By Kristin Bresnahan – Executive Director of the Ira M. Millstein Center for Global Markets and Corporate Ownership at Columbia Law School
For decades, the governance community has been working to build consensus around a set of best practices for US public companies and provide a framework for sound, long-term oriented governance. Now, that movement is gaining traction.
As shareholders have become more engaged and the general public has become more focussed on how corporations in the US and around the world run themselves, different groups have put forward their ideas on how to best advance the interests of sound corporate governance. The result has been a robust and healthy conversation that continues to evolve the thinking on what constitutes good governance for publicly owned companies.
Governance experts and the media took notice in 2016 when a group of about a dozen leading executives published the Commonsense Principles of Corporate Governance.[1] Their work represented an effort to reach common ground among representatives of some of America’s largest corporations and institutional investors. With the long-term prosperity of millions of American workers, retirees and investors depending on the effective governance of American public companies, they felt it was critical to foster a dialogue about the responsibilities and need for constructive engagement among those companies, their boards and their investors.
These original Commonsense Principles were not prescriptive, nor did they require a pledge to uphold a particular approach to an issue. Instead, they laid the baseline for what sound corporate governance, supported by a range of stakeholders, can look like in boardrooms of public companies. This group of leaders recognised that each stakeholder’s unique perspective may colour their thinking about a specific policy, but that it was possible and beneficial to develop a widely accepted framework to be used as a foundation for their decision-making. By putting these principles on paper, these leaders helped advance a national conversation that has only gained momentum since.
Other seminal works on the subject include an investor-led effort by the Investor Stewardship Group (ISG) called the Framework for US Stewardship and Governance,[2] a business-led effort by the Business Roundtable (BRT) called Principles of Corporate Governance[3] and a piece by Martin Lipton, a founding partner of the law firm of Wachtell, Lipton, Rosen & Katz, for the International Business Council of the World Economic Forum, called The New Paradigm.[4]
Each additional work added something to the broader discussion. The Stewardship Principles brought together 25 of the largest asset managers and asked them to pledge to use their influence with the companies in their investment portfolios to further the cause of good governance. The group encouraged other asset managers to sign on. The Business Roundtable’s Principles added important perspective from the business community at large and the Business Council of the World Economic Forum added an international perspective.
The authors of the Commonsense Principles endorsed these additions to the governance conversation and continued to keep up with the discourse. In 2018, they reconvened to update their principles to reflect the evolving conversation and developments across the field of corporate governance. The Commonsense Principles 2.0 were published in October 2018 and this time the signers were asked to make a pledge to uphold the principles at their own companies. The group expanded from the original signers and is now almost double the size.
At Columbia Law School’s Ira M. Millstein Center for Global Markets and Corporate Ownership, we have partnered with the leaders of the Commonsense Principles to foster this critical dialogue and advance the ball to benefit investors, public companies and the broader American public, all of whom are impacted by the decisions made in boardrooms in the US and around the world.[5] Through our engagement with business leaders on the toughest decisions they are facing in the boardroom and our academic research on these issues, we have learned how critical it is to have a baseline of core principles to guide the discussion. Identifying these best practices and bringing academic rigour to the process is core to our mission and we believe that the Commonsense Principles 2.0 make important progress to that end.
The original Commonsense Principles
When they were first issued in 2016, the Commonsense Principles of Corporate Governance contributed to the broader conversation on a number of topics.[6] The authors did not seek to opine on every issue of importance in the boardroom. Instead, they aimed to understand where there was broad consensus that could set the baseline for ongoing discussions among constituencies with different points of view. By putting their ideas in one place with such broad authorship, they reframed the conversation from advancing individual perspectives to collectively advancing the interests of all stakeholders over the long term.
“Through our engagement with business leaders on the toughest decisions they are facing in the boardroom and our academic research on these issues, we have learned how critical it is to have a baseline of core principles to guide the discussion”
The initial principles touched on topics ranging from board composition and independence to a board’s active engagement and access to leadership and information. Going beyond the boardroom, they noted the need for thoughtful practice around the frequency of earnings guidance and laid out best practices for investor engagement with corporate leaders, including both management and the board, to help inform sound decision-making.
With the caveat that the recommendations were not meant to be absolute, and a recognition that the significant variation among public companies would inevitably and appropriately be reflected in their approach to corporate governance, the Commonsense Principles included the following key points:
■ Truly independent corporate boards are vital to effective governance, so no board should be beholden to the CEO or management. Every board should meet regularly without the CEO present, and every board should have active and direct engagement with executives below the CEO level
■ Diverse boards make better decisions, so every board should have members with complementary and diverse skills, backgrounds and experiences. It’s also important to balance the wisdom and judgement that accompany experience and tenure with the need for fresh thinking and perspectives of new board members
■ Every board needs a strong leader who is independent of management. The board’s independent directors usually are in the best position to evaluate whether the roles of chairman and CEO should be separate or combined, and if the board decides on a combined role, it is essential that the board has a strong lead independent director with clearly defined authorities and responsibilities
■ Our financial markets have become too obsessed with quarterly earnings forecasts. Companies should not feel obligated to provide earnings guidance and should do so only if they believe that providing such guidance is beneficial to shareholders
■ A common accounting standard is critical for corporate transparency, so while companies may use non-Generally Accepted Accounting Principles (GAAP) to explain and clarify their results, they should never do so in a way that obscures GAAP-reported results. In particular, since stock- or options-based compensation is plainly a cost of doing business, equity compensation should always be reflected in non-GAAP measurements of earnings
■ Effective governance requires constructive engagement between a company and its shareholders. The company’s institutional investors making decisions on proxy issues important to long-term value creation should have access to the company, its management and, in some circumstances, the board; similarly, a company, its management and board should have access to institutional investors’ ultimate decision-makers on those issues
What’s changed?
The Commonsense Principles 2.0 built on the strong foundation of the 2016 Principles to reflect the evolving conversation and drive forward a more developed understanding of, and agreement on, the key tenants of corporate governance that support long-term value for all shareholders.[7]
Notably, 2.0 speaks to additional areas where boards and investors can be better positioned to drive long-term value creation. These updates and enhancements include recommendations regarding board tenure, transparency around staggered boards, proxy access, engagement on important proxy proposals and consideration of anti-takeover provisions. Finally, the updated principles call for enhanced transparency on the part of both companies and asset managers to ensure greater understanding between shareholders and the companies in which they invest.
Some noteworthy additions to the Commonsense Principles made in version 2.0 include:
- Board members should be prepared to serve for a minimum of three years
- If board elections are not annual, companies should explain why
- Companies and shareholders are encouraged to engage early on important proxy proposals
- Companies should allow some form of proxy access
- Poison pills and other anti-takeover defences should be put to a shareholder vote and re-evaluated by the board on a periodic basis
- Asset managers should disclose if they rely on proxy advisors to inform their decision-making
- Asset managers should disclose their conflict of interest policies in their proxy voting and shareholder engagement activities
- Portfolio managers should be compensated based on performance over an appropriate term, given the strategy and investment time horizon for the portfolio
- Asset owners should promote sound, long-term oriented governance in their direct interactions with both companies and asset managers
- Asset owners should use benchmarks and performance reports consistent with their investment time horizon to affect governance outcomes with asset managers and evaluate the asset managers’ performance on both investment returns and governance
Importantly, the developments enumerated in the Commonsense Principles 2.0 are not meant to be a final statement on these topics. Rather, they represent the growing consensus around key issues that will drive this conversation forward.
What’s next?
Like software, the Commonsense Principles will continue to be reviewed, considered and updated to best reflect the practices, policies and structures that emerge as the governance conversation progresses. While the Commonsense Principles 2.0 reflect the status quo of late 2018, we have no doubt that they will continue to serve as a touchpoint in the conversation about how to best serve the long-term interests of public companies, shareholders and other stakeholders.
As one of the world’s leading bodies studying corporate governance, the Millstein Center is eager to foster a robust, ongoing dialogue about these issues. We welcome any and all stakeholders to review the Commonsense Principles 2.0 and provide feedback about what can be done to enhance corporate governance to support the health of our economy.
Because of the complex global landscape of corporate governance, the Commonsense Principles 2.0 focusses on US companies. However, the spirit of the conversation and the ideas and policies it contains are applicable around the world. We look forward to broadening this conversation to understand how these principles might benefit from international learnings and how the international governance community can be supported by adopting parts – or all – of the Commonsense Principles 2.0.
Whether in the boardroom or around the kitchen table, these issues will become increasingly important in the years ahead. A sound governance framework that ensures transparency, shapes best practices and upholds the values that we as a society hold dear is indispensable to any stakeholder weighing investment decisions. The outcome impacts the health of the companies who adopt these governance standards and the millions of investors around the world who have staked their future on such investments.
As stewards of this important work, we will continue to welcome and consider any and all perspectives to ensure that this conversation continues to reflect the best practices of our times.
About the Author:
Kristin Bresnahan is the Executive Director of the Ira M. Millstein Center for Global Markets and Corporate Ownership at Columbia Law School. The mission of the Millstein Center is to positively shape and influence the future of the corporation. Through engagement with business leaders, corporate boards, investors, the legal community and academics, the Center creates meaningful dialogue, while balancing conflicting points of view, to strengthen corporate governance and performance. The Center also addresses critical research questions, bridging the gap between academics and practitioners and bringing academic rigor to the business and policy solutions required to tackle the challenges corporations face today.
Kristin joined the Millstein Center from Cleary Gottlieb Steen & Hamilton LLP, where she worked on a wide range of litigation and enforcement matters on behalf of corporate and sovereign clients. Kristin also clerked for the Honorable William H. Walls on the U.S. District Court for the District of New Jersey.
Footnotes:
1.http://www.governanceprinciples.org/
4.https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the-new-paradigm/
5.https://millstein.law.columbia.edu/
6.http://www.governanceprinciples.org/wp-content/uploads/2018/10/2016Open-Letter-Principles.pdf
7.https://millstein.law.columbia.edu/content/commonsense-principles-20
