The principles of accountability, transparency and engagement have always applied to best practices for good corporate governance. What’s changed is that there’s a greater emphasis on good corporate governance than ever before because of the fallout from the 2008 financial crisis. As investors, shareholders have the right to know how the companies they invest in are being managed. It eases the consciences of investors when they understand the board’s reasoning in how they make decisions and oversee management. In essence, enhanced accountability, transparency and engagement result in robust corporate governance that promotes stronger oversight.
Understanding the Emphasis on Transparency from Boards
Investors and financial experts learned many lessons from the fallout of the financial crisis of 2008. One of the major setbacks of the event caused shareholders to have a vast mistrust of financial institutions and a suspicious outlook on the overall economy.
One of the issues that came to light is that the bulk of investors are everyday Americans. They’re people from every walk of life who invest in mutual funds, pensions and 401(k) plans. Most Americans rely on these types of plans to supply their future financial needs, such as getting a down payment for a house, putting their children through college and saving for retirement. As the general public saw a decrease in their investments, and in many cases, a loss of funds, everyday citizens also began to lose trust in the stock market.
The lack of trust between shareholders and citizens in the marketplace has had an additional negative effect on the stock market and the economy. These concerns have led to a focus on the issues that have contributed to financial volatility, such as concerns about excessive compensation.
Strong Accountability Has a Major Positive Effect on Good Corporate Governance
Accountability is a central component of effective corporate governance. Actions and inactions by board directors and managers nearly always have consequences that affect shareholders and the overall economy.
Accountability is vital because it ensures that the board is measuring performance and misrepresenting the results internally or externally. The principle behind accountability is to reward good performance and not inappropriately reward poor or subpar managerial performance. Beyond rewarding stellar performance, accountability ensures that boards will practice strong oversight and not tolerate misconduct.
Executive compensation falls under the principle of accountability, which is why shareholders and others have taken a new perspective on how boards develop their executive compensation plans. While it makes perfect sense that corporate governance should align directly with the company’s financial performance, the market sees executive compensation plans continuing to increase. Financial experts are expressing concerns that the structure of today’s executive compensation plans rewards executives based on factors that are not related to performance and that executive compensation plans are seriously out of kilter with the amounts paid to lower-level employees.
The suspicion is that most compensation plans have a flaw in the structure. Equity-based compensation and other incentives often pay even when managers fail to perform to expectations. The assertion behind executive compensation plans is that when the company does well, managers should be compensated accordingly. However, in many cases, executives are enjoying bonuses and extra pay as the company prospers even when their role didn’t contribute directly to those positive results.
Another issue that’s getting attention is the role of severance pay. Many boards use severance pay as a recruitment tool for attracting the best talent. Severance pay packages are often extraordinarily high. High severance payouts take a negative turn when executives don’t stay with the company long term and when they fail to perform early on in their employment. Shareholders would like to see adjustments in severance packages that hold executives accountable for the work they actually perform.
As the financial realm begins to carve out new paths that replace outdated governance practices, shareholders’ voices and opinions have become stronger, which is helping to promote accountability. Some of the new approaches aren’t necessarily binding, although new trends are highlighting the need for accountability.
Past fraud schemes have also shed light on the importance of companies playing by the rules. Board oversight plays a major role in ensuring that companies report results accurately. Regulators enforce accountability standards by strongly enforcing rules and laws.
Shareholders Rely on Transparency to Ensure Accountability
While the Securities and Exchange Commission (SEC) has been reluctant to issue specific rules, they have issued many reports that guide expectations for companies to be more accountable and transparent. The SEC has been focusing on education and information about how investors can make good voting and investment decisions in the current climate.
Shareholders and regulatory bodies would like to see disclosures that include descriptions of the company’s business and biographies of board directors, nominees and senior managers. In addition, transparency demands that companies report current and future financial and operating data.
The proxy process is evolving, with the goal of giving shareholders a stronger voice in corporate leadership. The proxy process is intended to replicate what would happen if all shareholders could meet in person at one location. Proxy meetings account for the needs of investors, changes in the marketplace and the experiences of the SEC.
Trends More Accepting of Shareholder Engagement
An emerging trend is for corporations to be more accepting of the shareholder voice. Many corporations are opening up to the notion of having more frequent shareholder meetings to address shareholder concerns before the proxy meeting. More frequent shareholder meetings may also result in shareholder proposals, which is another new trend in corporate governance that companies are opening up to.
Good corporate governance is the foundation that stabilizes our capital markets and the economy while offering valuable protection for investors. Regarding executive compensation, the issue applies more to whether the compensation structure ensures accountability through transparency and shareholder engagement, rather than the actual amount of compensation.
To enhance corporate governance practices, boards will need to rely more heavily on digital tools such as the suite of tools that comprise Governance Cloud — software solutions that aid in streamlining and improving enterprise governance management.