The newly updated version of the Commonsense Principles of Corporate Governance (Principles 2.0) is worthy of note by the board of directors and its governance committee, to the extent that they further leadership discourse on the scope and substance of fiduciary conduct.
Released Oct. 21, the Principles 2.0 contain a series of discrete revisions to the high-level governance guidelines released in original form on July 21, 2016. The “Principles series” are the byproduct of a coalition of executives of major corporations, asset managers, and shareholder activists. Indeed, one purpose of Principles 2.0 was to announce the lengthy list of additional business and financial leaders who have now publicly endorsed these recommended guidelines. While primarily focused on public companies, many of the recommendations are quite relevant to large private and nonprofit corporations.
The overarching goal of Principles 2.0 is to continue the movement towards constructive engagement on director responsibilities, and harmony amongst leading statements of governance guidelines. As such, it carries forward the underlying theme (expressed in the original Principles) that current market participants are too short-term focused, with a resulting effect of discouraging companies with a longer vision from going public.
The combined Principles series address a number of elemental governance topics, including board composition; director responsibilities; shareholder rights; public reporting; board leadership; management succession planning; and compensation of management (with an emphasis on compensation of the CEO). They emphasize critical issues of director engagement; independence, accountability, diversity and refreshment and support a governance structure that is oriented towards the long term.
The revisions and refinements contained in the Principles 2.0 are not extensive, but are nevertheless significant and may warrant governance committee consideration. For example, they project a balance between a board that should be shareholder-oriented yet which is controlled by a significant majority of “strong and steadfast” independent directors. They also contain expanded recommendations with respect to shareholder rights, engagement with shareholders and investors’ role in corporate governance.
- Explicit references to the accountability of directors (to shareholders); their obligations of care and loyalty; and to the use of long term company performance as the primary director performance measurement;
- Increased focus on the role, function and committee participation of independent directors;
- The benefits of including within board composition senior managers of other companies, regardless of their potential time constraints;
- Specific emphasis on “diversity of thought” within the broader commitment to a diverse board;
- The commitment of directors to serving for at least three years;
- An explicit reference to the board’s responsibility to nominate directors consistent with specifically articulated criteria;
- A greater level of engagement with shareholders on proposals submitted both by shareholders and by management;
- Allowing some form of proxy access, subject to “reasonable requirements” that does not create burdens for significant, long term shareholders;
- A concern that “poison pills” and other anti-takeover measures can diminish board and management accountability to shareholders;
- The importance of independent leadership of the board; an emphasis on periodic review of the leadership structure, shareholder transparency with respect to whether leadership roles are separated or combined, and a clearly defined responsibilities for those roles;
- Renewed emphasis on robust and transparent public reporting, including with respect to management’s key financial performance metrics and, to the extent management reports or guides on the basis of non-GAAP performance metrics, they should be clearly explained and bridged back to their GAAP equivalents, with appropriate respect being paid to the impact of stock compensation on any earnings measures; similarly, the Company should be transparent about its strategic goals; and
- Guidance for: asset managers in the exercise of their voting rights; proxy advisory firms in the proxy voting process; and institutional asset owners in the advancement of long term oriented corporate governance.
Like its predecessor, Principles 2.0 is intended to be a “high level” discussion rather than a detailed reference. Its barely 13 pages are dwarfed by the Business Roundtable’s nearly 30 pages of detailed discussion in its 2016 report of recommended governance practices. But of course, it will always be difficult to condense a topic as broad as governance principles into a format that will facilitate reading and comprehension.
That being said, Principles 2.0 reflect some “missed opportunities”; important governance topics that arguably deserved note. For example (as with the original Principles) it includes only a limited reference to the critical nature of the board’s enterprise risk management responsibilities; no material reference is made to its compliance oversight duties; and no acknowledgment is offered of the value in positioning the general counsel at a prominent position within the senior leadership team; the oft-referenced role of the general counsel as “lawyer-statesman.”
Perhaps more notable absences (given current events) are to the board’s responsibility to address business disruption, and its need to exercise oversight over workforce culture. The latter omission is particularly significant given not only the #MeToo movement, but recently emerging focus on matters of gender equity (e.g., the McKinsey report).
Perhaps the greatest value of Principles 2.0—at least from the general counsel’s perspective—is the extent that it may further intra-board discussion not only on governance policies generally, but also on the broader question of what constitutes “best practices”. This includes consideration of best practices as aspirational goals (rather than legal requirements); what type of guideline might rise to the level of a “best practice”, and how that could be determined or confirmed (e.g. advice of counsel).
There is no suggestion that the Principles are intended to be a “one size fits all approach,” or otherwise absolute. Not every principle will work for every company, and not every principle will be applied in the same fashion by all companies. But the expanding list of prominent CEOs committing to apply Principles 2.0 to their corporations certainly adds to its credibility, and justifies presenting Principles 2.0 to the governance committee for consideration.
Michael Peregrine is a partner at McDermott, Will & Emery in Chicago. He represents corporations (and their officers and directors) in connection with governance, corporate structure, fiduciary duties, officer-director liability issues, charitable trust law and corporate alliances.
Tom Conaghan is a partner at McDermott, Will & Emery in Washington, D.C. He represents public and private companies, underwriters and other sources of capital, corporate boards and board committees, and corporate executives.