The Fearless Boardroom

Posted by Laurie Hays, Edelman, on Tuesday, September 24, 2019

Societal and governance issues pelting boards of directors—from the rise of the #MeToo movement, activist investors and impact funds are starting to redefine the traditional relationship between directors and the CEO. Boards once pals with leadership while keeping to the tradition of not meddling are now assessing potential structural changes needed to create a more productive—and safer—relationship.

With directors’ personal reputations at stake, as well as personal liability, they are strengthening monitoring programs, asking tougher questions and engaging in more vigorous debate on topics boards used to avoid, such as sexual harassment by the CEO. The upshot: The question now is not what did the board know but why didn’t the board know?

“The danger of the CEO getting directors in trouble as their personal activities have come into focus has grown exponentially,” observes Charles Elson, director of the Center for Corporate Governance at the University of Delaware.

The Business Roundtable, which includes some of the largest U.S. companies, just underscored the need for boards to represent all stakeholders—not just the shareholder—with a new statement redefining “the purpose of a corporation to promote ‘an economy that serves all Americans.’” The statement supersedes previous principles of corporate governance around shareholder primacy and outlines a “modern standard” for corporate responsibility.

Why Now?

Despite the Sarbanes Oxley Act in 2002 cracking down on corporate fraud and strengthening the role of the independent director, corporate crises have exploded in recent years. PwC, in its first-ever Global Crisis Survey released in June and considered the most comprehensive repository of corporate crisis data, found that 70% of 2,084 responding organizations had experienced at least one major crisis in the past five years. More chief executives were dismissed in 2018 for ethical lapses reflecting scandals or improper conduct than for financial performance or board struggles, according to a PwC study of CEO turnover.

Several factors explain the crisis cavalcade:

• The American dream has been fraying due in part to the enormous wealth gap

• Social media has enabled employees to more easily expose wrongdoing either through social media or traditional media. It’s no longer easy—almost impossible—to buy silence.

• Employees, especially millennials, increasingly favor their companies and CEOs helping solve societal issues—and protesting when they don’t. Edelman’s respected annual Global Trust Barometer found that 70% of employees this year considered it critically important for “my CEO” to take the lead on change.

• Activist investors, meanwhile, are circling and using any corporate governance weakness to gain leverage. Expect institutional investors and activists to accelerate their demand for board quality, effectiveness and shareholder accountability.

Dan Schulman, CEO of PayPal, identifies reverse-Friedmanism—that the sole purpose of a company isn’t to make money for shareholders—as the reason companies and boards must pay attention to more than shareholder returns. For his part, Schulman is paying particular attention to his employees, their salaries and their concerns. When the North Carolina legislature passed a law requiring people to use bathrooms that match the gender on their birth certificates instead of their gender identity in 2016, he canceled plans to open a global operations center in Charlotte and invest $3.6 million in the area.

He believes business needs a social mission. “You have to make your values and the values of your company real to people through action. It is not easy. Sometimes it’s uncomfortable to take those stands, but employees and customers expect that of us,” Schulman says.

Accurate Information

Directors for the most part say they are always sweating what they don’t know about what’s going on inside their companies. They prefer to assume the CEO isn’t hiding anything and that the CEO welcomes their questions and objective opinions. They worry about micromanaging.

“It’s not micromanaging if a board is giving consideration to the big “headline risk factors,” says Harvard Business School Professor Amy Edmondson, who studies how candor at all levels creates successor enterprises and better results. “Nobody wants to be the CEO who needs babysitting, so how about being the leader who welcomes the board as a partner looking out for the CEO and the company’s reputation?”

For sure, the buck increasingly stops with the board. In a recently published memo, noted mergers-and-acquisitions lawyer Martin Lipton warns boards that they face real exposure from failure to monitor their company properly. He cites a Delaware decision in June creates a new standard and that “to satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and monitor it themselves.” Exposure from the court’s decision is real, he maintains.

A sign: This year, companies including JPMorgan Chase, Blackstone, KKR, Carlyle Group, Aflac and Moelis & Co. added #MeToo language to their annual reports. Before 2018, the word ‘sexual’ had only been mentioned once in the risk section of publicly traded annual reports. But in the first half of 2019, nine public filings included it, according to Business Insider.

JP Morgan Chase’s reputation section reads: “Damage to JPMorgan Chase’s reputation could harm its businesses…Harm to JPMorgan Chase’s reputation can arise from numerous sources, including: employee misconduct, including discriminatory behavior or harassment, not appropriately managing social and environmental risk issues associated with its business activities or those of its clients.”

The New Playbook

The strains require a fresh approach to identify new structures for business strategy and governance. It isn’t clear yet what those structures look like.

Stephen Davis, a governance expert at Harvard Law School believes that the independent board model “isn’t truly workable without a crucial reboot.” Namely, directors need their own staff to provide oversight information that will help them assess whether all stakeholders’ interests are being served.

One example: Boards receive loads of homework and data to review before every meeting. Did the annual employee culture climate surveys at companies like NBC, Weinstein & Co. and CBS offer any hint of a hostile work environment that made women feel unsafe? Even if women didn’t speak up, an analysis around why questions weren’t answered can provide useful insights.

Directors with 20-20 hindsight need independent advisors to review such surveys and retool the analysis to generate questions that will be more insightful.

What is the structure for considering issues beyond financial performance for a CEO’s annual review discussion; How to hold a conversation about culture to ascertain whether the CEO and his team are following the company’s code of conduct and conflict of interest—which would take the question beyond checking boxes on the Directors and Officers liability insurance form.

Directors can also ask the kinds of tough questions that could give an activist an opening—whether it applies to muddled strategic communications, close relationships with the CEO that cloud judgments, or lavish spending? Directors can run through a simulation of an activist attack.

Can directors help CEOs decide when to take a stand on social issues that, if not handled properly, could harm trust with employees and endorsers? Sheila Hooda, independent director on the boards of Mutual of Omaha, ProSight Global, and Virtus Investment Partners, proposes the structure work more like a “partnership between the board and the CEO to serve these enhanced needs of governance.”

In today’s disruptive environment, CEOs might just welcome a fearless board. In the long run, they will attract longer-term investors and keep themselves and their companies out of reputation-busting trouble.