General Best Practices: Another Box-Ticking Exercise or Improved Corporate Governance?
Interestingly, there is no single accepted definition of the term “corporate governance.” Broadly speaking, it refers to the system by which companies are directed and controlled. It also refers to a structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined (OECD).
Unsurprisingly, many believe that only public companies should be concerned with implementing corporate governance practices given the need to bolster public confidence, while private companies (irrespective of their size) should be left to choose whether to adopt governance practices. For those private companies that chose to adopt governance practices, some argue that these practices should be based on their needs, which are in most cases pressured by capital, labor, or product markets and not imposed by statutes or corporate governance codes.
Some scholars have also argued that while corporate governance best practices are, by their very design, intended to enhance board members’ ability to discharge their responsibilities (to shareholders, the company, and each other), there is little evidence that corporate governance, specifically board effectiveness, has significantly improved over time in companies that are compliant with multiple elements of best practices. As such, imposing corporate governance practices on companies may result in (i) a misplaced focus on structural aspects of the board of directors at the expense of process issues; and (ii) yet another round of good-governance box-ticking and hood jumping, which evidence has shown produces no real improvement in corporate governance.
In Where Boards Fall Short, Barton and Wiseman reiterate that boards are not working, and most boards are not delivering on their core mission, which is to provide strong oversight and strategic support for management’s efforts to create long-term value. Directors also believe their respective boards are falling short of delivering on their core mission.
The million-dollar question now is how can boards effectively move away from overemphasis on short-term financial results and adopt governance practices that would not result in a box-ticking exercise but instead help directors build, maintain and refine a long-term mindset? This article will address this conundrum and discuss whether the way forward is to impose general “best practices” on all companies or whether individual companies should be left to choose the corporate governance structure best suited to their needs.
Corporate Governance Best Practices – what are they?
Historically, corporate governance best practices have focused on issues that include the composition and size of the board (i.e., the proportion of independent directors, women and/or minorities), whether the CEO concurrently holds the position of board chairperson, adopting a staggered/classified board, and the composition of the various board committees. Governance best practices are generally aimed at positively impacting long-term corporate performance, given that companies that prioritize long-term needs tend to outperform peers that bow to short-term market pressure.
However, the reality is that companies adopting these conditions may not result in overall board effectiveness. For instance, for public companies subject to the Sarbanes-Oxley Act 2002 or corporate governance standards imposed by various listing exchanges (such as the New York Stock Exchange and NASDAQ), there is little evidence that corporate governance has significantly improved over time.
More so, FCLTGlobal’s research showed that certain well-meaning governance practices for boards do not seem to improve long-term company performance. FCLTGlobal used global data to see which board actions actually correlated with long-term value creation and found no evidence that (i) director overboarding, (ii) CEO-chair duality, and (iii) tenure meaningfully affect returns.
Beyond complying with historical best practices (some of which are now imposed by corporate governance statutes, codes and listing rules, and often requested by institutional investors), a step in the right direction to help boards build, maintain, and refine a long-term mindset is adopting some of the following non-exhaustive strategies:
a) spending quality time on strategy;
b) ensuring a diversified board;
c) communicating directly with long-term shareholders;
d) ensuring that directors have a stake in long-term success; and
e) paying directors more.
It is the expectation that implementing these good governance strategies would not amount to another box-ticking exercise, but rather would improve the companies’ standards of corporate governance.
Another major concern is the common misconception that only public companies or publicly listed companies should be concerned with implementing governance practices, given the need to bolster public confidence in listed companies, meet demands of institutional investors, and enhance corporate ethics and democracy. However, the fact is that all companies (irrespective of size and whether privately held or public) can benefit from governance practices, because right-sized governance practices will positively impact the performance and long-term viability of every company. All companies compete in an environment where good corporate governance is crucial especially as it relates to internal board strategies, raising capital, securing third-party financing, and preparing for a potential acquisition. As such, private companies should also adopt governance practices.
Certainly, one size does not fit all – as a small cookie company should not be subject the same corporate governance standards as a large investment management company. Nevertheless, the small cookie company should ensure that it adopts right-sized corporate governance practices. However, a prevalent trend in private companies is the boards’ focus on profit-making and short-term results at the expense of long-term value creation. Many private companies measure performance by profit-making only, and therefore operate with little or no good governance structure in place.
Should the solution to this problem be to impose minimum corporate governance standards on all companies by statutes or governance codes? Would the statutes and/or codes be adequately drafted to provide right-sized governance practices for private companies operating in varying markets and at different stages of development? These, and more, are some of the critical questions that arise when considering the imposition of minimum corporate governance standards on private and public companies alike.
Funmilayo Fenwa is a Corporation LLM candidate at NYU and serves as a Graduate Editor of the NYU Journal of Law & Business. Prior to attending NYU, Funmilayo worked as an M&A and Project Finance lawyer for over three years at Olaniwun Ajayi LP, a top tier commercial law firm in Nigeria. She graduated with first class honors in law from Nottingham Trent University, England.