NACD Investor Perspectives: Critical Issues for Board Focus in 2015

As part of our mission to advance exemplary board leadership, the National Association of Corporate Directors (NACD) engages in ongoing dialogue with major U.S. institutional investors representing approximately $14 trillion in assets under management. [1] This post reflects NACD’s perspectives on recent conversations, including group and individual discussions with eight leading investors and several roundtable meetings between investors and Fortune 500 committee chairs. Several themes emerged regarding important issues for boards to consider in preparation for the upcoming proxy season:

• Investors are focused on “drivers” of effective board leadership.
• Investors will hold directors accountable when they believe shareholder rights have been undermined.
• High-quality communication between boards and investors is about context, not volume.

Investors are focused on “drivers” of effective board leadership.

Discussion participants noted that even where investors share priorities on a particular corporate governance issue, their “tactics”—such as specific proxy voting policy guidelines or approaches to engagement with portfolio companies on that issue—may be quite different.

Despite those differences, when asked about their 2015 priorities for the director community in general, several investors agreed with one who said, “Increasingly, compensation is often viewed as an outcome. We’re much more interested in what we see as the drivers [of such outcomes], including key board processes.” Discussion participants highlighted two particular categories of boardroom processes:

• Board “refreshment” practices. The importance of board composition, director succession planning, board evaluation processes, and director skillsets has been a common theme in NACD’s multi-stakeholder dialogues across 2014, and investors emphasized these issues will continue to be top-of-mind in 2015. Several investors noted that “observable components such as director tenure and backgrounds are neither inherently good nor bad, but they help investors get a picture of what’s important to the board and the company.” Evidence that boards are taking a strategic approach to director succession planning is of critical importance to investors: “At companies where one-third or even half of the board will be at retirement age in the next three to five years, what’s the plan? Will there be a staggered replacement or a wholesale change? We believe tenure has value, and continuity is important, so it’s very valuable to investors to understand how boards will be approaching this issue proactively.” Participants agreed that these responsibilities are particularly central to nominating/governance committees, but pointed out that certain investors “will hold the entire board responsible for good stewardship of its own succession plan.”
• Board engagement in strategy-setting and oversight of risk management activities. The recently released Report of the NACD Blue Ribbon Commission on Strategy Development recommends that boards move from a traditional “review and concur” approach to strategy, to a model of “engage[ment] with management on strategy issues on an ongoing basis, including early involvement to improve strategy development, adjustment, and monitoring.” [2] Investors strongly supported this approach in recent dialogues with NACD. “Everyone has an annual offsite, [but] how much and how often does the board get involved beyond that?” Several discussion participants observed that conversations with directors about executive compensation can be important indicators to investors of the quality of boardroom dialogue on strategy: “We always ask directors to talk about how the company’s compensation plan is linked to strategy. In that conversation, if a director can’t articulate the strategy clearly and concisely, it’s difficult to see them as actively engaged in oversight.” Similarly, investors are seeking indicators that the board is using, as one put it, “an inclusive and holistic definition of risk.” One investor asked, “How [are directors] keeping up—for example, are they getting access to a broad range of information on industry issues and new threats, or are they only hearing presentations from management?”

Investors noted that they look at both of these drivers of effective board leadership to understand how effective a board is likely to be at helping management navigate emerging risks, such as cyber threats, or dealing with unexpected crises and volatile economic conditions: “Cyber is the hot topic today, but risks change constantly,” one investor said. “If boards have the fundamentals in place, it inspires confidence among shareholders.” Conversely, investor concerns about director qualifications, the board’s approach to succession planning, and/or the level of board engagement in strategy and risk oversight may increase the likelihood that a company will appear on an activist investor’s target list.

Investors will hold directors accountable when they believe shareholder rights have been undermined.

In previous dialogues with NACD, investors highlighted the importance of “governance basics” such as majority voting, the right to call special meetings, and declassified boards. In the view of many investors, these mechanisms are—or should be—generally accepted practice, especially at large and mature companies. [3]

Bylaws are a case in point. While recognizing that directors “should be able to adopt amendments to improve [board] efficiency and effectiveness” and understanding that boards “sometimes need to take actions quickly,” investors emphasized that unilateral actions to change bylaws and/or their application in ways they believe adversely affect shareholder rights can be cause for significant concern. Said one investor, “We encourage directors to have some discussion—why a particular action is being taken, the potential impact on shareholders, whether investors should be allowed to weigh in—and provide a rationale where appropriate. Otherwise the board appears blind to investors’ views.”

Several discussion participants wondered if some board decisions that investors categorize in this way are a result of director reliance on the recommendations of outside advisors in the absence of broader input, especially feedback from major shareholders. One investor reported, “In the past few months, when we’ve met with some boards to discuss these issues, it became clear that they were unaware [of the impact the decision had on investors]. It makes us wonder about the quality of the advice they’re getting.”

High-quality communication between boards and investors is about context, not volume.

In a roundtable meeting earlier this year, investors noted that when it comes to proxy disclosures, “laundry lists and boilerplate statements about good governance just add length without adding very much meaning.” [4] Discussion participants elaborated on this advice, explaining that they are increasingly placing focus on the quality of responses to investor feedback: “When a board tells us, ‘We heard X [from shareholders] and we did Y,’ we’re now stepping back and saying, ‘Okay, but tell us more about why the board felt that action was appropriate.’ We want to know that the rationale goes beyond just checking a box because ISS said so.” Another investor observed, “We know many boards are already doing a lot in areas such as evaluation, but there’s often not much disclosure about the process or the intended outcomes. Sometimes directors just need to explain these things better.”

One investor observed, “So often, ‘engagement’ is defined as one company to one investor. There is a time and place for those meetings, but we also encourage companies and boards to look for one-to-many forms of communication. Beyond the proxy, those vehicles include investor days or video interviews with board members on the company website.”

Investors emphasized that providing a rationale for the board’s decisions is a valuable way to establish credibility and gain investor confidence. “When directors say, ‘We realize this was not a popular choice but we weighed the alternatives and here’s why we came to this conclusion,’ it sends a very positive signal about the board’s judgment.” Lack of disclosure, particularly on contentious issues, can be a red flag. “Outliers really stand out to investors these days. If you’re an outlier on a particular issue, it’s best to own it. Either provide a rationale for why the board believes its position is the right one, or outline how you plan to fix it.”

The complete publication is available here.

Endnotes:

[1] This post reflects NACD’s use of a modified version of the Chatham House Rule in which the names and institutional affiliations of participants are published, but their comments (shown in italics) are made anonymously. See the Appendix of the complete publication for a list of participants.
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[2] National Association of Corporate Directors (NACD), Report of the Blue Ribbon Commission on Strategy Development (Washington, DC: NACD, 2014), 19.
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[3] NACD: Investor Perspectives—Critical Issues for Board Focus in 2014 (Washington, DC: NACD, 2014), 5.
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[4] Id.
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