Corporate Governance and the Board -- What Works Best

1
Corporate Governance and the Board -- What Works
Best

• Financial Executives Summit
• Scottsdale
• May 7, 2001
• Richard M. Steinberg
• Leader, Corporate Governance

2
Why We Care About Corporate Governance

• Impetus for the PwC Study

3
Why All the Interest?

• Corporate upheavals, failures, misstated
  financial reports
• Increased regulatory scrutiny -- Blue Ribbon
  Committee-based new SEC and listing rules
• Shareholder activism -- institutional investors
  (CalPERS, TIAA-CREF), social investors (PIRC)
• Legal liability -- Federal Sentencing Guidelines,
  Caremark

3
4
Organizational Drivers - The US

• Corporate Directors Guidebook, American Bar
  Association, 1994
• Standards issued by investor groups such as
  CalPERS TIAA-CREF
• Statement on Corporate Governance, Business Round
  Table, 1997
• Principles of Corporate Governance Analysis and
  Recommendations, American Law Institute, 1994
• National Association of Corporate Directors
• SEC, NYSE, NASD and AMEX adopted new audit
  committee rules in December 1999

4
5
Around the World

• Canada -- Dey (94), CICA (95,99)
• UK -- Cadbury (92), Hampel (98), Turnbull (99)
• France -- Vienot (95,99)
• The Netherlands -- Peters (97)
• Belgium -- Cardon (98)
• Germany -- KonTraG (98)

• South Africa -- King (94)
• Australia -- Bosch (95)
• Hong Kong -- Hong Kong Exchange (99)
• Japan -- Principles (97)
• OECD -- Advisory Group (98)

5
6

The StudyCorporate Governance and the Board --
What Works Best
Conducted, written PricewaterhouseCoopers S
ponsored, published Institute of Internal
Auditors Research Foundation
7
Our Objective

• To help boards of directors improve the
  effectiveness of their oversight, thereby
  enabling them to enhance shareholder value

7
8
Methodology

• Reviewed over 200 publications
• Survey
• 72 directors, thought leaders in 9 countries
• In-person, in-depth interviews
• 28 directors in 5 countries
• PricewaterhouseCoopers experience in serving
  boards

8
9
Corporate Governance Responsibilities

• Board Responsibilities
• Corporate strategy and planning
• Risk management
• Values ethics -- tone at the top
• Measuring and monitoring performance
• Major transactions
• Management evaluation, compensation and
  succession
• Communications disclosure
• Board structure operations

9
10
1. Strategy and Planning

• Board contribution to strategy is lacking
• Area most in need of improvement
• One director says --

10
11
If the board isnt comfortable with the strategy
. . . it should tell management to rethink it,
and come back with something better. But, the
board shouldnt be involved in developing the
strategy. That is, noses in, fingers out.
U.S. director
11
12
1. Strategy Pitfalls

• Management
• Intractably committed to one course
• Impatient with directors not sharing commitment
  to chosen path
• Holding on to bad strategy too long
• Highly controlled strategy- discussion agenda

• Directors
• Hesitant to aggressively, constructively
  challenge
• Insufficiently prepared
• Fearing isolation, replacement
• Insufficient time, resources

12
13
1. Strategy and Planning

• Critical Elements for Effectiveness
• Enough time, atmosphere for full, frank strategy
  discussions
• Aggressive but constructive debates, bringing
  directors skills, knowledge, insight
• The right information on risks,
  interdependencies, resources, competitors
• Application of lessons learned from past
  successful, unsuccessful strategies

13
14
1. Strategy and Planning

• Critical Elements for Effectiveness
• Management uses robust process to develop
  strategy, with full buy-in
• Comfortable with planned extent of change
  incremental, substantial or transformational
• Satisfied tactical plans will result in
  successful implementation
• Consensus with management on performance measures
  for judging strategy

14
15
Theres nothing like a big screw up to make a
board get into the bowels of the real problem.
U.S. director
16
2. Risk Management

• Another top issue on the board agendaDirectors
  witness examples of unmanaged, unknown risk
  bringing other companies to their knees, and they
  want to avoid unpleasant surprises at their
  companies

16
17
2. Risk Management

• Pitfalls
• No common terminology -- talking at cross
  purposes
• Shortcutting the process, looking first at risk
  instead of strategic objectives
• Responsibility at too low organizational level
• Failing to eliminate programs not aligned with
  objectives
• Taking snapshot instead of ongoing program

17
18
2. Risk Management

• Critical Elements for Effectiveness
• Management has effective, robust process to
  identify, assess, manage risk
• Align risk management actions with companys
  strategy, business objectives
• Understands significant risks, and comfortable
  with how management addresses them
• Culture that assigns responsibility for and
  rewards appropriate risk management

18
19
Corporations are getting away from their core
activities and competencies into areas which have
far higher risk, without properly understanding
those risks. Australian director
19
20
3. Tone at the Top

• Critical Elements for Effectiveness
• Management practices desired values-based culture
• Robust code of conduct in place and adhered to,
  with effective communication channels
• Contact employees, customers, suppliers to
  independently assess de facto culture
• Focus on ethical issues in mergers and other
  major transactions -- including partner companies
• Directors ethics demonstrate desired values to
  management, employees, the world

20
21
Ive met some CEOs who had no respect for
ethical principles. They got ahead over the
strewn bodies of associates. U.S.
director
22
4. Measuring and Monitoring Performance

• A major issue boards grapple with today
• Few companies measure and track the right
  elements. Many companies dont understand what
  drives their shareholder value.
• Directors are reluctant to raise concerns about
  potential impending trouble, because conclusive
  evidence is often lacking.

22
23
Performance Measurement Linkages
IncentiveCompensation
Strategies Tactics
Value Drivers
Shareholder Value
RiskManagement
PerformanceMeasures
23
24
4. Measuring and Monitoring Performance

• Critical Elements for Effectiveness
• Measures link to strategy, tactics, value drivers
• Measures balance
• financial with non-financial
• forward looking with retrospective
• benchmarking against competitors, peers and best
  practice
• key scorecard categories operations, customers,
  employees, etc.
• Targets set are tough, but not disincentives

24
25
4. Measuring and Monitoring Performance

• Critical Elements for Effectiveness
• Comfortable information systems provide reliable,
  timely information
• Measures link to rewards throughout the company,
  so all are pulling toward common goals
• Rigorous follow up, identifying reasons for
  missed targets -- both under performing and
  greatly over performing

25
26
Although boards hate bad news . . . executives
need to get bad news on the table, and get it on
the table early. Australian director
27
5. Transformational Transactions

• Critical Elements for Effectiveness
• Complete comfort with business reasons for
  proposed transaction, including how it links to
  current strategy
• Critical evaluation of managements information,
  transaction assumptions, ability to integrate
  target successfully
• Application of lessons learned from past
  successful and unsuccessful transactions
• Courage to walk away from a bad deal

27
28
5. Transformational Transactions

• Critical Elements for Effectiveness
• Obtaining counsel of objective advisors
• Recognize change in allegiance and differing
  objectives of management in to-be-divested units
• Ensure company has right partners, reliable due
  diligence and properly structured deal before
  entering joint venture or alliance
• Critical review of proposed capital expenditures,
  ensuring link to strategy

28
29
6. Management Evaluation, Compensation and
Succession

• Tends to be a sticky issue for directors, given
  natural discomfort with judging peersBoards
  increasingly proactive in replacing executives
  who are not working out -- but problems might
  have been avoided

29
30
High executive turnover does not bode well. It
indicates a CEO that is fickle, intolerant or
difficult to work for. U.S. director
31
6. Management Evaluation, Compensation and
Succession

• Critical Elements for Effectiveness
• Agree upon performance criteria, targets, link to
  desired behavior
• Continually monitor performance, providing clear,
  constructive feedback to the CEO
• Ensure compensation helps retain the best talent,
  while paying for desired performance
• Courage to replace CEO if necessary
• Evaluate, develop relationships with key
  executives
• Comfortable with succession plans

31
32
7. External Communications

• Financial reporting reliability in spotlight,
  with close regulator attention to incidents of
  improper financial reportingMarket focus
  increasingly quarterly, short-term. Also
  witnessing markets moving on non-financial
  information
• SEC focus on fair disclosure -- Reg FD

32
33
7. External Communications

• Critical Elements for Effectiveness
• Ensure skilled directors evaluate financial
  reports
• Understand operating information disclosed by
  company, and how reliability is assured
• Satisfaction management has effective
  communications policies and processes
• Comfortable market-sensitive information properly
  handled to protect current, future shareholders

33
34
7. External Communications

• For leading audit committee practices, see the
  companion reportImproving Audit Committee
  Performance - What Works Best, 2nd edition

34
35
8. Board Dynamics

• Most corporate governance recommendations focus
  on matters of board form, as surrogates for
  improved board performance
• independence
• board size
• committee structure
• number of meetings
• While useful, these dont ensure effectiveness

35
36
I would rather see a smaller board wrestle with
all the problems than a larger board delegate
everything out. American director
37
Once you get beyond 10 or 12 at a board table,
you dont discuss -- you wait for your turn to
speak. British director
38
8. Board Dynamics

• Good
• CEO believes he/she can learn from board
• Real discussion in meetings
• Relationships outside boardroom
• Atmosphere of openness, trust
• Process, not event -- continuous responsibility
• Assertive, constructive engagement

• Bad
• Board is a necessary evil
• Good meeting short meeting
• Rigid agenda, regimented meetings
• Impatience with directors
• Directors beholden to CEO
• All information from manage-ment, little
  analysis, no options

38
39
Directors need to see their role as a process,
not an event. Their role goes beyond attending
meetings. American thought leader
40
8. Board Dynamics

• Thought leaders agreeDirectors need to spend
  more time fulfilling their duties, and need to be
  paid more

40
41
Contact Information

• Richard M. Steinberg
• PricewaterhouseCoopers, Leader, Corporate
  Governance
• e-mail richard.m.steinberg_at_us.pwcglobal.com
• phone [phone]

41
42
pwc