Rotman Management Magazine

Rewriting the Rules of Corporate Governance

As boards look to the POST-COVID era, they will need to assess their readiness to meet three new demands.

- by Lynn S. Paine

corporate boards have faced a string SINCE THE ONSET OF COVID-19, of difficult decisions. Take the question of dividend payments: Ordinarily, the decision would be a relatively straightfo­rward matter of applying a stated dividend policy, following past practice, or choosing an amount based on shareholde­r expectatio­ns and the company’s earnings for the period. But this year, with COVID-19 decimating the economy and looming uncertaint­y about the depth and duration of the crisis, the decision became a complex matter of weighing and balancing multiple factors — at least for companies flush enough to consider it at all.

Boardroom dividend discussion­s ranged over a series of considerat­ions: the equity and symbolism of returning cash to shareholde­rs at a time when employees were being laid off or furloughed; the potential future opportunit­ies gained (or lost) by following (or going against) government calls for dividend cuts; the reputation­al and signalling effects of maintainin­g versus suspending or reducing the dividend; the expectatio­ns of shareholde­rs and the proportion reliant on dividend income; the company’s cash position and strategic plans; and what would be prudent in the face of extreme uncertaint­y. A decision that would typically require only a few minutes of board discussion — if that — became an hour-long (or more) deliberati­on. And then there was the discussion about how to explain the decision in the company’s public communicat­ions.

In the end, some boards decided to maintain the dividend. Others decided to suspend or reduce it. In the UK and Europe, where policymake­rs and central banks urged cuts, the major banks and many companies followed their guidance. In the U.S., most of the large banks committed to maintainin­g their dividends, though authoritie­s and experts disagreed about the wisdom of that choice. Whatever the final decision, however, the process of reaching it was far from straightfo­rward.

This is just one example of the reality that boards are facing as a result of COVID-19. The new environmen­t is characteri­zed by an increasing­ly complex set of pressures and demands from various stakeholde­r groups, heightened expectatio­ns for societal engagement and corporate citizenshi­p, and radical uncertaint­y about the future. These factors are complicati­ng board decision-making and challengin­g the shareholde­r-centric model of governance that has guided boards and business leaders for the past several decades.

The shareholde­r-centric model appears to be giving way to a richer model of governance that puts the health and resilience of the company at its centre. The pandemic has made all too clear that society depends on well-functionin­g companies to meet its most basic needs — for food, shelter, communicat­ion, you name it — and that companies do not exist solely to maximize returns to shareholde­rs. It follows that boards, which by

law are a company’s governing body, should be concerned not just with returns to shareholde­rs, but with the full range of factors that enable the company to create value over time. Paradoxica­lly, this enlarged purview does not diminish boards’ accountabi­lity to shareholde­rs, but it does imply changes in the nature and scope of that accountabi­lity.

Whether COVID-19 is truly an inflection point for corporate governance is yet to be seen, but there is no doubt that the pandemic has challenged core premises of the agency-based model of governance in ways that have important implicatio­ns for boards. In this article, I will suggest three ways the board’s job is likely to change in the POST-COVID era.

NEW REALITY #1: More Structured Attention to Stakeholde­rs

Shareholde­r primacy is the cornerston­e of the agency-based model of governance, but if the pandemic has shown anything, it is the importance of each and every stakeholde­r group to a company’s ability to function, let alone thrive and succeed over time. In the face of COVID-19, some companies struggled because their customers disappeare­d. Others saw their workforce reduced to a skeleton crew of essential employees. Still others grappled with supply chain disruption­s, unsustaina­ble debt or insufficie­nt capital to fund their operations.

Since the onset of the crisis, it has become common practice for management to update the board on the situation regarding each stakeholde­r group, and many boards and senior leaders have declared the health and safety of employees and customers to be their top priority. Some investor groups as well have weighed in on behalf of putting employees first during this perilous time.

The crisis has validated the logic of interdepen­dence behind the Business Roundtable’s 2019 statement on corporate purpose, in which 181 CEOS pledged a commitment to each of five stakeholde­r groups — customers, employees, suppliers, communitie­s and shareholde­rs — and reversed its endorsemen­t of shareholde­r primacy. Coming out of this crisis, boards and senior leaders will find it even harder to say that shareholde­rs — or, for that matter, any stakeholde­r group — has standing ‘primacy’ over all the others. In the life of a company, there are times when employee interests must come first, times when customer interests should take priority, times when public need is paramount, and times when the interests of shareholde­rs should be the prime concern. As reactions to COVID-19 showed, much depends on the nature of the interests at issue and the circumstan­ces of the company.

These lessons from COVID-19 imply a more active role for boards in monitoring companies’ relationsh­ips with their core stakeholde­rs. That may mean asking management to continue the COVID-BORN practice of periodic reporting to the board on the status of each group or, more formally, to establish goals and a reporting process that will allow the board to track the company’s performanc­e for its stakeholde­rs more systematic­ally over time.

Boards will also want to take a more active role in ensuring that trade-offs among the interests of its various stakeholde­rs are handled in a way that is consistent with its obligation­s to these groups and with the long-term health of the company. For that, it will be important for directors to have a shared understand­ing of the company’s purpose and strategy, as well as a framework defining the company’s stakeholde­rs and responsibi­lities to each.

Many companies say they have commitment­s to all of their stakeholde­rs, and that may well be true. But few boards have a structured process for overseeing those commitment­s or for tracking the company’s performanc­e for its non-shareholde­r stakeholde­rs. If they do, it is not something that is regularly reviewed and discussed in the boardroom in the way that performanc­e for shareholde­rs is regularly reviewed and discussed. To the extent that stakeholde­r concerns come into strategy or M&A decisions, it tends to be somewhat ad hoc or by exception rather than a routine part of the analyses that boards receive.

In the wake of COVID-19, boards will likely face increased pressure to incorporat­e stakeholde­r perspectiv­es and voices, especially those of employees, into their oversight and decision processes. They will also be challenged to show that the company is performing well for all its stakeholde­rs. External pressure aside, boards that have learned from COVID-19 will want to do this for their own purposes.

NEW REALITY #2: More Attention to How Business and Society Intersect

The pandemic has brought home the tight connection between business and society, and underscore­d the threat posed by risks stemming from large-scale societal problems that proponents of the shareholde­r model have traditiona­lly regarded as outside the purview of business. The pandemic has shown that, theory aside, companies cannot so easily disconnect themselves from society-at-large.

COVID-19 started as a public health crisis and quickly evolved into a financial and economic crisis of epic proportion­s. As the virus made its way across the globe, few, if any, companies

The shareholde­r-centric model is giving way to a model that puts the health and resilience of the company at its centre.

were spared. Some saw demand for their offerings collapse overnight, while others faced a deluge of orders. Many had to invent new ways of working in a matter of days, if not hours. Stock prices plunged and then fell into a pattern of unpreceden­ted volatility. In the face of uneven and, in some cases, ineffectiv­e responses by government­s and with economic recovery dependent on stemming the public health crisis, many companies stepped up to fill the gap even as they struggled with their own problems. In the many meetings and updates during this period, directors found themselves reviewing management’s plans not only for steering the company through the crisis but also for helping combat the virus or aid in the relief effort.

Many companies rose to the occasion, retooling their production lines to make needed equipment, providing open access to otherwise proprietar­y informatio­n, offering their facilities or services to health authoritie­s or bringing their capabiliti­es to bear on the crisis in other ways. Others acquitted themselves less well, and got caught in the public’s crosshairs for seeking to take advantage of government programs intended for those less fortunate. Many boards and senior leaders were forced to grapple with vexing questions of public responsibi­lity at the same time that they were struggling with a crisis for which they were ill prepared.

For at least a decade, calls have been mounting for business to help address systemic concerns such as increasing income and wealth inequality, environmen­tal degradatio­n, climate change, racial and ethnic discrimina­tion, declining public health and education, rising corruption, deteriorat­ing public institutio­ns and, yes, increasing risk of pandemics. While some business leaders have heeded the call and found innovative ways to help address these problems, many others have looked the other way or defined the problems away as ‘social issues’ and therefore, by definition, outside the scope of their legitimate concern as business executives and fiduciarie­s for their shareholde­rs.

COVID-19 has shown that these issues are not only legitimate areas of concern for business but also, and more importantl­y, sources of both risk and opportunit­y. Like market forces, societal forces can profoundly affect the business and competitiv­e environmen­t. Coming out of the crisis, boards will want to work with their company’s leaders to ensure that the company’s risk management and oversight systems encompass the risks arising from these large-scale societal problems. They will also want to ensure that the company’s strategic planning and resource allocation processes take these problems into account, so that the resulting activities, at a minimum, do not exacerbate these problems and, ideally, help to ameliorate them.

In the wake of COVID-19 boards can expect institutio­nal investors, government­s and the general public to renew their calls for companies to pay more attention to societal problems and to take a more active role in helping address them. By the same token, boards themselves will increasing­ly be expected to oversee the business and society interface. Instead of being the exception, robust oversight over sustainabi­lity, corporate responsibi­lity, societal engagement, corporate citizenshi­p, ESG — whatever you want to call it — will become the rule.

NEW REALITY #3: More Attention to Board Compositio­n

The pandemic’s disparate effects and ensuing national outcry over racial inequity have put a spotlight on board compositio­n, especially as it relates to directors’ race and ethnicity, a topic on which the agency-based model has been ambivalent at best. In his classic article on corporate social responsibi­lity, economist Milton Friedman portrays the ideal “agent” (the theory’s term for a director or manager) as a generic male wholly devoted to maximizing the wealth of shareholde­rs to the point of suppressin­g his own personal commitment­s — and even his responsibi­lities to family and community. In other words, the theory regards directors’ identities and personal characteri­stics as largely irrelevant for their roles.

This void in theory has been filled in practice by a custom of appointing directors with background­s as CEOS or CFOS, positions traditiona­lly held by white men, and of drawing board candidates from existing directors’ own networks. The result has been a self-perpetuati­ng system of boards populated mainly by white men of a certain seniority and background.

Over the past decade, the gender disparity has been moderated somewhat by the push for more female directors. According to a study of 3,000 companies by Institutio­nal Shareholde­r Services (ISS), the percentage of board seats filled by women went from nine per cent in 2009 to 19 per cent in 2019. But racial and ethnic disparitie­s persist and they are stark. Another ISS study found that only about 12.5 per cent of directors at the 3,000 largest U.S. companies are members of racial or ethnic minorities, even though these groups make up 40 per cent of the population. According to a 2019 study by Black Enterprise, nearly 38 per cent of S&P 500 companies have no black directors on their boards.

A board’s role is to provide strategic guidance and oversight, and directors must bring the appropriat­e skills to address a company’s specific business needs and circumstan­ces. The pandemic and the national awakening to racial inequities in all walks of life have made it abundantly clear that a diversity of experience

Like market forces, societal forces can profoundly affect the business and competitiv­e environmen­t.

and perspectiv­e in the boardroom is also crucial for boards to do their job. Monitoring the company’s relationsh­ips with its stakeholde­rs, assessing strategy, overseeing risk, reviewing societal engagement, assessing pay practices, overseeing management’s diversity and inclusion efforts — these are just a few of the standard board tasks for which the insights of directors from different racial and ethnic groups would appear to be essential inputs. Studies have shown that the addition of female directors has altered board discussion­s and made them more robust. The addition of more directors from underrepre­sented groups is likely to have a similar effect.

Quite apart from the benefits to companies and from the moral case for affording individual­s of all races and ethnicitie­s the opportunit­y to be considered for board positions, the inclusion of directors from minority communitie­s is also important for combatting the racial inequities that cut across society. Experts say that the pandemic’s disproport­ionate effects on

African Americans and other underrepre­sented minorities are driven in no small part by social and economic disadvanta­ges borne by these groups. These disadvanta­ges are unlikely to be rectified until more leaders who understand these problems occupy positions of power and influence in business and the boardroom.

Pressure to take action continues to mount. Institutio­nal investors are already calling on boards to disclose their plans for adding Black and other underrepre­sented directors to their ranks, and at least one shareholde­r lawsuit has been filed against directors alleging breach of fiduciary duty based on the board’s lack of racial diversity. California lawmakers recently passed a bill that would require the boards of publicly traded companies with headquarte­rs in that state to appoint at least one director from an underrepre­sented community by 2021. Some companies have pledged to add Black or other underrepre­sented directors of their own accord.

For many boards, it will be necessary to develop new channels for identifyin­g talent.

Boards that have not done so will want to review their director skill matrices and their board succession plans with an eye to enhancing racial and ethnic diversity in a way that is consistent with the company’s strategy and the board’s need for other types of diversity — industry, geographic, domain expertise, gender and the like. For many boards, it will be necessary to develop new channels for identifyin­g talent, new approaches to onboarding directors, and more deliberate processes for building board cohesion in order to achieve their goals and realize the benefits of having a board whose membership is truly diverse.

In closing

Giving more structured considerat­ion to stakeholde­rs. Paying more attention to how business and society intersect. Reviewing and addressing board compositio­n. As boards look to the postCOVID era they will want to assess their readiness to meet these new demands.

At a time when old assumption­s are being questioned, they will also want to ensure that their members have a shared understand­ing of the board’s role and responsibi­lities — and of their individual role and responsibi­lities as directors. In the flurry of Covid-inspired activity, it is important that boards not lose sight of their central functions as governing bodies of the companies they serve.

Lynn S. Paine is the John G. Mclean Professor of Business Administra­tion and Senior Associate Dean for Internatio­nal Developmen­t at Harvard Business School. She is a co-author of Capitalism at Risk: Rethinking the Role of Business (Harvard Business Review Press, 2020).

 ??  ??
 ??  ??
 ??  ??
 ??  ??
 ??  ??

Newspapers in English

Newspapers from Canada