The new report by the National Association of Corporate Directors (“NACD”), A Framework for Governing into the Future (the “NACD Report”), is a valuable contribution to corporate governance discourse. Among its primary offerings are a forward-looking perspective on governance and a vision of a more engaged and committed board.
The NACD Report is perhaps the most prominent statement of governance principles since the 2018 release of the Commonsense Principles of Governance Practice 2.0. Furthermore, the NACD Report builds upon, yet differs in style and substance from, the tactical approach of the Commonsense Principles and the last (2016) version of the Business Roundtable’s Principles of Corporate Governance. The NACD Report’s key principles, their potential implications, and important questions for directors are all useful fodder for future board governance committee conversations.
Most stakeholders would readily acknowledge the specific challenges identified by NACD: geopolitical tensions; supply chain disruption; increased risks of inflation and recession; changes in the nature of the workforce; the pace of technological advancement; continued pressures from institutional investors on financial and environmental/social progress; increased disclosure requirements; “short-termism” based threats from activist investors; and increased regulatory and litigation risks.
In response to these challenges, the NACD Report encourages a more substantial platform for corporate governance that views the quality of board governance as increasingly critical to enterprise sustainability.
The specific principles emphasize the importance of an agile and well-informed board “that is purpose driven and understands the interrelationships and co-dependencies between long-term corporate success” and the interests of all the organization’s primary stakeholders.
Principle No. 1-Purpose: “The company’s purpose, as defined by the problems addressed and the needs filled by its goods and/or services, should drive its behavior, shape its governance, and position the company to create sustainable long-term value.”
This principle adopts the “stakeholder capitalism” perspective that the longer-term interests of the company and its shareholders depend on meeting the fair expectations of its constituents, while managing and mitigating the negative impacts (risks) of corporate activities. This may require addressing environmental and social issues.
Corporate purpose should inform corporate decisions relating to the strategic plan and its risk portfolio, making purpose a focus of board activity.
Principle No. 2-Accountability: “The board is responsible for the long-term sustainable performance of the company, and governance structures and practices should be designed by the board to position it to function effectively, efficiently, and in an accountable manner.”
This principle expresses the expectation that the board will periodically consider whether its governance structures further its purpose, and when considering a major transaction, it will make an informed evaluation of the decision’s impact on its primary stakeholders.
It is important that the board and management have a common understanding of the board’s primary responsibilities (e.g., the extent of its delegation of authority to management) and its responsibilities for setting policy and expectations regarding culture, and oversight of management’s performance.
Principle No. 3-Objectivity and Oversight: “Governance structures and practices should position the board to provide objective judgment and active oversight, supported by board leadership that is distinct from management.”
This principle stresses the importance of director independence from management, of a regular executive session practice, and of a formal reporting process on mission critical risks. The board should not be unduly dependent on management to determine and supply what the board needs to know. Rather, it should exercise its own judgment.
The board is responsible for determining its own priorities and thus should be directly involved in agenda setting (and not simply defer to management). The board is expected to allocate the majority of its time to strategy, risk, and talent concerns, and management should not load it with information that can be provided before board meetings.
Principle No. 4-Information: “Governance structures and practices should be designed to support the board in determining its own priorities, agendas, and information needs, and to assist the board in focusing on priority issues.”
This principle stresses that the board and management should work together to implement robust information and reporting systems for bringing essential information to the board’s attention in a timely manner. The board and management should also develop a framework for communicating between board meetings, including a process for assuring that meeting-specific material is distributed in advance.
The principle emphasizes board agility, meaning the capacity to attend to and address key issues in a decisive, efficient, and well-informed manner and to pivot from an established course of action when necessary.
Principle No.5-Relationships: “Governance structures and practices should support a relationship between the board and senior management that is open, objective, and both constructively supportive and challenging”.
This principle calls for the roles of board and management to be clear and distinct. This includes clear behavioral norms designed to support trust and the distinction between the roles of the board and of management.
The principle affirms the view that the board/management relationship can be collegial and supportive without marginalizing the board’s basic monitoring role and responsibility to be constructively skeptical.
Principle No. 6: Strategy and Risk: “Governance structures and practices should support the board as adaptive and agile, focused on strategy and risk, and prepared to take appropriate action in a crisis.”
This principle makes clear that directors are expected to devote more time to staying current on the range of performance, market, and competitive forces and other factors that may affect risk and strategy. The board may be expected to become more involved in “future-proofing” corporate strategy.
Similarly, boards should continue to closely oversee operational and corporate compliance risks and be prepared to address such risks when they arise. This may include active oversight of management’s crisis-related responses. The board should periodically review risk and compliance control systems to ensure they are sufficient.
Principle No. 7-Talent: “Governance structures and practices should support board focus on the corporate strategies, policies, and programs that support the attraction, retention, development, compensation, and well-being of the talented and motivated workforce required for the corporation to succeed.”
This principle calls for boards to provide greater oversight of workforce recruitment and retention efforts. This requires the board to appreciate the specific interests of the workforce (such as a clear corporate purpose and culture, appealing organizational values, and respect (through compensation or otherwise) for the broad range of contributions made by employees).
Also, additional emphasis should be placed on the board’s role in CEO selection and succession and on the development of compensation systems that align with a broader range of stakeholder interests. Increased board consideration should be given to rising CEO compensation relative to corporate performance and average worker pay.
Principle No. 8-Corporate and Board Culture: “Governance structures and practices should position the board to provide oversight of corporate and board culture, with the objective of promoting integrity, inclusion, and responsibility.”
This principle stresses that developing and maintaining a positive and ethical culture is a shared board/management responsibility. The board should thus communicate to management its expectations on corporate culture and the information systems by which the board is kept updated on culture matters.
Similarly, the board and management should agree on what matters/developments the board should be promptly informed of. The culture of the board and of its committees should also make directors comfortable engaging in complete and unfettered discourse.
Principle No. 9-Composition, Refreshment, and Diversity: “Governance structures and practices should be designed to ensure that board and committee composition align with changing needs and that directors are competent, committed, and diverse”.
This principle makes clear that the required levels of director competency and commitment are being elevated by a combination of the need for board agility and the expanding board agenda. This may require a reassessment and forward-looking upgrade of board composition. Furthermore, directorships should not be regarded as sinecures.
The commitment required of board members is significantly increasing and with it concerns about individual director over-boarding and the need for policies that limit director service on other boards. Board succession policies should be considered together with appropriate refreshment mechanisms.
Principle No. 10-Transparency, Communications, and Engagement: “Governance structures and practices should be transparent and designed to encourage communication and engagement with shareholders and other key stakeholders on matters of importance.”
This principle stresses the need for candor in shareholder communications. The board and management should work together to develop guidelines for corporate speech concerning political and social developments, as well as for oversight of the CEO’s public comments.
Boards should be attentive to improving relationships and communications with key stakeholders, including employees. Such communications should include some discussion of the company’s governance structures and practices and their suitability to the current business and social environment.
The new NACD Report is an important development in corporate governance law and serves to increase the role and responsibility of the board of directors and to clarify and enhance the board/management dynamic. It is thus an exceptional resource for boards and their advisers on governance matters and will be highly useful to the chief legal officer as he or she advises members of the board on their duties and responsibilities.
This post comes to us from Michael W. Peregrine, a partner at McDermott Will & Emery who advises corporations, officers, and directors on matters relating to corporate governance, fiduciary duties, and officer and director liability issues. His views do not necessarily reflect the views of the firm or its clients.