What Keeps Directors Up At Night?

The 17th annual Corporate Board Member "What Directors Think" survey points to growing concern over the direction of the business cycle and the regulatory environment.

Over the past two years, companies and their boards have had to adapt to a revised corporate tax code and cash repatriation rules, trade policy shifts, culture-related scandals and shortened CEO tenures. And the year ahead promises to be just as challenging, with geopolitical turbulence and a looming Presidential election casting an even brighter spotlight on issues like trade policy and regulation.

Looking ahead, board members participating in the 17th annual Corporate Board Member What Directors Think survey cited two issues as most concerning: the direction of the business cycle and the regulatory environment. Fifty-nine percent of respondents pointed to the potential for the lengthy growth cycle we’ve been experiencing to come to an end as a top concern.

Even those who don’t feel that current economic indicators point to a recession posit that political infighting and trade tensions may cause enough economic uncertainty to jeopardize future growth. “Optimism drives the world, and when people in positions of prestige and responsibility talk down what’s going on in the economy in a self-serving fashion, although the facts don’t support it, some of it actually has a negative impact on how people behave and on the economy,” says Christopher Harned, director at American printing company Quad Graphics and head of Chicago-based Arbor Investments’ New York office, who cautions against trying to forecast the next stage of the business cycle based on historical data. “You have to be much more focused on dynamics, which will drive business conditions in the current environment, and not just suggest that because we’re in the seventh year a cyclical recovery, that’s pretty late and things should be coming to an end.”

Harned is also concerned about the regulatory environment, noting that anti-trust reviews factor heavily in the outcome of potential M&A transactions. “With the turmoil in Washington, it’s been incrementally challenging to feel like the anti-trust authorities are going to exercise consistency and predictability in how they review consolidation transactions.”

The regulatory environment was named as a top concern by 54 percent of directors surveyed, among them a large telecom company’s compensation chair, who says potential regulatory changes and the assessment of the company’s ability to meet them are one of the most relevant issues to put on the next board meeting agenda.

ESG: Lots of Talk, Some Action

Despite mounting pressure for companies to be more proactive on environmental, social and governance issues, only 8 percent of directors cited ESG issues as a source of great concern. Plus, while large investors have been publicly advocating for ESG initiatives, directors report that the top areas of engagement by shareholders remain the same as ever: growth and performance.

Still, nearly half of directors surveyed (47 percent) acknowledge that incorporating ESG-related factors into a company’s decision-making process supports long-term success. And among another 39 percent who answered “it depends,” many cited “authenticity” as the determining factor.

“Companies need to walk the talk,” says James Lafond, chairman of diversified technical services company VSE Corporation. “People have to believe that these issues are contributing to long-term success. If they don’t believe that, it’s not going to be successful.”

Martha Goss, chair of the audit committee at American Water Works Company, agrees. “It’s like any other corporate initiatives,” she says. “If it’s just ‘do what I say, not what I do,’ it’s not going to have an impact …. And if senior management talks it but doesn’t walk it, it’s not going to happen.”

Directors’ views on ESG varied widely. “ESG is important but should not be the highest priority for all companies,” said the director of a mid-cap industrials company—voicing a perspective shared by several other respondents.

“Depends on which industry and sector you are in,” asserts the nom/gov chair of a small healthcare organization.

The audit chair of a real estate company made the case that ESG issues are overshadowing the real purpose of boards. “Activists need to be put in their place,” he said. “Boards need to focus on profits and quit worrying about how many women or men or other classification. We need to keep experienced people on boards. Let the snowflakes worry about ESG.”

However, some respondents argued that concepts of profit and sustainability can factor significantly in a company’s success: “Capitalism and meritocracy is the way for American industry to flourish,” said the director of a financial firm. “ESG is coming to the fore as a strong long-term view that operates well within those concepts…TSV with a long-term view serves all stakeholders consistently. That makes money.”

Brad Oates, chair of the comp committee at CIT Group, says the issue of ESG is part of a much larger governance conversation. “There is a shift taking place from a primarily shareholder-centric governance model to a balanced stakeholder governance model that is causing confusion across U.S. boardrooms on how to balance competing stakeholder interests and avoid creating governance complexities that could result in poor financial performance,” he says. “This basically means that effective stakeholder governance—if that is the governance strategy adopted by a company—will require boards to address ESG in a sequential and more intelligent way.”

Meanwhile, assessing ESG efforts also remains problematic. Directors rated the complexity of measuring the effectiveness of their ESG initiatives a 6.4 out of 10, on a 1-10 scale where 10 is “nearly impossible.” “You can measure carbon footprint, waste and such other aspects, [but] community benefit and social determinants are much more difficult,” said James Hunt, audit committee chair at Brown & Brown.

“Ultimately, it will be most decision-useful for investors if a company can quantify the impact its sustainability practices have on its valuation,” notes Hannah Orowitz, managing director of corporate governance at Georgeson.

Nonetheless, implementation of CSR policies is on the rise, with the number of companies who have them in place up 12 percent from 2018. “It’s becoming pretty commonplace that the younger generations and others are very concerned about [these issues],” says Lafond. “And the media is playing it up big. So, you’re starting to see more noise in that area than you ever saw even 10 years ago. Presidential candidates talk about corporate governance or governance issues… whether that’s going to be good or bad remains to be seen, but it’s on the agenda, that’s for sure.”

Board Composition: The Pursuit of Diversity

“SKILLS REQUIREMENT SHOULD drive board composition, not artificial quotas,” said the chairman of a REIT who, like the majority of directors (62 percent), believes U.S. boards are doing enough to broaden diversity among their ranks.

“I am a bit concerned public companies are missing the best talent for our boards because we are too concerned about diversity,” said a director at a multinational manufacturing company.

Some respondents, however, believe there are candidates who are both diverse and skilled—if boards take the time to find them. “Twenty-five years ago, it was hard to find diverse candidates,” Goss says. “There were a lot of people who put themselves out there as potential corporate directors who, just because they had a diversity component, thought they should be selected, and that isn’t sufficient. I absolutely agree. But it’s also real easy to go to the standard databases and get a bunch of names…. You have to push. You have to really work on it.”

Yet, most boards still rely on recommendations from sitting directors (51 percent) and search firms (33 percent) to recruit new members. In board diversification, ethnicity was the one area where most directors (69 percent) felt their boards needed improvement. Boards seem to be placing more emphasis on prioritizing racial diversity, which now occupies fourth place in the list of attributes boards seek in the selection of new members—up from seventh place last year.

Growing Concerns with Overboarding

Also in the area of board composition, the issue of overboarding was a focus on many large investors’ agendas during the 2019 proxy season. While investors cited concern that the ever-expanding scope of responsibilities was leading directors to overcommit, Georgeson’s Orowitz sees other contributing factors. “Investors’ heightened focus on diversity also seems to be at play here,” she says, “both in that overboarding policies will result in a broader diversity of perspectives reflected collectively across U.S. boardrooms and that these policies challenge companies to broaden the pool of diverse candidates they are considering to fill open board seats.”

The majority of directors surveyed (74 percent) were in favor of boardroom seat limits, but most (59 percent) felt that limits should be at the discretion of the company. Only 15 percent were in favor of regulation-imposed limits, and 27 percent were against limits entirely.

Terry Rappuhn, chair of Quorum Health and audit chair at Akorn, says the real concern should be about a director’s engagement level rather than the number of board seats held. “I think you can have a very engaged director who puts in the work to be fully functioning on a number of boards,” she says. “You can choose to work 80 hours a week and keep up with everything you’re doing if that’s how you’re built and you’re committed to doing it, but it does become a scheduling problem if you’re on multiple boards because their meetings overlap, so I think it is a real problem if you’re not attending and participating in all the board meetings.”

She suggests that instead of setting a hard limit on the number of boards that are acceptable for a director to sit on, boards should publish their meeting attendance record. “That’s fair. I think you could really tell if people were engaged.”

Top Three Challenges

Once again, cybersecurity topped the list of issues most challenging to oversee—and for reasons likely to resonate with any company that has experienced a cyber event. “You only have to miss one time for the bad guys to create really, really big problems,” says Quorum Health and Akorn’s Rappuhn, a seasoned board member in the healthcare space, who points out that a breach can be a matter of life and death in some industries. “I worry a lot about patient safety and the Internet of Things.…. That is the kind of thing that we have got to be on top of and continue to put more and more emphasis and effort on because it deals with people’s health.”

Some directors said that robust risk management has given them more confidence in their ability to prevent or cope with a cyber event. Several reported having added members with cyber expertise to their ranks. “We didn’t hire him just for his cyber expertise; he’s got an amazing range of experience, and he’s not from a corporate background,” says American Water Works Company’s Goss of their board’s cyber expert. “He has a very senior military background and has brought a whole new dimension to thinking about operational risks, specifically related to cybersecurity but also more broadly.”

Half of respondents said their boards have at least one director with the technical skills to provide the necessary cybersecurity oversight, and 42 percent regularly bring in outside consultants to guide them on the issue. Rappuhn says general knowledge rather than expertise is sufficient. “I don’t feel like you have to have a technical person on the board, but I believe the board has to have enough knowledge to know what questions to ask and what answers make sense and the ability to call in experts as necessary.”

Advanced technologies/innovation ranked second most challenging to oversee, cited by 53 percent of directors. “You need to be asking questions about what your competition would be and what we see that’s new, what’s coming at us, what are the potential disruptors that might attack our supply chain or how we sell or deliver our products, or even the very need for our product…” says VSE’s Lafond. “When you’re talking about strategy, the board has to be at least raising those questions and management has to at least have an answer that they’re thinking about it. And it’s always good to get third parties in front of a board periodically, futurists and others, to just talk about things outside the box.”

More than a third of this year’s survey respondents selected culture as one of the most challenging issues for boards. Directors reported struggling to get a true picture of what transpires at every level of the organization. “Do we really know what’s being driven down through the company?” asks Lafond. “What are the supervisors at the operating plants talking about?”

To get a pulse on that, he says, directors must get out of the boardroom, mixing with employees during annual meetings and other gatherings. “You’re not going to test the culture in the boardroom; you just can’t. You have to see it in reality.”

To learn more, read the full whitepaper here and attend the upcoming Corporate Board Member webinar on February 20th.