Improving the Way Boards, CEOs, and Shareholders Interact
A group of prominent corporate leaders and institutional investors — including Warren Buffett, Jeffrey Immelt, and Larry Fink — recently unveiled the Commonsense Principles of Corporate Governance. Intended to strengthen corporate governance at U.S. companies, the guidelines contain helpful (although not entirely novel or innovative) recommendations such as compensating outside directors with stock, giving non-executive directors unfettered access to management, and discouraging the practice of earnings guidance.
However, I find it extremely troubling that these luminaries — particularly the participating institutional investors — see such a limited role for non-executive directors to engage directly with shareholders on “governance and key shareholder issues,” leaving the job largely to the CEO. What could be more sensible than to have outside board members — particularly a non-executive chairman and lead independent director — directly engage those who elected them to oversee governance and other matters of shareholder concern?
In the section on board responsibilities, the Commonsense Principles state that “companies may wish to designate certain directors — as and when appropriate and in coordination with management — to communicate directly with shareholders on governance and key shareholder issues, such as CEO compensation.” (Emphasis added.) However, the primary responsibility for such communications is given to the CEO, who is charged to “actively engage” on these matters, except his own compensation, when meeting shareholders.
As I have written previously, U.S. companies are unusually apprehensive about non-executive directors speaking with shareholders. Yet concern that outside directors may divulge material, non-public information can be minimized through a briefing with management beforehand or scheduling engagement meetings to follow earnings reports and other significant announcements. In addition, shareholders don’t necessarily want directors and management to speak “with one voice” (another commonly cited reason for assigning shareholder engagement to the CEO) and value diversity of views that may suggest a board is looking at important matters holistically and has not succumbed to groupthink.
Topics on which shareholders should hear directly from non-executive directors go way beyond the CEO’s compensation. They include the board’s assessment of the company’s strategic direction, performance, and culture. They should also encompass critical governance issues, such as board structure and leadership, particularly when the board has agreed to combine the chairman and CEO roles. Lastly, shareholders need to discuss directly with the board management succession, including the CEO’s.
Importantly, non-executive directors and management are likely to come at issues from different vantage points, and it is healthy for shareholders to hear from both.
On many company matters, management will be understandably less objective than the non-executives. For example, a CEO who breathes the company day in and day out may feel that all is fine with the corporate culture. By contrast, an outside director may notice that subordinates seem to “know their place” and become concerned that the company is too hierarchical, with implications for effective risk management.
In addition, when CEOs meet with shareholders, they are often in “sell” mode, seeking to reassure shareholders or encourage them to buy more shares. Thoughtful independent chairmen do not typically view shareholder interactions in this way and tend to speak about the company with greater detachment.
In sharp contrast to the Commonsense Principles, the U.K. corporate governance code states unequivocally that the chairman, who is non-executive at most British companies, “should discuss governance and strategy with major shareholders” and the senior independent director “should attend sufficient meetings with a range of major shareholders to listen to their views in order to help develop a balanced understanding of the issues and concerns of major shareholders.” (Emphasis added.)
Even in Japan, which has only recently begun embracing Western corporate-governance practices and where management historically dominated the boardroom, the corporate governance code provides that “companies should engage in constructive dialogue with shareholders” and “during such dialogue, senior management and directors, including outside directors, should listen to the views of shareholders and pay due attention to their interests and concerns.” (Emphasis added.)
Beyond benefiting shareholders, engaging with investors may strengthen outside directors’ determination — or backbone — to be vigilant on matters where the CEO is likely to be conflicted, including executive compensation and leadership succession. Indeed, the remuneration committee chair of a large U.K. company once told me that directly hearing from shareholders about their views on executive pay helped her hold the line against overly aggressive management demands.
In an era when shareholders are expecting more from boards, having outside directors engage them directly as a matter of routine is no more than common sense.