Consultant Russell Reynolds Associates opens this report on 2020 corporate governance trends by observing that, “[f]or the first time, in 2020, we see the focus on the ‘E’ and the ‘S’ of environment, social and governance (ESG) as the leading trend globally, including in the United States, where it traditionally has not received as much attention by boards.” That conclusion—that sustainability has now ascended to the forefront of corporate governance trends—is reinforced by this year’s annual letter to CEOs from BlackRock CEO, Laurence Fink, announcing initiatives to put “sustainability at the center of [BlackRock’s] investment approach,” as well as the Business Roundtable’s new Statement on the Purpose of a Corporation, which outlined a “modern standard for corporate responsibility” that makes a commitment to all stakeholders. (See this PubCo post and this PubCo post.) For its report, RRA interviewed over 40 governance professionals, including institutional and activist investors, pension fund managers and proxy advisors to “identify the corporate governance trends that will impact boards and directors in 2020.” Those trends are summarized below.
Importance of E and S. As noted above, RRA has identified as the leading trend for 2020, both globally and in the U.S., the focus on the environmental and social components of ESG, with boards and management “playing catch-up on how best to define, integrate and oversee” material environmental and social issues. According to RRA, boards will need to “strengthen their oversight and knowledge of material E&S matters and disclose their connection to the business in the form of risks and opportunities.” RRA predicts a consensus forming around the Task Force on Climate-related Financial Disclosures (TCFD) (see this PubCo post) and the Sustainability Accounting Standards Board (SASB) (see this PubCo post) as the preferred disclosure frameworks. Notably, BlackRock’s Fink also advocates adoption of the SASB standards for reporting on sustainability across a wide range of issues and the TCFD for evaluating and reporting climate risks.
In the U.S., according to RRA, there is also demand for transparency and enhanced board oversight of all aspects of ESG: climate change, political expenditures, corporate culture and HCM, human rights concerns around supply chains, as well as board quality, composition and director overboarding. With regard to environmental and social issues, investors expect disclosures of the risks and opportunities and how they relate specifically to the business. (Similarly, BlackRock’s Fink noted in his letter, investors are now “recognizing that climate risk is investment risk.”) RRA advises boards to ensure they understand the priorities of their shareholders “and benchmark themselves to good E&S oversight practices among peers.”
Corporate purpose. Another key trend identified by RRA is a shift away from the shareholder primacy theory toward a stakeholder-centric model. In support, RRA points to the BRT’s new statement of corporate purpose, which “moves away from shareholder primacy” as a guiding principle and outlines in its place a “modern standard for corporate responsibility” that makes a commitment to all stakeholders. RRA also points to a “December announcement from the World Economic Forum updating their 2020 Davos Manifesto (last published in 1973) to center on principles that guide companies into the Fourth Industrial Revolution. The manifesto—like the Business Roundtable’s statement—challenges companies to put stakeholders at the heart of a company’s purpose.”
In the U.S., RRA contends that the shift in corporate purpose away from shareholder primacy to a commitment to all stakeholders, together with pressure for engagement on social and political topics, “will require boards and CEOs to ensure public positions align with business strategy before public pronouncements are made by a CEO. In an election year, heightened scrutiny of political spending and employee shareholder activism will be areas where boards and CEOs need to think carefully and scenario planning may be a valuable exercise.”
Oversight of corporate culture and human capital management. Corporate culture and HCM (both, essentially, components of ESG) have been a focus of major institutional investors for several years. RRA reports that investors want more transparency regarding board oversight of HCM and culture to ensure that oversight is adequate and that culture “is robust and can withstand transformation and change.” RRA suggests that data and analysis regarding corporate culture will be key to oversight. In addition, RRA advises that boards will need to understand the relationship between culture and “hiring, retention and productivity. Management will need to satisfy the board that the company has the culture and talent needed to successfully execute on strategy.”
In the U.S., RRA suggests, given the competition for talent, “appropriate HCM oversight is not only prudent risk management, it is strategic asset management,” and investors want to understand the relationship between HCM and business strategy and performance. Notably, RRA remarks, the SEC’s proposal for enhanced human capital disclosure could have a significant impact.
Board gender, racial and ethnic diversity. Although pressure for board gender diversity has been in evidence for several years, RRA reports that, in 2020, boards will experience increased pressure to also strive for ethnic and racial diversity, driven in the U.S. largely by institutional investors. For example, the NYC Comptroller’s Office, which oversees the NYC pension funds, announced the Boardroom Accountability Project 3.0, an initiative designed to increase board and CEO diversity. The initiative calls on companies to adopt a version of the “Rooney Rule,” a policy originally created by the National Football League to increase the number of minority candidates considered for head coaching and general manager positions. Under the policy requested by the Comptroller’s Office, companies would commit to including women and minority candidates in every pool from which nominees for open board seats and CEOs are selected. (See this PubCo post.) RRA cites ISS estimates that only “10 percent of Russell 3000 directors belong to an ethnic minority group and only 15 percent of new directors are ethnically diverse.”
Boards face continued activism. RRA advises that investor activism will continue and evolve, requiring director vigilance and preparedness to address activist concerns—be they climate risk or “#metoo.” In 2020, RRA expects “to see increased activism success rates and greater influence from both the traditional ‘activist’ investors in this space as well as larger non-governmental organizations….To prepare for these situations, boards are improving their effectiveness through more robust board evaluation processes. Boards are also engaged with management in scenario planning to ensure role clarity in crisis situations.” RRA notes that investors expect rigorous board assessments, with an independent board assessment every two or three years.
Executive compensation. In the U.S., RRA argues that board oversight of executive comp will continue to be an important topic in 2020, particularly with respect to alignment of comp with company performance, with potential negative fallout for comp committee chairs if alignment is viewed as inadequate. In addition, boards need to take into account the potential for reputational risk that could result from “quantum payout.”
Multi-class share structures. RRA expects continued scrutiny of multiclass share structures, particularly given recent “failed IPOs,” which RRA contends, have “triggered a backlash from numerous stakeholders concerned about corporate governance.”