The four pillars of corporate governance practices that build long term value for any company.
By Carlos Solorzano, Managing Partner and Jose Ruiz, CEO Alder Koten
There is a common belief that only large or public companies with many shareholders need to be concerned about, or can benefit from, implementing corporate governance practices.
The truth is that all companies regardless of size (big, medium or small), type of ownership (private or public), or stage early stage or established — compete in an environment where good governance is a business imperative.
One size doesn’t fit all, but good governance practices will impact the performance and long-term viability of every company.
In his final letter to directors of public companies worldwide, William McNabb III — current Chairman and CEO of Vanguard Group, he states the 4 pillars on how Vanguard evaluates corporate governance practices.
The 4 pillars are:
1. The board: The board must be a high-functioning, well-composed, independent, engaged, diverse, and experienced board with effective ongoing evaluation practices. It is common to see more and more how boards are removing and adding new directors to enforce diversity and independence, as Tesla did back in July when they added two directors to diversify a board that was closely tied to Musk.
2. Governance structures: Provisions and structures that empower shareholders and protect their rights. Directors must declare any conflict of interest and refrain from voting on matters in which they have interest. The company and the board must enforce a culture of integrity and compliance. There are plenty of examples of conflict of interest, one of the most recent, The Financial Industry Regulatory Authority who has deep ties to the securities industry. In order to create and cultivate this culture, you must adopt a conflict of interest policy, implement a code of business conduct and a clear process to report and deal with non-compliance, even consider a whistleblower policy.
3. Appropriate compensation: Pay that incentivizes relative outperformance over the long term.The board must set directors fees that will attract very good candidates, but at the same time won’t create conflict regarding independence.
Another key function of the board done through the Compensation Committee is to establish performance targets and objectives for top executives, including the CEO, and continuously evaluate their performance. It is very important that the compensation, including equity-and stock option plans), is strongly tied to performance. One current situation regarding compensation is the fight that Jerry Jones (Dallas Cowboys owner) has against the NFL´s Compensation Committee regarding the Commissioner new salary deal
4. Risk oversight: Effective, integrated, and ongoing oversight of relevant industry- and company-specific risks.Companies should regularly identify and assess the risks they face, including financial, operational, reputational, environmental, industry-related, cybersecurity and legal risks.The board must establish the risk tolerance of the company and must develop a framework and accountabilities to manage risk. It should also review the systems and controls that management has in place to identify, assess, mitigate and monitor risk.
Directors are responsible for understanding the current and emerging short and long-term risks the company faces and the performance implications. They should challenge management’s assumptions and the adequacy of the company’s risk management processes and procedures. There are countless stories about risk oversight, including Equifax who was made aware of a potential breach six months before the data breach that affected at least 145 million Americans.
There are also 3 important takeaways from that letter that serves as a blueprint on how Vanguard approaches their stewardship efforts and that we at Alder Koten agree are keys on how to shape an organization.
Good governance starts with a great board. — A great board is one of a company’s most critical strategic assets. It is important to have the right mix of skill, expertise, thought, tenure and personal characteristics as well as a diverse board in order to obtain a growth in sustainable economic value while protecting shareholders interests.
Diversity is and will continue to be a topic that companies need to focus on. As evidence proves, a board with more women outperform those that are less diverse. Diversity is one of the most important Best Governance Practices.
Based on information on the 30% Club ( a global organization that advocates for greater representation of women in boardrooms and leadership roles), currently in the S&P 100 the percentage is 23.6%, up from 20.2% in 2014, but in the S&P 500 the percentage is only 19.9%
Source: http://www.catalyst.org/charts/10752 [show]
Directors are shareholders´ eyes and ears on risk — Shareholders rely on a strong board to oversee the strategy for identifying opportunities and mitigating risks. Shareholders expect the board to disclose relevant risks (such as the recent Uber cybersecurity breach in which Uber concealed the cyber attack for more than a year.
Engagement builds mutual understanding and a basis for progress: Dialogue with companies is core to Vanguard’s stewardship approach and should be on top of the companies priorities not only with Vanguard but with the rest of shareholders. Board and Management alike must communicate their perspective and thinking on the issues at hand must be a priority for all companies regarding of size.
Long-term value building is possible if companies focus on the four pillars of Corporate Governance Practices.
About us: We help clients build boards that deliver value to management and to investors. Alder Koten consultants maintain close ties to outstanding leaders and potential directors, in multiple industries and geographies. These relationships support our ability to identify and evaluate exceptional candidates for every appointment.
