Global Corporate Governance Trends for 2023

Rich Fields leads the Board Effectiveness practice and Rusty O’Kelley co-leads the Board and CEO Advisory Partners in the Americas at Russell Reynolds Associates. This post is based on their Russell Reynolds memorandum.

Keeping up with the ever-changing trends in global corporate governance is no easy task, as countries introduce new governance rules that trigger knock-on effects around the world. To help you stay ahead of the trends, we produce an annual outlook of the corporate governance landscape. For this eighth edition, we interviewed dozens of global institutional investors, shareholder activists, pension fund managers, regulators, proxy advisors, and other corporate governance professionals to identify the most pressing corporate governance issues that boards and directors are likely to confront in 2023 and beyond.

Three global corporate governance trends to expect in 2023

1. Skepticism about board quality

With more savvy and empowered stakeholders paying close attention to many aspects of board performance, this year will see further scrutiny of board quality, effectiveness, and composition.

The US is entering a new universal proxy era that will invite a more assertive approach by shareholders on director qualifications and disclosure. In Brazil, the push for greater levels of gender diversity and independence may herald more formalized nomination processes. While India could experience a great refreshment of nonexecutive director appointments, European companies continue to face demand for upgrades to board skills and structure – such as the requirement for listed German companies to have two financial experts on their boards, as well as the explicit code recommendation for the skills profile to include sustainability expertise relevant to the enterprise.

These heightened demands for proof of board effectiveness will add momentum to existing efforts to make board evaluation processes more rigorous.

2. CEOs in the crosshairs

Regardless of region, the current global economic distress and turbulent markets are affecting the governance landscape. Everything from the war in Ukraine, post-covid supply chains, and rising inflation have put strain and stress on companies and their leadership, and experts expect an even greater emphasis on board oversight of CEO performance and succession planning across geographies.

As investors grow weary of outsized payouts and excessive bonuses, it’s not surprising that there will be a harsher spotlight on executive compensation. On this topic, expect significant differences from market to market. In some, such as the US and Singapore, new rules are now in force or expected. In others, private pressure might lead to additional change, such as with evolving expectations for compensation linked to Environmental, Social, and Governance (ESG) issues in the UK.

3. Maturation of ESG programs and disclosures

Despite some increasingly pushing back against the ESG agenda, global investors are doubling down on demands for enhanced sustainability reporting and environmental responsibility activities. Most notably, the Corporate Sustainability Reporting Directive will disrupt the ESG landscape across the European Union by harmonizing standards and shaping the reporting environment for years to come.

The aperture on ESG issues continues to broaden as a growing number of stakeholders demand sustainability and corporate social responsibility assurances. The Say on Climate movement is shaping up to be the next big thing in the UK, and there is a higher demand for ESG skills in Indian boardrooms. The climate agenda continues to demand attention in Latin America. In the US, expect an increased focus on human capital issues and labor rights.

Corporate governance trends in the US

Board quality will be under the microscope

New directors have lower support levels than ever before. While most directors still receive majority support, many face meaningful opposition. This past year, only 69.7% of directors received more than 95% support (down from 73.7% in the prior proxy season). And between 2021 and 2022, the percentage of directors receiving less than 80% support grew from 5.8% to 6.5%. We expect support levels to decline further as investors are giving more reasons to withhold support from directors, from disfavored governance practices, board diversity, and attentiveness to shareholder voting.

As we have previously written, the beginning of the universal proxy era will only add more fuel to the fire. Boards, investors, and advisors will and should be anticipating how a critical eye would evaluate board composition and expect motivated investors to exploit perceived weaknesses. Investors will be looking for boards to be agile, deliberative, thoughtful, and fit for purpose. They’ll assess individual directors across a range of factors, including industry and functional expertise, tenure, and diversity. Additionally, there will be growing attention on board interlocks and potential conflicts of interest.

Expect headlines about CEO performance and board oversight of succession planning

The challenging economic environment and tumultuous capital markets will, according to many experts we spoke with, lead to even greater attention on CEO performance in 2023, and likely to a higher number of CEO transitions. This could come as a shock after a period of relative quiet. According to Conference Board and ESGauge data, 2022 saw more than double the number of forced CEO successions than 2021. Some believe this is part of a broader trend that will rise sharply next year, as stakeholders become less patient with middling or underperformance.

All this will test recent board attention on CEO succession planning. While many boards have dramatically enhanced their thoughtfulness and proactivity on this critical topic, it remains a development area for many boards. Media attention on “failed” successions at prominent companies offers frequent, tangible reminders that developing the next generation of leaders, selecting the right person, and setting up that person for success is far from a given.

Investors and other stakeholders will likely be even more inquisitive about succession planning activities in 2023, with the activists among them feeling emboldened to demand change more swiftly than usual. We anticipate boards will invest even more time in succession planning activities in this environment.

Pressure from all sides on executive compensation

Given the focus on CEO performance, it is unsurprising that many experts predicted even greater attention on, and skepticism of, executive compensation in 2023. The perception that boards have been too generous with CEOs—and too willing to explain away missed incentive compensation targets—was high.

Looking ahead, companies should not expect the same “benefit of the doubt” that some investors were willing to give through the worst days of the pandemic. Investors will expect executives to share the pain they feel as investment returns diminish. Outsize payouts will likely generate meaningful scrutiny, more engagement requests, lower say on pay support, and votes against director nominees.

Recent SEC rule updates will also bring more attention to CEO pay. In August 2022, the SEC finalized rules requiring public companies to disclose information reflecting the relationship between executive compensation and the company’s financial performance – the so-called “pay-versus-performance” rule. And in October, it adopted the final clawback rule, which requires public companies to establish policies for recovering excess incentive payments from executive officers if material misstatements elevated the amounts.

In response to these rule changes, some experts expect pressure from executives to sidestep some potential impact of the rules by moving from more rigorous financial performance-based targets to strategic targets or cash. Such moves would invite additional investor scrutiny, which boards should consider before changing a company’s incentive structures.

Stakeholders expect continued maturation of sustainability initiatives

While specific expectations vary, institutional investors expect all boards to have thoughtful oversight processes for material ESG risks and opportunities, and boards should expect regular ESG engagement from their investors. Institutional investors are increasingly asking for the full board to be educated and conversant on ESG at a high level, with priority placed on ESG expertise for material issues. Investors will be most focused on structured board oversight, transparency of reporting, progress on material ESG issues, and specific sustainability-related topics, such as carbon reduction.

Most expect the SEC to finalize the long-anticipated (and, in some circles, dreaded) Climate Disclosure Rule in 2023. If this occurs, the rule will come into force in FY 2024, likely with Scope 1 and Scope 2 emission disclosure requirements. Experts told us that companies that wait for regulation will be lagging as the broader market is acting on what they anticipate. Many are expecting the Task Force on Climate-Related Financial Disclosures (TCFD) to be the framework of choice for climate-specific disclosures. New for 2023, BlackRock has also noted that recommendations from the Taskforce for Nature-related Financial Disclosures (TNFD) may prove useful to some companies.

The debate over ESG’s value will continue in 2023, amid a growing (but still largely fringe) anti-ESG movement and the tumultuous economic environment. However, this puts an even greater premium on thoughtful approaches to truly material ESG issues and oversight. Experts believe the companies that best understand and explain their approaches will thrive, while those that ignore the issues or appear to dither will be most at risk.

The aperture on human capital management issues will grow wider

In 2022, investors engaged with a broader range of human capital topics. In their communications with companies, some investors are preparing for campaigns related to workers’ right to organize, sometimes framed as “freedom of association.”

Indeed, a growing number of stakeholders, from single issue activists to traditional pension systems, have begun to press companies to re-examine their workplace policies. And recent shareholder proposals calling for labor rights audits at Apple and Starbucks suggest investors increasingly view companies’ human capital management practices as inextricable from long-term value creation. Coupled with a significant rise in shareholder proposals related to diversity, equity, and inclusion (DE&I), the implication is clear: companies will continue to face new pressures that extend well beyond financial performance. As SEC Chair Gary Gensler remarked in June, “Investors have said that they want to better understand one of the most critical assets of a company: its people.”

Corporate governance trends in the United Kingdom

Emphasis on realistic, measurable, and bespoke ESG agendas and outcomes

ESG will remain a high priority in UK boardrooms in 2023. Both the Financial Reporting Council (FRC) and investors are asking companies to be more realistic, transparent, and authentic in their disclosures, and bolder voices are calling for companies to drop separate ESG initiatives in favor of a fully integrated business strategy.

There are growing expectations that companies should move away from box-ticking to reporting on progress against metrics that are specific to their company and integral to their business strategy. This means embedding ESG-related actions in all the company does, including decisions on capital allocation, risk factors, and the overall business model. One size won’t fit all—companies will need to set their agenda to make ESG outcomes more meaningful and actionable.

Urgent call for action in the race for Net Zero

Energy continues to dominate the agenda. In 2023, the UK, which is already a standard-setter in climate reporting, has ambitions to lead the way globally. There will be a requirement for all UK-listed companies and regulated investment companies with over 25 billion GBP ($304.8 billion) in assets to start publishing their transition plans to Net Zero from June 2023 onwards, with smaller asset managers joining them by June 2024.

In parallel, investors are setting guidelines and targets for compensation metrics tied to ESG goals and requiring companies to publish short, mid, and long term plans for achieving Net Zero. ‘Say on Climate’ is the next big thing after ‘say on pay’ and investors may vote against the board if there is no credible path to Net Zero.

Presently, climate concerns dominate discussions around the ‘E’ in ESG. We expect these concerns to broaden to include the related topics of biodiversity loss, deforestation, and difficult water access in the year ahead.

Tighter diversity requirements and disclosure of policies

Compared to environmental goals, there has been less defined regulation of societal metrics, except for DE&I. However, by 2023, society at large, civil society organizations, media, and NGOs will call for further action to address issues such as the cost-of-living crisis, gender and equality pay gaps, human rights, health and safety, and rights to unionize. We expect regulation to lag societal pressure.

The Financial Conduct Authority announced new listing requirements in April 2022, including:

1. At least 40% of the board of directors must be women

2. A woman must hold at least one of the company’s senior board positions (chair, chief executive officer, senior independent director, or chief financial officer)

3. At least one member of the board needs to be from a minority ethnic background

The new requirements also say organizations need to make diversity disclosures in corporate governance statements, including:

1. How the diversity policy applies to its remuneration, audit, and nomination committees

2. How the diversity policy addresses the breadth of diversity characteristics, such as ethnicity, sexual orientation, disability, and socio-economic backgrounds

Governance, finance, and quality of audit will regain importance

To some extent, social and governance topics are interrelated as remuneration remains top of the agenda, especially with the cost-of-living crisis. The Financial Reporting Council has announced there will be a consultation on changes to the AGRA Code in the first quarter of 2023 and the new code will apply from January 2024. The draft under consultation includes the provision of a stronger basis for reporting and evidencing internal control effectiveness around the year-end reporting process.

These changes will result in wider responsibilities for the board and audit committee, specifically around expanded ESG reporting and, where commissioned by the company, assurance of said reporting. Audit committees and boards must consider how the audit tendering process responds to the need to further expand competition in this space. There is also a proposal for strengthened reporting on malus (remuneration arrangement that reduces the amount of a deferred bonus) and remuneration claw back arrangements.

Activism remains high but is more constructive

Activism is set to increase in the UK as financial, social, and geopolitical uncertainty continue to rise. Interestingly, the narrative of some activist investors is increasingly convergent with the broader ESG movement, and they are holding boards and executives accountable by publishing metrics and progress.

Corporate governance trends in the European Union

The Corporate Sustainability Reporting Directive will disrupt the ESG landscape

Many organizations are still in the initial stages of preparing for an unprecedented scope in sustainability reporting. November’s Corporate Sustainability Reporting Directive (CSRD) will impose harmonized standards, with the new reporting obligations coming in between the fiscal years 2024 and 2026, depending on the size of the company. Starting in 2028, the directive will also apply to non-EU companies with a net turnover above €150 million in the EU and at least one subsidiary or branch in the EU exceeding certain thresholds.

As the focus pivots to the consultation on the European Sustainability Reporting Standards (ESRS), leaders will need to understand that now is the time to influence standard setting on an EU level and actively participate in this process. The current decision process will fundamentally shape the reporting environment for the next decade.

Sustainability data will influence the supply chain approach

The importance of sustainability data governance along the entire supply chain influences the way leaders, particularly CIOs, need to think about processes and architectures. In fact, the aggregation and management of sustainability data is not only a regulatory burden arising from CSRD requirements; it will become a competitive differentiator in organizational compliance and risk management.

This particularly holds true considering the current EU-level discussions on a novel Corporate Sustainability Due Diligence Directive, which would impose substantial obligations regarding adverse impacts on human rights and the environment, including penalties and civil liability for violation, in corporate supply chains. The EU Council adopted its negotiating position in December 2022, which will lead to a 2023 focus on negotiations with the EU Parliament.

Reporting frameworks transposed into national law

The UK became the first country to align climate reporting obligations with TCFD recommendations, starting with the country’s largest businesses in April 2022. We expect more countries, including Switzerland, to follow in 2023.

EU regulators have also realized how powerful yet fragmented the existing sustainability standards are. As such, the European Financial Reporting Advisory Group has considered the TCFD recommendations and ISSB Standards as a blueprint to design the ESRS.

Biodiversity may be the next big wave

The EU Biodiversity Strategy for 2030, published in May 2020, constitutes the cornerstone of biodiversity protection within the European Union. Some countries, such as France, are spearheading this movement and have already introduced compulsory reporting of corporate biodiversity footprints in individual sectors.

In June 2022, the EU Commission adopted pioneering proposals for a Nature Restoration Law, aiming to restore 20% of the EU’s land and sea area by 2030, and all ecosystems by 2050. Leaders of corporations should be aware of these profound changes and proactively consider them in their business decisions over the coming year.

This post is an excerpt of a longer Russell Reynolds memorandum that covers governance trends in these and other jurisdictions. A link to the full piece, including the full list of authors, can be found here.

Both comments and trackbacks are currently closed.