The Board-Centric Annual Meeting
Posted by John C. Wilcox, Sodali, on
Tuesday, February 9, 2016
Editor’s Note:
John Wilcox
is Chairman of Sodali and former Head of Corporate Governance at
TIAA-CREF. This post is based on a Sodali publication by Mr.
Wilcox. |
For a growing number
of listed companies around the world the annual shareholder meeting
has come to resemble a trial by ordeal. Instead of the traditional
town-meeting business forum, the AGM has morphed into a jousting field
where activists, proxy advisors and various special interest groups
play a dominant role. This state of affairs has evolved because for
the past three decades companies have been resistant to change and
defensive about governance reform, while shareholders and activists
have taken the lead in successfully promoting greater board
accountability and stronger governance rules. Corporate scandals, the
financial crisis, escalating CEO pay, declining public trust in
business leaders together with enhanced shareholder rights have
transformed the annual meeting into an event where companies often
focus on damage control rather than showcasing their business.
The challenge for
companies is to restore balance to the AGM so that it can fulfill its
many important governance, accountability and business functions. To
do so, we believe that the focus of the AGM should be shifted away
from shareholders and back to the board of directors. The AGM should
be a board-centric event that brings control back into the company
where it belongs, while giving shareholders what they have always
wanted—greater boardroom transparency and director accountability.
The first step toward
a board-centric meeting is for companies to acknowledge that the AGM
(by which we mean the entire process of disclosure, communication,
proxy solicitation and engagement, as well as the meeting itself)
should be treated as a governance event. It should be an occasion for
directors to answer the question “How are we doing?” with respect to
their long list of duties and responsibilities relating to corporate
governance, sustainability and strategic oversight of the business.
The second step is for
companies to recognize that as the list of directors’ duties and
responsibilities has grown, the list of stakeholders and other
audiences whose interests the board must represent has also expanded.
The board’s question “How are we doing?” needs to be responsive not
only to the electorate of shareholders and investors, but also to the
management, employees, suppliers, customers, communities in which the
business operates and to future generations affected by the company’s
activities over the long term. Renewed attention to the idea of the
corporate social compact means that boards should also consider the
macro-economic impact and political implications of their decisions.
At the same time that
the board’s governance responsibilities and audiences are expanding, a
parallel set of related rules and best practice guidelines are raising
the bar for institutional investors at the AGM. Legislation and
stewardship codes now require asset managers to increase their
oversight and engagement with portfolio companies, monitor and
evaluate directors diligently and exercise voting rights with the same
fiduciary care that governs their investment decisions.
The AGM is the point
of convergence for all of these trends.
A proposal that we
believe could lead the way to the development of board-centric annual
meetings appears in a Working Paper entitled “Materiality in Corporate
Governance: The Statement of Significant Audiences and Materiality,”
published on September 3, 2015.
[1]
The authors are
well-known governance experts Professor Robert G. Eccles and Tim
Youmans of Harvard Business School. Their proposal builds on the work
of the International Integrated Reporting Council (IIRC) and is
supported by the American Bar Association’s Task Force on Sustainable
Development and the UN Global Compact.
The Working Paper
announces an ambitious goal: “… by 2025 the board of directors of
every listed company will be issuing an annual Statement of
Significant Audiences and Materiality.”
[2]
The authors further
assert that this goal is applicable to “… all listed companies
regardless of reporting regime or nationality.”
[3]
The Working Paper’s
call for an annual board statement is not unprecedented. As far back
as 1992 the Cadbury Report described the board’s role in the following
terms: “The responsibilities of the board include setting the
company’s strategic aims, providing the leadership to put them into
effect, supervising the management of the business and reporting to
shareholders on their stewardship.” (Italics added) For many years
voluntary board reporting has been mandated in principles-based
governance systems, where comply-or-explain is the primary
accountability mechanism. Despite these deep governance roots, board
reporting has been held back by restrictive disclosure rules and by
concerns about confidentiality, selective disclosure, marketplace
confusion and director liability.
Recognizing that there
are persistent legal and cultural obstacles to boardroom transparency
and communication, the Working Paper builds its case for an annual
board report on a careful step-by-step analysis that includes the
following assertions:
-
The primary fiduciary duty board of a board of
directors is to the corporation itself, not to shareholders. The
doctrine of shareholder primacy is “… ideology, not law.”
[4]
-
The board is responsible for “… taking a long-term
view and ensuring that management is doing so … .”
[5]
-
The board should apply a “materiality” standard as
the basis for its strategic decision-making and corporate reporting:
“The board must … decide which audiences are most significant for
the ability of the corporation to create value over the short,
medium and long term. Once it has done so, it has laid the
foundation of the materiality determination process for corporate
reporting.”
[6]
-
The “audiences” the board must consider in
determining materiality are not just shareholders and stakeholders,
but also society and future generations. The authors refer to a
company’s “intergenerational commitment,” for which the board serves
in a fiduciary capacity as “trustee.”
[7]
-
The board should issue an annual “Statement of
Significant Audiences and Materiality” that “… clearly communicates
the board’s view of the company’s priorities … . The Statement, like
the audited financial statement, is ultimately a responsibility of
the board—not management.”
[8]
This analysis breaks
new ground in three ways: (i) it adds a materiality standard to the
concept of the board’s fiduciary duty; (ii) it calls for an annual
written board statement; and (iii) it necessitates a process of
“integrated thinking” within the company.
In our view, this line
of reasoning represents a governance model that would increase the
board’s power, while also satisfying shareholder demand for greater
board transparency and accountability. As we have long maintained,
aligning the interests of the company and the shareholders is a board
responsibility and is best accomplished by the board itself rather
than by the imposition of external governance standards. Viewed from
this perspective, the Working Paper’s recommendations strengthen board
power rather than diminishing it, thereby supporting the principle of
board-centric corporate governance.
The
“Materiality” Standard
A materiality standard
that is defined as “entity-specific”
[9] and based on the judgment of
the board of directors grants substantial power and discretion to the
board. It assumes that: (i) the board should determine how governance
policies are prioritized and implemented; (ii) corporate governance
should serve business goals; and (iii) the board should explain
through the lens of materiality how its decisions serve the interests
of the corporation.
Similarly, a
materiality statement that has no prescribed format also gives the
board flexibility to decide how best to “… inform management,
providers of financial capital and all other stakeholders of the
audiences the board believes are important to the survival of the
corporation.”
[10] This flexible and expansive
approach recognizes that every business is unique and that one size of
corporate governance does not fit all companies and all business
circumstances. Formal rules cannot dictate which audiences and issues
are material with respect to an individual company. The company’s
board and management are best positioned to make that determination
and are obligated to do so.
Governance rules
guarantee that shareholders and activists have the right to disagree
with how the board determines materiality and prioritizes audiences.
But when a disagreement between the board and shareholders does arise,
the ensuing engagement is more likely to be constructive if discussion
focuses on business issues rather than on compliance with a governance
check list.
From the perspective
of developing a board-centric AGM, the materiality standard
accomplishes three important goals: (i) it reinforces director-centric
governance; (ii) it empowers boards to give business and strategic
goals priority over governance compliance; and (iii) it allows for a
customized approach to governance and board reporting that can be
adapted to the needs of individual companies. An added benefit is that
the materiality standard encourages boards to include in their
strategic explanation the type of forward-looking information about
the business that shareholders and investors prefer.
An
Annual Board Report
Although demands to
improve the quality of board reporting have been part of the
governance conversation for more than a decade, the idea of an annual
board report has failed to gain traction. Sodali is among those
advisors who have called for companies to establish direct
communication between boards and shareholders as a means to align
their interests. In addition, we have specifically recommended that
companies should publish an annual Directors Discussion and Analysis
(DD&A) that deals with governance and other board responsibilities not
covered by the financial reports, management reports or the annual
report to shareholders.
[11]
The Working Paper’s
recommendation for an annual board materiality Statement takes a big
step in this direction. Small steps have already been taken. Many
companies routinely publish a board report or an annual chairman’s
letter that summarizes governance policies. Board members are often
personally involved in communication with shareholders about
controversial proxy issues and contested elections. During the past
decade say-on-pay has opened the door to face-to-face communication
and robust exchanges between directors and shareholders. It is now
common practice for directors to step forward and explain the business
rationale for their pay decisions whenever proxy advisors recommend
votes against a compensation proposal.
Statistics verify that
these engagements have been highly effective. Their success reinforces
an important fact that is highly relevant to the concept of a
director-centric AGM: Institutional investors are generally willing to
support the board’s business judgment when a reasonable explanation is
provided.
As a result of these
positive results, “engagement” has become the remedy du jour for
companies facing shareholder activism and dissident campaigns. It is
important to remember, however, that most of these engagements have
been reactive—i.e., launched only after activists or proxy advisors
have fired the first shot across the company’s bow. These
after-the-fact campaigns come with significant risks for companies.
They are stressful, time-consuming, costly, inefficient, difficult to
manage and of uncertain outcome. These problems are exemplified by the
recent high-profile, last-minute engagement conducted by Bank of
America to obtain shareholder approval for combining the roles of CEO
and Chairman. Despite achieving a passing vote, the process created a
circus atmosphere, attracted unwanted public attention, produced
unfavorable commentary in the media, put a spotlight on the company’s
underperformance and left a residue of dissatisfaction with the board.
This type of confrontation might have been avoided if the board had
been fully informed in advance about the negative implications of its
decision and had then been willing to provide a convincing explanation
and reach out to shareholders before battle lines were drawn.
Prevention is always
better than a remedy. A written report that explains the board’s
governance decisions, particularly when they are noncompliant or based
on extraordinary circumstances, would go a long way toward reducing
the risk of confrontation with shareholders. A written board narrative
would also reduce the legal risk of selective disclosure that makes
many companies reluctant to have their directors engage in unscripted
communication with shareholders. In voluntary principles-based
governance jurisdictions around the world, including the EU, the board
statement would provide an opportunity to justify and give context to
governance policies, thereby improving the quality of explanations and
strengthening the comply-or-explain system without resort to
additional regulation.
In our view, an annual
report would be a vehicle for the board to address in advance the
issues and questions likely to be raised by shareholders and activists
at an annual meeting. In addition to co-opting these issues, a
convincing explanation of the board’s governance policies would also
dilute the impact of proxy advisors and reduce the importance of
one-size-fits-all governance box-ticking.
Integrated Reporting (<IR>)
The Working Paper’s
case for an annual board report builds directly on the work of the
International Integrated Reporting Council (IIRC), a well-established
international movement supported by the global business community.
Many companies have already embraced the concept of integrated
thinking and have issued integrated reports on a variety of topics and
in various formats.
The subject of <IR> is
beyond the scope of this memorandum, but a brief look at the
movement’s objectives demonstrates why it is relevant to corporate
governance and board reporting. Here is the IIRC’s definition of an
integrated report:
An integrated report
is a concise communication about how an organization’s strategy,
governance, performance and prospects, in the context of its external
environment, lead to the creation of value in the short, medium and
long term.
[12]
This definition
summarizes what a materiality statement or annual board report should
do. It also defines what a board-centric AGM should be. Materiality
and integrated thinking are complementary concepts. Requiring
companies to produce the type of materiality-based, integrated board
narrative envisioned by both the IIRC and the Working Paper would have
a positive impact in several ways. The process of
information-gathering and composition would alter behavior both inside
the boardroom and through the ranks of management and employees.
Holistic thinking about the business would break down operational
silos and introduce more nuanced perceptions about how the parts of
the business interact, how governance policies affect business
operations, how cultural and non-financial issues affect risk and
performance, how short and long-term objectives are linked. An
integrated picture of the business would make shareholders better
informed and less inclined to focus on single-issue concerns.
Recommendations
If the Working Paper’s
prediction is correct, within a decade every listed company around the
world will be issuing an integrated board report annually. The report,
explaining the board’s actions in terms of material audiences and
business conditions, will in turn function as an organizing document
for a board-centric annual meeting. In anticipation of these
developments, we encourage companies and boards to take the following
steps:
-
The board of directors and executive management
should become familiar with the IIRC’s concepts of integrated
thinking, integrated management and integrated reporting. These
topics should be the subject of educational sessions within
operating management and at the board’s annual strategic retreat.
Integrated reporting should also be discussed with the company’s
auditors, financial advisors, management consultants and
communications and investor relations professionals.
-
The board should take steps to meet the materiality
standard described in the Working Paper: “… identify audiences
relevant to the corporation, their interests (including where they
conflict), and the relative weight attached to each.” This will
require the board to work closely with management to identify all
audiences with a stake in the business and to prioritize their
interests in the context of the company’s business circumstances.
-
The board should review the company’s ownership
profile. As the board is directly answerable to the electorate of
shareholders and institutional investors, this audience is of
greatest concern in preparing for the annual meeting. The board must
have up-to-date knowledge of the shareholders’ governance policies
and voting practices, must understand how their interests may be
affected by board actions and must be able to prioritize their
interests against those of other audiences.
-
The board should review, update and benchmark its
Corporate Governance Principles. The Principles should be revised as
needed to include ESG issues, non-financial metrics, sustainability
and the principles of integrated thinking and reporting. The board
should explain how its governance principles align with best
practice and with peer companies, how it determines the materiality
of audiences and how its decisions are expected to achieve long-term
economic goals.
-
The board should establish a policy for directors to
communicate and engage with shareholders proactively. If such a
policy is already in place, it should be expanded to include not
just governance issues but also the broad array of topics that the
board must consider and prioritize in preparing its integrated
annual report.
-
The board should have a detailed timetable and
schedule of responsibilities in preparation for the annual meeting,
which should be a collaborative undertaking within the company. The
board’s annual report will play an important role in setting the AGM
agenda and will influence how shareholders vote on resolutions at
the meeting. Directors as well as management should be prepared to
engage directly with shareholders on controversial matters in
advance of the AGM.
-
The board should be well informed about the company’s
Investor Relations program. It is the responsibility of both the
board and management to ensure that financial and sustainability
goals are fully integrated into the company’s periodic meetings with
financial analysts and portfolio managers. The messages delivered by
the IR team should be consistent with the messages delivered to
institutional investors by the board on governance policy and proxy
voting issues.
-
The agenda for board’s annual self-assessment and its
annual retreat should include information and deliberations
necessary to prepare the annual board report. The annual retreat may
require participation by members of operating management and outside
advisors who can provide expertise and information for the board
report.
Conclusion
With corporate boards
under siege and facing a growing number of governance and activist
challenges, the concepts of integrated reporting, an annual board
report and a board-centric annual meeting have the potential to change
the governance game entirely. After 30 years of governance reforms
imposed by outside parties, companies and boards should welcome the
opportunity to exercise the powers these reforms have given to
directors, to take charge of their relations with shareholders and to
make the annual shareholder meeting a meaningful governance event that
aligns the interests of the business and all its stakeholders.
Endnotes:
[1]
Eccles R.G., Youmans T., Materiality in Corporate Governance: The
Statement of Significant Audiences and Materiality, 2015.
See also, The
Federation of European Accountants, The Future of Corporate
Reporting—creating the dynamics for change, 12 October 2015, at
www.fee.be.
[2]
Eccles R.G., Youmans T., 2015, p.9
[3]
Eccles R.G., Youmans T., 2015, p.1
[4]
Eccles R.G., Youmans T., 2015, p.2
[5]
Eccles R.G., Youmans T., 2015, p.4
[6]
Eccles R.G., Youmans T., 2015, p.7
[7]
Eccles R.G., Youmans T., 2015, p.4
[8]
Eccles R.G., Youmans T., 2015, p.6
[9] Eccles R.G., Youmans T., 2015, p.5
[10]
Eccles R.G., Youmans T., 2015, p.6
[11]
Wilcox J., The Autonomous Board, 2014;
Rethinking the Annual Meeting,
2013
[12]
Integrated Reporting,
www.integratedreporting.org
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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