As the world greets the New Year, investors and companies may take a moment to reflect on key corporate governance priorities in light of a potentially more challenging business environment in the year ahead. The prospect of slower global economic growth, combined with a higher cost of borrowing, and continued uncertainty regarding global trade will demand watchful management of a new set of risks in both developed and developing markets. Macroeconomic trends will likely have an impact on firm performance and companies’ balance sheets, raising greater awareness of audit quality concerns and executive compensation practices. Meanwhile, many governance topics that have dominated the landscape for the past few years, such as diversity, climate change, and cybersecurity, will continue to gain momentum and further prominence at boardrooms and company-shareholder engagements. Below is our list of ten corporate governance topics to watch in 2019.

1. Diversity: Beyond Gender and Beyond the Boardroom

Board gender diversity continues to be a focus item globally. We expect another record year for new female directors in many markets. A growing number of investors adopt voting policies on the issue, while regulatory mandates emerge in new jurisdictions, including the United States, where California recently adopted board gender diversity legislation that will take effect this year. However, as gender diversity among top executives has remained relatively stagnant, many companies and investors will likely begin to pay closer attention to the composition of the C-Suite and senior management, seeking for evidence of a diverse culture deeper within the organization. Furthermore, diversity assessments will likely expand beyond gender, to consider a more holistic view of backgrounds, including skills, qualifications, age, and ethnicity.

2. Climate Change: New Expectations on GHG Reduction Targets and Risk Management

As the Paris Agreement is set in motion, regulatory and industry-based initiatives are changing expectations about company behavior with respect to carbon emissions, energy efficiency, and the protection of the environment. As studies indicate that existing country commitments are not sufficient to curb temperatures to sustainable levels, we expect private ordering to intensify globally. Investor awareness of climate change risks pushes the issue to the top of the agenda in portfolio assessment and direct engagement with companies. Some investors will likely seek to devise proxy voting policies incorporating climate risk assessments, expressing concerns through votes on director elections, compensation, or other routine items.

3. Market Uncertainty and Audit Quality

In 2018, several major accounting scandals broke out across the globe, where a number of well-established firms either collapsed or are struggling to recover after revelations of poor accounting practices and audit failures. Tighter borrowing and slower economic growth may make more companies prone to accounting transgressions. In some emerging markets, excessive borrowing in dollars and weakening local currencies have already exposed companies to significant constraints. Investors will likely be very sensitive to any signal of weakness in internal controls. Overall, companies with robust governance practices are expected to be better positioned to face a market downturn, but the proof will be in the pudding.

4. Executive Misconduct and Key-Person Risk

2018 saw several business icons, such as Carlos Ghosn of the Renault-Nissan-Mitsubishi alliance, Martin Sorrell of WPP plc, Steve Wynn of Wynn Resorts, and Les Moonves of CBS, depart their leadership positions at their respective companies in embarrassment following misconduct allegations. Elon Musk maintained his post as CEO of Tesla, but was forced to relinquish the role of Chair of the Board after a settlement with the SEC over charges of stock manipulation in relation to a tweet claiming to take the company private. These and many other examples have given rise to concerns of how boards can provide sufficient oversight over CEO behavior, especially when the executive in person is considered emblematic of the company’s brand, and when their behavior can disproportionately impact the firm’s value. Investors are becoming more mindful of this key-person risk dependence, which can become more severe when the individual maintains control through economic ownership or via dual class shares. We expect more discussions about how companies can boost their succession plans and oversight mechanisms, including independent board leadership structures, to mitigate for such risks.

5. Executive Compensation: Pay in Volatile Markets  – and Fewer Guardrails?

Since the advent of say-on-pay in the U.S., we have not observed a major contraction in economic output, and stock prices have generally soared – and a contraction has only happened once in Europe, where say-on-pay existed in some markets before the financial crisis. 2018 was the first year of negative returns for the S&P 500 since 2008. However, some U.S. corporate profits reached record highs thanks to the stimulus provided by the Tax Cuts and Jobs Act of 2017. As the effect of the tax overhaul tapers off, and stock markets continue to reflect concerns over a potential economic slowdown, investors will pay close attention to trends in executive compensation. Will the prevalence of relative TSR ensure CEO pay increases despite a market downturn, and have companies installed safeguards to limit requisite payouts in down years? Will the use of stock-based awards result in higher dilution rates, as companies attempt to offset falling stock prices with issuance of more stock? In the U.S., the tax overhaul also triggered deregulation in performance-based pay practices, which may bring rise to potentially problematic pay structures. Furthermore, U.S. companies will provide additional context on CEO-worker pay ratios in response to shareholders and advocacy groups. Globally, transparency and oversight of compensation will be the main topics of concern at markets with less-detailed disclosure, as the case of Carlos Ghosn at Nissan exemplifies.

In the U.S., issues may be compounded by the removal of key provisions from the Internal Revenue Code Section 162(m). These provisions provided encouragement for companies to use performance-based compensation for executives, and to have a degree of transparency regarding performance metrics used in executive compensation programs. In addition, the code also promoted more frequent equity compensation plan submissions to shareholders than listing exchanges require. In the absence of these provisions, companies may opt to take a step back from the advances in good practices that the market has witnessed since 2011.

6. The #MeToo Movement: Equality in the Workplace

While #MeToo has primarily expressed itself over concerns about sexual harassment, the movement touches on a host of issues pertaining to equality in the workplace, including the gender pay gap, workplace discrimination, and gender diversity. Emphasis on accountability at the highest levels of the organization, employee training, and governance mechanisms to prevent inappropriate behavior should play a significant role in addressing sexual misconduct risks. Disclosures on gender pay equity, such as those now mandated in the U.K., will also serve as potential signs of gender imbalances, which may cause internal deliberations at companies as well as external engagement with investors and other stakeholders. As discussed above, a review of gender diversity at multiple levels of the organization may also help address unconscious biases and cultural obstacles.

7. Data Security and Data Privacy

Cybersecurity and data privacy will remain key topics of concern in most industries, and not only in the technology sector, as a vast array of companies rely on technology to manage sensitive information, including consumer data. Typically, governance weaknesses are discovered after the fact, so most investors will likely play close attention to crisis response and board or management oversight. The establishment of security risk management committees, the implementation of comprehensive programs across the organization, and the presence of directors with expertise in cybersecurity and technology may serve as preventive measures. In the U.S., perhaps the largest looming question regards potential legislation enacting regulatory safeguards on personal data.

8. Big Tech in the Spotlight

Technology companies are likely to face increased scrutiny given their size and their pervasiveness in the economy and society. From a pure governance standpoint, concerns over board independence, board leadership, and dual class share structures will continue to receive significant attention. As discussed above, data privacy and the use of consumer data are on the top of the agenda. Furthermore, the social impact of technology platforms will continue to be under review, including election interference and fake news. Social and environmental concerns regarding the supply chains and sourcing materials of technology devices may also be under the microscope. In other words, given their immense scale and their expansive user and consumer base, any activity conducted by big technology firms may be subject to examination.

9. Current Social Issues: Gun Violence and Opioids

In 2018, investor concerns over the public health crises in the U.S. associated with gun violence and the opioid epidemic appeared on proxy ballots in the form of shareholder proposals seeking better disclosure and governance mechanisms at companies that may be involved. Despite being relatively new, both campaigns proved very successful. Most opioid-related proposals were withdrawn by proponents following agreements with companies, while two of the three that went to a vote received majority support. Meanwhile both gun violence-related proposals at American Outdoor Brands Corporation and at Sturm, Ruger & Co. received support by a majority of votes cast. We expect these campaigns to continue in 2019 with further impetus given the level of responsiveness from companies and investors.

10. Politics, Protectionism, and Cross-Border Transactions

The race is on for the U.S. 2020 presidential election, and investors should expect to see a large number of shareholder proposals seeking disclosures on companies’ political spending or other political activities. Furthermore, politics in the era of populism can have a significant impact on markets and companies, as candidates will likely raise the anti-globalization rhetoric. In 2018, we saw the first example of government intervention in a merger transaction, with President Trump’s executive order to block the Qualcomm-Broadcom deal on the grounds of national security considerations. In Europe, Belgium and the Netherlands are raising protectionist measures against cross-border shareholder activism. Nevertheless, higher borrowing costs and market uncertainty may result in decreased M&A activity, as deals would become more expensive. That said, international investor activism is will likely continue in Europe and Asia, as we have recently seen at large-cap companies such as Nestle and Hyundai.

This post comes to us from Institutional Shareholder Services.