Top challenges for boards in 2014

If directors thought they worked harder than ever during 2013, they should expect to up the ante even further in 2014. For boards, ‘business as usual doesn’t work,’ says Ernest Brod, managing director of global forensic and dispute services for Alvarez & Marsal. The regulatory environment, both its aggressiveness and uncertainty, will keep directors on the defensive, as will unrelenting activist shareholders. Directors will need to find ways to ‘make nice’ while engaging shareholders – in fact, they’ll need to proactively anticipate shareholder concerns and needs to reduce the drama come proxy season. That’s just some of what will preoccupy directors in 2014 – here’s a look at what is likely to top the agenda.

Board composition

Increasingly, companies are realizing that although they may have a very talented group of directors around the boardroom table, these may not necessarily be the right directors to confront the growing challenges in a global economy, says Mark Rogers, CEO of online boardroom community BoardProspects.com.

In a PwC board survey, nearly a third of sitting directors said they felt someone sitting on their board should go, notes Alan Rudnick, co-founder of corporate governance specialists Masters-Rudnick. ‘That’s a startling number,’ he says. ‘There needs to be serious discussion as to why this is the case.’

Simply put, many boards still lack digital orientation and know-how, making it difficult for them to fully participate in strategic discussions regarding opportunities presented by digital technology and digital-based services or even to ask senior management the right questions, says Keith Meyer, vice chairman and global head of the CEO and board practice at executive search firm CTPartners. ‘With the way digital is transforming business models and the need for companies to continue to grow revenue via diversification, boards need leaders with the depth of experience, operational understanding, strategic business insights and gravitas to provide strong leadership and influence on digital matters addressed by the board,’ he explains.

The board composition debate is certain to include gender diversity. ‘I think we will see even more pressure to get qualified women onto boards,’ observes Rita Gunther McGrath, associate professor at Columbia Business School and author of The end of competitive advantage: how to keep your strategy moving as fast as your business. ‘Witness the fuss over the Twitter board – two Peters and a Dick.’

It will also include discussions about independence. Come proxy time, institutional shareholders are likely to raise the issue of term limits. ‘There’s an argument that after serving too long on a board, you are not independent,’ says Robert Kueppers, managing partner at the Center for Corporate Governance at Deloitte. ‘The average tenure on US boards is 10-12 years. Some will ask whether board members should be asked to step down after a certain time.’

Rudnick says boards have a difficult task ahead of them. ‘They have to ask, do we have the right members? What’s our strategy, our risk profile? How do we come to a consensus that it is time for someone to step down, and do it in a civilized way?’
Boards will also need to increase the emphasis placed on board and director-level evaluation processes and on the nomination process, according to Michael Peregrine, a partner with law firm McDermott Will & Emery.

There is no room for window dressing or non-contributing board members in the boardroom in 2014, says Jay Millen, board of directors and CEO practice leader for executive search firm DHR International.

Executive pay

Executive pay remains in the spotlight, and disclosure of the ratio of CEO to worker pay is a subject for hot debate. ‘While the aspirational hope behind this is to lower CEO pay, it’s unclear how the rules regarding this will change, but something will happen,’ says Peter Gleason, managing director and chief financial officer of the National Association of Corporate Directors. ‘Boards need to focus on this issue.’

Most commentators agree there needs to be a rethinking of executive pay, away from peer group comparisons. ‘Executive pay must be consistent and explainable,’ emphasizes Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. ‘The gap between the CEO and everybody else is just too wide. The board will have to insist that peer groups disappear. Some companies are going to look bad when they have to disclose their pay ratio.’

Shareholder activism and engagement

Activist investors had an extremely successful 2013 and there is no reason to believe that trend will slow in 2014, says Rogers. The concern for boards is that, depending on the circumstances, the activist investor can significantly alter the direction of the company, pushing for change among the management team and/or the board.

Whether the source is activist shareholders, dissident shareholders, a whistleblower, the government, unions or public policy groups, there will be increasing application of the ‘where was the board?’ line of inquiry when things go awry. Experts suggest there will be a much more intense focus on the conduct of individual directors in circumstances of conflict, pressure, risk disclosure, crisis, oversight or evaluation. There will be an increasing effort by different constituencies to assign blame to the board, either collectively or to individual directors, in circumstances that prove unfavorable to the organization, says Peregrine.

According to the Institute for Enterprise Ethics at the University of Denver, institutional shareholders will continue to sponsor hundreds of shareholder resolutions across a range of corporate governance issues. One hot topic among shareholders currently is the disclosure of corporate political spending and lobbying activities.

There are two ways for boards to address the perceived threat posed by activist investors. Traditionally, activist investors get involved with a company when the board fails to address one or more significant missteps at the management level in an appropriate and timely manner. To counter, boards can be proactive in their defense against activist investors by staying engaged with management and ensuring the company is fully apprised of its risk exposure, Rogers notes.

Secondly, after the investor has taken a substantial equity position in the company, ‘the company can take drastic action such as the ‘poison pill’ defense. Such action may create an unnecessary antagonistic situation with the activist investor, however,’ warns Rogers. He cautions boards to remember that they represent the interests of the shareholders and, more often than not, activist investors increase shareholder value. ‘Boards should be willing to meet the activist investor and determine what, if any, common ground can be reached,’ he concludes.

Like others, Rudnick believes shareholder engagement is a priority for 2014. ‘Any board that doesn’t listen carefully to shareholders, that doesn’t get to know who its shareholders are and what their concerns are, is doing itself and the company a disservice,’ he says.

Risk management

Third-party risk is still the Achilles’ heel of ethics and compliance. Baseline screening and enhanced due diligence have become the new normal, says Randy Stephens, vice president of the Ethical Leadership Group at ethics and compliance consultancy NAVEX Global. The public, investors, employees and consumers are increasingly demanding transparency and CSR throughout the manufacturing and distribution process. ‘Every company, and especially those with global supply and distribution networks, needs to assess the adequacy of its third-party risk management systems,’ Stephens advises.

Technology is revolutionary, but it is also full of risks. Gunther McGrath warns that as activities move to the cloud, they are going to require new kinds of due diligence from boards.

Even innovation has risks. ‘Say a garment company designs and digitizes its upcoming line,’ says Faye Wattleton, managing director of the corporate suite at Alvarez & Marsal. ‘If someone hacks into the firm’s database and steals the design before it gets to the catwalk, what are the implications for that company’s earnings?’

News reports involving hackings have become routine, but they are not to be taken lightly. IT risks can directly affect the revenues, profitability and viability of an organization, says Jerry Irvine, chief information officer at Prescient Solutions and a National Cyber Security Task Force member.

Cyber-security has become a full board issue, not just a committee concern, and the complexity involved can be vexing. In 2014 President Obama is expected to sign an executive order setting minimum security standards that could add requirements from regulators, points out Don Keller, partner with PwC’s Center for Board Governance.

Boards have to ask tough questions, says Rudnick, such as the following. ‘Can we keep our systems safe from hacking? If not, are we prepared for the consequences of someone hacking those systems? How do we as a board perform proper oversight? What questions should we ask? Risk is tough, because it’s dealing with the unknown. The big question is whether we have the right staff to handle IT issues.’

Increased regulatory oversight is not going away for the foreseeable future. ‘Boards must continue to ensure their risk protocols and procedures are in place and updated,’ says Rogers. ‘All boards should consider a standing risk committee.’

Corporate strategy

Developing the right corporate strategy in 2014 may be more complicated than ever, with economic volatility, the pace of change and the impact of emerging markets, says Keller. But while boards can’t do much with respect to the economy, notes Rogers, they can make sure management is prepared for another downturn by, for example, having the appropriate cash reserves on hand.

Companies can’t afford to sit still while competitors move ahead at full speed, but poorly executed forays have consequences, and although emerging markets hold promise, they also pose challenges. ‘What are the issues when you’re working in Myanmar?’ asks Brod. ‘China and India are not the nirvana we thought.’

The coming year may also mean an upswing in M&A. ‘Organic growth has been modest,’ says Kueppers. ‘I predict more growth through M&A.’

In this dynamic environment, companies risk obsolescence – think BlackBerry and Nokia this past year – if they aren’t constantly seeking out market development, product development and repositioning opportunities. ‘The board must constantly ask the question: what’s next for the business?’ says Millen. ‘And it must review the pipeline of products, markets and potential acquisitions for the company.’

The bottom line, according to Keller, is that boards must revisit their strategic thinking processes. ‘They can’t just hit strategy once a year – they have to do it quarterly. Things are not as static as they once were.’