July 21, 2016
Today a group of 13 executives at leading companies and institutional investors released "Commonsense Principles of Corporate Governance" for public companies, their boards of directors and their shareholders. The Principles are described as being intended "to provide a basic framework for sound, long-term-oriented governance" and to "promote further conversation on corporate governance." An open letter accompanying the Principles describes them as "conducive to good corporate governance, healthy public companies and the continued strength of our public markets." Full-page ads summarizing key parts of the Principles were published in national and international newspapers.
The Principles, which are the product of meetings that have been reported on for several months, acknowledge that not every Principle will work for every company or be applied in the same manner given the many differences among public companies. Institutional investor signatories include representatives of Berkshire Hathaway, BlackRock, Capital Group, J.P. Morgan Asset Management, State Street, T. Rowe Price and Vanguard. The signatories also include the chief executive officers at General Electric, General Motors Co., JPMorgan Chase and Verizon. The chief executive officers of hedge fund ValueAct Capital and the Canada Pension Plan Investment Board, a public pension fund, also are signatories.
The Principles are organized into eight areas: (1) Board of Directors – Composition and Internal Governance; (2) Board of Directors’ Responsibilities; (3) Shareholder Rights; (4) Public Reporting; (5) Board Leadership (including the lead independent director’s role); (6) Management Succession Planning; (7) Compensation of Management; and (8) Asset Managers’ Role in Corporate Governance. Some of the Principles address matters that are already required by state law, the corporate governance requirements in listing standards or the Securities Exchange Commission rules.
Recent high-profile public company governance issues and other matters that are addressed include:
- Proxy access: The Principles report on the terms generally adopted by most companies, but do not advocate the adoption of proxy access or the adoption of specific terms.
- Board leadership: "The board’s independent directors should decide, based upon the circumstances at the time, whether it is appropriate for the company to have separate or combined chair and CEO roles." When the CEO/chair roles are combined, the board should have a "strong designated lead independent director and governance structure." The Principles also include a list of possible duties for the lead independent director.
- Non-GAAP numbers: The Principles state that non-GAAP numbers "should be sensible and should not be used to obscure GAAP results." The Principles also note "that all compensation, including equity compensation, is plainly a cost of doing business and should be reflected in any non-GAAP measurement of earnings in precisely the same manner it is reflected in GAAP earnings."
- Earnings guidance: The Principles state that companies "should not feel obligated to provide earnings guidance – and should determine whether providing earnings guidance for the company’s shareholders does more harm than good."
- Board diversity: The Principles state that "[d]irectors should have complementary and diverse skill sets, backgrounds and experiences. Diversity along multiple dimensions is critical to a high-functioning board. Director candidates should be drawn from a rigorously diverse pool."
- Director election voting standard: The Principles state that directors should be elected using majority voting. They do not mention specifics such as whether majority voting should only be used in uncontested elections or advocate the adoption of companion director resignation policies.
- Board tenure: Instead of adopting a bright-line view on board tenure, the Principles emphasize the need for considering board refreshment and tempering "fresh thinking and new perspectives" with "age and experience" on the board.
- Term limits/retirement ages: Consistent with the approach on board tenure, the Principles do not recommend the adoption of retirement ages or term limits but instead state that, to the extent a board permits an exception to any such policy, the board explain the reasons for the exception.
- Director effectiveness: The Principles state that boards "should have a robust process to evaluate themselves on a regular basis" and "the fortitude to replace ineffective directors."
- Industry experience: The Principles state that a "subset" of directors should "have professional experiences directly related to the company’s business" and that the board should be "continually educated" on the company’s industry.
- Ability of shareholders to act by written consent and call special meetings: The Principles state that the ability of shareholders to act by written consent and call special meetings "can be important mechanisms for shareholder action" but, when adopted, should require "a reasonable minimum amount of outstanding shares . . . [to act] in order to prevent a small minority of shareholders from being able to abuse the rights or waste corporate time and resources."
- Director engagement with shareholders: The Principles encourage boards to engage in robust communication of the board’s thinking to shareholders. They note that there are many ways to do so, including designating certain directors "in coordination with management" to "communicate directly with shareholders on governance and key shareholder issues."
- Audit committee review of financial statements: The Principles state that audit committees "should focus on whether the company’s financial statements would be prepared or disclosed in a materially different manner if the external auditor itself were solely responsible for their preparation." This Principle was recommended during a 2002 Securities and Exchange Commission roundtable by Warren Buffett, a signatory to the Principles and at the time a member of the Coca-Cola Audit Committee, as one of several questions audit committees should be asking auditors.
- Access to management: The Principles state that "directors should have unfettered access to management, including those below the CEO’s direct reports."
- Director compensation: The Principles recommend that companies consider both paying "a substantial portion" of director compensation in equity and requiring directors "to retain a significant portion of their equity compensation during their tenure" on the board.
- Executive compensation:
- Executive compensation plans should "ensure alignment with long-term performance" and "have both a current component and a long-term component."
- "Benchmarks and performance measurements ordinarily should be disclosed to enable shareholders to evaluate the rigor of the company’s goals and the goal-setting process."
- "Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments."
The Principles do not explicitly mention some prominent governance issues, such as classified boards, supermajority voting requirements, poison pills or sustainability.
The Principles also address the role of asset managers in corporate governance. The Principles state that "[a]sset managers should exercise their voting rights thoughtfully and act in what they believe to be the long-term economic interests of their clients." They also note that when voting on matters, asset managers "should give due consideration to the company’s rationale for its positions" on those matters and vote based on "independent application of their own voting guidelines and policies." The Principles also encourage asset managers to evaluate the performance of the boards at the companies in which they invest.
Public companies – especially those whose institutional investor base includes significant holdings by the institutional investors who signed the Principles – should consider promptly distributing the Principles to their boards and/or governance committees. Public companies also should consider ways to enhance their shareholder communications – including proxy materials – to emphasize the Principles that the companies follow. Finally, directors may find it useful to review a summary of or discuss how the company’s governance practices compare to the Principles and, where they are different, the reasons why.
The Principles (click on link) and theopen letter (click on link) from the signatories are available at http://www.governanceprinciples.org/.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance practice group, or any of the following:
John F. Olson - Washington, D.C. (202-955-8522, [email protected])
Ronald O. Mueller – Washington, D.C. (202-955-8671, [email protected])
Elizabeth Ising – Washington, D.C. (202-955-8287, [email protected])
Lori Zyskowski – New York (212-351-2309, [email protected])
Gillian McPhee – Washington, D.C. (202-955-8201, [email protected])
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