Why Corporate Governance should not be stored on your C-drive

Being a director is often challenging and potentially lucrative, but if the prospect of being sued is looming, it can be a lonely and alarming position.

Directors and officers cover (D&O) provides a suit of armour in the face of legal action, with the insurer stepping in to provide guidance at the first sign of a problem and ensuring legal costs and damages are met.

According to Eleni Petros, commercial crime practice leader for broker Marsh: “Cyber risks are a key topic in many boardrooms and are driven onto the agenda by high profile data breaches, distributed denial of services attacks and rising ransomware and cyber extortion attacks.

In the digital age, threats are coming thick and fast and directors are now more frequently having to contend with cyberattacks and data breaches – these are not just issues that affect large organisations.

Directors and high-ranking officers in public and privately-held corporations are under scrutiny like never before as they conduct business in an increasingly regulated and complex global business environment.

As regulatory authorities have responded to public and shareholder pressure in the wake of the credit crisis with more rules, heightened vigilance and tougher enforcement powers, corporate leaders find themselves exposed to even greater risks on a daily basis as they go about their roles.

The pressures on their time are vast, not least for non-executives, who frequently spend as little as 30 days a year working in the business, and for the many directors who sit on the boards of four or five companies.
These directors tell us the information packs that they receive from the companies they run are either far too large, and make it difficult for board members to target the business-critical information, or that they tell directors far too little about the key issues.

Nevertheless, directors face sanctions that make them sit up and take notice, not least the threat of jail. Though probably the least likely outcome for corporate leaders, jail terms can be handed down for antitrust failings, insider trading, bribery and corruption, money laundering or sanctions violations.
There is also the very real concern of regulatory fines and penalties. And these penalties can extend to being prohibited from sitting on boards in the future: the SIF regime now means that directors of banks that perform badly, though not necessarily personally liable, can find themselves excluded from directorships in regulated businesses going forward.

Then of course there is the growing threat of civil actions, and particularly shareholder class actions on both sides of the Atlantic. For antitrust violations in the United States, the maximum jail term for executives is ten years, and there are instances where officers and directors have served four-year terms.
These penalties apply equally to foreign nationals running companies with U.S. operations as they do to those businesses headquartered in the States, and antitrust authorities around the world are increasingly adopting similar approaches.
There are now more than 120 regimes that pursue this conduct around the world, with around a dozen of those imposing criminal sanctions for breaches.

The number of antitrust cases being dealt with by the enforcement agencies has increased exponentially in recent years, not least because the incentives for reporting incidences of wrongdoing have increased, encouraging whistle blowers and pushing companies to approach the authorities when they are alerted to issues within their own organisations.

This first-mover advantage can work to the detriment of directors, who may be implicated by the companies they work for when detailed investigations take place

It is increasingly important for directors and officers to work hard to set the compliance tone for the organisation from the top, by making it clear to employees what is expected of them, by setting an example and by ensuring that the messages are communicated across, and become part of, the company.

The guidance published with the Bribery Act 2010 is just one example of express reference to the importance of “tone at the top”.

Business leaders need to design and implement systems and controls that are appropriate to their organisation, and regularly review and test those systems to ensure they are delivering results. At the same time, compliance requires a bottom-up approach, such that the system ensures that regular requests for information are made of all levels of the business, and frequent enquiries are initiated and followed up.
Directors need to ensure that the information that they receive is both timely and appropriately prioritised, so that they know they have done their best to be on top of what is going on.

In today’s environment, directors and officers also need to look out for themselves, which means that if they have questions they must not only raise them, but also pursue answers, and record the fact that they have done so.

Directors need to be assertive with their colleagues across the business. If they find themselves dealing with topics with which they are not comfortable, they should seek external advice. There were countless examples of directors of financial institutions telling Congressional hearings in the U.S.- that they didn’t understand the collateralised debt obligation products that their banks were trading, but ignorance is not an excuse that will find favour with regulators.

The key message is that devoting time, resources and effort to the compliance programme is the best guarantee of success, and that the companies that have successfully introduced effective cultures have done so only as a result of sustained commitment.

Directors must take responsibility for introducing and maintaining a culture of compliance across their organisation, which means building the right structures; delivering regular training to employees, and particularly those in high-risk areas; setting up proper audit procedures that allow for deep-dive checks on a regular basis; and acting on discoveries in a timely and effective way.

Finally, with an ever-growing list of mandatory and non-mandatory rules is ramping up the risks faced by directors & officers. The general trend is toward raising the level of care expected of D&Os and expanding their existing duties.

These higher standards increase the personal risks and liabilities for D&Os as they look to steer their organisations through the complexity of today’s business challenges. As a consequence, at-risk senior executives are searching for more sophisticated D&O coverage.

In many instances it is not the personal liabilities of directors that have changed, nor what constitute illegal acts, but rather the appetite of enforcement agencies to hold directors and officers accountable. Reprimanding senior executives is increasingly seen as the most effective means of changing behaviour and preventing criminal and civil offences going forward.
The trend of rigorous enforcement particularly holds true when it comes to international criminal acts, including crimes committed against antitrust legislation, against the UK Bribery Act or America’s Foreign and Corrupt Practices Act, or breaching international sanctions laws.

Final thought, whether you are a large corporation or a small business, reaffirming the significance of the role of good corporate governance.

Corporate governance performed properly, results in the protection of shareholder assets. Fortunately, many boards take on this difficult and challenging role and perform it well. They do so by, among other things, being active, informed, independent, involved, and focused on the interests of shareholders.

Good boards also recognise the need to adapt to new circumstances—such as the increasing risks of cyber-attacks. To that end, board oversight of risk management is critical to ensuring that companies are taking adequate steps to prevent, and prepare for, the harms that can result from mis-appropriation of management.
There is no substitution for proper preparation, deliberation, and engagement on company related issues. Given the heightened awareness of these rapidly evolving risks, directors should take seriously their obligation to make sure that companies are appropriately addressing those risks.

Nicolas Berggruen once said:

‘The biggest determinant in our lives is culture, where we are born, what the environment looks like. But the second biggest determinant is probably governance, good governance or a certain kind of governance makes a huge difference in our lives.’

Do we have international differences in corporate governance and conduct?

There has been much discussion of late on the values of corporate governance in companies and more importantly the international differences in governance and agenda. As we both advise on company boards, I decided to speak to my business partner in the US, Mark Herbert, and create some joint thoughts on the matter.

Some of the questions we discussed:
“How do you know a board is effective?”
“Do you balance trust with challenging discourse?”
“Is the CEO engaged enough with the board?”
“How can the board challenge management with critical questions without engagement and collaboration?”
“Do you engage in a continuous improvement process?”

As you can imagine, our discussions were quite heated on leadership and at times in the lack of engaged leadership in business today.
The first matter we considered was: “Is there such a thing as a typical board of directors, since size and composition will vary according to a company’s needs?”

Board size can range from five to eighteen board members, though the average board size across Europe stands at about nine members. Regardless of board size, there are certain practices that should be followed to achieve optimal results. Overall, it is important to establish the desired board profile for your company by identifying the types of directors needed in relation to your business goals and ambition.

The composition of boards continues to be a focus for investors, and companies are responding by paying increased attention both to who sits on their boards and to enhancing their disclosure and engagement with investors. The data reported in the 2016 Spencer Stuart Board Index on S&P 500 boards highlights emerging practices, compiled from proxy disclosure and a related survey. Overall, the trends have stayed steady from last year but represent a meaningful departure from 10 years ago.

Directors sit on an average of 2.1 boards. 74% of boards have an over-boarding policy to limit the total number of boards on which directors may serve; 76% set it at three or four boards. Only 43% of CEOs serve on one or more outside boards, the same as last year, but more than a 10% decrease from 10 years ago.

Many companies regularly review the list of skills that are desirable on the board and match them with board members’ profiles. Directors’ “softer” skills and personalities should not be forgotten as they are instrumental in establishing appropriate board dynamics. When deciding on the composition of your board of directors, you should keep in mind the balance between the number of executive directors (board members who are part of the company’s executive team) and nonexecutive directors (board members who are not part of the company’s executive team). You may also want to consider having independent non-executive directors on the board.

On average, 49 percent of board seats in Europe are held by independent, non-executive directors. Such directors can bring real value to your company by providing new business opportunities and more independent, objective advice. They also can provide constructive criticism, to an extent which is unlikely to come from within the company. When thinking about your board’s profile, you should keep in mind the practicalities related to the size of the board. In other words, consider that the effectiveness of the discussion is impaired when there are too many people around the table. Larger boards of directors are not always the best source of constructive challenge or fresh ideas.

Generally common convention suggests that a board size of between seven to 10 directors is optimal for most companies. Equally important is the issue of gender balance. This issue has received a lot of attention recently, since women tend to be under-represented on boards. In Europe, in particular, this issue is pertinent, since only about 12 percent of boards have a female board member.

While public attention mostly focuses on governance for larger and listed companies, many business leaders of smaller companies understand that the fundamental principles of corporate governance such as transparency, responsibility, accountability and fairness are beneficial to all companies, regardless of listing status or size.

Corporate governance is crucial for increasing an SME’s ability to attract funding from both direct investment and credit institutions. Good governance is particularly important to shareholders of unlisted SMEs. In most cases, these shareholders are less protected by regulators, have limited ability to sell their shares, and are dependent on controlling shareholders. Accordingly, the higher risk implicit in owning a stake in an unlisted company increases the demand for a good governance framework.

Positive corporate governance changes have the impact of improving access to investment, allowing the company’s to access facilities of equity and debt. There has also been the additional impact of helping the company position itself for an eventual exit, trade sale or IPO, as the changes help send a signal to the market about the company’s emphasis on good governance.

Corporate management is the general process of making decisions within a company. Corporate governance is the set of rules and practices that ensure that a corporation is serving all of its stakeholders. According to the Center for International Private Enterprise, “Successful development efforts demand a holistic approach, in which various programs and strategies are recognized for their important contributions to progress and prosperity. In this regard, linkages between corporate governance and development are crucial… Yet, corporate governance and development are strongly related. Just as good corporate governance contributes to the sustainable development prospects of countries, increased economic sustainability of nations and institutional reforms that come with it provide the necessary basis for improved governance in the public and private sector.

Alternatively, corporate governance failures can undermine development efforts by misallocating much needed capital and resources and developmental fall backs can reinforce weak governance in the private sector and undermine job and wealth creation.” Globalization of finance and trade has supported the widespread adherence to common underlying corporate governance principles. They are not always country-specific and have been applied in various and diverse emerging markets, adjusted for local regulations and business traditions.

Building a strong board of directors never seems to get easier. High-profile board failures, the boom in activist investing, and the disruptive forces of technology are only a few of the reasons effective board governance is becoming more important.

Start with oversight, a role of the board that, most directors would agree, is no longer its sole function. Directors are now required to engage more deeply on strategy, digital, M&A, risk, talent, IT, and even marketing. Factor in complexities relating to board composition, culture, and time spent not to mention social, ethical, and environmental responsibilities and the degree of difficulty is set to continue to rise.

Mark and I stipulated a few points to help CEO’s and board chairs, as well as executives and directors, build stronger boards, this guide synthesizes multiple areas to make quick sense of complex issues in corporate governance, while focusing on the areas that are essential for building a better board and ultimately a better company.

Corporate Management Development
Corporate management has changed over time as managers have acquired better tools for understanding the problems they face. Most corporate managers are able to quantify many of the issues they consider, in order to make the correct decision. Managers factor in costs, benefits and the uncertainty of projects they are considering.
A good corporate manager is someone who can perform sustainable functions within the company they work for, while either maximizing revenue or minimising cost, depending on the department. Since the principles of corporate management are so broad, there are often specific disciplines for different parts of a company. The way a sales team is managed differs from the way the accounting department is managed.

History of Corporate Governance
Corporate governance is a newer subject of study. In the past, many companies were run solely for the benefit of their managers or founders. A company might have outside shareholders, business partners and thousands of employees, but under older ideas of corporate governance, the company would pursue only the goals of their managers. Managers might choose to provide poor benefits for employees, knowing that these employees couldn’t find better opportunities. Managers might also pay themselves excessive salaries without paying attention to community standards with respect to such practices.

Rise of Corporate Governance
In recent years, many companies have become more conscious of the need for good corporate governance. As regulations have tightened, it has become more difficult for companies to exploit workers or harm the environment. In addition, changes in financial markets have made it harder for companies to harm their shareholders. A mismanaged company becomes vulnerable to being purchased by another firm, so managers tend to treat their shareholders better. An increased focus on sustainability as a business practice, not just an ethical position, has also affected corporate governance.

Measuring Corporate Management Success
Corporate management’s success can generally be measured in terms of numbers. If the department in question is meant to create a profit (for example, if the entity being measured is a retail store or a factory), a quantity like profit margin or return on investment can demonstrate that it is achieving its goals. For departments that don’t have such responsibility (like a shipping department, or an accounting group), many managers measure their results in terms of cost. If a department can accomplish the same functions and spend less money, then by this measure, it’s a success.

Integrating Corporate Management and Governance
In recent years, many management thinkers have tried to synthesize corporate management and corporate governance into a single discipline. Since corporate governance is meant to equitably distribute the results of good corporate management, they fit together naturally: the best situation for a company to be in is for it to have good governance and good management. Combining these can take a variety of forms, from giving workers representation in company management to pursuing more efficient manufacturing processes in order to cut costs and help the environment. The most effective companies combine these practices in a mutually reinforcing way.

Finally, we discussed one more topic that is very typical that is trust – trust is generally lacking when board members begin to develop back channels to line managers within the company. This can occur because the CEO hasn’t provided sufficient, timely information, but it can also happen because board members are excessively political and are pursuing agendas they don’t necessarily want the CEO to know about. If a board is healthy, the CEO provides sufficient information on time and trusts the board not to meddle in day-to-day operations. He or she also gives board members free access to people who can answer their questions, obviating the need for back channels.

Another common point of breakdown occurs when political factions develop on the board. Sometimes this happens because the CEO sees the board as an obstacle to be managed and encourages factions to develop, then plays them against one another. We used the example of Pan Am founder Juan Trippe who was famous for doing this. As early as 1939, the board forced him out of the CEO role, but he found ways to sufficiently terrorize the senior managers at the company and one group of board members that he was returned to office. When he was fired again following huge cost overruns on the Boeing 747 the company underwrote, he coerced the directors into naming a successor who was terminally ill.

Most CEOs aren’t as manipulative as Trippe, and in fact, they’re often frustrated by divisive, seemingly intractable cliques that develop on boards. Failing to neutralize such factions can be fatal. Several members of Jim Robinson’s American Express board were willing to provide the advice, support, and linkage he needed — but the board was also riddled with complex political agendas. Eventually the visionary CEO was pushed out during a business downturn by a former chairman who wanted to reclaim the throne and a former top executive of another company who many felt simply missed the limelight.

The CEO, the chairman, and other board members can take steps to create a climate of respect, trust, and candor. First and most important, CEOs can build trust by distributing reports on time and sharing difficult information openly. In addition, they can break down factions by splitting up political allies when assigning members to activities such as site visits, external meetings, and research projects. It’s also useful to poll individual board members occasionally: an anonymous survey can uncover whether factions are forming or if members are uncomfortable with an autocratic CEO or chairman. Other revelations may include board members’ distrust of outside auditors, internal company reports, or management’s competence. These polls can be administered by outside consultants, the lead director, or professional staff from the company.

The Rt Hon David Blunkett, Home Secretary, London made a great statement once, when he said;

“Business continuity and planning is just as important for small companies as it is for large corporations. Plans need to be simple but effective, comprehensive but tailored to the needs of the organisation. Employers have a responsibility to their staff for their safety and security, and we all share the desire to ensure that any disaster or incident – whether natural or otherwise – has a minimal effect on the economic well-being of the country.”