Boardroom Accountability

Accountability, Board composition, Board independence, Board performance, Boards of Directors, Director nominations, Director qualifications, Disclosure, Diversity, Proxy access, Shareholder nominations
More from: Michael Garland, Rhonda Brauer, New York City Comptroller

Michael Garland is Assistant Comptroller for Corporate Governance and Responsible of Investment and Rhonda Brauer is Director of Corporate Engagement in the Office of New York City Comptroller Scott M. Stringer. Comptroller Stringer is investment advisor to, and custodian and a trustee of, the New York City Pension Funds. The post is based on a recent campaign launched by the New York City Pension Funds and Comptroller Stringer.

Following up on the successful “Boardroom Accountability Project” launched in the fall of 2014 to give investors a meaningful voice in director elections through proxy access, New York City Comptroller Scott M. Stringer and the New York City Pension Funds (the “NYC Funds”) launched the “Boardroom Accountability Project 2.0” in September 2017. The next phase of the campaign ratchets up pressure on companies to improve the quality of their boards of directors, with particular emphasis on diversity of gender and race and on climate competence, so that they are positioned to deliver better long-term sustainable returns for investors.

The effort is the logical next step for the Boardroom Accountability Project, in which the NYC Funds negotiated company-by-company to make proxy access—the right for shareowners to nominate directors using the corporate ballot—a market standard. Today, more than 450 companies provide proxy access, including over 65% of the S&P 500, up from about six companies when the Project was launched in the fall of 2014.

Proxy access provides long-term investors with a powerful tool. The mere specter of a proxy access candidate is expected to make boards more responsive to shareowner engagement, particularly with respect to board composition, thereby limiting the need for its actual use. Boardroom 2.0 is an ambitious effort to test this theory.

As part of the Boardroom 2.0 launch, therefore, Comptroller Stringer sent letters to the nominating/governance committee chairs of 151 companies requesting a dialogue on their processes for adding, evaluating and replacing board members (i.e., board refreshment and evaluations). The letter also identified the board’s process for soliciting shareowner input for potential candidates who are women and people of color as being among other potential discussion topics.

The recipients of the letter include 139 companies that enacted proxy access after receiving a proxy access shareowner proposal from the NYC Funds (Template letter A) and 12 at which the NYC Funds’ proposal received majority support in 2017 (Template letter B). In most cases, the companies were initially targeted for proxy access because their board lacked adequate diversity or granted excessive CEO pay, they are carbon-intensive energy companies that face substantial risks related to climate change, or they are among the NYC Funds’ largest portfolio companies.

In addition to the requested dialogue, the Comptroller’s letter asked that each company disclose publicly a meaningful board matrix identifying each director’s most relevant skills, experience and attributes in light of the company’s long-term strategy and risks, as well as each such individual’s gender and race/ethnicity. At some of the companies, the NYC Funds subsequently submitted shareowner proposals requesting a board matrix that, among other attributes and qualifications, includes each director’s gender and race/ethnicity.

The initiative comes at a transformative moment in the way the NYC Funds, among other institutional investors, approach board of director engagement and voting. Director independence and accountability remain essential, but they are no longer viewed as sufficient. Investors today want to ensure we have the right directors in the boardroom, with the necessary mix of relevant and diverse skills, experience, attributes and perspectives to provide strong and effective oversight. For the NYC Funds and a growing list of other investors, this includes an explicit focus on diversity of gender and race/ethnicity.

There is a large and growing body of empirical research that suggests a positive correlation between board diversity and performance. Research by McKinsey, for example, suggests that companies with greater gender and ethnic board diversity have stronger financial performance. [1] Similarly, MSCI research suggests that gender diverse boards have fewer instances of bribery, corruption, and fraud. [2]

More and more boards report that recruiting diverse directors is a priority, and there is some evidence that this may be the case. In 2017, for example, white men for the first time represented a minority of the new directors added to S&P 500 companies, according to the 2017 Spencer Stuart U.S. Board Index. [3] Look a little deeper, however, and it’s apparent that for too many boards increasing diversity is only a priority when it is convenient; it is a priority that lacks any sense of urgency.

The root of the problem is that, rather than rely on robust director assessment and refreshment processes, which require board leaders to have difficult conversations with directors who are underperforming or whose particular qualifications are no longer as relevant to the business, too many boards only recruit new directors to fill vacancies created when directors hit the board’s retirement age or term limit.

This has significant consequences. Despite the high percentage of new women and minority directors in 2017, representation of women on S&P 500 boards inched up only 1%, from 21% to 22% of directors, and representation of African-American and Hispanics/Latino directors at the top 200 S&P 500 companies has not significantly changed over the past five to 10 years. [4] Equally concerning, 46% of the 886 directors who participated in PwC’s 2017 Annual Corporate Directors Survey sit on a board with at least one director they believe shouldn’t be there. [5]

The kind of meaningful board matrix requested by the NYC Funds—in which only each director’s most relevant qualifications are highlighted (and supported by more comprehensive detail in each director’s biography)—provides shareowners a “big-picture” view of directors’ attributes and how they fit together overall to provide the highest oversight competence around the boardroom table. By having the matrix go beyond the minimum qualifications that boards believe must be met by all nominees, boards enable investors to (a) better assess how well-suited individual director nominees are for the company in light of (i) the company’s evolving business strategy and risks and (ii) the overall mix of director skills and experiences; (b) more easily identify any gaps in skills, experience or other characteristics; and (c) make better informed proxy voting decisions.

The use of a matrix to present director qualifications is recommended by the National Association of Corporate Directors [6], among other business and investor groups. While many boards, as part of their board refreshments process, may already use a matrix to identify gaps in skills and experience in light of their company’s evolving strategy and risks, the EY Center for Board Matters recently reported that only 16% of S&P 500 companies publicly disclosed a director skills matrix in 2017. [7]

The quality of those matrices that are disclosed is mixed at best and even the more useful disclosed matrices almost never include individual directors’ gender and race/ethnicity. This is the state of play, despite the fact that many boards reportedly recognize the importance of, and disclose information on, their boards’ gender and racial/ethnic diversity and their policies on casting the net widely to include women and people of color in all or most of their new director searches:

According to a 2017 PwC survey of 886 directors, 68% believe gender diversity is very important and 42% believe racial diversity is very important. Among those who responded that diversity is important, 82% said it improved board performance and 59% said it improved company performance. [8]
According to a 2017 Equilar study of 500 large companies, 45.1% disclosed board composition by gender and 39.8% disclosed composition in terms of race/ethnicity. [9]

The specific matrix approach requested by the NYC Funds, with gender and race/ethnicity as critical dimensions, is consistent with the request in a March 31, 2015 rulemaking petition to the U.S. Securities and Exchange Commission seeking mandatory matrix disclosure by all U.S. public companies, which Comptroller Stringer submitted jointly with eight other major U.S. pension systems. [10]

The initial response rate to the Boardroom 2.0 engagement letters has been extremely high, a significant validation the underlying theory of proxy access, and the resulting engagements have been overwhelmingly positive. Through March 2018, the Comptroller’s Office has had meaningful engagements with over half of the companies, with many more engagements on the horizon, and has withdrawn some matrix proposals.

Director engagements have gone particularly well, with directors often pushing their management teams to go further in terms of their board refreshment processes and proxy statements disclosures. We have had meaningful director discussions on:

the qualifications that they want to have around their boardroom tables and how that relates to the company businesses and long-term strategies they have a fiduciary duty to oversee;
how they seek out all or most director candidates from pools that include women and persons of color (the so-called “Rooney Rule” of corporate governance);
how robust their board evaluation processes are, including how they evaluate each director individually in terms of their ongoing capability and availability to continue to serve and be nominated for election each year; and
the importance of gender and racial diversity, among other types of diversity, to avoiding “group-think” in their boardrooms. These discussions have included not only examples of how they have increased such diversity on their boards (often with first-time directors), but also the ongoing sensitive nature of race discussions that remain in their boardrooms, corporate America, and our society at large.

We have been repeatedly told that we are changing the nature of the discussion of these issues in U.S. boardrooms. These discussions reflect the broad continuum on which these companies and their boards are admittedly operating, with some further along than others and many aware of where they see themselves moving in the coming months and years. We expect to see enhanced disclosure that reflects our engagements in 2018 proxy statements and beyond, as well as an increasing amount of gender and racial diversity in our portfolio company boardrooms.