What Is Good Corporate Governance? A Commonsense Approach

It seems to be a very simple question that does not always produce a clear-cut response. A group of high profile executives, including CEOs of major US corporations, tried to reach consensus on commonsense principles that are “conducive to good corporate governance, healthy public companies and the continued strength of … public markets.” On July 21, 2016, they released Commonsense Principles of Corporate Governance for public companies to promote further conversation on corporate governance.

These principles do not break new ground in corporate governance – it was not the purpose; these principles serve as a compilation of best practices that provide a “basic framework for sound, long-term-oriented governance.” The authors acknowledge that given the differences among public companies “not every principle … will work for every company, and not every principle will be applied in the same fashion by all companies.” These principles should promote discussions at the executive and board levels. They are a must read for board members, C-suite executives and corporate secretaries. Some of these principles can also be used by private companies and large non-profit organizations.

The principles are divided into eight categories: (i) Board of Directors – Composition and Internal Governance; (ii) Board of Directors’ Responsibilities; (iii) Shareholder Rights; (iv) Public Reporting; (v) Board Leadership; (vi) Management Succession Planning; (vii) Compensation of Management; and (viii) Asset Managers’ Role in Corporate Governance.

Although some of the principles follow well-established listing standards of stock exchanges (for example, a “significant majority of the board should be independent under the New York Stock Exchange rules or similar standards”), certain principles express fairly strong points on a variety of governance issues.

In terms of board composition, the principles state, among other points, that “[d]iversity along multiple dimensions is critical to a high-functioning board. Director candidates should be drawn from a rigorously diverse pool.” The principles acknowledge that “[s]ome boards have rules around maximum length of service and mandatory retirement age for directors; others have such rules but permit exceptions; and still others have no such rules at all,” but state that “[w]hatever the case, companies should clearly articulate their approach on term limits and retirement age.”

The principles address public company reporting with a clear emphasis on creating long-term value for shareholders and encourage public companies to “take a long-term strategic view, as though the company were private, and explain clearly to shareholders how material decisions and actions are consistent with that view.” The principles state, in part, that:

  • Companies should frame their required quarterly reporting in the broader context of their articulated strategy and provide an outlook, as appropriate, for trends and metrics that reflect progress (or not) on long-term goals.
  • A company should not feel obligated to provide earnings guidance – and should determine whether providing earnings guidance for the company’s shareholders does more harm than good. If a company does provide earnings guidance, the company should be realistic and avoid inflated projections.
  • Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value destructive in the long run.

The principles related to public company reporting include non-GAAP financial measures and state that “[w]hile it is acceptable in certain instances to use non-GAAP measures to explain and clarify results for shareholders, such measures should be sensible and should not be used to obscure GAAP results.” The principles emphasized that “all compensation, including equity compensation, is plainly a cost of doing business and should be reflected in any non-GAAP measurement of earnings in precisely the same manner it is reflected in GAAP earnings.”

 

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