Defining the 3 New Rules of Corporate Governance - Boardroom News & Executive Insights

Defining the 3 New Rules of Corporate Governance

Though the idea of analyzing corporate governance is relatively new, the concept of corporate governance itself has been around for more than 50 years.

Over that time, many business analysts and experts have noticed the lack of agreement about what successful corporate governance looks like. Consequently, many corporations have experienced avoidable disasters resulting in wasted money and dubious behavior.

For many, the time for a shakeup in corporate governance has come. With ESG initiatives becoming more important to this and subsequent generations, the system needs new rules. With a little innovation and some principled, common-sense action, public companies in the U.S. can make decent progress and find long-lasting success with their corporate governance practices.

1. Focus On Long-Term Management

6 Actionable Steps to Forge a New Type of Corporate Governance

If it seems that everything in today’s version of corporate governance hinges on quarterly earnings, that’s because it does.

Companies get sued if stock prices take too big of a hit.

If earnings misses are too big or too frequent, it could wake up the sleeping giant of activist hedge funds that will soon come looking for change. 

This way of doing things, unfortunately, severely hampers innovation and creativity, creating a losing situation for employees and the customers they care about.

The good news is that there are several things public corporations can do about it. 

Do Away With Earnings Guidance

Earnings guidance is merely an estimate of how profitable the company will be in the upcoming quarter. When analysts report this information, investors begin to form expectations around it. If those expectations are not met, it can have a significantly negative effect on the stock price. 

Unfortunately, this treacherous cycle often leads to board members putting undue pressure on the company to achieve short-term results. Doing away with earnings guidance would allow companies to set and work toward long-term goals, like increasing market share or developing new products. 

Stabilize the Boardroom

Many companies hold elections every year and elect board members to one-year terms. However, staggering the board might be a better strategy. This involves holding an election each year to elect one-third of the directors to three-year terms. This is not a favorite for shareholder activists looking to gain majority control, but the staggered format does give the board some stability in leadership. 

This approach, once again, allows for a long-term outlook on wealth creation. With a few caveats and provisions, it is possible to balance the need for longevity and stability with the need to hold individual directors accountable (or the possibility that shareholders may need to dismantle the board altogether). 

Bring Back Exclusive Forum Provisions

Exclusive forum provisions state that shareholder attorneys can bring litigation against a company only in the state in which it was formed. Why would a rule like this be necessary? It wards off the attempts of attorneys to control corporations through the threat of multistate litigation. 

Having to fight multiple lawsuits — which are often an automatic response to any major transaction or decision the board makes — has become expensive and exhausting. It is often wholly unnecessary, especially when most board members strive to do what’s best for the company. 

Limiting litigation to one state gives everyone a fair chance and levels the playing field for board members who work every day in fear of shareholders and their attorneys.

2. Ensure the Boardroom Is Filled With the Best

If governance boards win the right to long-term seats, they have an obligation to ensure that those elected have the skills and experience necessary to help the company meet its goals and objectives. 

Many shareholder activists believe optimal board composition can be achieved with age and term limits. However, this perspective would push out many qualified members who bring valuable perspectives and the experience necessary to challenge younger CEOs when they make questionable decisions. 

There are, however, a few ways to reach the same goal that don’t require the very expertise that boards need to steer the company in the right direction:

  • Director Evaluations: Have a third party grade each director on relevant attributes and then share that feedback with the director and the chairman so they can take advantage of any opportunities for improvement
  • Shareholder Proxy Access: Successful companies like Hewlett-Packard and Western Union have allowed shareholders to put their own director candidates on the ballot each year, offering a way to ensure that those with specific expertise make it into roles where their knowledge is needed

Both of these methods would serve as a fair means of getting rid of underperforming directors and ensuring that boards comprise those who have the skills and experience necessary to be innovative leaders.

3. Let Shareholders Have a Voice — With Boundaries

Today, boards and shareholder activists are often at odds with each other. Once these activists have had enough of an underperforming board refusing to do things their way, they’re all too willing to enter into a battle for governance control. While this fight to replace the board can successfully bring much-needed change, it isn’t the only way.

Boards should instead create a process whereby each side can argue its viewpoints. Then they should let the shareholders decide what is best for the company. 

This process can be tough due to the absence of rules that prevent shareholders from acquiring more than 10 to 15% of total shares, not to mention the fact that the SEC allows a company 10 days to report more than 5% ownership and allows the shareholder to purchase more shares in the meantime.

Still, a process that would warn the board when shareholders are gaining ground is important. It can most certainly help boards position themselves for a fair fight in which everyone has equal time and space to prove their case and make their voice heard.

Good Corporate Governance Is About Balance and Collaboration

It can be difficult for boards and shareholders to “play by the rules” because there are very few rules in the game of corporate governance. Unfortunately, this lack of agreement has invited unprincipled behavior, corporate fumbles, and in some cases, an all-out war between directors and shareholders. 

Focusing on long-term management, ensuring high performance standards, and allowing shareholders to have a voice are three concrete ways to bring orderly conduct back to corporate governance. Implementing the “rules” can help boards and shareholders work together to rise to the top, even in competitive markets.

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