Board Evolution: Progress Made, Yet Challenges Persist

Corporate directors have adjusted to significant changes in the governance environment during the last year. On the regulatory front, the Securities and Exchange Commission (SEC) continues to implement new rules stemming from the Dodd-Frank Act, causing companies to rethink and react. The voice of shareholders has never been louder, pressuring companies to adopt structural governance changes by submitting proposals on board declassification, splitting CEO and board chair roles, and majority voting. Shareholder “say on pay” votes moved into a second year with some companies uncertain about how to respond based on their voting results. Plus, more companies had their shareholders withhold approval on their “say on pay” votes, maintaining the pressure on compensation committees.

In the summer of 2012, 860 public company directors responded to PwC’s 2012 Annual Corporate Directors Survey. Of those directors, 70% serve on the boards of companies with more than $1 billion in annual revenue. As a result, the survey’s findings reflect the practices and boardroom perspectives of many of today’s world-class companies. We structured the survey to provide pragmatic feedback directors can use to assess and improve performance in areas that are “top of mind” to today’s boards. The survey shows directors are clearly making progress and enhancing their practices. At the same time, directors acknowledge the numerous challenges they still face. The following are the highlights:

Boards are making progress

• There has been a marked increase in the hours directors dedicate to board work. More than half of directors say the amount of time they spent rose last year. Two-thirds of those increased their hours over 10%, and one-fifth more than 20%. Compensation committee hours rose for half of companies, and more than one-third of audit committees increased their hours. This is not surprising, given the pressure on compensation issues and fraud prevention, among others, these committees respectively need to address. However, directors still acknowledge challenges, as three-quarters want to dedicate more time to overseeing strategy and meeting with company executives.
• There are significant differences in how concerned directors are with the level of shareholder support for director nominees. Specifically, the longer a director has been on a board, the less concerned he or she is with negative shareholder votes when considering the renomination of a fellow board member.
• Of the companies that have a combined Chair and CEO, about half of these boards are already discussing splitting the role at their next CEO succession. The prevalence of these conversations suggests many directors are re-evaluating their board leadership structure—perhaps in response to continued shareholder activism against combining the role.
• With the SEC’s whistleblower rules in effect and a sharp increase in bribery enforcement, directors are taking specific actions overseeing compliance programs designed to reduce fraud. They have progressed by adopting a number of leading practices like spending more time discussing “tone at the top” and focusing on the risks embedded in compensation plans.
• Sixty-four percent of directors responded that their companies’ compensation practices changed in response to their “say on pay” vote. These changes included enhancing proxy statement compensation disclosures, making compensation more performance-based, and increasing communications with proxy advisory firms. The companies most likely to make changes were those that received less than 70% shareholder support for their pay plans. Our survey revealed that about 2% of companies decreased overall compensation levels.
• Directors spent less time on crisis management planning during the last year. Perhaps it’s not surprising, then, that more than one-third want to spend more time on it in the future. This may signal that boards feel that although this issue requires considerable oversight attention, it may not be a high-priority topic every year.

Yet challenges persist

• Dissatisfaction with the performance of an individual fellow board member is fairly common and presents an ongoing challenge—with aging and lack of expertise cited as the key reasons. Nearly one-third of directors believe someone on their board should be replaced. Other studies show both the average age of directors and average board tenure continues to grow. In our survey, 35% of respondents have served on their boards for over 10 years.
• 37% of boards have no clear allocation of specific responsibilities for overseeing major risks among the board and its committees. Many directors understand the risks the company faces but are not entirely sure how the board allocates responsibility for them. This structural disconnect is challenging and could prove troublesome in the long run.
• Over half of directors (52%) believe that some form of annual education should be required. However, nearly one in five (19%) had no board education during the last year; more than one-third (37%) did eight hours or less. Of those who believe annual director education should be required, 44% participated in less than four hours of education in the last year, and 21% did none at all. When thinking about this data, it should be noted that there are no specific external education requirements for directors. And director education is no longer considered part of the corporate governance evaluation of major proxy advisory firms.
• When asked about sources used to recruit new directors, nine out of 10 directors said they look to the recommendations of other directors; 11% consider investor-recommended board candidates.
• Many voices influence boards’ decisions about executive compensation: 86% of directors cited compensation consultants as “very influential,” followed closely by the CEO (79%), and institutional investors (54%). While the media has extensively reported on executive compensation issues—in some cases quite critically—only 12% of directors said this group had much of an influence on their decisions.
• Directors believe proxy advisory firms have a lot of influence, but nearly half of directors describe the thoroughness of those firms’ work and the quality of their recommendations, as “fair” or “poor.” Directors are reaching out to proxy advisory firms more frequently, with 53% communicating with them during the last year.
• While directors see the opportunities in emerging technologies like social media, some are uncomfortable with the challenge of effectively overseeing IT strategy and risk. More than two-thirds of directors we surveyed said they are not sufficiently aware of how their company monitors social media for adverse publicity. And more than half say they are not adequately engaged with new business models that are enabled by IT.
• Considering topics of particular regulatory and shareholder interest, directors are most concerned with (and spending the most time on) two: mandatory audit firm rotation and proxy access. 75% of directors have “not much” or no concern with conflict minerals, and 85% don’t expect to spend much time on the issue.