In its Annual Corporate Directors Survey for 2017, PwC surveyed 886 directors of public companies and concluded that there is a “real divide” between directors and institutional investors (which own 70% of U.S. public company stocks) on several issues. More recently, PwC observes, public companies have been placed in the unusual position of being called upon to tackle some of society’s ills: in light of the “new administration in Washington and growing social divisiveness, US public company directors are faced with great expectations from investors and the public. Perhaps now more than ever, public companies are being asked to take the lead in addressing some of society’s most difficult problems. From seeking action on climate change to advancing diversity, stakeholder expectations are increasing and many companies are responding.” But apparently, many boards are not taking up that challenge; PwC’s “research shows that directors are clearly out of step with investor priorities in some critical areas,” such as environmental issues, board gender diversity and social issues, such as income inequality and employee retirement security.
PwC identified the following key findings from the survey:
- ESG issues. Environmental, social and governance issues appear to be the area where directors and investors evidence the deepest chasm. For the first time, in 2017, three environmental-related shareholder proposals actually won majority votes, having received support from several large institutional holders (see this PubCo post). At all public companies, the survey shows, average support for climate change shareholder proposals increased from 24% in 2016 to 32% in 2017. Notwithstanding the focus of many institutional investors on ESG issues (see the SideBar below), 42% of directors say that these issues won’t affect their companies’ strategies: 40% say climate change should not play a role in determining strategy, 51% say the same about income inequality, 49% about immigration, and 29% say that resource scarcity should not play a role in shaping strategy. But women directors “are more likely to think that social issues should play a part in company strategy formation. And they are much more likely to think that issues like environmental concerns and social instability will force the company to change its strategy in the next three years.” A majority of directors don’t think that their boards need expertise in sustainability.
According to a recent survey by EY of over 320 institutional investors, investors do care about ESG issues and even take information about ESG into account in making investment decisions. At times, robust corporate attention to ESG is, to some extent, even read to signify sound operational practices overall. Those surveyed broadly concurred that ESG factors play a key role in achieving sustainable returns. For example, 93% of investors either agreed or strongly agreed that “[o]ver the long term, ESG issues—ranging from climate change to diversity to board effectiveness—have real and quantifiable impacts.” In particular, the report observes, “serious reputational and environmental risks can and do surface, and they can have very real impacts on the bottom line.” (See this PubCo post). And influential institutional investors, such as BlackRock, are advocating enhanced disclosures regarding the impact of climate change (see this PubCo post).
- Board diversity. Board diversity is also an ESG issue, and the survey indicates something of a gulf between the views of institutional holders and many directors in this context as well. The kinds of diversity respondents view to be most important to achieving diversity of thought in the boardroom are (in order) gender, board tenure, age, race, international background and socioeconomic background. In each case, women directors attribute more importance to the factor.
In 2016, PwC reports, women were appointed to fewer of the new board seats than in the prior year, and only 25% of boards in the S&P 500 had more than two female directors. According to the report, only 21% of board seats in the S&P 500 are held by women, and 15% of the board seats at the top 200 companies in the S&P 500 are held by racial minorities. Nevertheless, 58% of directors say that their boards do have racial diversity; almost 10% of directors acknowledge that their boards are not racially diverse, but say that they don’t need it. With regard to diversity as whole, 59% of directors say that their boards are diverse enough, and, PwC highlights, “about half of female directors tell us that their board is already sufficiently diverse. Which leads to the question—are female directors sufficiently championing the cause of gender diversity?”
About 82% of directors surveyed think that board diversity enhanced board performance, but only 59% believe that it enhances corporate performance. By gender, the vast majority (82%) of women directors believed that board diversity enhances corporate performance (compared with only 54% of men). And 43% of directors say that gender and racial diversity do not improve relationships with investors at all.
Eighty percent of women directors think the pace of achieving diversity is too slow, compared with 33% of male directors. What steps are boards taking to increase diversity? The survey shows that 57% prioritized diversity as a criterion in recruiting new directors, 43% nominated a director with no prior public company experience and 41% recruited from outside of the C-suite. Only 18% identified and mentored potential candidates.
Of course, as discussed in this PubCo post and this PubCo post, the research data show that these women are right with regard to impact of diversity on corporate performance. Board diversity is believed to be more than just a social issue. Rather, many view it as critical to corporate performance because research has shown that women directors have a salutary impact on companies’ financial performance and governance matters. For example, a recent study from the Peterson Institute for International Economics demonstrated that the presence of women in corporate leadership positions (both on corporate boards and in executive positions) can improve firm performance. The study looked at 21,980 firms headquartered in 91 countries, concluding that, for “the sample as a whole, the firm with more women can expect a 6 percentage point increase in net profit, while overall median net profit was just over 3 percent.” (See this PubCo post.) Similarly, it was reported that, in May, Morgan Stanley indicated that companies with more women in the ranks had better returns and lower volatility. Moreover, according to Bloomberg, “there’s a pile of research showing that boards and other leadership panels with 50 percent women think more critically, which may explain the better results. Group dynamics change for the better when both sexes are present. Diverse groups solve problems better than homogeneous ones do, possibly because the men and women monitor each other’s performance more closely.” (See this PubCo post.)
BlackRock, State Street and Vanguard have all indicated that board diversity is a potential voting issue and have included diversity among their goals for portfolio companies (see this PubCo post). For example, in its Investment Stewardship Report for Q2 2017, BlackRock (reportedly the largest asset manager, with $5.1 trillion under management) indicated that, in the second quarter, it supported eight out of nine shareholder proposals that requested the adoption of a policy on board diversity or disclosure around plans to increase board diversity. The majority of the companies in those instances did not have any women on their boards. Earlier this year, another significant asset manager, State Street Global Advisors, which manages $2.47 trillion in assets, announced in this press release that it was “calling on the more than 3,500 companies [in which] State Street invests on behalf of clients, representing more than $30 trillion in market capitalization to take intentional steps to increase the number of women on their corporate boards.” (See this PubCo post.) Vanguard has also recently announced, in its Investment Stewardship Report for 2017, that it too has been taking a more active role in advocating for effective corporate governance at its portfolio investments, including advocating for independent and diverse boards. (See this PubCo post.)
- Peer performance. Almost half (46%) of directors have identified someone on their boards that they think should be replaced—a high-water mark, according to the survey—and 21% hike the number of poor performers to two or more. Directors with less tenure are reportedly more likely to be discontented with the performance of their board colleagues: 53% of directors who have been on the board less than two years would replace at least one director, while only 39% of directors with tenure over 10 years would do the same. Reasons given included overstepping boundaries, reluctance to challenge management, negative impact of interactions on board dynamics, impact of advanced age, lack of preparedness and lack of expertise. PwC suggests that recent conversations about board refreshment and diversity, along with the “activist landscape,” may have contributed to the increased interest in jettisoning directors from their board seats.
About 87% of respondents contend that their board leadership is effective at promoting refreshment—generally viewed as the most effective approach to achieving refreshment—while investor input and terms limits are viewed as least effective. Board assessments are viewed as “at least somewhat effective” by 73% of respondents. PwC contends that board assessments can be useful in this regard, but only if the process is viewed “as one of continuous improvement, rather than as an annual compliance exercise” that is no more than a “check-the-box” event. Only 30% of respondents say that their board leadership is very effective at dealing with underperforming directors, while 24% of directors say their board leadership is not very or not at all effective.
Is anything being done to address these issues? The survey finds that the boards of 68% of directors “took action in response to their last assessment process,” a notable increase from 49% last year, with actions including addition of expertise or changing committee composition. But only 15% report that a director was not re-nominated or received counsel from leadership; however, directors on boards with independent chairs were more than twice as likely not to re-nominate a director or to provide counsel.
- Shareholder engagement. Only 23% of respondents think that directors should never engage with shareholders directly; more often, directors believe that engagement is appropriate only under certain circumstances, such as an activist taking a stake (48%), a negative say-on-pay recommendation (46%), a significant crisis (46%) or a shareholder proposal related to board composition (42%). By contrast, PwC contends that the best approach to shareholder engagement is not to wait for a crisis, but only 22%of directors say that regular dialogue not triggered by particular events makes sense. However, 42% report that one or more non-CEO directors engaged with shareholders during the past year, and most view the engagement as beneficial, a shift from last year. That shift may reflect the additional resources and personnel that institutional investors have begun to dedicate to the process, with 85% of directors now indicating that the right investor representatives have been participating, and 77% at least somewhat agreeing that engagement positively affects proxy voting (18% higher than last year). However, only 10% of directors believe that engagement positively affects investment decisions.
Interestingly, while companies may be spending a lot of time and money to beautify, expand and improve the readability of their proxy statements for investors, fewer than half of directors recognize any benefit in the enhanced disclosure. According to the survey, 43% of directors believe that the greatest impact of enhanced proxy disclosure on voting results relates to augmented executive comp disclosures, and only 15% say that better ESG disclosure would improve proxy voting results. Expanded disclosure regarding shareholder engagement is viewed to improve shareholder relations (55%) but only 26% think it affects voting. Consistent with the record number of company settlements with activists in 2016, 32% of directors predict that companies will increasingly be willing to negotiate and engage with activists.
- Strategy oversight. With regard to oversight of strategy, the survey shows that there are frequent discussions of strategy at the board level (with 71% indicating that they discuss strategy at every board meeting); however, only 60% of directors report that “their boards strongly challenge management’s assumptions when discussing strategy.” Over 90% of directors think speed of technological change and uncertain economic growth are at least somewhat likely to require a change to company strategy in the next three years. The survey reports that directors are also particularly concerned with changing consumer behavior and changes in the regulatory climate. With regard to receipt of risk-related information, 86% of directors report that “it’s very or somewhat challenging for their board to: (1) evaluate competitive threats and (2) understand emerging/disruptive technologies. And only 22% rate the quality of information they get on emerging/disruptive technologies as excellent.” PwC suggests that, to address these deficiencies, boards should encourage their companies “to develop key risk indicators. These can show when certain scenarios may be playing out and can be useful early-warning signs. Also, urge executives to seek more input from external parties who are thinking more broadly about how emerging risks could impact the company and its industry. Getting that input is one thing. Ensuring executives don’t dismiss it out of hand is another.”
- Executive pay. Nearly 70% of directors say that “US executives are overpaid. And 66% say executive pay promotes income inequality.” Nevertheless, 88% at least somewhat agree that the media unfairly criticizes executive pay, and they “overwhelmingly say that incentive plans promote long-term shareholder value.” Only 17% do not think that proxy advisors have too much influence.
- Challenging new technologies. Oversight of new technologies is a challenge for 86% of directors—only 19% say their boards have enough IT/digital expertise, and only 16% say they don’t need more cybersecurity expertise on their boards. PwC contends that oversight of cybersecurity risk is a responsibility that the entire board should share, yet only 30% of respondents say that their full boards monitor cyber risk; a full 50% assign that responsibility to the audit committee. About 90% of directors expect that their companies will need to modify itheir strategies in the next three years in response to technological change. In addition, 25% report that their companies haven’t identified potential digital attackers, and 19% think that their companies have not adequately tested their cyber response plans and are not adequately reporting to their boards on cybersecurity metrics.