Why Your Board Needs to Prioritize Its Discussion of Technology Disruption

Erin Essenmacher

Our mission at the National Association of Corporate Directors (NACD) includes continuous learning for directors. In pursuit of that mission our staff also seek out the most exciting events across the country to learn more about the disruptions that will impact members’ boards. I caught up with Erin Essenmacher, NACD’s chief programming officer, after her appearance at SXSW to discuss takeaways from the conference and how corporate directors can continue the conversation on technology disruption.

Erin moderated a panel, in partnership with KITE, entitled “Innovation: the Board Director’s Cut,” featuring leadership representatives from Spredfast, OurOffice, and Capital Expert Services. The panel discussed the strategies directors should take in order to best manage technology disruptions at their companies. Highlights from our conversation follow.

Katie Swafford: What led your panel to discuss technology disruption? What do you see at NACD—or among NACD’s members—that surfaced this particular topic for the panel?

Erin Essenmacher: Across the spectrum of industries, companies are being disrupted because they are not focused on how new technologies, paired with shifting trends, are completely changing business models. My first major takeaway from the panel was the need to focus on disruption. I don’t even like to say technology disruption, because I think that makes the issue sound too small and prescribed, which it is not. While technology is a big driver of disruption, so are issues like social and demographic shifts and other market-shaping forces as they intersect with technology. Disruption is a huge challenge to navigate for boards at companies of all sizes. We are reaching the point where the swift changes are blurring the lines between industries, and directors should be raising questions with managers about what is on the horizon for their companies, and if their companies are thinking sufficiently about the big picture and the nature and impact of those changes.

In terms of the discussion here at SXSW, the panel was really focused a lot more on flipping the script. A lot of the folks in the audience were on the boards of early-stage companies, and the panel really looked at how boards can add value to companies of all sizes. The panelists brought many perspectives—some are involved on the inside of early-stage companies, some are making investments in start-ups, and they all serve as directors at companies of various sizes, so it was a really interesting discussion.

Swafford: Are there specific skills gaps that NACD has seen when it comes to handling technology disruption or innovation?

Essenmacher: I would say the biggest skill gap is very low tech, but critically important: a sense of curiosity and a willingness to be a continuous learner. When you get to the top of your career and you’re on a board, you’re extremely seasoned and experienced. You’re an expert in many things that relate to the company business model or to the industry you serve, and it’s easy for that expertise to make you complacent. When you have a business environment like ours where things are changing so quickly, I think the most successful boards are the ones that acknowledge that disruption is happening. Most importantly, they acknowledge that because the environment is new, they will not have all of the answers. They are willing to get serious about what’s happening, they are willing to get curious about the gaps in their own knowledge, and they are willing to challenge the management team to evaluate the existing assumptions and expectations of the company culture and business model.

Swafford: Is there an ideal board composition that’s best able to navigate disruption? Is there a leading practice when it comes to board composition?

Essenmacher: I wouldn’t say that there’s an ideal board composition, because every company is different. Composition is going to vary widely depending on industry, company size, and many other factors. An overarching leading practice is to continually consider the board’s composition compared to your long-term strategy as a company. It’s not just about bringing in people that have the latest and greatest technology expertise. There is a critical role on any board for business judgment and experience. We need all of that in our boards. Once you start to dig into how you can think differently about your business model in the face of disruption, you can start to think differently about your board composition. It’s also not just about defaulting to a former CEO or CFO. Boards need to think critically about how diversity of experience, perspective, and expertise can help elevate their strategic discussions to map to where consumers and the market are headed.

Swafford: Where do you foresee some of the topics that came up in the panel flowing over into the Global Board Leaders’ Summit? I would think diversity, board composition, and growth, among other topics, will really flow into the conversations you will be having at Summit.

Essenmacher: We need to challenge ourselves to learn about new trends from the ground-level up. Our panel here at SXSW discussed topics that are important for board members to engage in, so how can we extend this conversation? At the NACD 2018 Global Board Leaders’ Summit we will be hosting the third annual “Dancing with the Start-ups” pitch competition. This event allows us, as board members, to hear what the leaders of start-ups are creating from the ground level—how they are using technology, how they are leveraging or setting trends, and how their ingenuity is disrupting the industry of the company on whose board you might serve. Yes, it’s a fun format and very exciting, but there is also a lot of great content. I think of it as a “meet the disruptors” session. It’s really an opportunity for directors to see the earliest stages of the next iteration of products, services, and trends that are disrupting their industry.

Our Summit theme this year is transformation. The theme provides a wonderful opportunity to keep engaging in this conversation on disruption, but to also look at disruption through a proactive lens. How can we take what we know about the shifting business landscape and leverage it for strategic advantage? On the risk side, we will learn from people who are experts on the important issues of technology and privacy, enabling us to delve into what those issues mean for public trust. We will discuss how new regulations are shifting what disruption means, including the European Union’s General Data Protection Regulation (GDPR). I believe this shift in how companies market their products and how business models are changing is creating an opportunity for large and small companies to learn from each other.

There will be a lot of opportunity to discuss disruption at the 2018 Global Board Leaders’ Summit happening September 29 through October 2 in Washington, DC. Don’t miss out on our early bird pricing through March 31 to save on registration.

What Every Corporate Director Should Know About the New Tax Law-Part 2

George M. Gerachis

This article is the second half of the discussion of the sweeping ramifications of The Tax Cuts and Jobs Act of 2017 (“Tax Act”). Part one discussed the transition tax on deemed repatriation of foreign earnings, the reduction in the corporate tax rate from 35 percent to 21 percent, the changes in the taxation of the international operations of U.S. companies, and changes to interest and depreciation deductions.

In this article, we address provisions of the Tax Act that potentially accelerate tax liabilities, repeal the performance-based exception to the limits on compensation deductions for certain corporations, change the treatment of net operating losses, and cut back the favorable tax treatment of research and development expenses.

David C. Cole

1. Potential Acceleration of Tax Liabilities. Before the Tax Act became law, the requirements for the recognition of taxable income were independent from those for financial reporting—or so-called “book” purposes. In fact, certain types of income could be recognized for tax purposes later than the period in which they were recognized as revenue for book purposes.  The Tax Act narrows these taxable income deferral opportunities by accelerating the recognition of certain taxable income to more closely match financial reporting.

This new rule is of particular concern in light of the new accounting rules under the Financial Accounting Standards Board’s  Accounting Standards Codification (ASC) Topic 606.  Under those accounting rules, expected revenue must generally be recognized as goods or services are provided to customers. Thus, unbilled receivables for partially performed services might be recognized for book purposes—and now for tax purposes, too—ratably as the services are performed, rather than when the services are complete or when the taxpayer has the right to demand payment from the customer.  Similarly, items such as performance bonuses might be recognized for book purposes—and  now for tax purposes—over the life of the contract, rather than when the standards for receiving the bonus have actually been met.

David C. D’Alessandro

The new tax rules may also affect taxpayers whose contracts with customers contain multiple-element deliverables (e.g., software sales agreements that include a license, updates, and support services, or sales of goods that include a warranty), because the rules now require that the allocation of payments among these deliverables be the same for tax and financial reporting purposes.

What Directors Should Do.  This potential acceleration of the recognition of taxable income could have significant cash flow consequences for certain businesses. Directors, and in particular audit committee members, should ensure that the company’s treasury and tax departments have coordinated and evaluated the potential acceleration of tax liabilities as a result of the combined effect of the Tax Act changes and ASC 606.  Depending on the extent of any accelerated tax liabilities, it may be necessary for a company to consider potential liquidity sources to meet its 2018 tax obligations.

2. Repeal of Performance-Based Exception to Limits on Compensation Deductions. Public companies may not deduct compensation paid to certain executives in excess of $1 million.   Previously, there was an exception to this rule for performance-based compensation that met certain requirements. However, the Tax Act removed the performance-based exception effective for tax years beginning after December 31, 2017. As a result, a public company will generally not be able to deduct compensation in excess of $1 million paid to its chief executive officer, chief financial officer, or its three other most highly-compensated officers. The Tax Act provides some relief through a transition rule, which preserves the deduction for performance-based compensation that is paid pursuant to a written binding contract that was in effect on and not materially modified after November 2, 2017 (the “Transition Rule”).

What Directors Should Do. In light of the removal of the tax incentives for granting performance-based compensation to certain executives, companies may be interested in revising their performance-based compensation programs by, for example, shifting a greater percentage of a covered executive’s compensation to guaranteed salary. However, the terms of some equity and cash incentive plans nevertheless require performance-based compensation to comply with the now-repealed requirements for deductibility, which would limit the changes that could be made to programs without amending the plans. As such, before changes are made to a company’s compensation programs, directors should ensure that the terms of the applicable plans are reviewed to determine if amendments to the plans are necessary to accommodate such changes to the compensation programs.

Additionally, some large institutional investors and proxy solicitation firms have indicated that they expect companies to continue with their existing compensation programs that condition awards on the achievement of rigorous, transparent, pre-established performance goals. Directors should also consider how changes to a company’s performance-based compensation programs will be viewed by the company’s shareholders.

Finally, it will be important for companies with outstanding long-term, performance-based awards to preserve the deductibility of those awards pursuant to the Transition Rule. As such, companies should determine whether performance-based compensation arrangements that were in effect on November 2, 2017 qualify as grandfathered under the Transition Rule and, if so, consider the implications of any potential modifications to such plans.

3. Changes to the Treatment of Net Operating Losses. The Tax Act makes significant changes to the utilization of net operating losses (“NOLs”). Previously, NOLs could generally be carried back to a taxpayer’s prior two tax years and carried forward for 20 years. Extended carryback periods applied to certain product liability-type losses and casualty and disaster losses. Also, under prior law, the corporate alternate minimum tax precluded corporations from completely eliminating their tax liability through NOL deductions. Instead, the alternative minimum tax (AMT) imposed an effective 2 percent tax rate on a corporation that otherwise would owe no tax because of NOLs.

Under the Tax Act, corporations (other than certain farmers and property and casualty insurers) cannot carry back NOLs arising in tax years beginning on or after January 1, 2018.  Those losses are no longer a means to generate cash refunds of previously paid taxes.  Also, a corporation may not eliminate more than 80 percent of its taxable income (determined without regard to the NOL deduction) for a given year. Thus, although the corporate AMT was repealed under the Tax Act, this limitation effectively results in a minimum tax of 4.2 percent on a corporation suffering losses (more than doubling the previous effective rate). On the positive side, NOLs now can be carried forward indefinitely instead of only 20 years.

What Directors Should Do. The changes to NOLs are particularly troublesome for early stage companies, corporations in cyclical businesses, and companies that suffer product liability-type and substantial casualty or disaster losses.  Losing the ability to carry back NOLs to generate tax refunds and the ability eliminate all taxable income with NOL deductions will negatively affect cash flow. Because of these changes, corporations should attempt to better match their income and deductions annually to reduce the extent of the NOLs they generate.

Directors of companies that incur NOLs should ensure that their tax departments are sensitive to this issue and are considering ways to better match income and deductions. For example, in years that appear likely to generate a net operating loss, opportunities to trigger or accelerate taxable income should be considered.  Also, the new 100 percent deduction for the acquisition of tangible assets (discussed in Part I of this article) is not mandatory. Accordingly, consideration should be given to electing out of that “immediate expensing” if doing so avoids creating NOLs.

4. Cutbacks to the Favorable Treatment of Research and Development (R&D) Expenses. The tax laws have long provided favorable treatment for certain R&D expenses in order to encourage U.S. companies to invest in research. These include a current deduction for such expenses and a tax credit based on specified increases in the level of certain R&D spending. Under the Tax Act, however, the favorable treatment of R&D expenses is scheduled to be reduced in future years.

First, beginning in 2022, corporations may no longer currently deduct R&D expenses. Instead, those expenses must be capitalized and amortized over 5 years (in the case of U.S. research) and 15 years (in the case of non-U.S. research). Also, the Tax Act created a new Base Erosion and Anti-Abuse Tax (BEAT) that applies to larger U.S. corporations that make certain payments to non-U.S. affiliates. Beginning in 2026, the amount of tax a U.S. corporation would owe under the BEAT will no longer reduced by its R&D credit—potentially resulting in a significant decrease in the value of such credit.

What Directors Should Do. Given the future effective date of the R&D changes, companies may wish to consider lobbying Congress to repeal the Tax Act changes before they become effective. In addition, the numerous changes to the taxation of international operations discussed in Part I of this article should be considered as part of any restructuring or expansion decisions. In the case of locating or expanding R&D centers, the pending changes reducing the tax benefits of U.S. R&D expenses should be included in that analysis.

George M. Gerachis serves as head of Vinson & Elkins’ Tax and Executive Compensation and Benefits (ECB) department. He represents corporate and individual clients in a wide range of tax planning and tax controversy matters. David C. Cole is a tax partner at Vinson & Elkins and represents corporations, partnerships, and high net worth individuals in a wide range of domestic and international tax matters. David C. D’Alessandro is an executive compensation and benefits partner at Vinson & Elkins and advises employers and executives in the structuring of employment agreements and executive compensation arrangements.

Lynne Hardman Promotes: Embedding a Coaching Culture

Today’s world of work is constantly changing. Operating within an environment of continuous and rapid change is the ‘norm’ for many organisations in 2018. Alongside this, more is being demanded of individual employees and flatter or continuously evolving structures are making career development opportunities more diverse and sometimes difficult to identify. To ensure success, leaders must ensure that their people are fully engaged and feel aligned to the business strategy.

Many companies invest in coaching programmes to develop leaders but the most forward thinking organisations recognise the value in offering coaching support more broadly throughout the workforce and in a range of situations. A strong culture of support for personal development, engendered by high quality coaching, helps to attract, engage and retain business critical talent.

Ensuring that organisational strategic priorities are understood at all levels of a workforce, and that behaviour and attitudes are aligned to ensure achievement of these goals, requires effective communication and collaboration between employer and employee. Leaders with well-developed coaching skills are most likely to achieve the required outcomes and those employees who have themselves benefitted from coaching are more likely to demonstrate the behaviours required for success. Although it can take time to invest in, build and embed this coaching culture, the increase in trust and commercial benefits to the organisation can be dramatic and long-lasting

Viewing coaching as an essential skill, required from all people managers across the organisation, is a good place to start. The ability to deliver tangible results from teams via effective coaching skills is something that can be measured and recognised. Developing these skills in people managers begins the process of embedding skills in the next generation.

However, the recent report ‘Good Work: The Taylor Review of Modern Working Practices’ found that only half of employees feel that their manager is good at seeking their views, something that a competent coaching style can avoid.

In our view, there are two common attributes of successful organisations. Firstly, business objectives and individual goals are closely aligned. Secondly, teams work together successfully to achieve common goals with these goals being well communicated, easily understood and embedded throughout the organisation at all levels.

However, for most organisations, achieving high levels of engagement needs focus. There is a wealth of evidence that suggests that, with the right coaching support, individuals can overcome many barriers – whether cognitive, behavioural, performance, attitudinal or career-goal related. This ensures that people both engage and align with their organisation’s objectives, as well as achieve their business and individual goals as part of an effective team.

To retain talent and maintain a competitive edge, companies should focus attention on building engagement, loyalty and job satisfaction. Organisations whose managers are effective coaches are the role models that create a coaching culture which ultimately creates a positive and productive environment for the entire workforce. A study conducted by Harvard Business School aligns with the Taylor Report and shows that the main motivator of employees is NOT reward and recognition, but progress. This sense of progress and development can be significantly enhanced by regular career coaching conversations between employee and employer within a companywide supportive coaching culture.

This article was featured on HR Grapevine Magazine.

This article was found on HR Grapevine.

The post Lynne Hardman Promotes: Embedding a Coaching Culture appeared first on CPIWorld.

Cyber Insecurity: Why We Keep Learning

Peter Gleason

Peter R. Gleason

Late last month, the US Securities and Exchange Commission (SEC) approved nonbinding guidance urging public companies to “inform investors about material cybersecurity risks and incidents in a timely fashion.” The guidance, which gives greater urgency to current cybersecurity risks, builds on an earlier document issued in 2011. In the SEC’s words, “Cybersecurity risks pose grave threats to investors, our capital markets, and our country.” A recent report from the Office of the Director of National Intelligence predicts that the world faces “imminent disruption” from cyber threats—potentially on a massive scale with “lethal” consequences.

Meanwhile, not surprisingly, Congress continues to take action on cyber risk, proposing 191 bills so far on the topic.

The imperative for boardrooms to conduct sound cyber-risk oversight is here to stay—in the boardroom and in the halls of legislation. Luckily, resources abound for corporate directors to get up to speed on what their companies need to know and disclose while awaiting regulations and rulemaking about cyber-risk oversight.

Ubiquity of Cyber Risk

The ubiquity of cyber risk poses a fundamental operating problem for all enterprises. Most businesses today depend on digital technologies to operate, which leaves sensitive data and other assets vulnerable to cyber risk. The new Berkshire Hathaway 2017 annual report puts it well. After listing cyber threats in great detail, the report notes that “These are risks we share with all businesses.” Hacking, phishing, malware, viruses—you name it, it’s happening for all of us. Such events can present a material, existential threat to corporations, and possibly could even physically harm the people who work for them or that they serve. That is why Berkshire’s founder and leader Warren E. Buffett has stated famously that cyberattacks are the “number one problem with mankind.”

Directors on Alert

Corporate directors by and large are keenly aware of their companies’ responsibilities around cyber-risk oversight. NACD’s 2017 survey of 660 US public company boards’ members indicated that only 37 percent of directors feel “confident” or “very confident” that their company is properly secured against a cyberattack. This result, which demonstrated lower confidence in a company’s preparation for a cybersecurity incident than in 15 other risk areas, is down from 49 percent the previous year.

Does this mean that companies are less prepared? I read things differently. It means that directors are less complacent.

More directors may be realizing that cybersecurity incidents are inevitable. Directors also are learning more about the topic, with 85 percent of boards reporting at least some knowledge of the topic, up from 78 percent two years before. (In 2015, 22 percent of directors reported that their boards had no or very little knowledge of cyber risk. That dropped in 2017 to 15 percent.)

If you’re feeling either behind or a little foggy on your understanding of these risks, you might consider brushing up with these resources:

  • Hundreds of directors have enhanced their cybersecurity literacy through the NACD Cyber-Risk Oversight Program, offered in partnership with Ridge Global and Carnegie Mellon University’s CERT Division of the Software Engineering Institute. More than 175 corporate directors and senior executives have completed the course, the world’s first and only program of its type, while an additional 135 now enrolled in the program are progressing to complete the CERT Certificate in Cybersecurity Oversight.
  • NACD offers the Director’s Handbook on Cyber-Risk Oversight, published jointly with the Internet Security Alliance (ISA) and available to all regardless of NACD membership status. The handbook is the most downloaded publication in NACD history, and the only private-sector publication that has been endorsed by the Department of Homeland Security and the Department of Justice, as well as a wide variety of private-sector organizations such as the US Chamber of Commerce and the International Auditors Association.
  • ISA and NACD also jointly produce summits on cybersecurity exclusively for corporate boards, where recognized experts and seasoned directors share best practices. As an outgrowth of this initiative, NACD and ISA will cohost our first international dialogue, the Global Cyber Forum, in Geneva, Switzerland, in April 2018.
  • Cyber-risk oversight is one of the most popular subjects for directors and advisors writing for NACD’s Board Leaders’ Blog. As you visit this blog you will see I am not the only one writing on the topic. (See, for example, blogs by Corey Thomas, CEO of Rapid7, on the risks of innovation; and Jim DeLoach, managing director of Protiviti, reporting on what was discussed during a director dialogue about cyber-risk oversight.)
  • The NACD Resource Center on Cyber-Risk Oversight is a repository of tools and thought leadership that empowers the board to provide effective oversight.

Big Picture

In all these venues, NACD’s resources on cyber-risk oversight keep driving home several key challenges:

  • Cyber risk is a global challenge that now threatens to undermine governments, markets, and businesses around the globe. Most cyberattacks are cross-border.
  • Cyber risk is also systemic, given our reliance on digital networks and devices for commercial, government, and personal use.
  • For corporations, cyber risk is a strategic, enterprise-wide matter demanding active board engagement. Continuous learning is a must, even for specialists, given how quickly technology and threats are evolving.

Questions to Help You Learn About Your Company’s Security Posture

In closing, I’d like to share some applicable questions shared recently with our members in our Weekend Reader e-newsletter. For your next board meeting, consider asking some of these pointed questions to begin establishing a deeper understanding of cybersecurity across the enterprise.

  • Which cyber risks are communicated to our company’s shareholders, and in what format?
  • Has our management team determined what constitutes a material cybersecurity breach?
  • How effective is our internal escalation process when incidents are discovered?
  • Have we set clear thresholds for when senior management and the board should be notified?
  • How is our company’s cyber-risk assessment process integrated into the overall risk-management process?
  • Can material risks be mitigated by insurance, and does the corporation have sufficient coverage?
  • Does our company’s cyberbreach response plan include an investor communications strategy?
  • Under what circumstances is it necessary to inform law enforcement, customers, and other relevant stakeholders?

While corporate directors have some catching up to do, we’re a community of curious, dedicated professionals. Let’s commit to continuous learning and applying that knowledge to sound cyber-risk oversight. We owe it to our shareholders, our customers, and to the security of our economy.

It’s Time to Get Uncomfortable in the Boardroom

Kimberly Simpson

Two NACD panels recently tackled issues surrounding sexual harassment in the corporate setting, and how directors should act and react to issues that could have profoundly negative impacts on company reputation and workforce satisfaction.

Key takeaways for directors ranged from careful CEO hiring to board composition. The following concepts could be readily applied to your own board’s conversation about overseeing this risk.

  • Aggregate Data to Spot Problems Before They Happen. Given that the board is ultimately responsible for overseeing company culture (including a culture that tolerates sexual harassment), the board should work to mitigate risks rather than taking up sexual harassment issues once a problem has surfaced, according to Michael Aiello, chair of the corporate department at Weil, Gostshal & Manges LLP. Lucy Fato, executive vice president and general counsel for American International Group (AIG), stated that boards should aggregate information to get the full picture, including:
    • Internal audit findings related to culture;
    • Employee relations/human resources reporting, including hiring trends, turnover statistics, and reports from exit interviews;
    • Hotline reporting, including whether there are too many or too few complaints; and
    • Company legal settlements and insurance payouts.
      Board members should also probe whether the company’s investigative processes are fair and thorough.
  • Go the Extra Mile in CEO Hiring. In light of the board’s primary role of hiring and firing the CEO, along with the fact that fallout from CEO misconduct can significantly impact shareholder value, a board should take steps to ensure that its candidate of choice does not have a history of sexual misconduct or even tolerance for a culture in which harassment is an open secret. According to Sabina Menschel, president and chief operating officer at Nardello & Co., to really know who you are hiring into the corner office, conduct an investigation that includes public records, social media, and supplemented standard reference checks. With regard to CEO hiring, Fato stressed, “Ethics, integrity, and how you carry yourself as a public figure should be a factor in whether you can lead the brand.”
  • Risk Starts at the Top. The CEO and senior management are not alone in the potential spotlight of the #MeToo movement. Board members also must be vetted fully, and once in place, board members should receive code of conduct training, just as employees do, said Fato. In addition, the board should pick one corporate policy per year on which to do a deep dive as part of its oversight duties. Tabletop crisis preparedness exercises also should be conducted.
  • Superstar? A board may face a difficult choice if a superstar CEO is found to have violated the company’s code of conduct, fearing that a dismissal could impact short-term shareholder value. According to Brenda Gaines, director, Tenet Healthcare, Southern Co. Gas, and NACD, superstar status is always irrelevant when investigating misconduct. She suggests that the board should take action to remove an offending CEO and then have a separate conversation about revenue and valuation implications. She added that the company must be clear about its culture and key principles, and should have zero tolerance for misconduct, applied to everyone in the company equally. “Board members have to keep each other honest,” she said.
  • Expand the Company’s Enterprise Risk Management (ERM) Framework. Sexual harassment should be a part of each company’s ERM framework, given that fallout from a misstep can be quite severe, emphasized Fato. Also, when doing employee surveys, ask specifically about harassment issues. To do so demonstrates that the company cares about these issues, said Menschel. Also, in terms of monitoring potential issues with long-tenured employees or even board members, consider updating background checks at regular intervals, stressed Fato.
  • Diverse Boards Matter. The #MeToo movement will have an impact on the boardroom, as well as on investor relations, according to Renee Glover, director, Fannie Mae, Enterprise Community Partners, and NACD Atlanta. Indeed, large shareholders are asking about diversity on the board, and they may request sexual harassment policies and pay equity measures. Gaines emphasized the clear-cut nature of the need for more diverse boards. “Diversity is good business,” she said, “and we are nowhere near where we should be. We need more gender diversity and more people of color on boards. Don’t miss this in the search for skill sets.”
  • Find an Ally. Rochelle Campbell, manager for board recruitment services at NACD, says that she encourages boards to have at least two diverse members on the board, as such boards tend to be more successful. For women and people of color who are new to a board, they can play an important role in discussions about sexual harassment and equal pay for equal work. When asked for practical advice for new board members, Gaines shared best-practice approaches to oversight of misconduct:
    • Get the facts right.
    • Take the emotion away.
    • Look for an ally on the board.
    • Be persistent.

Glover summed up the issue: “We can do better. And when we do, we can get on with realizing the deeper value that a diverse board can deliver.”

Kimberly Simpson is an NACD regional director, providing strategic support to NACD chapters in the Capital Area, Atlanta, Florida, the Carolinas, North Texas and the Research Triangle. Simpson, a former general counsel, was a U.S. Marshall Memorial Fellow to Europe in 2005.

What to Look for in an Effective Audit Committee Chair

Paula Loop

The entire board relies on the hard work of the audit committee to meet its overall objectives. But audit committees today are faced with the heavy burden of regulatory mandates and growing investor expectations. Workloads are increasing, and they have to oversee more complex areas. Many audit committees are asking whether they have the right approach to meet the demands.

One way to ensure the effectiveness of the audit committee is to have a strong chair. Good leadership and effectiveness go hand in hand, and a strong chair can get the most out of the committee members. By choosing a strong leader for this essential role, your entire board will be able to have greater confidence that the audit committee is on top of the issues.

So what makes a strong audit committee chair? Audit committee chairs need to have experience, healthy skepticism, integrity, and strong communication skills. And to be a truly effective, he or she has to take the time to really work on the committee agenda and make sure meetings run well. They also need to be able to effectively coordinate with other board committees, such as the risk and compensation committees.

Here are six other attributes that I have observed in great audit committee chairs:

  • Highly experienced: Strong audit committee chairs need to have a good understanding of the business, its risks, and controls. They also know what topics to elevate to the full board, and when to do so.
  • Professionally skeptical: They’re willing to provide an independent point of view and are intellectually curious. They will look for additional information when they aren’t happy with the answers they get frommanagementand
  • Possesses integrity and confidence: They promote a strong “tone at the top” for the company and for the committee. They also need to ensure that all elements of the charter are being addressed.
  • Organized and proactive: They’re able to prioritize the most important items on the agenda. They’re good discussion facilitators and know when to cut off low-value discussions.
  • Strong communication and interpersonal skills: They provide clear updates of issues to the full board. They’re not afraid to ask difficult questions and have uncomfortable conversations with members of management, service providers, and even other committee members.
  • Willing to devote the time and energy: Chairing the audit committee requires a big time commitment—agendas are denser, filings are more voluminous, and compliance is more time-consuming. So the chair has to be ready, willing, and able to dedicate the time to the job. Strong chairs take the time to develop the agenda and effectively execute meetings. They also make themselves available to management and other board members. The time commitment of the audit committee chair goes well beyond just the meeting time dedicated to that committee, not to mention meetings of the full board.

Strong audit committee chairs understand that an effective audit committee means more than simply meeting stock exchange composition requirements. They recognize the importance of having a diverse committee made up of members with the right experience, expertise, and both hard and soft skills. They keep the committee refreshed and use the assessment process to ensure that all committee members are functioning effectively.

Having a strong audit committee chair at the helm can help ensure that the audit committee not only keeps up but excels.

For more on this topic, read the latest in our Audit Committee Excellence Series, Audit committee effectiveness: practical tips for the chair. You can also find more audit committee resources on our website.

Today’s Board Member: Activist, Strategist, Counselor

Sanjay Gupta

More than ever, organization leaders need committed counselors—individuals who will push them to greater heights and encourage them to pursue transformation. They need objective individuals who can advise, envision, and strategize for long-term success.

To find these advisors, companies are looking to their boards. Yet at the same time, the role of the board is changing dramatically.

In eras past, leaders looked to their boards to reflect and support their efforts. More recently, boards have been called upon to have more active oversight of the wave of risk and regulatory challenges. And, today’s board is being asked for still more. Navigating through a period of constant and fast-moving change, corporate leaders need a cast of engaged, insightful, curious supporters—people who are willing to press for innovation and contribute creative, strategic thinking. It is demanding new territory for board members. And it calls for a demanding new process to identify and engage the right individuals for the job.

To understand this process better, we conducted in-depth interviews with a dozen directors—all high profile current and former executives whose board experience covers more than 40 publicly traded companies across a wide range of industries. What we found was a great deal of change in board needs—and a tremendous difficulty in articulating that change. We found that companies want and need directors with a mix of activist and strategist skills. At the same time, they have been slow to realize that what they want is a new breed of director—and that finding these new individuals will require not just a change in attitude but also a change in tactics. Boards must change their thinking now if they want any hope of being ready for the future.

What Has Changed

What we learned was that the expectations of the new board member are not so much different as they are expanded. Boards need more from their members.

In the past, ideal competencies of a board member might have been insight, intellectual curiosity, and strategic advisory skills. Yet in our interviews, directors said they need new members with all these skills—plus. They need insights plus an abstracted way of thinking, curiosity plus the ability to adapt, the ability to advise plus engage.

This is not a job that can be filled by someone seeking to boost a resume. This calls for someone who sees board membership as an opportunity to learn and grow as a person. It calls for individuals with the time and desire to invest in the board and make the business successful.

Because of the expanded demands, the search for the right board member must expand as well. Instead of reviewing the usual candidates—CEOs (former or current) with prior board experience, often from the same industry—today the search must span a wider range of experience, with more diversity in geography, job function, and company status. And while a new board member must still be compatible with the existing roster, the “fit” must be considered in the context of change making. New members will be judged on what they can bring to the board—not just to help with current problems, but to help the company think about what’s next.

“A decade ago, there was more a focus on board collegiality — everybody getting along, feeling this was such a great board,” says Phil Martens, who has served on boards such as Graphic Packaging Holding, Trinseo SA, and Plexus Corp. “Today, what’s required is very different. The whole dynamic has changed. What’s required now is all about what you bring — your confidence to speak up and provide input, your point of view.”

The New Board Member

As boards wrestle with these new demands, and a profile for the new, ideal board member is emerging:

  • Recently retired CEO: Our research found there is a “sweet spot” in the experience level of the ideal board member. The individual should not be active in his or her own company. That intense responsibility leaves them too little time to devote to this new, more demanding board role. On the other hand, an individual too far removed from active leadership may be out of touch with the fast-changing business world. Therefore: look for recently retired or about-to-retire candidates. Zero to five years out from their leadership position is ideal for many directors.
  • Originate board candidates from both in and outside the industry circle. Boards should have a mix of backgrounds with some directors from the company’s traditional orbit and some from other industries and geographies.
  • Active counselor mentality: Rather than solely focused on containing risk, board members should be focused on helping to get the most out of the business.

Edward D. Breen, courtesy DowDupont

Some experienced directors already take this new process to heart. Edward D. Breen, CEO of DowDuPont, chair of Tyco International and E.I. DuPont de Nemours & Co., and currently as the lead independent director of Comcast Corp. His watchword is “options.”

“The question I bring up in meetings is: What could you do to create long-term shareholder value and how to create options around this?” he says. This is a key role of the director, says Breen—to ensure the CEO and executive team are thinking about a range of possible futures and paths forward. If that’s not coming from the CEO, then the board has to push the subject.

There are many reasons why boards have not pressed CEOs in this manner in the past, he says. Some boards were just too nice to the CEOs. In other cases, the CEO may have been insecure or arrogant and discouraged that sort of input. But a CEO today needs directors who think like activists. “The board needs to be thinking ahead,” says Breen.

One director, who served on the board of a century-old manufacturer, has seen this forward-thinking board help executives make necessary changes. When he first came to the board, the director recalls management was stuck in outdated patterns, clinging to old product lines and markets. But the board was able to take a more forward-thinking perspective. He and other board members pushed management to be more aggressive in M&A activity and to prune lower margin product lines. Today, the company sports a wide array of new products and a renewed focus on innovation.

Directors can also provide support for companies wrestling with regulatory demands. One director joined the board of a financial services firm soon after the financial crisis of 2008. While oversight and regulatory responsibilities were still present, the director says, the board helped the company to see and pursue a broader strategy. That played out, for example, in the company’s acquisition of a regional competitor. The board was able to provide advice, support, and counsel during a time of change. This is the way the new and improved board member should approach the job, the director says.

First Steps

This new, active, counselor-director is not a pipe dream; it is possible to find these individuals. But it will require a new set of board search tactics:

  • A more thorough assessment, interview, and onboarding process led by the board or search partner. This differs from traditional processes, which may have been less detailed and demanding.
  • An increased willingness and openness of the board and the CEO to look at potential board members outside of the traditional board member profile, reaching out to candidates in different industries and different geographies.
  • A commitment to develop the existing board to adapt to this new profile of board director.
  • There is no one-size-fits-all process for boards today, but the overall goal is universal: Like the fast-moving business world around it, the search for new directors must also grow and change to meet new demands.

Boards are recognizing their need for a more nuanced profile of directors. They are acknowledging that the traditional insightful, curious, advisor who has been a CEO is no longer enough. What they really need requires a deeper level of insight into the individual candidate, a greater level of assessment of potential directors, and more time invested into the selection.

Done correctly, the results will make a significant impact on the performance of the company. The board will be working as an internal activist force to think about the future of the business and push shareholder value. It is a level of engaged support and advice no organization can afford to be without.


Sanjay Gupta is global industrial practice group leader at Egon Zehnder, an executive recruitment firm. 

Dynamic Governance: Rethinking the Purpose of the Corporation

Edward Waitzer

In his classic treatise on the Wealth of Nations, Adam Smith noted a discrepancy between the interests of owners and the managers who are handling those “other people’s money.” In the twentieth century, Michael C. Jensen and William H. Meckling—citing Smith as well as Adolf A. Berle and Gardiner C. Means’s The Modern Corporation and Private Property—gave new urgency to this issue by introducing the concept of agency costs—the costs of aligning the incentives of these different corporate actors. This led to more than four decades of searching for the best way to align the interests of shareholders and managers.

At first it seemed that the solution would be stock price, since shareholders and managers alike want to optimize that. The advent of the efficient market hypothesis reinforced the focus on market pricing as the arbiter of corporate performance, and of short term shareholder value as the purpose of the corporation. We have learned, painfully, that neither of these ways of thinking about governance issues is adequate.

Meanwhile, corporate law has been overwhelmed by the advent of a litany of corporate governance norms. This has spawned an active governance industry and a variety of new analytical models for framing corporate law, including:

  • shareholder primacy, in which boards are accountable above all to shareholders;
  • the stakeholder model, in which the interests of all stakeholders are to be considered and mediated by the board of directors;
  • the team production model, in which the inputs of various stakeholders are acknowledged; and
  • the nexus of contracts theory, director primacy, and others.

What has become clear is that there is no “right” corporate governance model. Governance is highly contextual, and is dependent on what a particular company does, its ownership structure, and the markets and political frameworks in which it operates. The focus on corporate governance reflects a move from a simple legal view of the corporation to one that has become increasingly complex and dynamic, constantly responding to societal expectations. Governance is messy because that is life.

One of the consequences is that there seem to be new controversies and consequential regulatory proposals every year. We have spawned a corporate governance reform industry (private sector and regulatory) that has become adept at generating activity to feed itself. A related oddity is the fact that many of the regulatory proposals are symbolic—they certainly cannot be explained by their relevance to improving corporate governance or performance.

To take a current example, think of say on pay. We now have several years of data resulting from the legal ability of shareholders in the US to cast an advisory vote on executive compensation. Rhetoric aside, shareholders have typically approved compensation with votes in favor, typically exceeding 90 percent.  There is a double irony here. First, executive compensation is paid mostly in equity with a value based mostly on short-term stock prices. Second, shareholder support for executive pay also appears to be highly correlated with a company’s short-term stock performance. To the extent that the say on pay vote has heightened executives’ incentives to focus on short-term stock price at the potential expense of creating sustainable value, this regulatory initiative would appear to be counterproductive.

Another recent example is last year’s shareholder resolutions asking companies to report on their exposure to climate risk (and related regulatory, technological, legal, and meteorological forces). In spite of proclaimed commitments to engagement on environmental, social, and governance issues, both executive management teams and investors seem indifferent to such proposals. Management typically recommends a vote against the measure, claiming that the company’s reporting is already thorough, and shareholders vote thumbs down accordingly. Preventable Surprises, a self-described “think-do” tank in the United Kingdom, reports that only one of nine such resolutions at the major U.S. utilities received majority support. Three of the largest institutional investors (owning, on average, close to 20 percent of the shares of the nine companies) voted against each of the resolutions. Equally surprising is the lack of disclosure by these investors regarding the impacts of climate risk on their portfolios and investment strategies.

It is unlikely that the explanation for this lies in false perceptions. The actors we are talking about are among the most sophisticated and influential in our society. A more likely explanation is that governance is often viewed as a moral crusade that is tapping into broader public sentiment without regard for materiality or the difficulty of effecting fundamental change. The exercise of governance then becomes largely symbolic and political and, as a result, it is often conservative and self-serving. One systemic danger is that such reforms dull the desire for deeper introspection and more fundamental change.

Might there be a more nuanced and constructive way to think about corporate purpose? Tamara Belinfanti and Lynn Stout begin to develop one such approach in their recent paper “Contested Visions: The Value of Systems Theory for Corporate Law.” They first describe two basic principles of systems theory:

  1. That systems are integrated (i.e., more than the sum of their parts), and
  2. That systems are fractal (i.e., they are comprised of subsystems which in turn are comprised of other subsystems on so on).

A third principle flows from the first two: that the overall health of the system depends on the continued health of each of its essential subsystems, as well as of the larger systems in which it is embedded. They then reflect on how each of these principles applies to corporations.

Well-managed corporations achieve resilience through positive mechanisms such as economy (i.e devoting the appropriate level of  resources based on current conditions), homeostasis (i.e., information and feedback loops that allow a system to adjust to disturbances in its environment and stay within the parameters necessary for its continued functioning), and self-organization (i.e., the ability of a system to learn, diversify and evolve in response to shifts in its environment that might otherwise threaten its survival).

By contrast, poorly managed corporations remain vulnerable due to negative mechanisms such as redundancy (i.e., devoting more resources than needed for a given purpose); imbalance (e.g., information asymmetry between management and directors); and rigidity (doing the same thing over and over and expecting different results).

In systems, multiple purposes are the rule, not the exception. What we observe about a system’s purpose or purposes, actual or apparent, will depend on our level of analysis. The relevant lesson that systems thinking offers on corporate purpose is that the overall goal of a corporate system should not be subordinated to the goals of any one of its subsystems (such as the share ownership subsystem). A critical, ongoing role of effective boards should be to mediate these competing interests.

Systems theory suggests that corporate purpose can be viewed from different perspectives, including the expectations of the state whose laws made incorporation possible. This doesn’t offer a definitive answer to the difficult question of corporate purpose. Indeed, one of the primary insights of systems theory is that the purpose and functions of a system is often the least obvious part of the system, especially to outside observers who pay attention to only a few events or to rhetoric or stated goals.

Where does this thinking lead? First, systems theory counsels against focusing on any single metric. To take the obvious example, short-term profitability is not so much an objective as a constraint a firm may have to meet in order to remain in business. Metrics such as profits, employee turnover, customer satisfaction, and so forth are not ends in themselves. Rather, they are a source of information about whether the corporation is relevant, resilient, and sustainable. Sustainable value creation is the singular goal boards should be focusing on and to which managers should be held accountable.

A related lesson is the need to develop new tools and techniques to measure system-level effects. Increasingly the focus will be on the ability of corporations to generate and account for positive externalities. The work of one organization, The Investment Integration Project, may provide guidance for corporations as well as institutional investors. The organization’s work looks beyond financial metrics to consider system-level events and the integration of the United Nations’ sustainable development goals, for instance.

A third lesson from systems theory is that, given multiple purposes and the complexity inherent in systems analysis, the three branches of government—courts, lawmakers, and regulators—will rarely be well positioned to judge corporate performance. (It is fortunate that the U.S. Securities and Exchange Commission has not yet finalized the proposed Dodd-Frank rule on pay versus performance, which defines performance as no more or less than three years of annualized Total Shareholder Returns (TSR) .)It will also be difficult for academics or the corporate governance profession to identify “one size fits all” reforms that can reliably improve the performance of all companies. Attempts to impose such silver-bullet solutions are more likely to result in what Roberta Romano has described as “quack corporate governance” that often does more harm than good.

This suggests the exercise of restraint by regulators—assuming positive intent and encouraging adaptive responses rather than imposing rigid and formal compliance requirements. In this manner, we can ensure that our corporations can continue to function as dynamic systems that foster the wealth of nations and the globe.


Edward Waitzer is a partner and head of the corporate governance group at Stikeman Elliott LLP. All thoughts are his own.