What Directors Think: Part 4

Another tough leadership decision boards have to face is whether to split the chairman/CEO role, an issue that was elevated following the financial crisis of 2008. In light of increasing investor pressure, it’s not surprising that 69% agree or strongly agree that splitting these roles results in more favorable proxy advisory recommendations; likewise, 64% agree or strongly agree that doing so offers more independence of thought within board discussions, and 60% affirm that it establishes more effective CEO evaluations.

However, external forces to persuade boards to split the roles are often met with just as many compelling internal reasons to combine them. In the end, boards need to feel comfortable they are doing the right thing for the company—and for the right reasons. Director John Bagalay, the EuroUS Ventures executive, says that in past CEO searches in which he has been engaged, many CEO candidates have told him they would not take the job unless they were also made chairman. “I have never acceded to that request. The insistence on having both positions is a clear indication that the candidate doesn’t want an ‘intrusive’ board. The separation of the two positions is unwise only if it leads to board micromanagement.” Bagalay believes that separation is essential in order to establish that the board has the right and responsibility to be certain that the company’s business strategy is given a tough and challenging review.

Yet another thorny issue related to board leadership emerges when a CEO steps down and is subsequently offered the chairman’s seat. Whether such appointments stem from personal board loyalty or a desire for continuity, the situation is far from ideal, governance experts say, because the perception of influence from a past CEO is usually too much to overcome. When we asked respondents if, as a hypothetical incoming CEO they would want the past CEO serving as chairman of the board, 82% resoundingly said no (Figure 3).

The common thread running through these issues involves board independence and effectiveness. While a good relationship must exist between the board and senior management to run a successful company, there must also exist a healthy separation for good decisionmaking at the board level. Kasnet’s company has a separate board chair and CEO, along with a lead director who has fairly broad powers, and he says the system works, but he also says he would be against keeping a past CEO on the board if it became a disincentive for an incoming CEO. Hunt adds that while he has observed situations where a new CEO could and would benefit from the departing CEO either remaining in or stepping into the chairman role, he believes such matters are situational and require each board to undergo a considered review to deliver the best outcome for shareholders.

SETTING EXECUTIVE COMPENSATION

Since 2010, every public company has been through some level of angst related to Dodd-Frank–imposed legislation requiring a shareholder advisory vote on executive pay. In year one, the fear of the unknown created the lion’s share of work and worry, but most companies saw smoother roads in subsequent years. In this year’s survey, we wanted to see how companies fared after the 2013 proxy season, especially in comparison to prior years. Forty-five percent (45%) of directors surveyed said their board spent more time on say on pay in 2013 than the previous year, and 24% acknowledged receiving tougher scrutiny from shareholders. On a positive note, fully 70% said their efforts to improve shareholder communications paid off and termed 2013’s proxy season a smoother experience.

Interestingly, when we asked if three years of say on pay had resulted in making executive pay more aligned with shareholders’ interests, only 21% of those surveyed agreed. Nearly two-thirds (62%) said no, because, in their opinion, executive pay was not out of alignment in the first place (Figure 4).

As a follow-up, we offered several scenarios and asked which situation would warrant a board making changes to its executive compensation plan prior to the company’s next say-on-pay vote. Not surprisingly, we found that relative company performance is the key.

Fully 80% of those surveyed said if executive compensation were higher than peer level and the company was underperforming, that would be reason to make changes; 52% agreed even if compensation were in line with peers. A much smaller group (15%) said changes would be in order if compensation levels were higher than those of peers even if the company was hitting performance targets.

Wrapping up the compensation arena, we asked for opinions about the new SEC disclosure of CEO/median employee pay ratios: 70% worry that such disclosure will result in a misleading indicator, while nearly half believe it will be costly and difficult to accurately compile and report. Only 17% of those surveyed believe it will provide meaningful information to investors. One director echoed the comments of several others, saying, “Regulators (SEC, PCAOB, Dodd-Frank, etc.) are out of control with new policies that are very costly and often do not improve governance.” Another added, “Governance changes have become more publicized, but the end results have not dramatically changed overall operating results [which are] a function of operating efficiencies as well as good governance.”

MANAGING RISK

Of paramount importance year after year is the board’s responsibility to oversee risk across the enterprise. As a demonstration that boards are fulfilling this role appropriately, 87% of those surveyed affirmed that new strategic objectives are reviewed by the full board to ensure they align with the company’s risk appetite. But there is no denying the job is an overwhelming one. In terms of what would improve the board’s ability to oversee risk, 44% of directors said getting management reports with more key highlights but fewer details would be helpful, while 29% said more lead time to digest those reports would be appreciated. However, some directors obviously feel overwhelmed and find the process burdensome and a distraction. As one director put it, there is “too much ritual risk management and too little emphasis on generating shareholder value.”

Meanwhile, 33% said the ability to delegate risk to a separate committee that could keep closer tabs would be advantageous. Others, however, don’t agree with this approach. “Risk oversight should rest with the full board,” says Bagalay. “Every board member should understand and accept that corporate risk oversight is his or her special responsibility—that requires every board member to know and understand company strategy and the risks that go with it.” Kasnet says that while his company established a risk management committee early on and its function has grown substantially, still “the subject is discussed in great detail regularly in board meetings.”

Interestingly, nearly 40% of those surveyed agreed they could do a better job at risk oversight if they had a better understanding of how to do so (Figure 5). Hot spots crop up all the time, and even traditional risk areas are often murky.

For example, 20% of respondents said they are not confident in directors’ understanding of the many facets of IT risk, one of the most elusive new risk areas for companies today.

THINKING STRATEGICALLY

In addition to overseeing compensation and risk and finding the right company leaders, board members must keep profitability and increasing shareholder value in their cross-hairs. Without meeting these goals, all the others hold little value. Therefore the board’s role in shepherding strategic planning for future growth is imperative, particularly in an environment where competitive change happens quickly. Bagalay noted that this is another good reason for refreshing the board: “The danger of strategic direction stagnation dictates the need for orderly and predictable change in board composition.” Another survey respondent agreed, saying, “Our board has put a strong focus on discussing our strategic plan with more regularity. We have a number of board members aging out over the next five years, which will create a nice opportunity to bring in fresh blood and some different skill sets.”

Accordingly, 81% of directors we surveyed chose strategic planning as a top agenda item—the most popular response, followed by M&A opportunities (61%), succession (47%), global business strategy (42%), and IT strategy (38%), (Figure 6). One director who commented on the survey noted, “Boards need more experience from members who have private equity or other similar experience to assist the board in matters of M&A and activism. I believe this is a missing component of board composition.”

“There is no question in my mind that boards have gotten significantly more effective at performing their duties over the last 10 years, even though we still see some repetitive negative trends associated with risk and CEO succession duties,” Kerstetter of Corporate Board Member notes. “More and more, boards are understanding and embracing the need for effective board leadership, which should result in more confidence in boards’ abilities to perform effectively in all areas of governance.” In the end, he continues, overseeing risk and selecting/retaining the right CEO are two of the most fundamental duties a board of directors must administer. “My hope is that we will see that confidence reflected in future director opinion surveys.”

 

LOOKING AHEAD

In all, directors this year appear to be laser focused on ways they can help their companies grow and prosper in the year ahead and are working to better understand and come to grips with the battery of risk elements that continue to make the job more challenging. In doing so, they are on track to ensure that their boards are operating as effectively as possible and have the requisite skill sets to ask the right questions and stay ahead of the risk curve.

Corporate Board Member would like to thank Spencer Stuart for supporting and sponsoring this important annual research as well as to thank the nearly 600 directors who took the time to respond to our survey and to those who offered additional comments and perspectives to this year’s findings. For a full copy of the results, visit www.boardmember.com/WDT2014.

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