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Law Firm Outlines Key Board Challenges

At an audit committee workshop hosted by the Practising Law Institute, Gerald Backman, a partner with Weil, Gotshal & Manges LLP, submitted a paper prepared by members of his firm on several key challenges currently faced by corporate boards. The paper lists the first challenge as establishing an appropriate tone at the top. Rather than approach tone at the top with a compliance mentality, boards should focus on standards of behavior, according to the paper. The paper advises that every corporate action and communication should reflect the tone at the top.

The paper next points to executive compensation and advises that astronomic executive pay should only be awarded for astronomic performance. Boards should carefully consider the basis on which to set executive pay, and should reduce reliance on compensation surveys, according to the paper. The authors suggest that boards consider ways to integrate the tone at the top into performance reviews and compensation, and remind them that compensation decisions are transparent and subject to increasing scrutiny. Boards will be judged on their compensation decisions.

The paper urges boards to recognize the fine line between oversight and micromanagement. The board must be actively engaged in oversight without managing, the authors explain. An over-engaged board may result in a risk-adverse management. The foundation of corporate governance is constructive tension between the board and management, according to the paper.

Another challenge is creating a meaningful independent board leadership. If the chair also serves as CEO, the paper urges special care in designating an independent board leader for board tasks that involve conflicts, such as the review of management performance and strategies. Independent leadership is also key to setting the board's agenda, according to the paper, including the information that is provided to the board and notification about any red flags. The leader's role should be formalized in writing.

The authors of the paper note that the pace of governance reform has slowed since the SEC enacted the rules required by the Sarbanes-Oxley Act. However, the authors warned that corporate America is "only a major scandal or two away" from another round of regulation. They warn against a narrow approach to compliance with governance reforms.

The paper also suggests that boards take the initiative in shareholder relations. The SEC's shareholder access proposal is stalled, but pressures to give shareholders a greater voice in corporate affairs is unlikely to cease. The authors note that this regulatory pause provides an opportunity to voluntarily improve board relations with shareholders. Boards should consider actions to improve shareholder participation in the nomination and election of directors or in other key areas.

The paper encourages boards to stay informed of evolving standards for director liability, explaining that the expectations of directors continue to evolve. Disinterested and independent directors are key protectors of board decisions from challenge in the courtroom and in shielding directors from liability. However, since these attributes are context-dependent when viewed by the courts, the authors advise directors to reassess them when making major decisions and to rely heavily on special committees made up of directors who are beyond challenge.

Protective exculpatory charter provisions no longer insulate gross neglect, according to the authors. Exculpatory provisions, indemnification and director and officer insurance policies do not provide absolute protection against liability, as evidenced by the WorldCom settlement.

The paper notes that audit committees face a long list of additional responsibilities that risks turning them into formalistic box-checkers rather than an engaged and deliberative body as intended. The core task of providing oversight of financial reporting, accounting and internal compliance has not changed, however. By focusing on these tasks, audit committees will "check the boxes" through effectiveness rather than by rote, according to the authors.

Boards must attempt to normalize their relations with outside auditors. The authors acknowledge that audit firms have become defensive in their client interactions, which at times has put them at odds with the board. The paper urges boards to develop a constructive working relationship with the outside auditor, including a discussion about the changes in their relationship.

Finally, the paper notes that corporate governance is not an end unto itself. Best practice is not the end game, according to the authors. The end game is obtaining the best competitive performance of which the company is capable. Boards must focus on corporate strategy, understand the key risks to the drivers of corporate performance and understand how management is controlling for such risks, the paper concludes.