Corporate directors are positioned to lead the way in implementing measures that contribute to economic growth and sustainability. This article, published by the National Association of Corporate, discusses how strong corporate governance is necessary for directors to be effective in these efforts. There are four areas of corporate governance the NACD has identified as being the most important and of immediate concern: risk oversight, corporate strategy, executive compensation, and transparency.
There is an increased need for boards to exercise risk oversight as insufficient governance that did not sufficiently safeguard against excessive risk taking contributed to the current economic crisis. The NACD provides recommendations to help design governance structures and practices to support the board in determining its own priorities, agenda, and informational needs, and to assist the board in focusing on strategy and risk. One recommendation is that a risk program should help mitigate the risks in implementing a strategy and boards can contribute to this through a strong “tone at the top”. Boards should be active in assessing an organizations’ risk appetite, considering a broad view of risk from the perspective of all stakeholders. Boards should also recognize that strategic goals may need to change with changes in risk exposure and vice versa. Boards should help management identify potential risks and continually monitor risks, and the quality, dependability, and timeliness of information is essential to boards being able to perform these functions. Boards are also responsible for ensuring sound crisis response planning has occurred, which can decrease mistakes made in crisis situations.
In moving forward, there are future challenges boards will face in improving risk oversight. Risk oversight responsibilities currently fall to the audit committee in the majority of companies, with only 25% of boards using their full boards for risk oversight and only 6% using a risk committee. Risk oversight responsibilities should be assigned to the full board as well as committees apart from the already heavily burdened audit committee. A large majority of directors indicated that management provides the information needed to effectively execute the board’s risk governance role. However, risk identification procedures need to be improved because directors identified two top challenges in providing risk oversight: management’s capacity to define and explain the organization’s risk management structure and process, and the organization’s capacity to identify and assess risks. Further improvement in risk identification can be gained by directors understanding smaller high-risk operations within the organization that could impact the whole company. Directors should evaluate risk models used and learn and understand their limitations to properly apply judgment regarding their output. Overall information flow also needs to be improved because relevant, accurate, timely information is critical to risk oversight and a culture of open and effective information flow can promote these qualities. Boards need to manage the quantity and quality of information received, the risk of asymmetrical information coming from the perspective of management, and should consider if there is sufficient skepticism expressed during risk conversations.
A core responsibility of the board is to engage with management in the development of an effective corporate strategy. The NACD recommends boards become more strategically engaged by jointly establishing with management the process the company will use to develop its strategy, providing ongoing evaluation of the strategy by monitoring implementation and encouraging changes as needed, and by establishing executive compensation objectives and metrics that tie to long-term strategic goals. Boards can improve their ability to balance strategy and risk with better strategic information, earlier and greater collaboration with management in creating and refining strategy, closer alignment of board composition with strategy, and better alignment of goals in the short, medium, and long-term.
Boards have the ability to build an executive compensation system that reflects the risk appetite and profile of the company and incents the correct behavior. The NACD recommends boards adopt a compensation philosophy to guide their actions, ensure independence of the board and compensation committee, strive for pay packages perceived as fair internally and externally, design pay packages that promote long-term shareholder value, link pay to performance, and ensure transparency both internally and externally. Boards can improve executive compensation through better performance metrics, stronger oversight of human capital development, increased independence of the compensation committee, use of independent compensation advisors, and more proactive shareholder communications.
There is a need for increased useful transparency surrounding board decisions, providing a foundation for constructive management oversight, better and more relevant information for shareholder decisions, and clearer accountability of management and the board. Boards can improve transparency by becoming more proactive in shareholder communications, making greater use of technology in communications such as annual shareholder meetings and by use of Extensible Business Reporting Language, and by disclosing more about board processes. Safe harbor laws providing legal protection could be helpful in implementing these methods to improve transparency.
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