This issue of BoardroomDirect® takes a look at how boards address transformational changes, such as M&A’s, new product and technology rollouts; how boards and companies should abide by the new proposed CEO pay ratio disclosure rules; the latest data on political spending disclosure; and why cash flow statements have become the most read by boards.
Boards confront an evolving landscape
There is unprecedented change in the corporate governance world: new perspectives on boardroom composition, higher levels of stakeholder engagement, more emphasis on emerging risks and strategies, and an increasing velocity of change in the digital world. These factors, coupled with calls for enhanced transparency around governance practices and reporting, the very active regulatory and lawmaking environment, and the perceived increased influence of proxy advisors are all accelerating evolution in the boardroom. In some cases, even a revolution.
The following are some of the insights from Boards confront an evolving landscape: PwC’s 2013 Annual Corporate Directors Survey. During the summer, 934 public company directors responded to survey questions. Of those directors, 70% serve on the boards of companies with more than $1 billion in annual revenue.
To read the results of this year’s survey, click on each of the following category links: Board composition and behavior, IT oversight, Executive compensation, Stakeholder communications, Strategy and risk management, Regulatory and governance environment.
Many boards today are trying to figure out if they have the proper skills and experience to guide their companies now and in the future. Each board needs to consider whether the backgrounds and experience of its existing directors are appropriate or if new skills are needed. Recently, some critics have been outspoken about their perception of deficiencies in the current state of board renewal.
And some board members themselves are questioning the competency of their fellow directors. While a majority of directors at companies with annual elections are elected with at least 90% of the vote, there are still plenty of directors dissatisfied with their current board’s composition. Early results from PwC’s 2013 Annual Corporate Directors Survey show that 35% of 934 directors responding say someone on their board should be replaced, up from 31% a year ago. The top three reasons cited are diminished performance because of aging, lack of expertise, and lack of preparation for meetings.
On average, directors are getting older and fewer are leaving boards to make way for the next generation. The 2012 Spencer Stuart US Board Index reports that the number of new directors has slowed to 291 of 5,184 total director seats in 2012, a 27% decrease from 2002. At the same time, the average age of directors (68), average board tenure (8.7 years), and mandatory retirement age (72-75) have all risen. Currently 73% of S&P 500 companies have existing mandatory retirement age policies, but sometimes they are waived. Only 4% of S&P 500 boards specify director term limits with the majority setting the limits between 10 and 15 years.
Non-financial companies that use over-the-counter (OTC) derivatives to hedge risks, such as currency, interest rates, and fuel costs, are facing myriad decisions regarding the execution and management of those financial tools under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
While management is still responsible for making the business decisions, under Dodd Frank the board is now charged with some specific oversight responsibilities. The regulatory reform, which is going into effect in phases this year, will lead to changes in business strategy, funding, operations, and accounting related to the use of derivatives.
Derivatives are agreements between a corporation and a bank that derive their value from underlying assets, such as interest rate payments, currency, commodities, stock, or any other financial instruments that can be traded. Meant to manage future uncertainty, derivatives often occur in the form of swaps and futures. The Dodd-Frank reforms, which include SEC and Commodities Futures Trading Commission (CFTC) rules, regulate the swap market. The futures market is already regulated by the CFTC.
Some in the political and regulatory communities perceive derivatives as a key contributor to the 2008 financial crisis. One of the goals of the Dodd-Frank derivatives provisions is to lessen risk and increase stability in the market. This comes with increased compliance, reporting, and recordkeeping requirements, which will lead to increased costs and changes related to the use of derivatives.
Many companies provide sustainability disclosure, but few embrace integrated reporting
As more companies feel pressure from investors to disclose their sustainability and corporate responsibility information, their boards are asking management for their plans on integrated financial reporting.
Olivia Kirtley, a director at Papa John’s International and US Bancorp, raised the question of integrated reporting at a recent PwC event as she cited a new reporting model from the Investor Responsibility Research Center Institute (IRRC) and Sustainable Investments Institute (Si2).
She asked Kayla Gillan, leader of PwC’s Investor Resource Institute, if she thought integrated reporting is a priority for some of the larger investors. Gillan, who has previously served as general counsel at CalPERS, a board member of PCAOB, and Deputy Chief of Staff to the SEC Chari, responded that certain institutional investors do support integrated reporting but that is not the case throughout the investment community. “I haven’t seen a lot of embracing of integrated reporting,” said Gillan “CalPERS, CalSTRS and BlackRock, who are leaders in the investment community on sustainability issues, do support it. But I haven’t seen a lot of others put significant weight behind it right now.”
Integrated reporting is not required of or commonly done by US companies. Almost all of the S&P 500 have some form of sustainability disclosure, but most of those companies don’t go as far as using integrated reporting, according to the 285-page report from IRRC and Si2.
Putting the spotlight on illegal insider trading
Insider trading has been making big headlines lately. Since 2010 168 actions have been filed against nearly 400 individuals and entities.
Illegal insider trading is defined as trading in a corporation’s securities while in possession of material non-public information, which is in breach of a fiduciary duty or other relationship of trust and confidence to either the corporation or the source of the information. Some trading activity by insiders is not considered to be “illegal insider trading” if it occurs under Rule 10b5-1, as discussed below.
The financial, reputational, and criminal penalties for illegal insider trading can be severe for individuals and companies. Violators can face civil penalties such as being disgorged of profits gained or losses avoided, paying three times that amount in fines, and being barred from serving as a director or officer of a public company. Criminal penalties include fines up to $5 million and up to 20 years in prison. Employers may face potential civil and criminal exposure; either vicariously liable for the actions of their employees, or for recklessly failing to prevent employees from engaging in illegal trading. There’s also the potential for negative publicity that can impact a company’s reputation.
While the most high-profile insider trading allegations have historically been made against individuals, more recently, the focus has shifted. The SEC and US Department of Justice (DOJ) are now investigating hedge funds, expert networks, 10b5-1 plans—and even directors.
Cybersecurity risk on the board’s agenda
As the number of database breaches, company web site hacks and loss of intellectual properties grows, company boards realize cybersecurity is not just a technology risk. It can be an enterprise risk management issue.
What’s at stake for companies are their so-called “crown jewels”, those information assets or processes that, if stolen, compromised, or used inappropriately would render significant hardship to the business.
Cybersecurity issues are among the top risk management issues facing companies, according to recent surveys by PwC. The PwC 2012 Annual Corporate Directors Survey of 860 public company directors found that nearly three-quarters (72%) of directors are engaged with overseeing and understanding data security issues and risks related to compromising customer data.
Issue in focus: Capital projects: Is your board doing enough?
A PwC analysis of 52 capital project missteps at public companies has revealed that after a public announcement of a capital project delay or shutdown, a majority of companies experience a steady decline in share price. By the three-month mark following the announcement, the decline in share price averages 15 percent. In the most severe case of the companies analyzed, one experienced an almost 90 percent decline in share price.
Large capital projects - with their multi-year timelines, changing requirements, and complex procurement issues — are inherently risky. They require diligent oversight from management and the board because of their impact on the company’s financial health. PwC research found that most major capital projects are likely to exceed their budgets by at least 50%.
Lack of board oversight can result in severe consequences. For example, in the power sector, regulators have rejected substantial portions of capital funding requests in situations where they believe management and the board could have exercised better oversight of costs, schedules, and risks.
Issue in focus: Therapy for “deal fever”: An objective, disciplined due diligence process
In this post-financial crisis environment, the mergers & acquisitions market is extremely competitive as both corporate and private equity investors have capital to invest but fewer quality deals in the marketplace to invest in. A competitive deal environment drives up bids and puts pressure on transaction timelines, increasing the potential for deal bias and conflicting interests.
These risks can be exacerbated when public companies are involved. Buyers may pay significant control premiums over the trading price of the stock but may have limited access to the information necessary to assess the deal strategy, risks, and value. The limitations imposed on receiving non-public information can arise from a variety of factors, including the dynamics of the sale process, regulatory considerations, and commercial sensitivity. Since there are virtually no contractual protections if something goes wrong in public deals, buyers are essentially taking the business “as is.”
Issue in focus: Lagging economy, active regulatory environment on boards’ minds
Understanding key issues that affect the company is a critical element of a director’s responsibility. As part of their oversight, directors should ask questions that help them get their arms around those issues in an ever-changing world and governance environment.
PwC’s 2013 Key questions for board and audit committee members focuses on areas including strategy and risk management, anti-corruption and compliance, financial reporting, information technology, and shareholder and stakeholder communications. Read more.
Many company directors and their chief information officers (CIOs) are struggling to understand each other's information technology needs. Directors are often challenged by IT’s complexity and related technical language. CIOs aren't always sure which information the board wants or how to simplify the discussion. Read more.
More US public company boards are making climate change issues a regular part of their strategic risk oversight.
The 2012 Carbon Disclosure Project (CDP) S&P 500 Climate Change Report, co-written by PwC and the CDP and released on September 12, shows that 92% of the 2012 S&P 500 respondents reported board or executive-level oversight over sustainability issues including carbon reduction, compared to 86% in 2011. Read more.
This issue of BoardroomDirect® from PwC covers audit firm inspection reports, board declassification, proxy issues, virtual shareholder meeting guidelines, and FASB inputs on disclosure frameworks and a revised asset impairments model. Read more.
This issue of BoardroomDirect covers the fraud risk management expectation gap between internal audit and company stakeholders, which includes empowering the chief audit executive. Don Keller, a partner in PwC's Center for Board Governance, shares a tool internal audit can use to enhance its brand. Read more.
Also highlighted in this month's edition: latest on conflict minerals disclosure rules, the closing of an online shareholder voting platform, the SEC staff release of its long-awaited report on IFRS, and FASB's decision to remove the loss contingencies project from its agenda.
The US Supreme Court on June 28 upheld the 2010 Affordable Care Act (ACA). The Court ruled that a core provision of the healthcare law — the requirement that every American have health insurance — is constitutional since the Court considers it to be a tax.
The PwC publication Implications of the US Supreme Court ruling on healthcare briefly outlines the implications for hospitals and healthcare providers, insurers, pharmaceutical companies, and employers from every sector. In particular, directors may wish to focus on the "Path forward" sections that are relevant to their companies.
Also inside this edition:
This issue of BoardroomDirect covers diversity, compensation clawbacks, say on pay, the JOBS Act, and FASB private company standard council. Read more.
This month's headlines
In a year in which a new president could be elected in November, and with the campaign process narrowing to two candidates (observers suggesting the likely Republican candidate will be Mitt Romney versus the incumbent Democrat President Obama), political spending disclosure shareholder proposals take on even more importance for companies that make political contributions.
Such shareholder proposals have been among the most popular this proxy season.
As of April 16, shareholders have filed 119 proxy proposals requiring corporate political spending disclosure.
Also inside this edition:
Shareholder proxy access as originally proposed may be dead, but the alternate version known as "private ordering" is something boards should be watching during the 2012 proxy season.
A number of institutional and individual investors have gotten an early start on the proxy season by filing shareholder proxy access proposals seeking to amend company bylaws to allow shareholder director nominations to be included in the annual proxy statement. While it is not surprising who filed the proposals, what is noteworthy is the number of companies targeted (16) thus far. Read more.
Also inside this edition:
The economic crisis has been a catalyst for change in the governance landscape. The changes include new regulations enacted as a result of the Dodd-Frank Act, increased regulatory enforcement activities, and increased influence by shareholders and proxy advisory firms. How can directors measure their own effectiveness in this environment? This edition of BoardroomDirect highlights recommendations based on new research we performed and describe in our report, Board Effectiveness - What works best, 2nd edition. Read more.
Also inside this edition:
Not surprisingly, the most-watched shareholder votes this proxy season were the mandatory say on pay vote and the related say on frequency vote. Most companies received strong majority shareholder support for their say on pay vote, and there was a strong preference by shareholders for an annual voting policy. So, what should directors be thinking about now? Read more.
Also inside this edition:
On July 22, 2011, the U.S. Court of Appeals for the D.C. circuit decided to reject the SEC's proxy access rule that would require a company to include in its proxy statement a shareholder's, or group of shareholders', director nominees that meet certain requirements. This supplement to our BoardroomDirect quarterly update series alerts directors to this important development. Read more.
BoardroomDirect serves as a quarterly update designed to provide you with highlights of recent key developments affecting directors. However, we have also committed to notify you between quarters when important events unfold. The SEC's issuance of final whistleblower rules on May 25, 2011, is just such an event. As a director, you may be impacted by these rules, and we want to ensure you have the information you need. Read more.
One of a director's most important obligations is to engage in meaningful strategy discussions with the CEO and other senior executives. These discussions should include understanding critical trends, their impact, and how they could create opportunities for growth. The results of PwC's 14th Annual Global CEO Survey can help directors gain perspective and understand what issues are on CEOs' agendas, which will enhance the quality of those discussions. Find out what over 1,200 business leaders had to say: read more.
Also inside this edition:
Companies, business organizations, academicians, auditors, lawyers, whistleblower attorneys, and others have expressed their views about the new whistleblower rule proposed by the SEC in November 2010 in response to the Dodd-Frank mandate for a whistleblower program. With the comment period behind us, the SEC has received nearly 1,200 comment letters, including 950 form letters. Find out what respondents had to say: read more.
Also inside this edition: