Shadow Governance

Yaron Nili is Assistant Professor of Law at the University of Wisconsin-Madison Law School; and Cathy Hwang is Associate Professor of Law at the University of Utah S.J. Quinney College of Law. This post is based on their recent paper, forthcoming in the California Law Review.

Some of the most important battles in corporate governance have been fought on the grounds of charters and bylaws: board de-staggering, poison pill, and forum selection provisions come to mind readily. In recent years, however, many battles have moved into the less visible universe of committee charters, corporate governance guidelines and other corporate internal policies—an area of governance that has been largely overlooked in research.

In our new paper Shadow Governance, we investigate these non-charter, non-bylaw shadow governance documents and show how they influence corporate decision-making. We find that shadow governance documents are important and influential. They merit a more robust conversation about their role, impact, and use within the corporate governance ecosystem.

Among our paper’s major contributions is an original, hand-collected dataset of shadow governance documents collected from the investor sites of companies listed in the S&P 1500. These documents include documents required by the SEC or by NYSE and NASDAQ listing requirements, such as board committee charters, corporate governance guidelines, and conflict minerals disclosures. We also collected a plethora of non-required documents such as sexual harassment guidelines, campaign finance disclosures, environmental sustainability statements, diversity disclosures, and more. Finally, we interviewed directors, officers, and general counsels of major American companies to add nuance and context to our findings.

Here, we highlight a few of the major findings:

Committee charters and other required documents are the most commonly disclosed shadow governance documents—but some companies do not disclose even required documents. Not surprisingly, the most oft-disclosed documents are the five required to be disclosed by the SEC or NYSE/NASDAQ listing requirements: committee charters for the three major board committees, corporate governance guidelines, and codes of conduct. Surprisingly, however, a number of companies do not disclose them—8.5% of companies, for example, do not disclose nom/gov committee charters. Outside of the five required disclosures, disclosure rates (perhaps reflecting adoption rates) drop off sharply—the next most-disclosed document, for example, is the policy covering human rights, environmental, or conflict minerals issues. Only 19.8% of companies in the sample disclosed a policy that fits this description. Among the least-disclosed policies were succession plans (disclosed by 0.2% of the sample), cybersecurity committee charters (0.2%), and anti-harassment policies (0.1%).

Document % of Companies Number of Companies
Audit and Financial Committee Charter 95.2% 1415
Compensation/HR Committee Charter 93.2% 1386
Nominating and Corporate Governance Committee Charter 91.5% 1361
Corporate Governance Guidelines/Governance Principles 87.1% 1295
Business Code of Conduct Policy 86.6% 1288
Human Rights/Environment Statement (Conflict Minerals, etc.) 19.8% 295

There is a relationship between market cap and the number of shadow governance documents that a company discloses. Companies in the highest quartile of market cap seemed to disclose the most documents—nearly 11 documents on average. All other companies disclosed about 8.5 documents on average. Based on our interviews, one reason for this difference may be that larger companies may have larger legal teams, with more organized routine review of documents and addition of documents.

There appears to be a relationship between board size and the number of shadow governance documents that a company discloses: As board size increases, the number of documents increases. Based on our interviews, new incoming or interlocking directors often suggest adopting new documents. A larger board may thus have increased access to peer companies’ policies. Larger boards also tend to have more committees and therefore need more documents to guide their work.

Shadow governance documents are sticky. Interview participants repeatedly emphasized that shadow governance documents are important and guide board and committee behavior. Committee charters, for instance, set the board’s agenda for the year. In routine decision-making, shadow governance documents are also influential. If the board wants to take an action that is not aligned with something in a governance document, for example, the board will not take the action—even though the board can generally change the document at any time, without consequence. Shadow governance documents are, unsurprisingly, particularly sticky when they are disclosed to the public (even if that disclosure is voluntary), because companies fear the public relations backlash of changing a document in order to facilitate a previously-disallowed action.

Companies differ in how they disclose these documents—and the disclosure decision is often ad hoc. The decision to disclose—or not disclose—each shadow governance document appears to be ad hoc in most companies. General counsels usually make disclosure decisions. Disclosure decisions are also dictated at times by the terms of settlements with shareholders, or the desire to obtain favorable reviews or ratings on various metrics from proxy advisors or other watchdogs.

Proxy advisors drive some adoption and disclosure. The existing academic literature suggests that shareholder settlements—especially in the campaign finance space—influence voluntary disclosures. Our research shows that proxy advisors also have enormous influence. Several interview participants noted, for instance, that they believed that proxy advisor ISS primarily relied on website disclosures in creating its Environmental, Social and Governance QualityScore. Companies’ desire to be rated favorably by proxy advisors causes companies both to adopt policies and to disclose them on company websites.

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The findings in this paper are particularly timely in light of the recent announcement by the Business Roundtable, in which nearly 200 CEOs of major American companies announced a commitment to stakeholder governance. The findings in this paper suggest that shareholders play a major role in pushing companies toward adoption of the environmental, social, and governance policies that are often associated with stakeholder governance.

This paper builds on some of our previous work, including work about other influential ancillary documents in corporate practice (on ancillary agreements in M&A here and on preliminary agreements in M&A here and here), about retail investors here, and about boards here, here and here.

The complete paper is available for download here.

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