Director turnover is likely to be a significant focus for governance teams in 2018 – in part because it is wrapped up in issues such as board cohesion, cyber-security and diversity – while ESG proposals and the pay ratio rule are also likely to keep corporate secretaries and general counsel busy, according to industry professionals.
When PwC released the results of its annual corporate director survey in October, one result stood out as particularly surprising: almost half (46 percent) of public company directors say that at least one of their fellow board members needs to be replaced, up from roughly a third in previous years’ surveys. Another 21 percent of respondents say two or more directors should be replaced. That means two thirds of board members want to switch out at least one of their colleagues.
The level of dissatisfaction uncovered in the survey is highest among the most recently appointed directors, and its underlying causes appear to be changing. In the past, respondents complained that colleagues were unprepared for meetings or unfocused. Now they cite directors as being detrimental to the dynamic of the board, stalling forward progress, overstepping the boundaries of their role or being reluctant to challenge management, notes Dottie Schindlinger, vice president and governance technology evangelist at Diligent. ‘You’ve got a group of fresh directors coming in the door who are seeing the picture very differently from directors who’ve been on the board a long time,’ she tells Corporate Secretary.
Amid increasing investor pressure to bring in new blood and ensure the right skills are represented, board dynamics and development are going to be important issues in the coming year, requiring proactive steps to ensure strong cohesion and forestall problems, Schindlinger adds. ‘The board is changing, [and] boards might need to invest time in development work to ensure they function well as a team,’ she notes. ‘Making sure everyone is on the same page, able to communicate securely and regularly, will be critical to this success. Corporate secretaries play a role in helping the nominating and governance committee expand its role to thinking about the ongoing development of the board as a high-functioning team.’
‘Investors are pushing forward on a progressive agenda, and while directors have made strides with taking action on performance assessments and warming up to shareholder engagement, there’s still more work to do on areas such as increasing boardroom diversity – including gender, ethnic and socio-economic diversity – prioritizing key societal issues and challenging management on strategy,’ writes Paula Loop, leader of PwC’s Governance Insights Center, in a note on the study.
CYBER-SECURITY
The issue of new blood and diversity on boards impacts another hot-button issue: cyber-security. With a median age in the low 60s, board directors may be slow to adapt to fundamental shifts in the threats posed by new technologies, observers say. ‘I don’t think there are many millennials on boards,’ Curt Kramer, senior vice president and general counsel with Navistar International, tells Corporate Secretary. He cites the ‘continued explosion of technology’ as an area of concern for general counsel and corporate secretaries. ‘The law has always chased technology, from day one,’ he adds.
Schindlinger agrees that board demographics are not on the side of a robust approach to cyber-security issues, noting that many of today’s board members did not grow up with technology but had to learn it as a second language. ‘They really, truly want to believe the security team at their company has the cyber-security picture locked down,’ she says. ‘But as any [chief information officer (CIO)] would tell you, you’re just kind of fooling yourself. It’s not a matter of if, it’s a matter of when [you’ll be hacked]. In fact, what we’re now learning is that most companies have already been hacked. They just might not know it yet.’
Directors themselves can represent an area of risk. Schindlinger says her firm’s research has found directors at some companies are using personal, unsecured email accounts to conduct board business. Many don’t get cyber-security training, and no one is doing audits of how board members handle sensitive documents. It has not been the norm to have the CIO or other security officers regularly take part in board meetings, she says. But things are improving, at least in places.
‘I think we’re starting to see that change, thankfully – maybe later than it should have [happened],’ Schindlinger says. ‘If boards haven’t [already] woken up to the fact that this is the primary thing that will destroy their business if they’re not careful, they’ll be thinking about it and talking about it in 2018.’
‘Risks related to cyber-security are top-of-mind for boards and top-of-mind for senior management,’ Gibson Dunn & Crutcher partner Lori Zyskowski says. Several derivative lawsuits against directors and officers have stemmed from cybersecurity incidents, based on alleged failures to oversee company policies and procedures. ‘Directors need to show they were using their business judgment and that the company had policies,’ Zyskowski adds.
In light of high-profile hacking attacks, the SEC staff may come out with additional disclosure guidance around cyber-security in the coming year, some professionals say.
ESG
Betty Moy Huber, counsel and co-head of the environmental group at Davis Polk & Wardwell, tells Corporate Secretary she expects companies to see more climate change-related shareholder proposals in 2018. Such proposals typically urge companies to produce reports on how they will be affected by action taken to limit climate change. Three were successful in 2017, and Huber notes that support has been growing in general and proposals have become more sophisticated each year. She also expects to see proposals around methane emissions and sustainability reporting in the coming year.
On the flip side, the options for companies to defeat such proposals may have expanded. The SEC in November issued staff guidance on the scope and application of rules 14a-8(i)(7) and 14a-8(i)(5), each of which provides a basis for excluding shareholder proposals from a company’s proxy materials. In the past, environmental proposals were not considered to fall under the so-called ‘ordinary business’ exception via which companies could exclude a proposal that dealt with a matter related to its ‘ordinary business operations’.
But Huber says the legal bulletin potentially opens up the ordinary-course argument for ESG proposals, though it’s not certain the SEC would agree that the exception applies – and invoking it may spark public relations blowback. ‘I think a lot of people are confused,’ she says. ‘A lot of companies are feverishly analyzing and considering the impact of this new [SEC staff legal bulletin] on environmental and social proposals and whether – from a time, energy and public relations standpoint – they will pull the trigger on it this season, as it would entail determining that the environmental, climate change or social issue is not significant to the company.’
Companies are looking for a test case, a board willing to be the first to raise its hand, Huber adds. An SEC spokesperson declined to comment beyond the staff bulletin.
PAY RATIO RULE
Observers say the SEC’s new pay ratio rule, which from 2018 will require public companies to disclose the ratio of their CEO’s pay and that of its median employee, could be a flashpoint with ramifications for say-on-pay votes, PR, investor relations and recruitment in the year ahead.
Huber says the ratio can be misleading when comparing one firm with another, or one industry with another. Ratios can change depending on how much of a workforce is unionized, or on how much is based domestically and how much overseas, as well as other factors. Huber says companies need to make sure their messaging to relevant stakeholders around the ratio is managed appropriately, particularly with respect to rank-and-file employees.
Zyskowski says she hears concerns about employee engagement and fears about recruitment around pay ratio disclosures, noting that companies use different assumptions in their calculations, which might limit how meaningful the ratio is. Ultimately, such disclosures could impact say-on-pay votes, but the effects might not be felt until after the upcoming proxy season once companies evaluate how and whether the data gets used, she adds. Increasingly, she notes, there is a focus on outsized director compensation and gender pay equity, and she expects to see more proposals asking companies to issue reports on whether or not they have disparate compensation policies for men versus women.
This article originally appeared in the Winter issue of Corporate Secretary.
