  3. Let Financial Reporting Reflect Economic Reality.

    This, of course, is the goal of the Financial Accounting Standards Board in setting accounting and financial reporting standards, and is the aim of the many conscientious CFOs and others at the heart of the financial reporting process. We know all too well, however, that there are temptations to fight for that extra penny per share, especially where market expectations have been set.

    Suggested resolution for 2005: Quite simply, let the chips fall where they may. You might justifiably ask whether this is a realistic expectation. To give this resolution a chance of fulfillment across a wide range of companies, there must be a change in the mindset of financial analysts, and indeed investors in the capital markets. They must recognize the reality of earnings volatility, and reward not those companies that find the wherewithal to meet some predetermined EPS number, but those that have the courage and honesty to tell it like it is. And, they need to embrace a range of relevant information about a company’s potential future performance that extends well beyond share price.

    Some companies have already started down this path, and others hopefully will follow. And it’s not just about the earnings per share number, but fuller and clearer disclosure as well. With more companies following this lead, the aforementioned change in mind-set and marketplace rewards are more likely to occur—and enhanced trust and ultimately lower cost of capital should result.

  4. Recognize The Usefulness Of Information On Board Performance.

    Institutional shareholders, D&O insurance providers, and other market participants are increasingly looking for insight into the effectiveness of corporate boards. Governance rating services have proliferated, proxy voting firms are ranking board metrics, and new disclosure requirements are providing unprecedented data on board protocols.

    And, while—at least to my (now outdated) knowledge—no one has published a study proving a correlation between effective boards and stock price, there is little doubt that a cause-and-effect correlation does exist.

    But the relationship has less to do with many of the factors used by rating services, and more with the quality of the advice, counsel, monitoring and direction the board provides to management in the boardroom.

    So while certain data—such as wealth transfer from shareowners to management—can serve as a “window” into board performance, one must be inside the boardroom to know how effective a board truly is.

    So the suggested resolution for 2005: Keep your eyes on the ball, especially when it comes to the substance of your board’s core responsibilities. Don’t get hung up on ratings numbers, governance matrixes, or board indexes. In fact, all users of such data garnered solely from external sources should make their own resolutions: to recognize what that information can, and cannot, do.

  5. Make Sure You And Your Fellow Directors Receive The Right Information.

    Many boards are provided good information. But often the information is too much, too little, or in a form that is not conducive to directors’ unique needs.

    There is no one “right” form or type of data, as each company’s circumstances and each board’s needs are different. But each board should get the information it needs to do the job right.

    The suggested 2005 resolution here: Think hard about what you and your board colleagues need, not simply accept the data you’ve been receiving for years. Your board should get relevant information, and should get it on a timely basis. Just as importantly, the information should come with the proper depth, and in a readily digestible format. That means it must include appropriate analysis and insights—from sources both internal and external to the company—so that you are positioned to make informed judgments to provide the best input and direction to management.

  6. Create The Justification For Reducing The Regulatory Burden.

    We all know the tremendous burden that Sarbanes-Oxley and related promulgated rules have placed on corporate America. Coupled with an ever increasingly litigious environment—not to mention concerns over physical security, IT security and fraud—companies are spending extraordinary resources on priorities that have little to do with their core function; namely, designing and delivering better products and services that enhance growth and profitability so that shareowners and the economy truly benefit.

    So here is the most challenging of our resolutions for 2005: Help to create a good reason to reduce or eliminate these compliance burdens.

    Now, please note that my wish is not necessarily that the rules be reduced or eliminated, but rather that the underlying impetus for the more onerous rules evaporates. In other words, do everything you can to restore trust in your company and your industry. Instill a culture of ethics and integrity in your operation. Ensure your company’s people produce transparent and high-quality disclosures, set an appropriate tone at the top, and conduct your business affairs honestly.

    No one board or company can make this happen—it will take similar actions across the entire business community. But you can start, and at least your company can benefit on a micro level.

These suggested resolutions might be viewed as a wish list for 2005, and in that context, and perhaps most importantly, I wish you a successful and satisfying year, both personally and professionally.

Of course, that you’ve already started.

The column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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