Corporate Governance 2.0: Back to First Principles (HBR)
Extract from Corporate Governance 2.0
We need to return to first principles rather than meander toward “best practices.” by Guhan Subramanian From the Magazine (March 2015)
Although corporate governance is a hot topic in boardrooms today, it is a relatively new field of study. Its roots can be traced back to the seminal work of Adolf Berle and Gardiner Means in the 1930s, but the field as we now know it emerged only in the 1970s. Achieving best practices has been hindered by a patchwork system of regulation, a mix of public and private policy makers, and the lack of an accepted metric for determining what constitutes successful corporate governance. The nature of the debate does not help either: shrill voices, a seemingly unbridgeable divide between shareholder activists and managers, rampant conflicts of interest, and previously staked-out positions that crowd out thoughtful discussion. The result is a system that no one would have designed from scratch, with unintended consequences that occasionally subvert both common sense and public policy.
Consider the following:
- In 2010 the hedge fund titans Steve Roth and Bill Ackman bought 27% of J.C. Penney before having to disclose their position; Penney’s CEO, Mike Ullman, discovered the raid only when Roth telephoned him about it.
- The proxy advisory firm Glass Lewis has announced that it will recommend a vote against the chairperson of the nominating and governance committee at any company that imposes procedural limits on litigation against the company, notwithstanding the consensus view among academics and practitioners that shareholder litigation has gotten out of control in the United States.
- In 2012 JPMorgan Chase had no directors with risk expertise on the board’s risk committee—a deficiency that was corrected only after Bruno Iksil, the “London Whale,” caused $6 billion in trading losses through what JPM’s CEO, Jamie Dimon, called a “Risk 101 mistake.”
- Allergan, a health care company, recently sought to impose onerous information requirements on efforts to call a special meeting of shareholders, and then promptly waived those requirements just before they would have been invalidated by the Delaware Chancery Court.
- The corporate governance watchdog Institutional Shareholder Services (ISS) issued a report claiming that shareholders do better, on average, by voting for the insurgent slate in proxy contests; within hours, the law firm Wachtell, Lipton, Rosen & Katz issued a memorandum to clients claiming that the study was flawed.
- The same ISS issues a “QuickScore” for every major U.S. public company, yet it won’t tell you how it calculates your company’s score or how you can improve it—unless you pay for this “advice.”
We can do better. And with trillions of dollars of wealth governed by these rules of the game, we must do better. In this article I propose Corporate Governance 2.0: not quite a clean-sheet redesign of the current system, but a back-to-basics reconceptualization of what sound corporate governance means. It is based on three core principles—principles that reasonable people on all sides of the debate should be able to agree on once they have untethered from vested interests and staked-out positions. I apply these principles to develop a package solution to some of the current hot-button issues in corporate governance.
The overall approach draws from basic negotiation theory: Rather than fighting issue by issue, as boards and shareholder activist groups currently do, they should take a bundled approach that allows for give-and-take across issues, thereby increasing the likelihood of meaningful progress. The result would be a step change in the quality of corporate governance, rather than incremental meandering toward what may (or may not) be a better corporate governance regime for U.S. public companies.
Principle #1: Boards Should Have the Right to Manage the Company for the Long Term
Perhaps the biggest failure of corporate governance today is its emphasis on short-term performance. Managers are consumed by unrelenting pressure to meet quarterly earnings, knowing that even a penny miss on earnings per share could mean a sharp hit to the stock price. If the downturn is severe enough, activist hedge funds will start to become interested in taking a position and then clamoring for change. And, of course, there are the lawyers, ever ready to file litigation after a big drop in the company’s stock.
It is ironic that companies today have to go private in order to focus on the long term. Michael Dell, for example, took Dell private in 2013 because, he claimed, the fundamental changes the company needed could not be achieved in the glare of the public markets. A year later he wrote in the Wall Street Journal, “Privatization has unleashed the passion of our team members who have the freedom to focus first on innovating for customers in a way that was not always possible when striving to meet the quarterly demands of Wall Street.” The idea that “innovating for customers” can be done more effectively in a private company is deeply troubling; public companies, after all, are still the largest driver of wealth creation in our economy.
Principle #2: Boards Should Install Mechanisms to Ensure the Best Possible People in the Boardroom
In exchange for the right to run the company for the long term, boards have an obligation to ensure the proper mix of skills and perspectives in the boardroom. Shareholder activists have proposed several measures in recent years to push toward this goal—principally age limits and term limits, but also gender and other diversity requirements. According to the most recent NACD Public Company Governance Survey, approximately 50% of U.S. public companies have age limits, and approximately 8% have term limits. ISS is urging more companies to adopt such limits, and if history is any guide, boards will give the idea serious consideration.
Activists and corporate governance rating agencies are motivated by a sense that boards don’t take a hard look at their composition and whether the skill set on the board reflects the needs of the company. Too often directors are allowed to continue because it’s difficult to ask them to step down. But age and term limits are a blunt instrument for achieving optimal board composition. Anyone who has served on a corporate board knows that an individual director’s contribution has little to do with either age or tenure. If anything, the correlation is likely to be positive. As for age limits, directors who have retired from full-time employment can devote themselves to their work on the board. And as for term limits, directors will often need a decade to shape strategy and evaluate the success of its execution; moreover, directors who have been in office longer than the current CEO are more likely to be able to challenge him or her when necessary. Yet these are precisely the directors who would be forced out by age limits or term limits.
Principle #3: Boards Should Give Shareholders an Orderly Voice
Today, when an activist investor threatens a proxy contest or a strategic buyer makes a hostile tender offer, boards tend to see their role as “defender of the corporate bastion,” which often leads to a no-holds-barred, scorched-earth, throw-all-the- furniture-against-the-door campaign against the raiders. As George “Skip” Battle, then the lead director at PeopleSoft, put it to me in the context of Oracle’s 2003 hostile takeover bid for his company, “This is the closest thing you get in American business to war.”
SOURCE: https://hbr.org/2015/03/corporate-governance-2-0
Question 1 (25 marks)
The article criticises JP Morgan Chase for having no directors with risk expertise on the board’s risk committee. In light of this, discuss other characteristics such as ICRAFT that the board of directors should require to link ethics to corporate governance.
Question 2 (25 marks)
The biggest problem in governance is the focus on short-term performance with Dell for example going private to avoid Wall Street’s quarterly earnings. Considering this argue the characteristics and merits of the alternative to the Shareholder Theory in a comparative analysis.
Question 3 (25 marks)
To improve corporate governance, evaluate why Corporate Social Responsibility (CSR) would or would not be a good approach for a company.
Question 4 (25 marks)
In an analysis of King IV and the Companies Act of 2008, critically examine this article in the South African context.
Business Ethics Answers: Expert Answers on Above Business Ethics Questions
Board characteristics (ICRAFT & ethics in governance)
The board characteristics features are integrity, competence, responsibility, accountability, fairness and transparency.
Shareholder theory versus alternatives
The main focus of shareholder theory is on profit maximization and short term returns whereas the stakeholder theory takes into consideration the proper balance with respect to the needs of shareholders, employees, customers and the society. The stakeholder model is therefore the best one in terms of promoting long term sustainability, innovation and ethical practices to operate.
CSR as a governance tool
CSR is considered as an important governance tool as it helps businesses in aligning its ethics, sustainability and community interest. It is also helpful in building reputation and positive stakeholder relationships. The chances of litigation are less and its main limitation is the loss of its impact if it is not properly integrated into the strategy.
King IV & Companies Act
King IV is known for promoting ethical leadership, transparency and stakeholder inclusivity. Companies Act is responsible for promoting accountability, stakeholder protection and director duties. If they are utilised in combination, they would positively strengthen governance by merging compliance with principles
| Disclaimer: This answer is a model for study and reference purposes only. Please do not submit it as your own work. |
