Citing the importance of publicly owned companies to the U.S. economy, a group of thirteen leading executives issued a set of principles, on July 21, 2016, outlining their vision for the critical elements of good corporate governance. The report, entitled, Commonsense Principles of Corporate Governance, was signed by a diverse group of executives ranging from Jamie Dimon, JP Morgan Chase; Warren Buffett, Berkshire Hathaway, Inc.; and Mary Barra, General Motors Company to Bill McNabb, Vanguard and Larry Fink, Blackrock. According to the group’s press release, the “principles set forth a number of commonsense recommendations and guidelines about the roles and responsibilities of boards, companies and shareholders” that are “conducive to good corporate governance, healthy public companies and the continued strength of our public markets.”
Boards of Directors
The report generally endorsed principles of director loyalty to shareholders, independence, business competence and diversity. The specific recommendations of the report included, among others:
- Board Independence. A significant majority of the board should be independent directors, and all directors should be elected by a majority vote. Directors should have unfettered access to management, including those below the CEO’s direct reports. The board’s independent directors should decide whether it is appropriate to separate or combine the chair and CEO roles, with a strong designated lead independent director and governance structure in place if the roles are combined.
- Board Effectiveness. A subset of directors should have professional experiences directly related to the company’s business. Boards should be as small as practicable, so as to promote an open dialogue among directors. The full board should have input into agendas. Boards should consider periodic rotation of board leadership roles (i.e., committee chairs and the lead independent director).
- Board Self-Evaluation and Refreshment. Boards should have a robust process to evaluate themselves on a regular basis, including careful consideration of a director’s service on multiple boards and other commitments. Companies should clearly articulate their approach on director term limits and retirement age, balancing the need for new thinking through board refreshment with experience and judgment. Boards must be willing to replace ineffective directors.
- Director Compensation. Independent directors should receive a substantial portion of director compensation in stock, performance stock units or similar equity-like instruments and boards should consider requiring directors to retain a significant portion of their equity compensation for the duration of their tenure.
- Board Responsibilities. Only designated directors should communicate directly with shareholders on governance and key shareholder issues, such as CEO compensation. Directors should speak with the media about the company only if authorized by the board and in accordance with company policy. The report lists ten discrete topics for board deliberations during each year, including long-term strategy, major strategic issues, significant risks, key shareholder concerns, executive performance and compensation.
The report takes several shareholder-friendly positions, including:
- support for proxy access bylaws;
- strong disapproval of dual class voting as “not a best practice;” the report recommends that, if dual class voting is adopted, it should be subject to “sunset” or other termination provisions; and
- support for shareholder action by written action or special meeting, subject to reasonable minimum share ownership requirements in order to call a special meeting or a written action.
The report articulates several principles for public reporting, including that:
- disclosure should focus on transparency and long-term strategy and performance;
- companies should not feel obligated to provide earnings guidance; if guidance is provided, companies should avoid “inflated” guidance or a short-term management approach to meet guidance;
- use of non-GAAP measures should be sensible, should not be used to obscure GAAP results;
- all compensation, including equity compensation, is “plainly a cost of doing business” and should therefore be reflected in any non-GAAP measurement of earnings in precisely the same manner” as it is reflected in GAAP earnings; and
- audit committees should focus on whether the company’s financial statements would be presented in a materially different manner if the external auditor itself were solely responsible for the preparation of the financial statements.
Compensation of Management
The report articulated several principles for executive compensation. A company’s compensation plans should have continuity over multiple years and ensure alignment with long-term performance. Executive compensation should not be entirely formula-based, and companies should retain discretion (appropriately disclosed) to consider qualitative factors, such as integrity, work ethic, effectiveness and openness. Companies should consider paying a substantial portion of executive compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. Companies should maintain clawback policies for both cash and equity compensation.
Asset Managers’ Role in Corporate Governance
The report also sets out expectations for the role of asset managers in corporate governance, including:
- asset managers should devote sufficient time and resources to evaluate matters presented for shareholder vote and should actively engage with the management and/or board on corporate governance matters;
- asset managers should vote based on independent application of their own voting guidelines and policies, although they may rely on a variety of information sources to support their evaluation and decision-making processes, including recommendations from proxy advisors; and
- asset managers should make public their proxy voting process and voting guidelines and have clear engagement protocols and procedures.
Boards of publicly owned companies and their advisors will want to review the Commonsense Principles as a valuable new guidepost for how to organize and run an effective board. The Commonsense Principles also provide useful recommendations for boards on setting the proper tone for public disclosure, engaging shareholders and asset managers and prioritizing long-term goals over short-term market pressures. Governance committees may wish to consider how their companies’ policies and procedures match up with the Commonsense Principles. For that reason alone, the Commonsense Principles may prove to be a very useful addition to the corporate governance debate.